CAPC 10-Q
Capstone Companies, Inc. (CAPC)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
For the quarterly
period ended
For the transition period from _____________ to _____________
Commission File Number:
(Exact name of Registrant as specified in its charter)
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
| (Address of principal executive offices) |
| (Issuers Telephone Number) |
Indicate
by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days. ☒
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted during
the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Indicate by check mark whether the registrant is a large, accelerated file, an accelerated filer, a non-accelerated filer, smaller reporting company, or emerging growth company. See the definitions of “large, accelerated filer, “accelerated filer, “smaller reporting company and “emerging growth company in Rule 12b-2 of the Exchange Act.
| Large accelerated filer ☐ | Accelerated filer ☐ |
| Smaller
reporting company | |
| Emerging
Growth company |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
| None | N/A | N/A |
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐
Yes ☒
As of November 1, 2022, the Company had shares of Common Stock issued and outstanding. The Common Stock is quoted on the OTCQB Venture Market of the OTC Markets Group, Inc. under the trading symbol “CAPC”.
1
EXPLANATORY NOTE
As used in this Form 10-Q Quarterly Report for the fiscal period ending September 30, 2022 (“Form 10-Q Report), “COVID-19 refers to Coronavirus/COVID-19 virus and all variants of that virus, a highly contagious novel virus that was declared a global pandemic by the World Health Organization or “WHO on March 11, 2020. “COVID-19 pandemic refers to “global pandemic (as defined by WHO) caused by COVID-19. “Company, “Capstone, “we, “our, and “us refers to Capstone Companies, Inc., and its subsidiaries, unless context indicates just Capstone Companies, Inc.
The COVID-19 pandemic has had a significant, adverse economic disruption in the United States, Thailand and China, especially the locality of the Thailand and Chinese original equipment manufacturers or “OEMs of the products sold by the Company. The products sold by us are primarily sold by traditional brick-and-mortar retailers and the COVID-19 pandemic significantly, adversely impacted those retailers and our sale of traditional LED products. We developed a new product line for internet connected surfaces, smart mirrors, (“Connected Surface”) for residential use and as a replacement core product line for the LED lighting products. Connected Surface products were received initially in the United States in the first quarter 2022. The original marketing launch of the initial products of the Connected Surface program began in February 2021. The impact of COVID-19 pandemic on the Company’s business and financial performance has been significant and ongoing and, coupled with the delayed development of the Connected Surface product line, has placed a significant financial strain on the Company due to decreasing demand and sales for our LED Lighting products and a lack of sufficient compensating sales from the Connected Surface products. Despite the ramped-up vaccination program in the United States and its beneficial impact on the adverse effects of the COVID-19 pandemic, new mutations or variants of the virus, including the Omnicron subvariant BA.5 (“BA.5”) has continued to cause periodic major city lock downs and port closures in China as the government pursues a Zero- Covid-19 policy. The World Health Organization recently determined that the ongoing COVID-19 pandemic continues to constitute a Public Health Emergency of International Concern. The possibility of a vaccine-resistant strain and a future waive of economic disruption from a new wave of pandemic infections continues to create economic uncertainty. The full impact of a mutant variant is not fully understood or understandable as of the date of the filing of this Form 10-Q Report, but BA.5 appears to be highly contagious and virulent for unvaccinated persons and the significant percentage of people who are not fully vaccinated (including getting most recent booster shots) raises the specter of a new round of economic disruption in key markets for Connected Surface products and possible emergence of new variants that are not effectively combated by current vaccines. The emergence of a new variant that is not effectively combated by vaccines could cause a second global economic crisis and possibly ruinous impact of demand for the company-critical Connected Surface products. Further, consumer demand for the Connected Surface product line has not been sufficient to off-set loss of revenues from LED Lighting products.
This Form 10-Q Report contains forward looking statements (as defined by the Private Securities Litigation Reform Act of 1995 (“PSLRA”). Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Forward-looking statements can be identified by words such as “future,” “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “will,” “would,” “could,” “can,” “may,” and similar terms or variants thereof. Forward-looking statements are not guarantees of future performance and the Company’s actual results may differ significantly from the results discussed in the forward-looking statements. Actual results may differ materially from those results implied in the forward-looking statements contained in this Form 10-Q Report as a result of various factors, some factors being beyond the Company’s control or ability to foresee. Among the factors that could cause plans, actions and results to differ materially from current expectations are, without limitation: disruption from natural or human causes, including severe weather, accidents, fires, earthquakes, terrorist acts, regional wars and epidemic or pandemic diseases, such as the COVID-19 pandemic, which pandemic could result and has resulted in delays or suspension of product production from Thailand and China or other regions, where our products are made, or otherwise dampen consumer demand for products like our products, which are a discretionary purchase. The information contained in the filed Form 10-K Annual Report for fiscal year ended December 31, 2021 (“2021 Annual Report”), including the “Management’s Discussion and Analysis of Results of Operations and Financial Condition and “Risk Factors identifies other important factors that could cause such differences. When, in any forward-looking statement, the Company, or its management, expresses an expectation or belief as to future results, that expectation or belief is expressed in good faith and is believed to have a reasonable basis, but there can be no assurance that the stated expectation or belief will result or be achieved or accomplished. The Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law. Further, the Company is a “penny stock company with no primary market makers and limited market liquidity. Such a status makes highly risky any investment in the Company Common Stock.
You should also read the filed Form 10-K report and the documents that we may reference in Form 10-K report and have been filed with the SEC on March 31, 2022, with the understanding that our actual future results, performance, and events and circumstances may be materially different from what we expect or may be implied by any forward looking statements in the Form 10-K.
2
CAPSTONE COMPANIES, INC.
Quarterly Report on Form 10-Q
Three and Nine Months Ended September 30, 2022
TABLE OF CONTENTS
| PART 1 | FINANCIAL INFORMATION | |
| Item 1. | Condensed Consolidated Financial Statements (Unaudited) | 4 |
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operation | 24 |
| Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 44 |
| Item 4. | Controls and Procedures | 44 |
| PART II | Other Information | 44 |
| Item 1. | Legal Proceedings | 44 |
| Item 1A. | Risk Factors | 44 |
| Item 2. | Unregistered Sale of Equity Securities and Use of Proceeds | 48 |
| Item 3. | Defaults of Senior Securities | 48 |
| Item 4. | Mine Safety Disclosures | 48 |
| Item 5. | Other Information | 48 |
| Item 6. | Exhibits | 49 |
3
CAPSTONE COMPANIES, INC., AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
| September 30, | December 31, | |||||||
| 2022 | 2021 | |||||||
| Assets: | (Unaudited) | |||||||
| Current Assets: | ||||||||
| Cash | $ | $ | ||||||
| Accounts receivable, net | ||||||||
| Inventories | ||||||||
| Prepaid expenses | ||||||||
| Income tax refundable | ||||||||
| Total Current Assets | ||||||||
| Property and equipment, net | ||||||||
| Operating lease- right of use asset, net | ||||||||
| Deposit | ||||||||
| Goodwill | ||||||||
| Total Assets | $ | $ | ||||||
| Liabilities and Stockholders’ Equity: | ||||||||
| Current Liabilities: | ||||||||
| Accounts payable and accrued liabilities | $ | $ | ||||||
| Notes payable related parties and accrued interest-current | ||||||||
| Notes payable unrelated party and accrued interest-current | ||||||||
| Operating lease- current portion | ||||||||
| Total Current Liabilities | ||||||||
| Long-Term Liabilities: | ||||||||
| Operating lease- long-term portion | ||||||||
| Notes payable related parties and accrued interest, less current portion | ||||||||
| Notes payable unrelated party and accrued interest, less current portion | ||||||||
| Deferred tax liabilities -long-term | ||||||||
| Total Long-Term Liabilities | ||||||||
| Total Liabilities | ||||||||
| Commitments and Contingencies: ( Note 4 ) | ||||||||
| Stockholders’ Equity: | ||||||||
| Preferred Stock, Series A, par value $ per share, authorized shares, issued and outstanding- - shares | ||||||||
| Preferred Stock, Series B-1, par value $ per share, authorized shares, issued and outstanding- shares at September 30, 2022, and December 31, 2021 (Liquidation Preference $ | ||||||||
| Preferred Stock, Series C, par value $ per share, authorized shares, issued and outstanding -- shares | ||||||||
| Common Stock, par value $ per share, authorized shares, issued and outstanding shares at September 30, 2022 and shares at December 31, 2021. | ||||||||
| Additional paid-in capital | ||||||||
| Accumulated deficit | ( | ) | ( | ) | ||||
| Total Stockholders’ Equity | ||||||||
| Total Liabilities and Stockholders ‘Equity | $ | $ | ||||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
4
CAPSTONE COMPANIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
| For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||
| Revenues, net | $ | $ | $ | $ | ||||||||||||
| Cost of sales | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Gross Profit | ||||||||||||||||
| Operating Expenses: | ||||||||||||||||
| Sales and marketing | ||||||||||||||||
| Compensation | ||||||||||||||||
| Professional fees | ||||||||||||||||
| Product development | ||||||||||||||||
| Other general and administrative | ||||||||||||||||
| Total Operating Expenses | ||||||||||||||||
| Operating Loss | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Other Income (Expenses): | ||||||||||||||||
| Other income | ||||||||||||||||
| Interest expense, net | ( | ) | ( | ) | ( | ) | ||||||||||
| Total Other Income (Expenses), net | ( | ) | ||||||||||||||
| Loss Before Income Taxes | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Income Tax (Benefit) Expense | ( | ) | ||||||||||||||
| Net Loss | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||||
| Net Loss per Common Share | ||||||||||||||||
| Basic and Diluted | $ | ( | ) | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||||
| Weighted Average Shares Outstanding | ||||||||||||||||
| Basic and Diluted | ||||||||||||||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
5
CAPSTONE COMPANIES, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2022, AND SEPTEMBER 30, 2021
(Unaudited)
| Preferred Stock | Preferred Stock | Preferred Stock | Additional | |||||||||||||||||||||||||||||||||||||||||
| Series A | Series B | Series C | Common Stock | Paid-In | Accumulated | Total | ||||||||||||||||||||||||||||||||||||||
| Shares | Par Value | Shares | Par Value | Shares | Par Value | Shares | Par Value | Capital | Deficit | Equity | ||||||||||||||||||||||||||||||||||
| Balance at December 31, 2021 | — | $ | — | $ | — | $ | $ | $ | $ | ( | ) | $ | ||||||||||||||||||||||||||||||||
| Stock options for compensation | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Net Loss | — | — | — | — | — | ( | ) | ( | ) | |||||||||||||||||||||||||||||||||||
| Balance at March 31, 2022 | — | ( | ) | $ | ||||||||||||||||||||||||||||||||||||||||
| Stock options for compensation | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Repurchase of shares | — | — | — | — | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||||||||||
| Net Loss | — | — | — | — | — | ( | ) | ( | ) | |||||||||||||||||||||||||||||||||||
| Balance at June 30, 2022 | — | — | — | ( | ) | |||||||||||||||||||||||||||||||||||||||
| Stock options for compensation | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Net Loss | — | — | — | — | — | ( | ) | ( | ) | |||||||||||||||||||||||||||||||||||
| Balance at September 30, 2022 | — | $ | — | $ | — | $ | $ | $ | ($ | ) | $ | |||||||||||||||||||||||||||||||||
| Balance at December 31, 2020 | — | $ | — | $ | — | $ | $ | $ | $ | ( | ) | $ | ||||||||||||||||||||||||||||||||
| Stock options for compensation | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Stock issued to Directors for loan | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||
| Net Loss | — | — | — | — | 0 | ( | ) | ( | ) | |||||||||||||||||||||||||||||||||||
| Balance at March 31, 2021 | — | — | — | ( | ) | |||||||||||||||||||||||||||||||||||||||
| Stock options for compensation | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Common stock for cash, net of fees | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||
| Net Loss | — | — | — | — | — | ( | ) | ( | ) | |||||||||||||||||||||||||||||||||||
| Balance at June 30, 2021 | — | — | — | ( | ) | |||||||||||||||||||||||||||||||||||||||
| Stock options for compensation | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Common stock for cash, net of fees | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||
| Net Loss | — | — | — | — | — | ( | ) | ( | ) | |||||||||||||||||||||||||||||||||||
| Balance at September 30, 2021 | — | $ | — | $ | — | $ | $ | $ | $ | ( | ) | $ | ||||||||||||||||||||||||||||||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements
6
CAPSTONE COMPANIES, INC., AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| For the Nine Months Ended | ||||||||
| September 30, | ||||||||
| 2022 | 2021 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
| Net Loss | $ | ( | ) | $ | ( | ) | ||
| Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
| Depreciation | ||||||||
| Stock based compensation expense | ||||||||
| Noncash lease expense | ||||||||
| Non-cash stock issued to Directors for loan | ||||||||
| Accrued interest added to notes payable related and unrelated parties | ||||||||
| (Increase) decrease in accounts receivable, net | ( | ) | ||||||
| Increase in inventories | ( | ) | ( | ) | ||||
| (Increase) decrease in prepaid expenses | ( | ) | ||||||
| (Increase) decrease in deposits | ( | ) | ||||||
| Decrease in accounts payable and accrued liabilities | ( | ) | ( | ) | ||||
| Decrease in tax refundable | ||||||||
| Decrease in operating lease liabilities | ( | ) | ( | ) | ||||
| Net cash used in operating activities | ( | ) | ( | ) | ||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
| Purchases of property and equipment | ( | ) | ||||||
| Net cash used in investing activities | ( | ) | ||||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
| Proceeds from sale of common stock and stock option exercise, net of costs | ||||||||
| Repurchase of Shares | ( | ) | ||||||
| Proceeds from notes payable related parties | ||||||||
| Proceeds from note payable unrelated party | ||||||||
| Net cash provided by financing activities | ||||||||
| Net Decrease in Cash | ( | ) | ( | ) | ||||
| Cash at Beginning of Period | ||||||||
| Cash at End of Period | $ | $ | ||||||
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: | ||||||||
| Interest cash paid | $ | $ | ||||||
| Income taxes paid | $ | $ | ||||||
| Preferred Stock issued to directors for deferred loan fees | $ | $ | ||||||
The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
7
CAPSTONE COMPANIES INC., AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
This summary of accounting policies for Capstone Companies, Inc. (“CAPC”, “Company, “we, “our” or “us”), a Florida corporation and its wholly owned subsidiaries is presented to assist in understanding the Company’s consolidated financial statements. The accounting policies conform to accounting principles generally accepted in the United States of America (“U.S. GAAP)” and have been consistently applied in the preparation of the consolidated financial statements.
Organization and Basis of Presentation
The condensed consolidated financial statements contained in this report are unaudited. In the opinion of management, the condensed consolidated financial statements include all adjustments, which are of a normal recurring nature, necessary to present fairly the Company’s financial position as of September 30, 2022, and results of operations, stockholders’ equity and cash flows for the three months and nine months ended September 30, 2022 and 2021. All material intercompany accounts and transactions are eliminated in consolidation. These condensed consolidated financial statements and notes are presented in accordance with the rules and regulations of the United States Securities and Exchange Commission (“SEC”) relating to interim financial statements and in conformity with U.S. GAAP. Certain information and note disclosures have been condensed or omitted in the condensed financial statements pursuant to SEC rules and regulations, although the Company believes that the disclosures made herein are adequate to make the information not misleading. The condensed unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021 (the “2021 Annual Report”) filed with the SEC on March 31, 2022.
The operating results for any interim period are not necessarily indicative of the operating results to be expected for any other interim period or the full fiscal year.
Effects of COVID-19 Pandemic
The Company’s top priority has been to take appropriate actions to protect the health and safety of our employees as a result of the COVID-19 pandemic. We have adjusted standard operating procedures within our business operations to ensure the continued safety of our employees and we continually monitor evolving health guidelines to ensure ongoing compliance and protection of our employees.
In response to COVID-19 pandemic and Centers for Disease Control (‘CDC) guidelines, the Company has practiced the following actions since March 2020:
| ● | Followed the CDC guidelines for social distancing and safe practices. |
| ● | Placed restrictions on business travel for our employees. |
| ● | Modified our corporate and division office functions to allow employees to work remotely and attend the office on a rotating schedule. |
As of the filing of this Form 10-Q Report, the Company continues to adhere to local government practices and mandates. With government mandated restrictions in Thailand and parts of China resulting from the upsurge in various mutant variants, the Company restrictions on international business travel remains in effect. While all the above-referenced steps are appropriate considering COVID-19 pandemic, they have impacted the Company’s ability to operate the business in its ordinary and traditional course. Our personnel is limited to management with a limited number of employees in Florida and we rely on contractors and consulting services in Thailand and Hong Kong for production, inventory and distribution of our products. As such, our COVID-19 pandemic measures do not remediate fully the impact of COVID-19 pandemic on all operations affecting our business and financial condition.
Our business operations and financial
performance for the three and nine months ended September 30, 2022, continued to be adversely impacted by the supply disruptions
experienced earlier in 2022 resulting from COVID-19 pandemic, which, also contributed to the poor performance of our traditional
LED product line in 2021 and the lack of revenues from the new Connected Surface products. Thailand experienced mutant variants
including Omnicron mutant of COVID-19 pandemic which disrupted our overseas OEMs and delayed some of the Smart Mirror certification
testing which resulted in shipment delays of the Company’s critical Connected Surface devices. The Company reported a net
loss of approximately $
8
CAPSTONE COMPANIES INC., AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company has invested in its infrastructure to transition into the online retail business by developing an e-commerce website and a social media presence over the last year and these systems are up and running to process the Smart Mirror product. Prior to 2022, the Company’s wholesale business relied on brick-and-mortar retail for sale of its products to consumers and sought to piggyback off retailers’ e-commerce websites as well as dedicated online retailers like Amazon. As the Company focuses its effort on social media driven e-commerce, the Company’s online strategy is projected to deliver future growth and reduce reliance on big box retail. The gross margin is generally more favorable in e-commerce business, which can translate to better returns on lower revenues. The Company does not have extensive experience in conducting its own e-commerce business and the Company’s e-commerce efforts may not produce results that compensate for any lack of robust sales from brick-and-mortar sales. During the quarter ended March 31, 2022, the Company introduced the Smart Mirror on its Capstone Connected website.
The fact that the COVID-19 pandemic adversely impacted our Company at the same time as we were implementing a major shift in product line, from mature LED products to new Connected Surfaces products, amplified the financial impact of COVID-19 pandemic by disrupting development and production of new Connected Surfaces products in Thailand and China. This delay in launching the new product line coupled with the decline in sales of the LED product line adversely impacted the Company and created uncertainty about the ongoing viability of the current product lines of the Company. Now that the Smart Mirror inventory is available for sale in the U.S., the Company is experiencing economic factors that are affecting the consumers buying trends. Current economic indicators suggest that the United States economy is at risk of stagflation in the near future. Future trends in consumer spending show that purchasing of durable goods will continue to decline from the highs during the pandemic. This is resulting from the higher interest rates and the increased prices of durable goods. Various market surveys are reporting that American consumers are starting to adopt “ a value-conscious behavior ”. Company’s view of economic trends is that consumers are making or are likely to make fewer purchases and cutting back on or delaying non-essential purchases.
As of September 30, 2022, management determined that sufficient indicators existed to trigger the performance of an interim goodwill impairment analysis. The analysis concluded that the Company’s fair value of its single reporting unit exceeded the carrying value and a goodwill impairment charge was not required in the quarter ended September 30, 2022, as the fair value of the reporting unit exceeded the carrying amount based on the Company’s market capitalization.
The World Health Organization recently stated that the ongoing COVID-19 pandemic continues to constitute a Public Health Emergency of International Concern. The extent to which COVID-19 pandemic will continue to impact the Company’s results will depend primarily on future developments, including the severity and duration of the crisis, the acceptance and effectiveness of the national vaccine inoculation program, potential mutations of COVID-19 pandemic, and the impact of future actions that will be taken to contain COVID-19 pandemic or treat its impact.
These future developments are highly uncertain and cannot be predicted with confidence, especially if mutations of the COVID-19 virus become widespread and prove resistant to vaccines. The Omnicron variant of COVID-19 recent resurgence in Asia, has caused sporadic regional lockdowns and initially resulted in delays in finalizing certain Smart Mirror certifications, production of the initial Smart Mirror inventory and a major logistics backlog. The Company has received the rollout inventory in the United States from its manufacturing suppliers which is now available to support the 2022 sales program, but sales of this inventory has not been sufficient to compensate for drop in LED products sales.
Liquidity and Going Concern
The accompanying unaudited condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business.
The COVID-19 pandemics resurgence globally and in many states or emergence of new vaccine-resistant strains of the virus could have a continuing negative impact on the brick-and-mortar retail sector, with consumers unwilling to visit retail stores, causing reduced consumer foot traffic and consumer spending. However, with a successful relaunch of the Smart Mirror portfolio using the online retail platform, the Company will not be as dependent on brick-and-mortar and e-commerce sites of Big Box retailers for our revenue streams as in previous years. The Company has not achieved sufficient sales of Smart Mirror products, whether online or by brick-and-mortar retail sales, to compensate for drop in LED Lighting product sales.
As of September
30, 2022, the Company had working capital of approximately $
9
CAPSTONE COMPANIES INC., AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
These liquidity conditions in the short term raise substantial doubt about the Company’s ability to continue as a going concern. The Company has had discussions with alternate funding sources that offer programs that are more in line with the Company’s future business model, particularly a facility that provides funding options that are more suitable for the e-commerce business. The borrowing costs associated with such financing are dependent upon market condition and our credit rating. We cannot be certain that we will be able to negotiate competitive rates, which could increase our cost of borrowing in the future, particularly as the interest rates have increased substantially over recent months.
Certain insiders and directors have provided necessary funding including a working capital line to support the Company’s cash needs through this period of revenue development. There is no assurance that this funding will be available in the future or, if available, will be adequate to meet working capital needs.
On April 5, 2021, the Company entered into five separate securities purchase agreements (“SPAs”) whereby the Company privately placed an aggregate of 2,496,667 shares of Common Stock for an aggregate purchase price $1,498,000 (transactions being referred to as the “Private Placement). The five investors in the Private Placement consisted of four private equity funds and one individual – all being “accredited investors (under Rule 501(a)Regulation D under the Securities Act of 1933, as amended, (“Securities Act”). The $1,498,000 in proceeds from the Private Placement was used mostly to purchase start up a inventory for the Company’s new Smart Mirror product line, and the remainder for advertising and working capital.
On July 2, 2021, the Board of Directors (“Board”) resolved that the Company required a purchase order funding facility to procure additional inventory to support the online Smart Mirror business. The Board resolved that certain Directors could negotiate the terms of a Purchase Order Funding Agreement for up to $1,020,000 with Directors S. Wallach and J. Postal and E. Fleisig, a natural person. This agreement was finalized, and the Company received the $1,020,000 funding under this agreement on October 18, 2021. As of September 30th, 2022, the amount due on this loan is $1,068,485 including accrued interest.
On May 1, 2022, the Company negotiated three $200,000 each, working capital funding agreements, to provide funding for daily operations. The Board resolved that certain Directors could negotiate the terms of a Working Capital Funding Agreement for up to a total of $600,000, with Directors S. Wallach (through Group Nexus, a company controlled by Mr. Wallach), J. Postal and Mouhaned Khoury, a natural person. On May 1st the three individual agreements became effective. The term of each of the agreement is 18 months with principal accruing a simple interest rate of 5 percent per annum. These loans may be prepaid in full or partially without any penalty. The Company received the $600,000 funding under these agreements on May 5, 9 and 11, 2022 As of September 30, 2022, the amount due on these loans is $612,575 including accrued interest.
The $1,393,000 equity investment , the
$1,020,000 purchase order funding facility and the $600,000 working capital line, collectively this cash insertion has provided adequate
liquidity to meet the Company’s cash needs for our daily operations, capital expenditures and procurement of the Smart Mirror rollout
inventory. However, the Company’s will need to continue seeking additional funding through either debt or equity to continue
meeting our current financial obligations until the Company is able to generate sufficient operating cash flows from the sale of the
Smart Mirror inventory, that as of September 30, 2022, has a cost value of $
Management is closely monitoring its operations, liquidity, and capital resources and is actively working to try to minimize the current and future impact of the current operational and working capital funding challenges facing the Company.
Nature of Business
The Company has its principal executive offices in Deerfield Beach, Florida.
Since the beginning of fiscal year 2007, the Company through its wholly owned operating subsidiary, CAPI, has been primarily engaged in the business of developing, marketing, and selling home LED products (“Lighting Products) through national and regional retailers in North America and in certain overseas markets. The Company’s products are targeted for applications such as home indoor and outdoor lighting and have different functionalities to meet consumer’s needs. The development of the smart interactive mirror or “Smart Mirrors is part of the Company’s strategic effort to find new product lines to replace or supplement existing LED products that are nearing or at the end of their product life cycle. These LED and Smart Mirror products are offered under the “Capstone” brand. The Smart Mirror launch was announced in February 2021, but because of operational delays and regional lockdowns resulting from the upsurge in variants of COVID-19 in Thailand, the product shipments were delayed and only started to ship in the first quarter 2022.
10
CAPSTONE COMPANIES INC., AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The Company’s products are typically manufactured in Thailand and China by contract manufacturing companies. The Company’s future product development effort is focused on its connected surfaces initiative as the Company believes, based on Company’s management understanding of the industry, there is a greater potential for growth and higher profit margins than the Company’s historical LED consumer products. Technological developments and changes in consumer tastes could alter the perceived potential and future viability of Smart Mirrors as a primary product. Aggressive marketing and pricing by larger competitors in the smart mirror market could also adversely impact the Company’s efforts to establish Smart Mirrors as Company’s core product line. The Company may change its product development strategies and plans as economic conditions, competitive environment in smart mirrors and consumer tastes change, which condition and changes may be unforeseeable by the Company or may be beyond the ability of the Company to timely or at all adjust its strategic and product development plans.
The Company’s operations consist of one reportable segment for financial reporting purposes: Lighting Products.
Accounts Receivable
For wholesale product revenue, the Company invoices its customers at the time of shipment for the sales value of the product shipped. Accounts receivables are recognized at the amount expected to be collected and are not subject to any interest or finance charges. The Company does not have any off-balance sheet credit exposure related to any of its customers.
As of September 30, 2022, outstanding
accounts receivable in the United States has been collateralized against the May 1st 2022 working capital loans totaling $
Allowance for Doubtful Accounts
The Company evaluates the collectability of accounts receivable based on a combination of factors. In cases where the Company becomes aware of circumstances that may impair a specific customers ability to meet its financial obligations subsequent to the original sale, the Company will recognize an allowance against amounts due, and thereby reduce the net recognized receivable to the amount the Company reasonably believes will be collected. For all other customers, the Company recognizes an allowance for doubtful accounts based on the length of time the receivables are past due and consideration of other factors such as industry conditions, the current business environment and the Company’s historical payment experience. An allowance for doubtful accounts is established as losses are estimated to have occurred through a provision for bad debts charged to earnings. This evaluation is inherently subjective and requires estimates that are susceptible to significant revisions as more information becomes available.
As of September 30, 2022, and December 31, 2021, management determined that accounts receivable is fully collectible. As such, management has not recorded an allowance for doubtful accounts.
Inventories
The Company’s inventory, which consists of finished Thin Cast Smart Mirror products for resale to consumers by Company , is recorded at the lower of landed cost (first-in, first-out) or net realizable value. The Company writes down its inventory balances for estimates of excess and obsolete amounts. The Company reduces inventory on hand to its net realizable value on an item-by-item basis when the expected realizable value of a specific inventory item falls below its original cost.
Management regularly reviews the Company’s
investment in inventories for such declines in value. Write-downs are recognized as a component of cost of sales. Management did
not feel a reserve was necessary as of September 30, 2022 or December 31, 2021 based on its analysis. As of September 30, 2022,
and December 31, 2021, the inventory was valued at $
Goodwill
On September 13, 2006, the Company entered into a Stock Purchase Agreement with Capstone Industries, Inc., a Florida corporation (“Capstone” or “CAPI”). Capstone was incorporated in Florida on May 15, 1996 and is engaged primarily in the business of wholesaling technology inspired consumer products to distributors and retailers in the United States. Under the Stock Purchase Agreement, the Company acquired 100% of the issued and outstanding shares of Capstones common stock, and recorded goodwill of $1,936,020. Goodwill acquired in business combinations is initially computed as the amount paid by the acquiring company in excess of the fair value of the net assets acquired.
11
CAPSTONE COMPANIES INC., AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Goodwill is tested for impairment on December 31 of each year or more frequently if events or changes in circumstances indicate that
the asset might be impaired. If the carrying amount exceeds its fair value, an impairment loss is recognized. Goodwill is not amortized. The Company estimates the fair value of its single reporting unit relative to the Company’s market capitalization.
As a result of the economic uncertainties caused by the COVID-19 pandemic and decline in revenue during the quarter ended September 30, 2022, management determined sufficient indicators existed to trigger the performance of an interim goodwill impairment analysis for the three months ended September 30, 2022. The analysis concluded that the Company’s fair value exceeded the carrying value of its single reporting unit and a goodwill impairment charge was not required. The Company estimates the fair value of its single reporting unit relative to the Company’s market capitalization which utilizes level 1 inputs.
Fair Value Measurement
The accounting guidance under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC), “Fair Value Measurements and Disclosures (ASC 820-10) requires the Company to make disclosures about the fair value of certain of its assets and liabilities. ASC 820-10 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. ASC 820-10 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The three levels of the hierarchy are as follows:
Level 1: Observable inputs such as quoted prices in active markets for identical assets or liabilities.
Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly.
Level 3: Significant unobservable inputs.
Basic earnings per common share is computed by dividing net income (loss) by the weighted average number of shares of Common Stock outstanding as of September 30, 2022, and 2021. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue Common Stock were exercised or converted into common stock. For calculation of the diluted earnings per share, the basic weighted average number of shares is increased by the dilutive effect of stock options and warrants using the treasury stock method. In periods where losses are reported, the weighted average number of common shares outstanding excludes common stock equivalents because their inclusion would be anti-dilutive. For the nine months ended September 30, 2022 and 2021, the total number of potentially dilutive common stock equivalents excluded from the diluted earnings per share calculation was 1,887,921 which was comprised of 688,288 stock options, 199,733 warrants and 15,000 of Preferred B-1 stock convertible into 999,900 of common stock.
Revenue Recognition
The Company generates wholesale revenue from developing, marketing, and selling consumer electronic products through national and regional retailers. The Company’s products are targeted for applications such as home indoor and outdoor lighting and have different functionalities. Capstone currently operates in the consumer lighting products category in the United States and in certain overseas markets. These products may be offered either under the Capstone brand or licensed brands.
A sales contract occurs when the customer-retailer submits a purchase order to buy a specific product, a specific quantity, at an agreed-fixed price, within a ship window, from a specific location and on agreed payment terms.
The selling price in all of our customers’ orders has been previously negotiated and agreed to including any applicable discount prior to receiving the customers purchase order. The stated unit price in the customer’s order has already been determined and is fixed at the time of invoicing.
12
CAPSTONE COMPANIES INC., AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The Company recognizes product revenue when the Company’s performance obligations as per the terms in the customers purchase order have been fully satisfied, specifically, when the specified product and quantity ordered has been manufactured and shipped pursuant to the customers requested ship window, when the sales price as detailed in the purchase order is fixed, when the product title and risk of loss for that order has passed to the customer, and collection of the invoice is reasonably assured. This means that the product ordered and to be shipped has gone through quality assurance inspection, customs and commercial documentation preparation, the goods have been delivered, title transferred to the customer and confirmed by a signed cargo receipt or bill of lading. Only at the time of shipment when all performance obligations have been satisfied will the judgement be made to invoice the customer and complete the sales contract.
With the Company launching the Smart Mirror program, these orders are sold initially through e-commerce platforms. The Company will only bill the customer and recognize revenue upon the customer obtaining control of the Smart Mirror order which will occur upon delivery.
The Company may also sell the Smart Mirror program through independent retailers. The Company will only bill the customer and recognize revenue upon the customer obtaining control of the Smart Mirror order which will generally occur upon order shipment.
The following table presents net revenue by geographic location which is recognized at a point in time:
| For the Three Months Ended September 30, 2022 | For the Three Months Ended September 30, 2021 | |||||||||||||||
| Revenues | % of Revenue | Revenues | % of Revenue | |||||||||||||
| Lighting Products- U.S. | $ | % | $ | % | ||||||||||||
| Lighting Products- International | % | % | ||||||||||||||
| Smart Mirror Products- U.S. | % | % | ||||||||||||||
| Total Net Revenue | $ | % | $ | % | ||||||||||||
| For the Nine Months Ended September 30, 2022 | For the Nine Months Ended September 30, 2021 | |||||||||||||||
| Revenues | % of Revenue | Revenues | % of Revenue | |||||||||||||
| Lighting Products- U.S. | $ | % | $ | % | ||||||||||||
| Lighting Products- International | % | % | ||||||||||||||
| Smart Mirror Products- U.S. | % | % | ||||||||||||||
| Total Net Revenue | $ | % | $ | % | ||||||||||||
We provide our wholesale customers with limited rights of return for non-conforming product warranty claims. As a policy, the Company does not accept product returns from customers, however occasionally as part of a customers in store test for new product, we may receive back residual inventory.
Customer wholesale orders received are not long-term orders and are typically shipped within six months of the order receipt, but certainly within a one-year period. Our payment terms may vary by the type of customer, the customer’s credit standing, the location where the product will be picked up from and for international customers, which country their corporate office is located. The term between invoicing date and when payment is due may vary between 30 days and 90 days depending on the customer type. In order to ensure there are no payment issues, overseas customers or new customers may be required to provide a deposit or full payment before the order is delivered to the customer.
The
Company selectively supports retailers’ initiatives to maximize sales of the Company’s products on the retail floor
or to assist in developing consumer awareness of new products launches, by providing marketing fund allowances to the customer.
The Company recognizes these incentives at the time they are offered to the customers and records a credit to their account with
an offsetting charge as either a reduction to revenue, increase to cost of sales, or marketing expenses depending on the type
of sales incentives. Sales reductions for anticipated discounts, allowances and other deductions are recognized during the period
when the related revenue is recorded. The reduction of accrued allowances is included in net revenues and amounted to $
13
CAPSTONE COMPANIES INC., AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Warranties
The Company provides the end user with limited rights of return as a consumer assurance warranty on all products sold, stipulating that the product will function properly for the warranty period. The warranty period for all products is one year from the date of consumer purchase. Certain retail customers may receive an off invoice-based discount such as a defective/warranty allowance, that will automatically reduce the unit selling price at the time the order is invoiced. This allowance will be used by the retail customer to defray the cost of any returned units from consumers and therefore negate the need to ship defective units back to the Company. Such allowances are charged to cost of sales at the time the order is invoiced. For those customers that do not receive a discount off-invoice, the Company recognizes a charge to cost of sales for anticipated non-conforming returns based upon an analysis of historical product warranty claims and other relevant data. We evaluate our warranty reserves based on various factors including historical warranty claims assumptions about frequency of warranty claims, and assumptions about the frequency of product failures derived from our reliability estimates. Actual product failure rates that materially differ from our estimates could have a significant impact on our operating results. Product warranty reserves are reviewed each quarter and recognized at the time we recognize revenue. For the new online Smart Mirror customers the product has a One Year Limited Warranty. The purchaser must register the product within 30 days from date of purchase with specific product information to activate the warranty. Capstone warrants the product to be free from defects in workmanship and materials for the warranty period. If the product fails during normal and proper use within the warranty period, Capstone at its discretion, will repair or replace the defective parts of the product, or the product itself.
Advertising and Promotion
Advertising and promotion costs,
including advertising, public relations, and trade show expenses, are expensed as incurred and included in sales and marketing
expenses. Advertising and promotion expense was $
Product Development
The Company’s research and development consultants located in Hong Kong working with our designated contractor factories, are responsible for the design, development, testing, and certification of new product releases. The Company's engineering efforts support product development across all products, as well as product testing for specific overseas markets. All research and development costs are charged to results of operations as incurred. With the reduction of revenue resulting from the impact of the COVID-19 pandemic and combined with the transfer of manufacturing to Thailand, the CIHK operation was closed down in March 2022 and the Company will remain registered in Hong Kong in a dormant status. Two key Members of Management were retained as consultants to support product development and sales operations.
Product development expenses were $
Accounts Payable and Accrued Liabilities
The following table summarizes the components of accounts payable and accrued liabilities as of September 30, 2022, and December 31, 2021, respectively
| September 30, | December 31, | |||||||
| 2022 | 2021 | |||||||
| Accounts payable | $ | $ | ||||||
| Accrued warranty reserve | ||||||||
| Accrued compensation and deferred wages, marketing allowances, customer deposits. | ||||||||
| Total | $ | $ | ||||||
Income Taxes
The Company is subject to income taxes in the U.S. federal jurisdiction, various state jurisdictions and certain other jurisdictions.
The Company accounts for income taxes under the provisions of ASC 740 Income Taxes. ASC 740 requires recognition of deferred
14
CAPSTONE COMPANIES INC., AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
income tax assets and liabilities for the expected future income tax consequences, based on enacted tax laws, of temporary differences between the financial reporting and tax bases of assets and liabilities. The Company and its U.S. subsidiaries file consolidated income tax returns. The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. Tax regulations within each jurisdiction are subject to the interpretation of the relaxed tax laws and regulations and require significant judgement to apply. The Company is not subject to U.S. federal, state and local tax examinations by tax authorities generally for a period of 3 years from the later of each return due date or date filed.
On March 27, 2020, the CARES Act was enacted into law. The CARES Act is a tax and spending package intended to provide economic relief to address the impact of the COVID-19 pandemic. The CARES Act includes several significant income and other business tax provisions that, among other things, would eliminate the taxable income limit for certain net operating losses (“NOLs”) and allow businesses to carry back NOLs arising in 2018, 2019, and 2020 to the five prior tax years. If the Company were to subsequently record an unrecognized tax benefit, associated penalties and tax related interest expense would be recorded as a component of income tax expense.
The Company accounts for stock-based compensation under the provisions of ASC 718 Compensation- Stock Compensation, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options, based on estimated fair values. ASC 718 requires companies to estimate the fair value of share-based payment awards on the date of the grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expenses over the requisite service periods in the Company’s condensed consolidated statements of operations. Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period. In conjunction with the adoption of ASC 718, the Company adopted the straight-line single option method of attributing the value of stock-based compensation expense. The Company accounts for forfeitures as they occur. Stock-based compensation expense recognized during the three months ended September 30, 2022, and 2021 was $1,120 and $1,615, respectively and $7,844 and $10,015 for the nine months ended September 30, 2022 and 2021, respectively.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and the disclosure of contingent assets and liabilities. The Company evaluates its estimates on an ongoing basis, including those related to revenue recognition, periodic impairment tests, product warranty obligations, valuation of inventories, tax related contingencies, valuation of stock-based compensation, other contingencies and litigation, among others. The Company generally bases its estimates on historical experience, agreed obligations, and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis of making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Historically, past changes to these estimates have not had a material impact on the Company’s financial statements. However, circumstances could change, and actual results could differ materially from those estimates.
Recent Accounting Standards
In June 2016, the FASB issued Accounting Standards Update (“ASU) 2016-13, “Financial Instruments – Credit Losses. This ASU sets forth a current expected credit loss model which requires the Company to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. In November 2019, the effective date of this ASU was deferred until fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, with early adoption permitted. The Company is in the process of determining the potential impact of adopting this guidance on its consolidated financial statements.
15
CAPSTONE COMPANIES INC., AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Adoption of New Accounting Standards
In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740). The amendments in ASU 2019-12 seek to simplify the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application and simplify GAAP in other areas of Topic 740. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. The adoption of ASU 2019-12 did not have a material effect on the Company’s consolidated financial statements.
The Company continually assesses any new accounting pronouncements to determine their applicability to the Company. Where it is determined that a new accounting pronouncement affects the Company’s consolidated financial reporting, the Company undertakes a study to determine the consequence of the change to its financial statements and assures that there are proper controls in place to ascertain that the Company’s consolidated financial statements properly reflect the change.
NOTE 2 - CONCENTRATIONS OF CREDIT RISK AND ECONOMIC DEPENDENCE
Financial instruments that potentially subject the Company to credit risk consist principally of cash and accounts receivable. The Company has no significant off-balance-sheet concentrations of credit risk such as foreign exchange contracts, options contracts or other foreign hedging arrangements.
Cash
The Company at times has cash with
its financial institution in excess of Federal Deposit Insurance Corporation (“FIDC) insurance limits. The Company places
its cash with high credit quality financial institutions which minimize the risk of loss. To date, the Company has not experienced
any such losses. As of September 30, 2022 and December 31, 2021, the Company had approximately $
Accounts Receivable
The Company grants credit to its customers, located throughout the United States and their international locations. The Company typically does not require collateral from national retail customers. Credit risk is limited due to the financial strength of the customers comprising the Company’s customer base and their dispersion across different geographical regions. The Company monitors exposure of credit losses and maintains allowances for anticipated losses considered necessary under the circumstances. As the Company’s ecommerce revenue starts to increase the makeup of the accounts receivable will change significantly. Stripe is the company that processes online payments for our e-commerce website. We should receive payment from them within 3 days of the product shipment. If the product is shipped through Amazon online platform it could take between 20 and 30 days for collection.
Financial instruments that potentially subject the Company to credit risk, consist principally of cash and accounts receivable. The Company has no significant off-balance-sheet concentrations of credit risk such as foreign exchange contracts, options contracts or other foreign hedging arrangements.
Major Customers
With
the availability of the new Smart Mirror inventory, the Company has started to expand its business into the on-line market for
the Smart Mirror program. The Company had two customers who comprised
As of September 30, 2022, approximately
$
As the Company increases its ecommerce business, rather than having hundreds of individual consumer customers we will have as customers those companies that we have selected to process our orders such as Stripe, Amazon or Wayfair.
Major Vendors
The Company had two vendors from which it purchased 73% and 22%, respectively, of merchandise during the nine months ended September 30, 2022, and two vendors from which it purchased 48% and 26% of merchandise during the nine months ended September 30, 2021. The loss of these suppliers could adversely impact the business of the Company. As of September 30, 2022, approximately $6.6 thousand or 11% of accounts payable was due to one vendor. As of December 31, 2021, approximately $92 thousand or 73% of accounts payable was due to one vendor.
16
CAPSTONE COMPANIES INC., AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 – NOTES PAYABLE TO RELATED AND UNRELATED PARTIES
On January 4, 2021, the Company entered a $750,000 working capital loan agreement with Directors, Stewart Wallach and Jeffrey Postal (the “Lenders). There were no borrowings on this working capital loan. The short-term facility ended June 30, 2021.
In consideration for the Lenders providing the loan under this agreement and agreeing to a below market rate of interest, and as payment of a finance fee for the loan on an unsecured basis, the Company issued to the Lenders 7,500 shares of the Company’s Series B-1 Convertible Preferred Stock (“Preferred Shares) Each Preferred Share converts into 66.66 shares of common stock at option of Lender . The Preferred Shares and any shares of Common Stock issued under the loan agreement are “restricted securities under Rule 144 of the Securities Act of 1933, as amended. The Preferred Shares have no further rights, preferences, or privileges. The fair value of the Preferred Shares was determined to be $48,996 based on the number of shares of Common Stock to be issued upon conversion and the market price of the Common Stock on the date the working capital loan agreement was executed. The Company amortized the $48,996 into interest expense over the six months of the agreement and included in interest expense on the consolidated statements of operations.
On July 2, 2021, the Board of Directors (“Board) resolved that the Company required a purchase order funding facility to procure additional inventory to support the online Smart Mirror business. The Board resolved that certain Directors could negotiate the terms of such a funding facility for up to $1,020,000 with Directors S. Wallach and J. Postal and E. Fleisig, a natural person who is not affiliated with the Company. This agreement was finalized on October 18, 2021, and the Company received the funding of $1,020,000 on October 18, 2021 which is due 18 months from receipt of the funds. Under this agreement, the interest terms are 5% based on a 365- day year. This agreement shall continue in full force for 18 months from the start date. As of September 30, 2022, the note balance of $1,068,484 includes accrued interest of $48,484, and $712,323 of principal and accrued interest due to related parties which has been presented separately on the unaudited condensed balance sheet. As of September 30, 2022, the entire principal and accrued interest has been classified as a current liability due to the maturity in April 2023.
On
May 1, 2022 the Company negotiated three separate $200,000 Working Capital Funding agreements, to provide funding for daily operations
(the “Working Capital Funding Agreements”). The Board resolved that certain Directors could negotiate the terms of
a working capital funding agreement for up to a total of $600,000, with Directors S. Wallach (through Group Nexus, a company controlled
by Mr. Wallach), J. Postal and Mouhaned Khoury. The term of each agreement is 18 months or November 2023 with principal accruing
simple interest at a rate of 5 percent per annum. The loans may be prepaid in full or partially without any penalty. The Company
received the $
NOTE 4– COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company had operating lease agreements for its principal executive offices in Fort Lauderdale, Florida expiring at June 2023. The Company’s principal executive office is located at 431 Fairway Drive, Suite 200, Deerfield Beach, Florida 33441.
Effective November 1, 2019, the Company entered a prime operating lease with the landlord, 431 Fairway Associates, LLC, ending June 30, 2023, for the Company’s executive offices located at 431 Fairway Drive, Suite 200, Deerfield Beach, Florida 33441 with an annualized base rent of $70,104 and with a base rental adjustment of 3% commencing July 1, 2020 and on July 1st of each subsequent year during the term. Under the lease agreement, Capstone is also responsible for approximately 4,694 square feet of common area maintenance charges ,respectively in the leased premises which has been estimated at $12.00 per square foot or approximately $56,000 on an annualized basis.
The Company’s rent expense
is recorded on a straight-line basis over the term of the lease. The rent expense for the three months ended September 30, 2022,
and 2021 amounted to $
17
CAPSTONE COMPANIES INC., AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4– COMMITMENTS AND CONTINGENCIES (Continued)
| Supplemental balance sheet information related to leases as of September 30, 2022 is as follows: | ||||
| Assets | ||||
| Operating lease - right-of-use asset | $ | |||
| Accumulated amortization | $ | ( |
) | |
| Operating lease - right - of -use asset , net | $ | |||
| Liabilities | ||||
| Current | ||||
| Current portion of operating lease | $ | |||
| Noncurrent | ||||
| Operating lease liability, net of current portion | $ | |||
| Supplemental statement of operations information related to leases for the period ended September 30, 2022, is as follows: | ||||
| Operating lease expense as a component of other general and administrative expenses | $ | |||
| Supplemental cash flow information related to leases for the period ended September 30, 2022, is as follows: | ||||
| Cash paid for amounts included in the measurement of lease liabilities: Operating cash flow paid for operating lease | $ | |||
| Lease term and Discount Rate | ||||
| Weighted average remaining lease term (months) | ||||
| Operating lease | ||||
| Weighted average Discount Rate | ||||
| Operating lease | % | |||
Scheduled maturities of operating lease liabilities outstanding as of September 30, 2022 are as follows:
| Year | Operating Lease | |||
| 2022 (remaining months) | $ | |||
| 2023 | ||||
| Total Minimum Future Payments | ||||
| Less: Imputed Interest | ||||
| Present Value of Lease Liabilities | $ | |||
Consulting Agreements
On July 1, 2015, the Company entered into a consulting agreement with George Wolf, whereby Mr. Wolf was paid $10,500 per month through December 31, 2015 increasing to $12,500 per month from January 1, 2016 through December 31, 2017. On January 1, 2018, the agreement was further amended, whereby Mr. Wolf was paid $13,750 per month from January 1, 2018 through December 31, 2018 and was further amended at various periods to be paid at the same rate through December 31, 2021.
On January 1, 2022, the sales operations consulting agreement with George Wolf, was further extended, whereby Mr. Wolf will be paid $13,750 per month from January 1, 2022 through December 31, 2022.
Effective September 1, 2020 through March 31, 2021, payment for fifty percent or $6,875 of the monthly consulting fee or approximately $48,125 for the effective period, was deferred until 2022. As of September 30, 2022 and December 31, 2021, the amount due to Mr. Wolf for deferred consulting fees was $48,125 which is included in accounts payable and accrued expenses on the accompanying condensed consolidated balance sheets.
18
CAPSTONE COMPANIES INC., AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 – COMMITMENTS AND CONTINGENCIES (Continued)
Effective April 1, 2021, the sales operations consulting fee with Mr. Wolf was restored to the contract amount of $13,750 per month.
Effective October 1, 2022 through December 31, 2022, one hundred percent of Mr. Wolf’s consulting fee payment will be deferred until 2023.
The consulting agreement can be terminated upon 30 days’ notice by either party. The Company may, in its sole discretion at any time convert Mr. Wolf to a full-time Executive status. The annual salary and term of employment would be equal to that outlined in the consulting agreement.
Employment Agreements
On February 5, 2020, the Company entered into a new Employment Agreement with Stewart Wallach, whereby Mr. Wallach will be paid $301,521 per annum. The initial term of this new agreement began February 5, 2020 and ends February 5, 2023. The parties may extend the employment period of this agreement by mutual consent with approval of the Company’s Board of Directors, but the extension may not exceed two years in length.
On February 5, 2020, the Company entered into an Employment Agreement with James McClinton, whereby Mr. McClinton was paid $191,442 per annum. The term of agreement began February 5, 2020 and ended February 5, 2022.
Effective September 1, 2020, through March 31, 2021, payments equivalent to fifty percent of both Mr. Wallach and Mr. McClinton’s salary were deferred to be repaid in the future. As of December 31, 2021, $86,977 and $20,616, respectively, have been deferred until later in 2022. As of September 30, 2022, total wages deferred for Mr. Wallach were approximately $86,977 and $0 for Mr. McClinton.
Effective October 1, 2022, through December 31, 2022, one hundred percent of Mr. Wallach’s salary payment will be deferred until 2023.
On February 6, 2022, the Company entered into an Employment Agreement with James McClinton (Chief Financial Officer and Director), whereby Mr. McClinton will be paid $736.41 per day. The term of this new agreement began February 6, 2022 and ends August 30, 2022.
On August 30, 2022. the Company amended the Employment Agreement with James McClinton (Chief Financial Officer and Director), whereby Mr. McClinton will be paid $736.41 per day. The term of this extended agreement began August 30, 2022 and ends November 30, 2022.
There is a provision in Mr. Wallach’s employment agreement, if the officer’s employment is terminated by death or disability or without cause, the Company is obligated to pay to the officer’s estate or the officer, an amount equal to accrued and unpaid base salary as well as all accrued but unused vacation days through the date of termination. The Company will also pay sum payments equal to the sum of twelve (12) months base salary at the rate the Executive was earning as of the date of termination and (b) the sum of “merit based bonuses earned by the Executive during the prior calendar year of his termination. Any payments owed by the Company shall be paid from a normal payroll account on a bi-weekly basis in accordance with the normal payroll policies of the Company. The amount owed by the Company to the Executive, from the effective Termination date, will be payout bi-weekly over the course of the year but at no time will be no more than twenty (26) installments. The Company will also continue to pay the Executives health and dental insurance benefits for 6 months starting at the Executives date of termination. If the Executive had family health coverage at the time of termination, the additional family premium obligation would remain theirs and will be reduced against the Executives severance package. The employment agreements have an anti-competition provision for 18 months after the end of employment.
On March 4, 2022,with the closure of the CIHK operation, the Company entered a consulting agreement with Fayyyaz Fakhruddin Bootwala (Frank),who previously was a direct employee as the CIHK Business Development and Product Manager. Frank will continue to perform similar duties but as an independent contractor. The agreement will end February 28, 2023, which term maybe extended by mutual agreement between the consultant and Company on an agreed upon schedule with prior written notice. Notwithstanding the foregoing , the Agreement may be terminated by either party at any time after the initial 60 day term, upon 30 days prior written notice. The consulting fee in consideration for these services will be $6,119.00 USD paid in arrears monthly on receipt of invoice.
19
CAPSTONE COMPANIES INC., AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 – COMMITMENTS AND CONTINGENCIES (Continued)
On March 4, 2022, with the closure of the CIHK operation, the Company entered a consulting agreement with Yee Moi Choi (Johnny),who previously was a direct employee as the CIHK Logistics Manager. Johnny will continue to perform similar duties but as an independent contractor. The agreement will end February 28, 2023, which term maybe extended by mutual agreement between the consultant and Company on an agreed upon schedule with prior written notice. Notwithstanding the foregoing , the Agreement may be terminated by either party at any time after the initial 60 day term, upon 30 days prior written notice. The consulting fee in consideration for these services will be $4,127.00 USD paid in arrears monthly on receipt of invoice.
Public Relations
Effective May 1, 2022, the Company finalized a marketing/ public relations agreement with Tongal, which is an online service that connects companies with branding and marketing consultants and services, will provide services for the development and creation of digital assets for use on the Company’s website, social media ads and other ecommerce websites such as Amazon. The platform fee will be $30,000 with production expenses additional. The initial period will be for six months. The Company can terminate the agreement with a written notice 30 days prior to the end of the Agreement and will automatically renew for a further six months at the same rate.
Directors Compensation
On May 6, 2021, the Company approved the following basic compensation arrangement for independent directors of the Company for their continued services, effective August 6, 2021 and ending August 5, 2022: A total compensation value of $15,000 per annum, payable $750 monthly cash, compensation or $9,000 or (60% of total value) and remainder $6,000 payable in non-qualified stock options vesting as of August 6, 2022 and with an exercise price equal to market price of common stock as of August 6, 2021, less 20% (discount). See Note 5– Stock Transactions for further disclosures.
On July 5, 2022, the Company approved that the cash compensation for services as a director and services as a member of the Audit Committee, Compensation and Nomination Committee for independent directors Jeffrey Postal and Jeffrey Guzy was suspended for the remainder of 2022.
On July 5, 2022, the Board of Directors of the Company held a special meeting and approved the following corporate actions or proposals:
| ● | The Board nominated the following incumbent directors to stand for election to the Board for a term commencing upon election and ending in 2023 and the election and assumption of office of successors: (a) Stewart Wallach; (b) James McClinton; (c) George Wolf; (d) Jeffrey Postal; and (e) Jeffrey Guzy approved a resolution to seek shareholders vote or consent to these nominees. |
| ● | July 8, 2022 was set as the record date for holders of record of issued shares of Company Common Stock entitled to vote for election of, or written consent to election of, directors in 2022 and for any other matters presented for shareholder approval. |
On September 30, 2022, the Board rescinded the approval of the record date of July 8, 2022 and approved the record date to be changed to September 30, 2022.
The vote to elect directors has not occurred as of the date of the filing of this Form 10-Q.
NOTE 5 - STOCK TRANSACTIONS
Stock Purchase Agreements
On April 5, 2021, the Company entered into a Private Equity Placement with five separate securities purchase agreements (“SPAs”) whereby the Company privately placed an aggregate of 2,496,667 shares (“Shares) of its common stock, $0.0001 par value per share, (“common stock”) for an aggregate purchase price $1,498,000. The five unrelated investors in the Private Placement consisted of four private equity funds and one individual – all being “accredited investors (under Rule 501(a) of Regulation D under the Securities Act of 1933, as amended, (“Securities Act). The $1,498,000 in proceeds from the Private Placement was used mostly to purchase start up inventory for the Company’s new Smart Mirror product line, and the remainder for advertising and working capital. Under the SPA, each investor is granted five-year piggyback, ‘best efforts registration rights with no penalties. The Shares are ‘restricted securities under Rule 144 of the Securities Act and are subject to a minimum six month hold period. Based on representations made to the Company, the five investors do not constitute a “group” under 17 C.F.R. 240.13d-3 and have purchased the Shares solely as an investment for each investors own account. No individual investor owns more than 2% of the issued and outstanding shares of common stock. The Private Placement was required to raise needed working capital to purchase U.S. domestic inventory, to support the Company’s new Smart Mirror product line that initially was to be sold online in the second quarter 2021. The Company engaged Wilmington Capital Securities, LLC, a FINRA and SEC registered broker to act as a placement agent to assist to raise capital through a private placement from one or more accredited investors. As compensation for their services Wilmington was paid 7% of the gross proceeds or $104,860 as a placement fee. The placement fee was offset against the $1,498,000 gross proceeds and the net amount of $1,393,140. This increased the Company’s additional paid in capital as presented on the accompanying condensed consolidated statement of stockholder’s equity statement as of September 30, 2022. In addition, the Company issued to Wilmington as consideration for their placement fee services, warrants equal to 8% of the shares issued or 199,733 warrants. The warrants can be exercised for five years from date of issuance, exercisable at a price per share equal to 110% or $0.66 of the price per share paid by the investors.
20
CAPSTONE COMPANIES INC., AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - STOCK TRANSACTIONS (Continued)
Warrants
On April 28, 2021, Company issued common stock warrants to purchase 199,733 shares of common stock at an exercise price of $0.66 and exercisable for five years from the issuance date. The warrants were issued to Wilmington Capital Securities, LLC, a FINRA and SEC registered broker under a financial services and placement agreement with a broker dealer in connection with the Company’s placement of $1.4 million of restricted shares of common stock to five investors on April 5, 2021. The issuance of these warrants were made an exemption from registration under Section 4(a)(2) and Rule 506(b) of Regulation D under the Securities Act. The estimated fair value of these warrants since issued as issuance costs, had no impact on the Company’s condensed consolidated financial statements as of September 30, 2022.
As of September 30, 2022, and 2021, the Company had 199,733 and 0 warrants outstanding, respectively.
Series “B-1 Preferred Stock
In 2009, the Company authorized 2,108,313 shares of Series B-1 preferred stock (“B-1). The B-1 preferred stock are convertible into common shares, at a rate of 66.66 of common stock for each share of B-1 convertible preferred stock. The par value of the B-1 preferred shares is $0.0001. The B-1 shares shall not be entitled to any dividends and have no voting rights. In the event of a liquidation, the B-1 holders are entitled to distribution prior to common stockholders but not before any other preferred stockholders. On June 7, 2016, the Company authorized 3,333,333 of the B-1 preferred stock. The B-1 share have a liquidation preference of $1.0 per share or $15,000 as of eptember30, 2022.
On January 4, 2021, the Company entered a $750,000 working capital loan agreement with Directors, Stewart Wallach and Jeffrey Postal (“Lenders”). In consideration for the Lenders allowing for loan advances under the loan agreement, a below market rate of interest and the loan made on an unsecured basis, as payment of a finance fee for the loan, the Company issued a total of seven thousand five hundred shares of Company’s Series B-1 Convertible Preferred Stock, $0.0001 par value per share, (“Preferred Shares”) to each of the Lenders. Each preferred share converts into 66.66 shares of common stock at option of Lender. The Preferred Shares and any shares of common stock issued under the loan agreement are “restricted securities under Rule 144 of the Securities Act of 1933, as amended (See Note 4).
Options
In 2005, the Company authorized the 2005 Equity Plan that made available shares of common stock for issuance through awards of options, restricted stock, stock bonuses, stock appreciation rights and restricted stock units.
On May 2, 2017, the Company’s Board of Directors amended the Company’s 2005 Equity Incentive Plan to extend the Plans expiration date from December 31, 2016 to December 31, 2021.
On June 10, 2020, the Company granted 100,000 stock options each to two directors of the Company for their participation as members of the Audit Committee and Nominating and Compensation Committee, and 10,000 stock options to the Company Secretary.
The Director options have a strike price of $.435 with an effective date of August 6, 2020 and vested on August 5, 2021 and have a term of 5 years. The Company Secretary options have a strike price of $.435 with an effective date of August 6, 2020 and vested on August 5, 2021 and have a term of 10 years.
21
CAPSTONE COMPANIES INC., AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - STOCK TRANSACTIONS (Continued)
On May 6, 2021, the Company approved the following basic compensation arrangement for independent directors of the Company, effective August 6, 2021 and ending August 5, 2022: A total compensation value of $15,000 per annum, payable $750 monthly cash compensation or $9,000 or (60% of total value) and the remainder payable in non- qualified stock options vesting as of August 6, 2022 and with an exercise price equal to $1.4448 per share and exercisable for a period of five years. On August 6, 2021, the Company granted the two independent directors 4,144 common stock options each with a grant date fair value of $1.81.
On July 15, 2021, Jeffrey Guzy a Company director, exercised a previously granted non-qualified stock option and purchased 100,000 shares of Company common stock for an aggregate purchase price of $43,500 or a per share price of $.435. The shares are restricted shares under federal securities laws. The proceeds will be used by the Company for general working capital to support the rollout of the Smart Mirror product line.
On August 5, 2022, 200,000 stock options expired. 100 thousand stock options each to directors Jeff Guzy and Jeff Postal. The exercise price of these stock options was $0.435 per option.
As of September 30, 2022, there were stock options outstanding, and vested and exercisable. The stock options have a weighted average exercise price of $0.435 and have a weighted average contractual term remaining of 2.18 years. Stock options were issued under Section 4(a)(2) and Rule 506(b) of Regulation D under the Securities Act of 1933.
The Binomial Lattice (Suboptimal) option pricing model was used to calculate the fair value of the stock options granted. The expected dividend yield is based upon the fact that the Company has not historically paid dividends and does not expect to pay dividends in the near future.
For the three months ended September 30, 2022 and 2021, the Company recognized stock-based compensation expense of $ and $, respectively and $ and $ for the nine months ended September 30, 2022 and 2021, respectively, related to these stock options. Such amounts are included in compensation expense in the accompanying consolidated statements of operations. A further compensation expense expected to be approximately $0.0 will be recognized for these options through 2022.
Adoption of Stock Repurchase Plan
On August 23, 2016, the Company’s Board of Directors authorized the Company to implement a stock repurchase plan for up to $750,000 worth of shares of the Company’s outstanding common stock. The stock purchases can be made in the open market, structured repurchase programs, or in privately negotiated transactions. The Company has no obligation to repurchase shares under the authorization, and the timing, actual number and value of the shares which are repurchased will be at the discretion of management and will depend on several factors including the price of the Company’s common stock, market conditions, corporate developments, and the Company’s financial condition. The repurchase plan may be discontinued at any time at the Company’s discretion.
On December 19, 2018, Company entered a Purchase Plan pursuant to Rule 10b5-1 under the Exchange Act, with Wilson Davis & Co., Inc., a registered broker-dealer. Under the Purchase Plan, Wilson Davis & Co., Inc will make periodic purchases of up to an aggregate of 750,000 shares at prevailing market prices, subject to the terms of the Purchase Plan.
On June 10, 2020, the Company’s Board of Directors approved a further extension of the Company’s stock repurchase plan through August 31, 2021. Since the Board of Director approval there have been no further repurchase of the Company’s common stock during 2020 and further Stock repurchases have been placed on hold in order to conserve cash during the COVID-19 pandemic.
On May 6, 2021, the Company’s Board of Directors approved a further extension of Rule 10b-5, the Company’s stock purchase agreement with Wilson-Davis & Company, Inc. through August 31, 2022. Since the Board of Directors approval last year, in May 2022, there has been a further repurchase of 66,167 of the Company’s common stock. Further, stock repurchases will be dependent on the Company future liquidity position.
During May 2022, the Company repurchased 66,167 shares of the Company’s outstanding common stock in the open market. The total purchase cost was $11,662.
As of September 30, 2022, and
December 31, 2021, a total of
22
CAPSTONE COMPANIES INC., AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6- SUBSEQUENT EVENTS
On October 13, 2022 the Company negotiated a Working Capital Funding agreement with Jeffrey Postal, a director, to provide funding for daily operations (the “Working Capital Funding Agreement”). The term of this agreement is 18 months and principle accrues simple interest at a rate of 5 percent per annum. The loan may be prepaid in full or partially without any penalty. The Company received $50,000 on October 13 , 2022 which was the maximum loan available under this Working Capital Funding Agreement.
Effective October 1, 2022, through December 31, 2022, one hundred percent of Mr. Wallach’s salary compensation will be deferred until 2023 (see also Note 4).
Effective October 1, 2022 through December 31, 2022, one hundred percent of Mr. Wolf’s consulting fee payment will be deferred until 2023 (see also Note 4).
23
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This discussion should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s 2021 Annual Report.
Cautionary Statement Regarding Forward-Looking Statements
**This Form 10-Q Report contains forward-looking statements that are contained principally in the sections describing our business as well as in “Risk Factors, and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance, or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. All statements other than statements of historical facts contained, or incorporated by reference, in this Form 10-Q Report, including, without limitation, those regarding our business strategy, financial position, results of operations, plans, prospects, actions taken or strategies being considered with respect to our liquidity position, valuation and appraisals of our assets and objectives of management for future operations, our ability to weather the impacts of the COVID-19 pandemic (including variant viruses), financing opportunities, and future cost mitigation and cash conservation efforts and efforts to reduce operating expenses and capital expenditures are forward-looking statements. These risks and uncertainties include, but are not limited to, the factors described in the section captioned “Risk Factors” in our latest 2021 Annual Report. In some cases, you can identify forward-looking statements by terms such as “anticipates, “believes, “could, “estimates, “expects, “intends, “may, “plans, “potential, “predicts, “projects, “should, “would and similar expressions (including the negative and variants of such words). Forward-looking statements reflect our current views with respect to future events and are based on assumptions and are subject to various risks and uncertainties. Given these uncertainties, a reader of this Form 10-Q Report should not place undue reliance on these forward-looking statements. The forward-looking statements contained in this Form 10-Q Report are made as of the date of filing this Form 10-Q Report. You should not rely upon forward-looking statements as predictions of future events. The Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law. Examples of these risks, uncertainties and other factors include, but are not limited, to the impact of:
| ● | COVID-19 pandemic and new emerging variants of the virus on our financial condition and operations, which could adversely affect our ability to obtain acceptable financing in an amount equal to the resulting reduction in cash from operations, disruption of our Thai or Chinese OEM operations and the current, and uncertain future, other impacts of the COVID-19 pandemic outbreak, including its effect on the retail market place and the closure of retail stores and its effect on consumer confidence and on the ability or desire of consumers to purchase nonessential goods, such as our products, which are expected to continue to adversely impact our results, operations, outlook, plans, goals, growth, cash flows, liquidity, demand for consumer products and share price. |
| ● | Failure of e-commerce marketing and sales initiatives to counter reduced sales of products in retail brick-and-mortar or to elicit consumer interest in our Connected Surface product line. |
| ● | Our success in reducing operating expenses and the impact of any such reductions. |
| ● | Adverse general economic and related factors, such as fluctuating or increasing levels of unemployment, declines in the securities and real estate markets, and perceptions of these conditions that decrease the level of disposable income of consumers or consumer confidence and the impact of inflationary cost increases to disposable income. |
| ● | The spread of other epidemics, pandemics, and viral outbreaks. |
| ● | Our anticipated need for additional financing, which may not be available on favorable terms, or at all, and may be dilutive to existing shareholders. |
| ● | Our ability to raise sufficient capital or take other actions to improve our liquidity position or otherwise meet our liquidity requirements that are sufficient to eliminate the substantial doubt about our ability to continue as a going concern. |
| ● | An impairment of our goodwill, in future reporting periods. |
| ● | The risks and increased costs associated with production of products in foreign nations. |
| ● | Fluctuations in foreign currency exchange rates and impact of inflation in the U.S. and abroad. |
| ● | Our expansion into and investments in new product categories and any inability to establish the Connected Surface product line as a viable primary revenue source in 2022. |
| ● | Our inability to obtain adequate insurance coverage. |
| ● | Volatility and disruptions in the credit and financial markets, which may adversely affect our ability to borrow or obtain funding. |
| ● | Our inability to recruit or retain qualified personnel or the loss of key personnel. |
| ● | Our inability to keep pace with developments in technology and changes in consumer preferences. |
| ● | Other factors are set forth under “Risk Factors” in our 2021 Annual Report. |
24
Additionally, many of these risks and uncertainties are currently amplified by and will continue to be amplified by, or in the future may be amplified by, the COVID-19 pandemic outbreak and emergence of new variant viruses. It is not possible to predict or identify all such risks. There may be additional risks that we consider immaterial, or which are unknown as of the date of the filing of this Form 10-Q.
The challenge facing the Company is to establish a new profitable product line, the Connected Surfaces, before the poor performance of Company’s traditional LED product line and economic disruptions imposed by COVID-19 pandemic and variant viruses and cost of marketing and penetrating a new product market company impose unsustainable financial burdens and losses on the Company.
The Company is a “penny stock company under Commission rules and the public stock market price for our common stock is impacted by the lack of significant institutional investor and primary market maker support. Investment in our common stock is highly risky and should only be considered by investors who can afford to lose their investment and do not require on demand liquidity. Potential investors should carefully consider risk factors in our SEC filings. Increases in the public market price of the common stock in first fiscal quarter of 2021 is not indicative of potential performance of the common stock in the public market. The Company’s common stock also lacks the primary market maker and institutional investor support to protect the public market from being unpredictable and volatile.
The above examples are not exhaustive and new risks emerge from time to time. Such forward-looking statements are based on our current beliefs, assumptions, expectations, estimates and projections regarding our present and future business strategies and the environment in which we expect to operate in the future. These forward-looking statements speak only as of the date made. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statement to reflect any change in our expectations with regard thereto or any change of events, conditions, or circumstances on which any such statement was based, except as required by law.
Use of Certain Defined Terms. Except as otherwise indicated by the context, the following terms have the stated meanings
| (1) | “Capstone Lighting Technologies, L.L.C.” or “CLTL” is a wholly owned subsidiary of Capstone Companies, Inc. |
| (2) | “Capstone International Hong Kong Ltd” or “CIHK” is a wholly owned subsidiary of Capstone Companies, Inc. and a Hong Kong registered Company, that is currently moving to a dormant status. |
| (3) | “Capstone Industries, Inc.”, a Florida corporation and a wholly owned subsidiary of CAPC, may also be referred to as “CAPI” or “Capstone”. |
| (4) | “Capstone Companies, Inc.”, a Florida corporation, may also be referred to as “we”, “us,” “our”, “Company”, or “CAPC”. Unless the context indicates otherwise, “Company” includes in its meaning all of Capstone Companies, Inc. Subsidiaries. |
| (5) | “China” means Peoples Republic of China. |
| (6) | “W” means watts. |
| (7) | References to “33 Act” or “Securities Act” means the Securities Act of 1933, as amended. |
| (8) | References to “34 Act” or “Exchange Act” means the Securities Exchange Act of 1934, as amended. |
| (9) | “SEC” or “Commission” means the U.S. Securities and Exchange Commission. |
| (10) | “Subsidiaries” means Capstone Industries, Inc. (“CAPI”), Capstone International H.K Ltd., (“CIHK”), and Capstone Lighting Technologies, Inc. (“CLTL”). |
| (11) | Any reference to fiscal year in this Annual Report on Form 10-K means our fiscal year, ending December 31st.2021. |
| (12) | “LED” or “LEDs” means a light-emitting diode component(s) which can be assembled into light bulbs or can be used in lighting fixtures. |
| (13) | “OEM” means “original equipment manufacturer. |
| (14) | “Connected Surfaces” or “Connected Products” means smart home devices with embedded sensors that provide communication and data transfer between the Connected Surface and internet-enabled systems of the Company or associated third parties. Connected Surfaces may permit internet access for defined functions. |
We may use “FY” to mean “fiscal year” and “Q” to mean fiscal quarter ended September 30, 2022.
Overview of Our Business
Capstone Companies, Inc. (“Company” or “CAPC”) is a public holding company organized under the laws of the State of Florida. The Company is a designer, manufacturer and marketer of consumer inspired products that bridge technological innovations. The primary operating subsidiary is Capstone Industries, Inc., a Florida corporation located in the principal executive offices of the Company, (“CAPI”). Capstone International Hong Kong, Ltd., or “CIHK”, was established to expand the Company’s product development, engineering, and factory resource capabilities. With the 2021 shift of manufacturing to Thailand from China, the CIHK operation was downsized and closed in March 2022.
25
The Company has exploited technologies in areas of induction charging, power failure control, security and home LED lighting products and most recently has entered the electronics market with its introduction of Capstone’s Smart Mirrors. The Company’s focus through 2017 was the integration of LEDs into most commonly used consumer lighting products in today’s home. Over the last few years there has been significant LED price erosion, which has commoditized LED consumer products. The LED category has matured and is no longer the innovative “must have consumer product as in previous years. The Connected Surfaces is the Company’s effort to establish business in an emerging segment that will allow for future revenue growth. The smart home segment is the umbrella category in which we will participate with the Connected Surfaces program.
In late 2017, as management recognized that the LED category was maturing, it sought a business opportunity that would transition the Company’s revenue streams to an emerging new product category. While we currently continue to supply LED products on a limited basis, our strategic plan to develop and launch new innovative product lines, like Connected Surfaces Smart Mirrors, is believed to be essential for sustaining or growing revenues.
The Company began its foray into the electronics industry in 2019 with its Connected Surfaces initiative. We decided to enter the market as we identified the smart home category to be emerging with strong long term growth potential. This strategy would require the Company to adopt a different short term business model as a way of building awareness and revenues. The business model is consumer direct through e-commerce marketing including a company webstore as well as third party resellers like Amazon, Wayfair and other recognized, available e-commerce platforms. The smart mirror business requires maintenance of inventory in order to be responsive to e-commerce and retail sales orders and lessen the impact of logistical problems with the delivery of products from Asia. The e-commerce platform is designed to build product awareness among consumers but will also allow the Company to potentially exploit and promote sales of products in brick-and-mortar retailers stores.
The Company’s financial initiatives are driven by its entry into new distribution channels and calls for an increased emphasis on an e-commerce business model. As a result of the COVID-19 pandemic, retail foot traffic has diminished, and e-commerce platforms have advanced with consumers across all product lines. The COVID-19 pandemic accelerated an existing trend of consumers purchasing more products online. The Connected Surfaces category is intended to find its way to retail shelves after it has been established through its direct-to-consumer e-commerce platform. The Company does not have prior experience in operating and promoting its own e-commerce website. The Company’s e-commerce marketing and sales strategy will shift its historic reliance on ‘Big Box, brick and mortar retailers’ to an emphasis on e-commerce marketing and sales. If Connected Surfaces is successful, the gross margins generated by the e-commerce model should be greater than LED consumer lighting products. This assumption is subject to the Company establishing a viable e-commerce presence on an affordable basis. The Company will require additional funding to build its marketing effort, inventory levels and service levels, which funding must be timely and affordable to fund the desired marketing and product launch. The future growth will be directly impacted by the level of exposure, messaging and distribution capabilities. Certain members of the Company’s management (“Corporate Insiders and Directors”) have provided funding from time to time to support the Company’s basic operational funding needs, but there is no guarantee that this funding will continue or be adequate to fund operations or Smart Mirror program marketing and inventory as well as possible enhancements or an expansion of the portfolio with additional items.
During the three months ended September 30, 2022, the general U.S. economic indicators show signs of a slowdown caused by interest rate increases in order to reduce the impact of increasing inflationary pressures. The unemployment rate increased to 3.7% in August 2022 and the consumer confidence index dropped and is at its lowest point in one year. Retail sales in September 2022 increased 1.0% higher than May 2022 as consumers remained resilient despite inflation. But the impact of inflation on consumer prices and consumer buying patterns will be a factor through 2022 and into 2023. It is projected that the inflation rate will average 7.9% through 2022. Management believes that the national vaccine inoculation program made major advances, and initially increased consumer confidence. However, the recent impact of the increased interest rates in response to inflation and higher energy costs have seriously eroded into consumers available spending or adversely impacted consumer confidence in the economy. Since our Connected Surface product line is not an essential product, but a discretionary purchase, consumer products that are discretionary purchases are generally adversely impacted by uncertain or negative economic news and downturn in consumer confidence. The Company anticipates that the States will continue to open their economies and consumer foot traffic will increase in brick-and-mortar retailers in 2022 but the volume of spending may be greatly reduced. Additionally, during 2022 if the Omnicron variant of COVID 19 or a new variant proves to be vaccine resistant or causes a surge in severe illness and death among a significant percentage of unvaccinated Americans and to others in other nations the negative impact to consumer confidence will be significant.
Future economic indicators are trending that the U.S. economy will slowdown in 2022-23 but narrowly avoid a recession. Reducing inflation and providing price stability will protect real incomes and help sustain growth over the medium term, however, as our wholesale business revenue is dependent on customer orders issued many months in advance, the revenue shortfall during the period continued to be driven by the uncertainty felt by retail buyers as to the short and long-term impact on the retail market of COVID-19 and its overall long-term impact on the U.S. economy and in-store retail foot traffic. Given the evolution of the COVID-19 pandemic, emergence of variants and uncertainty about future variants, and the global response to curb its spread, the Company is not able to estimate the effects of the COVID-19 pandemic on its results of operations, financial condition, or liquidity for fiscal year 2022. Management actively monitors the impact of the global pandemic on the Company’s financial condition, liquidity, operations, suppliers, industry, and workforce.
26
Effects of COVID-19
During the three and nine months ended September 30, 2022, the continued outbreak and global spread of COVID-19 pandemic caused significant global economic volatility, uncertainty and disruption in our operating environment.
In response to the COVID-19 and various state and local orders, the Company instituted the following actions in March 2020:
| ● | Placed restrictions on business travel for our employees. |
| ● | Closed our Corporate offices both in the U.S. and in Hong Kong. |
| ● | Modified our corporate and division office functions to allow all employees to work remotely. |
As of the filing of this Form 10-Q Report, the Company continues to adhere to the same practices. With government mandated restrictions in Thailand and parts of China resulting from the upsurge in the Omicron variant, the Company restrictions on business travel remains in effect. While all the above-referenced steps are appropriate considering COVID-19 pandemic, they have impacted the Company’s ability to operate the business in its ordinary and traditional course. The Company does not have a vaccination mandate for its employees.
Our business operations and financial performance for the period ended September 30, 2022, continued to be adversely impacted by COVID-19, which Company believes contributed in part to the continued poor performance of our traditional LED product line in 2021 and the lack of revenues from the new Connected Surface products by adversely impacting consumer discretionary spending and depressing foot traffic to brick and mortar retailers. Company also does not have the marketing and sales resources, extensive distribution channels and brand recognition of larger competitors and has not been actively marketing smart mirrors as long as other competitors, especially on social media. Further, in Thailand, the Omnicron variant of COVID-19 has recently surged which disrupted our overseas OEMs and delayed some of the Smart Mirror certification testing. This resulted in shipment delays of the company critical Connected Surface devices. The Company reported a net loss of approximately $379 thousand for the three months ended September 30, 2022, compared to a net loss of approximately $618 thousand for the three months ended September 30, 2021, respectively and a net loss of $1,452 and $1,692 million for the nine months ended September 30, 2022, and 2021, respectively.
During the quarter ended March 31, 2022, the Company introduced the Smart Mirror on its Capstone Connected website. Prior to 2021, the Company’s wholesale business relied on brick-and-mortar retail for sale of its products to consumers and sought to piggyback off retailers’ e-commerce websites as well as dedicated online retailers like Amazon. As the Company focuses its effort on social media driven e-commerce, the Company’s online strategy is projected to deliver future growth and reduce reliance on Big Box retail. The Company believes that the gross margin is more favorable on the e-commerce business which then should translates to better returns on lower revenues if the Company can successfully implement its marketing strategy on an affordable basis. The Company does not have operational experience in running its own e-commerce site for Connected Surfaces products to substantiate this expectation of better returns on lower revenues. If the Company cannot operate an effective e-commerce site or effectively market in the e-commerce marketplace, the launch of the Connected Surfaces product line may not be successful.
Further, the market for Connected Surfaces products may not materialize as anticipated and to the extent necessary to generate sufficient revenues to fund Company operations. Since the Connected Surface products are intended to be the core business line of the Company, the failure of the Connected Surface products to gain consumer acceptance and generate sufficient revenues to sustain Company operations would leave the Company without a viable business line. It is possible that the interactive smart mirror market does not have the anticipated potential for a niche market competitor like the Company or that the Connected Surface products do not match then current consumer demand in the smart mirror market. The Company has not conducted a third party marketing survey to support its anecdotal evidence of possible lack of sufficient consumer demand for Connected Surface products to establish that product line as a viable replacement for. the LED Lighting product line.
Further reliance on brick-and-mortar retailers may not provide the necessary financial benefits to address the Company’s current financial problems. COVID-19 pandemic may have substantially altered the consumer product distribution environment. The extent to which COVID-19 pandemic will continue to impact the Company’s results will depend primarily on future developments, including the severity and duration of the crisis, the acceptance and effectiveness of the national vaccine inoculation program, potential mutations of COVID-19 pandemic, and the impact of future actions that will be taken to contain COVID-19 pandemic or treat its impact. These future developments are highly uncertain and cannot be predicted with confidence, especially if mutations of the COVID-19 virus become widespread and prove resistant to vaccines. The Delta and Micron variant of COVID-19 for the last few months had a major surge in Thailand which necessitated sporadic regional lockdowns and has resulted in delays in finalizing certain Smart Mirror certifications, production of the initial Smart Mirror inventory and a major logistics backlog. The Company placed orders for the initial inventory rollout which has received shipments in the U.S. warehouse as part of the domestic inventory buildup.
27
As a result of the continuing economic uncertainties and the reduced revenue during the period, Management determined sufficient indicators existed to trigger the performance of an interim goodwill impairment analysis as of September30, 2022. The analysis concluded that the Company’s fair value of its single reporting unit exceeded the carrying value and a goodwill impairment charge was not required in the quarter ended September 30, 2022.
On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act, which we refer to as the “CARES Act”. was enacted into law. The CARES Act includes several significant income and other business tax provisions that, among other things, would eliminate the taxable income limit for certain net operating losses (“NOLs) and allow businesses to carry back NOLs arising in 2018, 2019, and 2020 to the five prior tax years. The Company was able to carryback the 2018 and the 2019 NOLs to 2017 tax year and generate an estimated refund of previously paid income taxes at an approximate 34% federal tax rate. As of December 31, 2020, the Company had an income tax refundable of approximately $862 thousand of which approximately $576 thousand of income tax was refunded on February 3, 2021 and approximately $232 thousand tax was refunded on February 9, 2022 . The remaining balance of approximately $54.5 thousand was charged off in the three month period ended June 30, 2022 as the refund had been previously over estimated. leaving $0 remaining balance to be refunded as of September 30, 2022.
Goodwill Impairment
As a result of the economic uncertainties caused by the resurgence of the COVID-19 pandemic, management determined sufficient indicators existed to trigger the performance of interim goodwill impairment analysis for the three months ended September 30, 2022. The analysis concluded that the Company’s fair value exceeded the carrying value of its single reporting unit and a goodwill impairment charge was not required. For the three months and nine months ended September 30, 2022, and 2021, the Company recognized a goodwill impairment charge of $0 for both periods.
With the continuing economic uncertainties caused by the COVID-19 pandemic including variant viruses and the increasing anti-inflationary measures, the capital markets may have a downturn and adversely affect the Company’s stock price which will require the Company to test its goodwill for impairment in future reporting periods.
Liquidity and Going Concern
The accompanying condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business.
The economic uncertainty and the continuing negative impact that the COVID-19 disruption and anti-inflationary policies could have on the future retail business and consumers’ willingness to visit retail stores, causing reduced consumer foot traffic and consumer spending, could negatively impact the demand for our products or delay future planned promotional opportunities. However, with the launch of the Smart Mirror portfolio using the online retail platform, the Company secured an additional working capital credit line of $600 thousand to support the Company’s working capital needs during the period needed to facilitate revenue growth in that category. This additional funding may not improve the financial results for the Connected Surface product line, but the Company will not have sufficient operational experience to determine the effectiveness of addition marketing efforts until the end of 2022 or early 2023.
Our business operations and financial performance for the nine months ended September 30, 2022 continued to be adversely impacted by the developments discussed above. For the nine months ended September 30 2022 and 2021, the Company reported a $164 thousand or 34% decrease in net revenue from $483 thousand in 2021 to $319 thousand in 2022. The net loss for the nine months ended September 30, 2022 and 2021 was approximately $1.452 million as compared to approximately $1.692 million in 2021. During the nine months ended September 30, 2022 and 2021 the Company used in operating activities approximately $1.603 million of cash in 2022 and $1.658 million in 2021. The net loss in the period accounted for cash usage of $1.015 million, inventory increased by $486 thousand as we started building inventory for the Smart Mirror program. The cash usage was partially offset by $286 thousand decrease in prepaid expenses and $284 thousand decrease in income tax refundable.
As of September 30, 2022, the Company has working capital of approximately $107 thousand and an accumulated deficit of $7.8 million. The Company’s cash balance decreased by approximately $1.015 million from $1.277 million as of December 31, 2021 to $262 thousand as of September 30, 2022. These conditions raise substantial doubt about the Company’s ability to continue as a going concern,
As discussed above, the overall impact of the COVID-19 pandemic to our business, financial condition, cash flow and results of operations remains uncertain. If any of our major wholesale customers fail to maintain normal operations or the Connected Surfaces program is not accepted by consumers, then the revenue could further decline, which could have a material adverse effect on our business, financial condition, results of operations and liquidity. Management believes that with the ongoing national distribution of vaccines, the economic impact of the COVID-19 pandemic in the U.S. will continue through 2022, but ultimately may not impact the Company’s long-term strategy and initiatives if the e-commerce initiative succeeds.
28
We will seek alternative sources of liquidity, including but not limited to accessing the capital markets, or other alternative financing measures. However, instability in, or tightening of the capital markets, could adversely affect our ability to access the capital markets on terms acceptable to us. An economic recession or a slow recovery could adversely affect our business and liquidity. The Company’s declining financial performance, which may suffer an ongoing adverse impact of from the COVID-19 pandemic , may also affect the Company’s ability to obtain working capital funding to sustain operations.
The Company has had discussions with alternate funding sources that offer programs that are more in line with the Company’s future business model, particularly a facility that provides funding options that are more suitable for the e-commerce business. The borrowing costs associated with such financing are dependent upon market conditions and our credit rating. We cannot assure that we will be able to negotiate competitive rates, which could increase our cost of borrowing in the future or obtain necessary funding. Based on past performances and current expectations, Management believes that with the $1,393,000 equity investment and the recent $1,020,000 purchase order funding and the $600,000 working capital loans, the deferral of approximately $100 thousand executive and consultant compensation for the fourth quarter ended December 31, 2022, provides adequate liquidity to meet the Company’s cash needs for our daily operations, capital expenditures and procurement of the Smart Mirror inventory for the short-term. However, in the event that sales of the on hand inventories do not occur in the fourth quarter 2022,we will need to continue seeking additional funding through either debt or equity to continue meeting our financial obligations, which consist approximately of $267 thousands of accounts payable and accrued expenses as well as a $1,680,000 note payable with related parties and accrued interest that becomes due approximately $1,068,000 in April 2023 and $612,000 thousand in November 2023, until we are able to generate sufficient cash flows from the sale of the Smart Mirror inventory. Company may be unable to secure future necessary long term funding in adequate amounts, on affordable terms and conditions or in a timely manner.
The COVID-19 pandemic resurgence in many states or emergence of new vaccine-resistant strains of the virus could have a continuing negative impact on the brick-and-mortar retail sector, with consumers unwilling to visit retail stores, causing reduced consumer foot traffic and consumer spending. However, with a successful relaunch of the Smart Mirror portfolio using the online retail platform, the Company will not be as dependent on Big Box retailers for our revenue streams as in previous years.
On April 5, 2021, the Company entered into five separate security purchase agreements (“SPAs”) whereby the Company privately placed an aggregate of 2,496,667 shares of Company common stock for an aggregate purchase price $1,498,000 (transactions being referred to as the “Private Placement”). The five investors in the Private Placement consisted of four private equity funds and one individual – all being “accredited investors (under Rule 501(a) of Regulation D under the Securities Act of 1933, as amended, (“Securities Act”). The $1,393,140 in net proceeds from the Private Placement will be used mostly to purchase start up inventory for the Company’s new Smart Mirror product line, for a major online e-commerce fulfilment company, and the remainder for advertising and working capital (See Note 6).
On July 2, 2021, the Board of Directors (“Board”) resolved that the Company required a purchase order funding facility to procure additional inventory to support the online Smart Mirror business. The Board resolved that certain Directors could negotiate the terms of a Purchase Order Funding Agreement for up to $1.020 million with Directors S. Wallach, and J. Postal and E. Fleisig, a natural person who is not affiliated with the Company other than as a lender. This agreement was finalized, and the Company received the $1.020 million, funding under this agreement on October 18, 2021. As of September 30, 2022, the loan balance $1.068 million includes an accrued interest of $48 thousand.
On May 1, 2022 the Company negotiated three $200,000 each, working capital funding agreements, to provide funding for daily operations. The Board resolved that certain Directors could negotiate the terms of a Working Capital Funding Agreement for up to a total of $600,000, with Directors S. Wallach (through Group Nexus, a company controlled by Mr. Wallach), J. Postal and Mouhaned Khoury, a natural person. On May 1st the three individual agreements became effective. The terms are for 18 months with a simple interest rate of 5 percent per annum. The loans may be prepaid in full or partially without any penalty The Company has received the $600,000 funding under these agreements. As of September 30, 2022, the notes balance $612 thousand includes an accrued interest of $12 thousand.
With the global resurgence of the Omicron variant of COVID-19, the Company’s manufacturers both in Thailand and China experienced sporadic regional lockdowns which caused production delays for Connected Surface products. With the same virus now becoming the dominant variant in the United States, the future impact on the retail marketplace remains uncertain, which places uncertainty on the timing of the Company’s new retail programs that are planned to be introduced during 2022. Further delays in the shipment of Connected Surface products to consumers and distributors could have a significant impact on the ability of the Company to continue to withstand the multiple challenges of a declining LED product line, delay in shipping the new product line and the ongoing impact of COVID-19 pandemic.
29
As part of its traditional strategic planning, the Company reviews alternatives to its current business approach, including, without limitation, development of a new product line, sale of the public company or merger of the Company with a private operating company and other common strategic alternatives to a company facing business and financial challenges and uncertainties.
Management is closely monitoring its operations, liquidity, and capital resources and is actively working to minimize the current and future impact of this unprecedented situation. Those efforts may not successfully remediate or combat in all instances the adverse impact of COVID-19 pandemic and the affected efforts to launch the Connected Surfaces product line.
Our Growth Strategy
The Company’s looking forward strategy requires continued expansion of its product development and engineering, manufacturing base marketing and distribution of a broadened portfolio of consumer electronic products. The Company will pursue new revenue opportunities through the introduction and expansion of its “Connected Surfaces” portfolio into alternate distribution channels that the Company has not previously focused on. The Company also intends to leverage its existing valuable customer base to achieve organic growth initiatives within this new category when buying budgets open. These efforts will depend on having adequate working capital from funding and cash flow from product sales. We may be unable to achieve sufficient working capital when and, in the amounts, required to meet operational needs and overhead.
Capstones past success has been in its ability to identify emerging product categories where Capstones management experience can be fully leveraged. We demonstrated this when the Company entered the LED lighting category. Our branding and product strategies delivered the Company to a well-respected market position. The Company’s low-cost OEM manufacturing and operations have typically, in the past, provided an advantage in delivering great products affordably. The Company had extended its manufacturing plan to include Mexico in 2023. The quicker turn around time, reduced transit costs and easier access make this an obvious direction.
Our expectation is that the new product portfolio appeals to a much larger audience than our traditional LED lighting product line. The new Connected Surfaces portfolio is designed to tap into consumers ever-expanding connected lifestyles prevalent today. The products have both touch screen and voice interfacing, internet access and an operating system capable of running downloadable applications. The average selling prices will be comparable to that of tablets and smartphones, expected MSRP retail to start at $899.00, with the goal to deliver exceptional consumer value to mainstream America. Whereas, during the day your smartphone/tablet keeps you connected, whether it is work or personal, now when entering your home, Capstones new Connected Surfaces products will enable users the same level of connectivity in a more relaxed manner that does not require being tethered to these devices.
The Company competes in emerging, highly competitive consumer market channels that can be affected by volatility from a number of general business and economic factors such as, consumer confidence, employment levels, credit availability and commodity costs. Demand for the Company’s products is highly dependent on economic drivers such as consumer spending and discretionary income.
Although the overseas factories have previously been fully functioning, a resurgence of the Omnicron variant of COVID-19 caused sporadic regional lockdowns with certain overseas factories that could delay shipments of products from Thailand and China, which produces all of our products. With the United States now being impacted by the Omnicron variant of the COVID-19 pandemic, we believe the impact of the virus in the U.S. will continue through 2022, but this disruption has not impacted our long-term strategy and initiatives as of the date of the filing of this Form 10-Q Report.
Last year, the Company expanded its investment and commitment in social media marketing. With our Company’s plan to shift its focus to on-line commerce in the first half of 2022 and thereafter, its social media presence will be key to the Company’s growth initiatives. The analytics derived from testing various messaging on social media platforms (i.e., Facebook Ads, Google Ads) has validated consumer interest in the Smart Mirror program. Based on the results from the Smart Mirrors product rollout, the Company’s social media marketing efforts may be revised or expanded. Additional capital may be required to fully exploit an effective social media and e-commerce effort to support the company-critical Smart Mirrors product launch. As stated, the Company is new to social media and ecommerce marketing on the current contemplated scale and no assurances can be given, due to the lack of operational experience, on the success of those efforts, which are critical to our future financial performance and condition.
Organic Growth Strategy
Subject to adequate funding, the Company intends to pursue various initiatives to execute its organic growth strategy, which is designed to enhance its market presence, expand its customer base and maintain its recognition as an industry leader in new product development. Key elements of our organic growth strategy include:
30
Connected Surfaces. Historically, LED lighting products have been our core business. The Capstone Lighting and Hoover Home LED brands combined, have sold millions of LED lighting products over the recent years and consequently the Company holds a well-respected position in the retail lighting category. While consistently launching successful lighting programs, the Company has determined that it needs to diversify and expand its core focus in order to continue to meet revenue growth initiatives. The Company has refocused its development and marketing initiatives and is determined to build on its success with a broader product portfolio beyond lighting products only. The new category “Connected Surfaces” was officially launched in January 2020 at CES. The Company intends to expand the new line of “Connected Products for the next several years. Two new product introductions are being finalized and are planned to be available in the first quarter of 2023.The Company’s product roadmap outlines plan for product introductions into 2023and this will continue to expand as consumer product acceptance validates its innovations. The Company hopes that this program will leverage existing relationships with its current retail partners, deliver on its e-commerce initiatives and collectively contribute organic growth for the Company.
The Company acknowledges that smart homes will become more mainstream over the next several years and will present significant growth opportunities for the Company and its Connected Surfaces portfolio.
While our focus of Connected Surface products is the smart home market, smart mirrors are being employed by retailers like Ralph Lauren and Neiman Marcus to allow customers to compare outfits on fitting room smart mirrors. Further, single application smart mirrors are emerging in the fitness industry for interactive workouts at home as a result of the global pandemic. These other markets are not a focus of our company but show the scope of applications and appeal of smart mirrors.
Perceived or Essential Strengths
Capstone believes that the following competitive strengths serve to support its business strategies.
In North America, the Company has been recognized for more than a decade as an innovator and highly efficient, low-cost manufacturer in several product niches. Capstone believes that its insight into the needs of retail programming and its proven execution track record with noted retailers globally positions it well for future growth.
Capstones core executive team has been working together for over three decades and has successfully built and managed other consumer product companies.
Operating Managements experience in hardline product manufacturing has prepared the Company for successful entries into various consumer product markets, especially its experience in using foreign OEMs to provide capabilities not possessed internally by our company.
Product Quality: Through a combination of sourcing quality components, stringent manufacturing quality control and conducting rigorous third-party testing, product experiences by consumers are of the highest ranking. To deliver cost-competitive products without compromising quality standards, we leverage purchasing volume and capitalize on strategic vendor relationships.
Perceived Weaknesses : The Company does not possess the business, marketing, and financial resources of larger competitors or the brand recognition or international markets of some of the larger competitors. The declining financial performance of the Company due to declining sales and appeal of its LED lighting product line has placed the Company in a weakened financial position, which in turn increases the need for working capital funding from investors or lenders. The Company lacks the hard assets for affordable, sufficient debt financing and the low market price of its Common Stock makes equity funding difficult in terms of finding suitable investors who will provide adequate, affordable, timely working capital funding.
The Company’s previous core products lines were focused on consumer LED lighting, which is a declining revenue source with relatively low profit margins, and long-term revenue prospects of the recent diversification into Connected Surfaces products is uncertain as of the date of this Form 10-Q Report t. As a mature product line, LED business is a declining business line and revenue source and is not deemed as sufficient to sustain the Company as a revenue source through 2022 and into 2023.
The Company does not have the large internal research and development capability of its larger competitors. Capstone operates with a limited number of employees whose functions are dedicated to executive management, sales and marketing or administrative support. The limited number of employees may hinder or delay the ability of the Company to identify or respond to consumer preferences or new technology developments in a product line. Hiring may be required with any growth and qualified personnel may not be readily available. We cannot match the compensation packages to prospective employees that many larger competitors may offer, and we lack the funding and other resources to change our operational model and its reliance on contractors for many functions and capabilities, including development, production, shipping, warehousing and distribution of products.
As a smaller reporting company, we are more vulnerable to events like COVID-19 pandemic, production and shipping delays, travel and operational disruptions and restrictions and an accelerated shift to e-commerce from reliance on brick-and-mortar retail sales. We lack, the staff, money, internal capabilities and resources and operational experience to significantly or timely respond to significant challenges and adverse changes in business and financial requirements.
31
COVID-19 pandemic closures of companies and shipping-distribution channels produced a delay in shipping and receipt of products from abroad and in the United States. The problems include a lack of sufficient drivers for trucking industry. The Company relies on OEMs located in Thailand and China, which have been impacted by the COVID-19 pandemic in meeting development, production and shipping deadlines. The extent of the continuing economic impact of the COVID-19 pandemic and resulting logistical delays is uncertain as of the date of this Form 10-Q Report. The Company is actively exploring production capabilities in Mexico as an alternative product development and production source in order to eliminate shipping delays from Asia, but a Mexican source has not been identified as of the date of the filing of this Form 10-Q Report and the Company may not be able to locate a Mexican source. Even if identified, a Mexican production source for products would not be in place prior to 2023, if then.
Capstones international purchases can become more expensive if the U.S. Dollar weakens against the foreign currencies. Should the increased U.S. tariffs imposed on Chinese manufactured goods remain it may increase the cost of electronic components used in our products.
While we have established new production capacity in Thailand, there is no final resolution of the U.S. / China trade dispute from which specific components are sourced. Developing a new, efficient OEM relationship in a new country takes time and effort to reach acceptable production efficiencies. We have only a short operational experience with Thai OEMs and cannot predict long term effectiveness of the relationship.
If the COVID-19 pandemic and increasing inflationary pressures continues to adversely impact operations and consumer confidence in 2022, it could have a detrimental impact on our ability to maintain operations by depressing consumer purchase of our products, whether online or in retail stores. Withstanding continued losses could cause the Company to consider significant corporate transaction, including, without limitation, a possible merger and acquisition transaction or reorganization to protect the core operations from the ongoing impact of the COVID-19 pandemic. Like many companies, the Company conducts periodic strategic reviews where the feasibility of significant corporate transactions are considered, including mergers, asset purchases or sales and diversification or change in business lines. The Company lacks the financial resources of larger companies to withstand adverse, significant and sustained changes in business and financial condition. This vulnerability necessitates an ongoing consideration of alternatives to current operations. Due to the decline in financial performance of the Company since 2021, and the Company being in transition from a declining product line and not yet establishing a profitable product line, as well as the Company having its shares of Common Stock quoted on The OTC Markets Group, Inc. QB Venture Market, the Company may be unable to consummate a corporate transaction that sustains operations.
Products and Customers
While the Company is expanding its product portfolio through the introduction of the Capstone Connected Surfaces program, it still offers a select number of LED lighting products under the “Capstone Lighting” brand for both the U.S. and overseas market. The product lines available as of the date of this Form 10-Q Report are as follows:
Connected Surfaces – Smart Mirrors
Standard Rectangular
Wardrobe/Fitness Mirror
LED Power Failure Handheld Lights
The plan to expand the Company’s product portfolio through Connected Surfaces involves the inherent risk of increased operating and marketing costs without a corresponding increase in operational revenues and profits. Expense categories including molds, prototyping, engineering, advertising, public relations, tradeshows and social media platforms will continue to be incurred for a period before revenues occur.
Over the past ten years, the Company has established product distribution relationships with numerous leading international, national and regional retailers, including but not limited to: Amazon, Costco Wholesale, Sam’s Club-Walmart, the Container Store and Firefly Buys. These distribution channels may sell the Company’s products through the internet as well as through retail storefronts and catalogs/mail order. In a post-COVID-19 pandemic environment, these distribution channels may be less valuable as distribution channels, especially for the Smart Mirrors product line and if our e-commerce initiative succeeds and expands. The effective development of an e-commerce-based approach to distribution of products may be critical to the future performance of the Company. The Company believes it has developed the scale, manufacturing efficiencies, and design expertise that serves as the foundation for aggressive pursuit of niche product opportunities in our largest consumer domestic and international markets. While Capstone has traditionally generated the majority of its sales in the U.S. market, urbanization, rising family incomes and increased living standards abroad have spurred a perceived demand for small consumer appliances internationally. To capture this market opportunity, the Company has continued its international sales by leveraging relationships with our existing global retailers and by strengthening our international product offerings. The Company has sold Capstone brand products to markets outside the U.S., including Australia, Japan, South Korea, and the United Kingdom. International sales for the nine months ended September 30, 2022, were approximately $44 thousand or 14 % of net revenue as compared to $341 thousand or 71% in the same period 2021. The Company’s performance depends in the Company’s initiatives to distinguish its brands from competitors by design, quality, and scope of functions and new technology or features. Efforts to expand into new international markets may be adversely impacted in the near term by COVID-19 pandemic and impact of Company’s declining financial and business performance on obtaining sufficient, necessary working capital funding.
32
The Company’s products are subject to general economic conditions that impact discretionary consumer spending on non-essential items. Such continued progress depends on a number of assumptions and factors, including ones mentioned in “Risk Factors” below. Critical to growth are economic conditions in the markets that foster greater consumer spending as well as success in the Company’s initiatives to distinguish its brands from competitors by design, quality, and scope of functions and new technology or features. The Company’s ability to fund the pursuit of our goals remains a constant, significant factor.
With the Company’s “Connected Surfaces category, Capstone has developed a comprehensive product offering. Within the selection of products offered, Capstone seeks to service the needs of a wide range of consumers by providing products to satisfy their different interests, preferences, and budgets. The Company believes in its strategy to offer consumers with an array of innovative connected products and quickly introduce additional products to continue to allow Capstone to further penetrate this developing market.
Tariffs. The previous U.S. administration implemented certain tariffs that directly affected the Company’s competitiveness. While all companies in certain industries are affected equally, the appeal for these products to consumers was negatively impacted when retail prices increased due to higher duty rates. The Company has seen promotional schedules cut back and retailers have requested pricing adjustments that would not be known to them in advance to products being shipped. Capstones business model insulates the Company from paying duties as its retail partners are the importers of record. The obvious unknown is the final impact of tariffs to the landed costs. Accordingly, retailers have demonstrated caution in their promotional planning schedules and will continue to do so until the administration has clarified its position enabling importers to calculate estimated landed costs.
Tariffs and trade restrictions imposed by the previous U.S. administration provoked trade and tariff retaliation by other countries. A “trade dispute of this nature or other governmental action related to tariffs or international trade agreements or policies has the potential to adversely impact demand for our products, our costs, customers, suppliers and/or the U.S. economy or certain sectors thereof and, thus, to adversely impact our businesses. As of the date of this Form 10-Q Report, the new U.S. administration is currently reviewing its future position on this issue and there has not been a resolution of the Chinese American trade dispute.
Sales and Marketing
Our LED products have been sold nationally and internationally through a direct sales force. The sales force markets the Company’s LED products through numerous retail locations worldwide, including larger retail warehouse clubs, hardware centers and e-commerce websites. Our business model has been designed to support “direct import sales made directly to the retail customer. However, we also offer “domestic sales programs which will be expanded in the future as a result of the Capstone Connected Surfaces program becomes available. As we shift to Connected Surfaces products, the LED products will become a secondary product line.
Direct Import Sales. We ship finished products directly to our retail customer from Thailand and China. The sales transaction and title of goods are completed by delivering products to the customers overseas shipping point. The customer takes title of the goods at that point and is responsible for inbound ocean freight and import duties. Direct import sales are made in larger quantities (generally container sized lots) to customers worldwide.
Domestic Sales. The strategy of selling products from a U.S. domestic warehouse enables the Company to provide timely delivery and serve as a domestic supplier of imported goods. With this model the Company imports goods from overseas and is responsible for all related costs including ocean freight, insurance, customs clearance, duties, storage, and distribution charges related to such products and therefore such sales command higher sales prices than direct sales. Domestic orders are for a much smaller size and could be as low as a single unit directly to the end consumer if ordered through an online website. To support an effective e-commerce business model, we will be required to warehouse adequate inventory levels enabling the Company to ship orders directly to the end consumer expediently.
To the extent permitted by our current financial condition, we continue to make investments to expand our sales, marketing, technical applications support and distribution capabilities to sell our product portfolio. We also continue to make investments to promote and build market awareness of the products and brands we offer. Our sales within the U.S. are primarily made by our in-house sales team and our independent sales agencies. Our independent sales agencies are paid a commission based upon sales made in their respective territories. Our sales agencies are recruited, trained, and monitored by us directly. We will utilize an agency as needed to help us provide service to our retail customers as required. The sales agency agreements are generally one (1) year agreements, which automatically renew on an annual basis, unless terminated by either party on 30 days prior notice. Our international sales to divisions of U.S. based retailers are made by our in-house sales team. The Company has actively promoted its products to retailers and distributors at North American trade shows, such as the Consumer Electronics Show (“CES”) or the International Hardware Show, but also relies on the retail sales channels to advertise its products directly to the end user consumers through various promotional activities. Subject to adequate working capital, this marketing effort will continue as a complement to the social media and e-commerce initiatives.
33
In the nine months ended September 30, 2022, and 2021, the Company had two customers who comprised approximately 77 % and 81%, respectively, of net revenue. Although we have long established relationships with our customers, we do not have contractual arrangements to purchase a fixed quantity of product annually. A decrease of business or a loss of any of our major customers could have a material adverse effect on our results of operations and financial condition.
The Company has been focused on establishing an on-line e-commerce presence to support the introduction of the “Connected Surfaces program and deliver direct to consumer. In 2021, we utilized social media platforms and online advertising campaigns to further grow the Company’s online presence. In addition to Facebook, Instagram, Pinterest and LinkedIn, Capstone has launched a YouTube channel Smart Mirror videos and established a Twitter account. The Company has a social media presence on the following social media platforms:
FACEBOOK1: https://www.facebook.com/capstoneindustries and https://www.facebook.com/capstoneconnected
INSTAGRAM2: https://www.instagram.com/capstoneconnected
PINTEREST3: https://www.pinterest.com/capstoneconnected/
LINKEDIN4: https://www.linkedin.com/company/6251882
TWITTER5https://twitter.com/capc capstone
YOUTUBE6 https://www.youtube.com/channel/UCMX5W8PV0Q59qoAdMxKcAig
1 Facebook is a registered trademark of Facebook, Inc.
2 Instagram is a registered trademark of Instagram.
3 Pinterest is a registered trademark of Pinterest.
4 LinkedIn is a registered trademark of LinkedIn Corporation.
5 Twitter is a registered trademark of Twitter Corporation.
6YouTube is a registered trademark of YouTube Corporation.
Competitive Conditions
The Company operates in a highly competitive environment, both in the United States and internationally, in the lighting and smart mirror segments. The Company competes with large multinationals with global operations as well as numerous other smaller, specialized competitors who generally focus on narrower markets, products, or particular categories.
Competition is influenced by technological innovation, brand perceptions, product quality, value perception, customer service and price. Over the past several years while the Company’s focus has been on LED lighting, principal competitors include Energizer, Feit Electric and Jasco Products Co. (an exclusive licensee of General Electric Company). The Company believes private-label sales by large retailers has some impact on the market in some parts of the world as many national retailers such as Costco, Home Depot, Target and Sam’s/Wal-Mart offer lighting as part of their private branded product lines. Many of the Company’s competitors have greater resources and capabilities, including greater brand recognition, research and development budgets and broader geographical market reach. Competitors with greater resources could undermine Capstone’s expansion efforts by marketing campaigns targeting its expansion efforts or price competition.
Other competitive factors include rapid technological changes, product availability, credit availability, speed of delivery, ability to tailor solutions to customer needs, quality and depth of product lines and training, as well as service and support provided by the distributor to the customer. Smart mirrors and other connected surface products are an emerging industry, and the Company may be unable to develop or license emerging new technologies that are dominant.
The COVID-19 pandemic has accelerated the decrease in consumer reliance on traditional brick-and-mortar retailing and heightened the importance of e-commerce and online marketing and sales. We have started our social media marketing. Many competitors have more established, widespread and effective e-commerce and social media campaigns than we do. We may not be able to effectively compete in e-commerce and social media marketing and sales. The COVID-19 pandemic has dramatically impacted marketing and sales of many products and the long-term impact of the pandemic remains uncertain as of the date of the filing of this Form 10-Q Report.
With trends and technology continually evolving, and subject to adequate and affordable funding, Capstone will continue to invest and develop new products that are competitively priced with consumer centric features and benefits easily articulated to influence point of sale decision making. Success in the markets we serve depends upon product innovation, pricing, retailer support, responsiveness, and cost management. The Company continues to invest in developing the technologies and design critical to competing in our markets. Our ability to invest is limited by operational cash flow and funding from third parties, including members of management and the Board of Directors, and by the ongoing impact of the COVID-19 pandemic on our business and financial performance. Subject to adequate and affordable funding, absence of unexpected competition or technological developments in connected surface devices, and a curbing of the impact of the COVID-19 pandemic, the Company believes that it can effectively pursue and exploit product market niches because of managements proven track record in delivering innovation to the market and cost-effective and timely manner.
34
Research, Product Development, and Manufacturing Activities
The Company’s product development operations based in Florida and Thailand design and engineer many of the Company’s products, with collaboration from its third-party manufacturing partners, software developers and Capstone U.S. engineering advisers. The Company outsources the manufacture and assembly of our products to a select group of OEM manufacturers overseas. Our research and development focus includes efforts to:
| ● | Establish Capstone Connected Surfaces portfolio as an innovator in the smart home segment. |
| ● | Develop product with increasing technology and functionality with enhanced quality and performance, and at a very competitive cost; and |
| ● | Solidify new manufacturing relationships with contract manufacturers in Thailand. |
The Company establishes strict engineering specifications and product testing protocols with the Company’s contract manufacturers and ensure that their factories adhere to all Regional Labor and Social Compliance Laws. These contract manufacturers purchase components that we specify and provide the necessary facilities and labor to manufacture our products. We leverage the strength of the contract manufacturers and allocate the manufacturing of specific products to the contract manufacturer best suited to the task. Quality control and product testing is conducted at the contract manufacturers facility and at their 3rd party testing laboratories overseas.
Capstones research and development team enforces its proprietary manufacturing expertise by maintaining control over all outsourced production and critical production molds. To ensure the quality and consistency of the Company’s products manufactured overseas, Capstone uses globally recognized certified testing laboratories such as United Laboratories (UL) or Intertek (ETL) to ensure all products are designed and tested to adhere to each country’s individual regulatory standards. The Company also hires quality control inspectors who examine and test products to Capstones specification(s) before shipments are released.
To successfully implement Capstones business strategy, the Company must continually improve its current products and develop new product segments with innovative imbedded technologies to meet consumers growing expectations. The Connected Surfaces product development is our current effort to achieve those expectations. The continuation of Company’s declining business and financial performance may significantly hinder or undermine efforts to establish a profitable Connected Surface product line capable of sustaining operations. Investments in technical and product development are expensed when incurred and are included in the operating expenses.
Raw Materials
The principal raw materials currently used by Capstone are sourced in Thailand and China, as the Company orders product exclusively through contract manufacturers in the region. These contract manufacturers purchase components based on the Company’s specifications and provide the necessary facilities and labor to manufacture the Company’s products. Capstone allocates the production of specific products to the contract manufacturer the Company believes is more experienced to produce the specific product and whose facility is located in the country that most benefits from the U.S. Tariff regulations. To ensure the consistent quality of Capstones products, quality control procedures have been incorporated at each stage of the manufacturing process, ranging from the inspection of raw materials through production and delivery to the customer. These procedures are additional to the manufacturers internal quality control procedures and performed by Quality Assurance personnel.
| ● | Raw Materials – Components and supplies are subject to sample inspections upon arrival at the contract manufacturer, to ensure the correct specified components are being used in production. |
| ● | Work in Process – Our quality control inspectors conduct quality control tests at different points during the product stages of our manufacturing process to ensure that quality integrity is maintained. |
| ● | Finished Goods – Our inspectors performs tests on finished and packaged products to assess product safety, integrity and package compliance. |
Raw materials used in manufacturing include plastic resin, copper, led bulbs, batteries, and corrugated paper. Prices of materials have remained competitive in the last year. CAPC believes that adequate supplies of raw materials required for its operations are available at the present time. CAPC, cannot predict the future availability or prices of such materials. These raw materials are generally available from a number of different sources, and the prices of those raw materials are susceptible to currency fluctuations and price fluctuations due to transportation, government regulations, price controls, economic climate, or other unforeseen circumstances. In the past, CAPC has not experienced any significant interruption in availability of raw materials. We believe we have extensive experience in manufacturing and have taken positions to assure supply and to protect margins on anticipated sales volume.
35
Section 1502 of Title XV of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires SEC-reporting companies to disclose annually whether any conflict minerals are necessary to the functionality or production of a product. Based on our inquiries to our manufacturers, we do not believe as of the date of such inquiries that any conflict minerals are used in making our products.
Distribution and Fulfillment
Since January 2015, the Company has outsourced its U.S. domestic warehousing and distribution needs to a third-party warehousing facility situated in Anaheim, California. The warehouse operator provides full inventory storage, packaging and logistics services including direct to store and direct to consumer shipping capabilities that electronically interface to our existing operations software. The warehouse operator provides full ERP (Enterprise Resource Planning), Inventory Control and Warehouse Management Systems. These fulfillment services can be expanded to the east coast in Charleston, South Carolina, if the Company needed to establish an east coast distribution point. This relationship, if required, will allow us to fully expand our U.S. distribution capabilities and services. As the Company transitions into the e-commerce and direct to consumer marketplace, the Company has developed a new website with full shopping cart capabilities. To complete this project the Company has negotiated contracts for secured credit card processing capability, state sales tax compliance services and order fulfillment and logistics services, at a very competitive rate. The Company will also warehouse and supply its Smart Mirror program through Amazon fulfilment and Wayfair.
Seasonality
In general, sales for household products and electronics are seasonally influenced. Certain gift products cause consumers to increase purchases during key holiday winter season of the fourth quarter, which requires increases in retailer inventories during the third quarter. In addition, natural disasters such as hurricanes and tornadoes can create conditions that drive increased needs for portable power and power failure light sales. Climate change may increase the number and severity of hurricanes, tornadoes and flooding. Historically, the lighting products had lower sales during the first quarter due to the Chinese New Year holiday as factories are closed and shipments are halted during this period. Our transition to Thailand manufacturers may reduce the impact of Chinese New Year holiday.
We do not have sufficient operational experience with Connected Surfaces to predict the seasonality of Connected Surfaces.
Intellectual Property
CAPC subsidiary, CAPI, has filed a number of U.S. trademarks and patents over the past decade. These include the following trademarks: Exclusive license and sub-license to Power Failure Technology; Capstone Power Control, Timely Reader, Pathway Lights, and 10 LED - Eco-i-Lite Power Failure Light, 5 LED - Eco-i-Lite Power Failure Light, 3 LED - Eco-i-Lite Power Failure Light, 3 LED Slim Line Eco-i-Lite Power Failure Light, LED Induction Charged Headlight. We also have a number of patents pending; Puck Light (cookie), Puck Light Base, Multi-Color Puck Lights, LED Dual Mode Solar Light, Integrated Light Bulb (Coach Light), LED Gooseneck Lantern, Spotlights, Security Motion Activated Lights, Under Cabinet Lighting and Bathroom Vanity Light. CAPC periodically prepares patent and trademark applications for filing in the United States and China. CAPC will also pursue foreign patent protection in foreign countries if deemed necessary to protect a patent and to the extent that we have the available cash to do so. CAPCs ability to compete effectively in the Home Lighting categories depends in part, on its ability to maintain the proprietary nature of its technology and manufacturing processes through a combination of patent and trade secret protection, non-disclosure agreements, licensing, and cross-licensing agreements. CAPC owns a number of patents, trademarks, trademark and patent applications and other technology which CAPC believes are significant to its business. These intellectual property rights relate primarily to lighting device improvements and manufacturing processes.
While the Company may license third party technologies for its products, or may rely on other companies, especially OEMs, for design, engineering and testing, the Company believes that its oversight of design and function of its products and its marketing capabilities are significant factors in the ability of the Company to sell its products.
Value of Patents.
The actual protection afforded by a patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage and the availability of legal remedies in the country. Issued patents or patents based on pending patent applications or any future patent applications may not exclude competitors or may not provide a competitive advantage to us. In addition, patents issued or licensed to us may not be held valid if subsequently challenged and others may claim rights in or ownership of such patents. The validity and breadth of claims in technology patents involve complex legal and factual questions and, therefore, the extent of their enforceability and protection is highly uncertain.
Reverse engineering, unauthorized copying or other misappropriation of our technologies could enable third parties to benefit from our technologies without paying us. We cannot assure shareholders that our competitors have not developed or will not develop similar products, will not duplicate our products, or will not design around any patents issued to or licensed by us. We will assess any loss of
36
these rights and determine whether to litigate to protect our intellectual property rights on a case by case basis. We rely on trademark, trade secret, patent, and copyright laws to protect our intellectual property rights. We cannot be sure that these intellectual property rights will be effectively utilized or, if necessary, successfully asserted. There is a risk that we will not be able to obtain and perfect our own intellectual property rights, or, where appropriate, license intellectual property rights from others to support new product introductions. There can be no assurance that we can acquire licenses under patents belonging to others for technology potentially useful or necessary to us and there can be no assurance that such licenses will be available to us, if at all, on terms acceptable to us. Moreover, there can be no assurance that any patent issued to or licensed by us will not be infringed or circumvented by others or will not be successfully challenged by others in lawsuits. We do not have a reserve for litigation costs associated with intellectual property matters. The cost of litigating intellectual property rights claims may be beyond our financial ability to fund.
As is customary in the retail industry, many of our customer agreements requires us to indemnify our customers for third-party intellectual property infringement claims. Such claims could harm our relationships with customers and might deter future customers from doing business with us. With respect to any intellectual property rights claims against us or our customers, we may be required to cease manufacture of the infringing product, pay damages and expend significant Company resources to defend against the claim and or seek a license.
Information Technology
The efficient operation of our business is dependent on our information technology systems. We rely on those systems to manage our daily operations, communicate with our customers and maintain our financial and accounting records. In the normal course of business, we receive information regarding customers, associates, and vendors. Since we do not collect significant amounts of valuable personal data or sensitive business data from others, our internal computer systems are under a light to moderate level of risk from hackers or other individuals with malicious intent to gain unauthorized access to our computer systems. Cyberattacks are growing in number and sophistication and are an ongoing threat to business computer systems, which are used to operate the business on a day to day basis. Our computer systems could be vulnerable to security breaches, computer viruses, or other events. The failure of our information technology systems, our inability to successfully maintain our information or any compromise of the integrity or security of the data we generate from our systems or an event resulting in the unauthorized disclosure of confidential information or degradation of services provided by critical business systems, whether by us directly or our third-party service providers, could adversely affect our business operations, sales, reputation with current and potential customers, associates or vendors, results of operations, product development and make us unable or limit our ability to respond to customers’ demands.
We have incorporated into our data network various on and off-site data backup processes which should allow us to mitigate any data loss events, however our information technology systems are vulnerable to damage or interruption from:
| ● | hurricanes, fire, flood and other natural disasters |
| ● | power outage |
| ● | internet, computer system, telecommunications or data network failure Hacking as well as malware, computer viruses, ransomware and similar malicious software code |
Environmental Regulations
We believe that the Company is in compliance with environmental protection regulations and will not have a material impact on our financial position and results of operations.
The Company is not aware of any national, state or local environmental laws or regulations that will materially affect our earnings or competitive position or result in material capital expenditures. However, the Company cannot predict the effect on our operations due to possible future environmental legislation or regulations. During the first fiscal quarter of 2022, there were no material capital expenditures for environmental control facilities and no such material expenditures are anticipated.
Intellectual Property Issues. Market participants rely on patented and non-patented proprietary information relating to product development and other core competencies of their business. Protection of intellectual property is important. Therefore, steps such as patent applications, confidentiality and non-disclosure agreements, as well as other security measures are generally taken. The Company has not created a litigation reserve for intellectual property rights litigation. As a business judgment, the Company does not patent or copyright or trademark all intellectual property due to a combination of factors, including, in part, the cost of registration and maintenance of registration, odds and cost of successful defense of the registration and commercial value of the intellectual property rights. To enforce or protect intellectual property rights, litigation or threatened litigation is common. The Company has not sued any third parties over intellectual property rights and has not been sued over intellectual property rights as of the date of the filing of this Form 10-Q Report.
37
Critical Accounting Policies
We believe that there have been no significant changes to our critical accounting policies during the three months ended September 30, 2022, as compared to those we disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 2021 Annual Report.
CONSOLIDATED OVERVIEW OF RESULTS OF OPERATIONS
Results of operations.
Net Revenues
Revenue is currently mainly derived from sales of our residential lighting products. These products are directed towards consumer home LED lighting for both indoor and outdoor applications. Revenue is subject to both quarterly and annual fluctuations and is impacted by the timing of individually large orders as well as delays or sometimes advancements to the timing of shipments or deliveries. We recognize revenue upon shipment of the order to the customer when all performance obligations have been completed and title has transferred to the customer and in accordance with the respective sale’s contractual arrangements. Each contract on acceptance will have a fixed unit price. Most of our sales are to the U.S. market which in the quarter ended September 30, 2022 represented 100% of revenues and we expect that region to continue to be the major source of revenue for the Company. We derived 0 % of our revenue from overseas sales. Net revenue also includes the cost of instant rebate coupons, and product support allowances provided to retailers and online orders to promote certain products. All of our revenue is denominated in U.S. dollars.
Cost of Goods Sold
Our cost of goods sold consists primarily of purchased products from contract manufacturers, associated duties and inbound freight. In addition, our cost of goods sold also include inventory adjustments, warranty claims/reserves and freight allowances. We source our manufactured products based on customer orders.
Gross Profit
Our gross profit has and will continue to be affected by a variety of factors, including average sales price for our products, product mix, promotional allowances, our ability to reduce product costs and fluctuations in the cost of our purchased components
Operating Expenses
Operating expenses include sales and marketing expenses, consisting of sales representative’s commissions, advertising and trade show expense and costs related to employee’s compensation. In addition, operating expense include charges relating to accounting, legal, insurance and stock-based compensation.
CONSOLIDATED RESULTS OF OPERATIONS AND OUTLOOK
| Three Months Ended September 30, 2022, Compared to Three Months Ended September 30, 2021 | ||||||||||||||||
| (In Thousands) | ||||||||||||||||
| September 30, 2022 | September 30, 2021 | |||||||||||||||
| Dollars | % of Revenue | Dollars | % of Revenue | |||||||||||||
| Revenues, net | $ | 36 | 100 | % | $ | 44 | 100 | % | ||||||||
| Cost of sales | (27 | ) | (75 | )% | (32 | ) | (73 | )% | ||||||||
| Gross Profit | 9 | 25 | % | 12 | 27 | % | ||||||||||
| Operating Expenses: | ||||||||||||||||
| Sales and marketing | 84 | 233 | % | 7 | 16 | % | ||||||||||
| Compensation | 211 | 586 | % | 315 | 716 | % | ||||||||||
| Professional fees | 91 | 253 | % | 81 | 184 | % | ||||||||||
| Product development | 30 | 83 | % | 113 | 257 | % | ||||||||||
| Other general and administrative | 115 | 319 | % | 115 | 261 | % | ||||||||||
| Total Operating Expenses | 531 | 1475 | % | 631 | 1434 | % | ||||||||||
| Operating Loss | (522 | ) | (1,450 | )% | (618 | ) | (1,405 | )% | ||||||||
| Other Income (Expense): | ||||||||||||||||
| Other income | 161 | 447 | % | — | — | |||||||||||
| Other expense | (20 | ) | (56 | )% | — | — | % | |||||||||
| Total Other Income (Expense) | 141 | 392 | % | — | — | % | ||||||||||
| Loss Before Tax Benefit | (381 | ) | (1,058 | )% | (618 | ) | (1,405 | )% | ||||||||
| Income Tax Expense) | 1 | 3 | % | — | — | |||||||||||
| Net Loss | $ | (380 | ) | (1,056 | )% | $ | (618 | ) | (1,405 | )% | ||||||
38
| Nine Months Ended September 30, 2022, Compared to Nine Months Ended September 30, 2021 | ||||||||||||||||
| (In Thousands) | ||||||||||||||||
| September 30, 2022 | September 30, 2021 | |||||||||||||||
| Dollars | % of Revenue | Dollars | % of Revenue | |||||||||||||
| Revenues, net | $ | 319 | 100 | % | $ | 483 | 100 | % | ||||||||
| Cost of sales | (226 | ) | (71 | )% | (342 | ) | (71 | )% | ||||||||
| Gross Profit | 93 | 29 | % | 141 | 29 | % | ||||||||||
| Operating Expenses: | ||||||||||||||||
| Sales and marketing | 278 | 87 | % | 19 | 4 | % | ||||||||||
| Compensation | 626 | 196 | % | 1017 | 211 | % | ||||||||||
| Professional fees | 353 | 111 | % | 284 | 59 | % | ||||||||||
| Product development | 126 | 39 | % | 192 | 40 | % | ||||||||||
| Other general and administrative | 374 | 117 | % | 313 | 65 | % | ||||||||||
| Total Operating Expenses | 1757 | 551 | % | 1825 | 378 | % | ||||||||||
| Operating Loss | (1,664 | ) | (522 | )% | (1,684 | ) | (349 | )% | ||||||||
| Other Income (Expense): | ||||||||||||||||
| Other income | 313 | 98 | % | 41 | 8 | % | ||||||||||
| Other expense | (48 | ) | (15 | )% | (49 | ) | (10 | )% | ||||||||
| Total Other Income (Expense) | 265 | 83 | % | (8 | ) | (2 | )% | |||||||||
| Loss Before Tax Benefit | (1,399 | ) | (439 | )% | (1,692 | ) | (350 | )% | ||||||||
| Income Tax Expense | (54 | ) | (17 | )% | — | — | ||||||||||
| Net Loss | $ | (1,453 | ) | (455 | )% | $ | (1,692 | ) | (350 | )% | ||||||
Net Revenues
Our business operations and financial performance for the quarter ended September 30, 2022, continued to be adversely impacted by the economic effects of the COVID-19 pandemic to the U.S. and global economy. As our LED revenue is dependent on customer orders issued many months in advance, this revenue shortfall continued to be driven by the uncertainty felt by retailers, as to the short and long-term impact on the U.S. retail market of COVID-19 resulting from the reduction of consumer foot traffic in brick-and-mortar stores.
Net revenues for the three months ended September 30, 2022, were $36 thousand, a decrease of $8 thousand or 18% from approximately $44 thousand in the same period 2021.
Net revenues for the nine months ended September 30, 2022, were $319 thousand, a decrease of $164 thousand or 34% from approximately $483 thousand in the same period 2021.
For the three months ended September 30, 2022, international sales were $0 or 0% of revenue as compared to $44 thousand or 100% of revenue in 2021.
For the nine months ended September 30, 2022, international sales were $44 thousand or 14% of revenue as compared to $341 thousand or 71% of revenue in 2021.
The following tables disaggregates revenue by geographic area:
| For the Three Months Ended September 30, | For the Three Months Ended September 30, | |||||||||||||||
| 2022 | 2021 | |||||||||||||||
| Revenues | % of Total Revenue | Revenues | % of Total Revenue | |||||||||||||
| Lighting Products- US | $ | 26,421 | 74 | % | $ | — | — | % | ||||||||
| Lighting Products- International | — | — | % | 44,640 | 100 | % | ||||||||||
| Smart Mirror Products- U.S. | 9,455 | 26 | % | — | — | % | ||||||||||
| Total Revenue | $ | 35,876 | 100 | % | $ | 44,640 | 100 | % | ||||||||
39
| For the Nine months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||
| 2022 | 2021 | |||||||||||||||
| Revenues | % of Total Revenue | Revenues | % of Total Revenue | |||||||||||||
| Lighting Products- US | $ | 228,680 | 72 | % | $ | 141,900 | 29 | % | ||||||||
| Lighting Products- International | 44,640 | 14 | % | 341,163 | 71 | % | ||||||||||
| Smart Mirror Products- U.S. | 45,442 | 14 | % | — | — | % | ||||||||||
| Total Revenue | $ | 318,762 | 100 | % | $ | 483,063 | 100 | % | ||||||||
Gross Profit and Cost of Sales
Gross profit for the three months ended September 30, 2022, and 2021, was $9 and $12 thousand, respectively, a decrease of $3 thousand from the previous year. Gross Profit as a percent of revenue was 25% in the third quarter 2022 as compared to 27% in the same quarter 2021.
Gross profit for the nine months ended September 30, 2022, and 2021, was $93 and $141 thousand, respectively, a decrease of $48 thousand from the previous year. Gross Profit as a percent of revenue was 29% in the period 2022 as compared to 29% in the same period 2021.
During the three months ended September 30, 2022, and 2021, the Company provided approximately $1 and $0 thousand, respectively of marketing allowances, which are recorded as a reduction of revenues.
Operating Expenses and Other Income (Expenses)
Sales and Marketing Expenses
For the three months ended September 30, 2022, and 2021, sales and marketing expenses were approximately $84 thousand and $7 thousand respectively, an increase of $77 thousand or 1100%. The Social Media expense was $49 thousand in 2022 as compared to $6 thousand in 2021 and the smart mirror inventory storage, shipping and handling charge was approximately $13 thousand dollars as compared to $0.1 in the same period 2021.
For the nine months ended September 30, 2022, and 2021, sales and marketing expenses were approximately $278 thousand and $19 thousand respectively, an increase of $259 thousand or 1363 %. The Consumer Electronics Show expense was $100 thousand in January 2022 as compared to $0 in 2021 and Social Media expense was $106 thousand in 2022 as compared to $12 thousand in 2021 and the smart mirror inventory storage, shipping and handling charge was approximately $30 thousand dollars as compared to $0.5 thousand in the same period 2021.
Compensation Expenses
For the three months ended September 30, 2022, and 2021, compensation expenses were approximately $211 thousand and $315 thousand, respectively, a decrease of $104 thousand or 33 %. The elimination of all positions from the Hong Kong office has resulted in expense reduction of approximately $71 thousand or 22% for the three months ended September30, 2022, as compared to 2021.
For the nine months ended September 30, 2022, and 2021, compensation expenses were approximately $626 thousand and $1.017 million, respectively, a decrease of $391 thousand or 38%. The elimination of all positions from the Hong Kong office has resulted in expense reduction of approximately $250 thousand or 24% for the nine months period ended September 30, 2022, as compared to 2021.
As part of the COVID-19 cost mitigation plan, the Company eliminated all positions including one executive in the Hong Kong office which have not been restated and is the main reason for the expense reduction.
Professional Fees
For the three months ended September 30, 2022, and 2021, professional fees were approximately $91 thousand and $81 thousand respectively, an increase of $10 thousand or 12%. During the third quarter of 2022, professional fees related to the Hong Kong sales operation were approximately $27 thousand as compared to $3 in 2021.
For the nine months ended September30, 2022, and 2021, professional fees were approximately $353 thousand and $284 thousand, respectively, an increase of $69 thousand or 24%. During the nine months ended September 30, 2022, consulting fees related to the setup of a manufacturing operation in Mexico were approximately $14 thousand and approximately $67 thousand related to the closure of the Hong Kong sales operation as compared to $0 in the same period 2021.
40
Product Development Expenses
For the three months ended September 30, 2022, product development expenses were approximately $30 thousand as compared to $113 thousand in 2021, a reduction of $83 thousand or 73%. During the third quarter 2022 the Company invested approximately $6 thousand in software and hardware development and certifications for the Smart Mirror project compared to $82 thousand in the same period in 2021 resulted in an expense reduction of approximately $77 thousand . In 2022 the Company also invested approximately $12 thousand for the development of a new product line Connected surface cutting board and approximately $2 thousand in patent , trademark and sample fees and approximately $9 thousand in Quality Control inspections in Thailand.
For the nine months ended September 30, 2022, product development expenses were approximately $126 thousand as compared to $192 thousand in 2021, a decrease of $66 thousand or 34%. During the nine months ended 2022 the Company invested $44 thousand in software and hardware development and certifications for the Smart Mirror project compared to $158 thousand in the same period in 2021, a decrease of approximately $114 thousand. In 2022 the Company also incurred $31 thousand of patent, trademark and sample fees compared to $32 thousand in the same period 2021.The Company also invested approximately $32 thousand for the development of a new product line Connected surface cutting board during the period 2022 as compared $0 in the same period 2021.
Other General and Administrative Expenses
For the three months ended September 30, 2022, other general and administrative expenses were approximately $115 thousand as compared to $115 thousand in 2021.
For the nine months ended September 30, 2022, other general and administrative expenses were approximately $374 thousand as compared to $313 thousand in 2021, an increase of $61 thousand or 19%. During the nine months ended September 30, 2022, increased expenses were mainly due to a $22 thousand prorated charge from Costco Wholesale related to a claimed LED patent infringement, that they settled, approximately $22 thousand increased Directors and Officers insurance premium and lodging fees approximately $18 thousand for Smart Mirror electronics consultant as compared to the same period in 2021.
Total Operating Expenses
For the three months ended September 30, 2022, and 2021, total operating expenses were approximately $531 thousand and $631 thousand, respectively, a decrease of approximately $100 thousand or 16%.
For the nine months ended September30, 2022, and 2021, total operating expenses were approximately $1.757 million and $1.825 million, respectively, a decrease of approximately $68 thousand or 4%.
Operating Loss
For the three months ended September 30, 2022 and 2021, the operating loss was approximately $522 thousand and $618 thousand, respectively, a decreased loss of $96 thousand or 16%.
For the nine months ended September 30, 2022 and 2021, the operating loss was approximately $1.664 million and $1.684 million, respectively, a decreased loss of $20 thousand or 1%.
Total Other Income (Expense), net
For the three months ended September 30, 2022, and 2021, other income was $141 thousand, net as compared to other income $0 thousand, net in 2021.
For the nine months ended September 30, 2022, and 2021, other income, net was $265 thousand, as compared other expense, net $8 thousand, in 2021.
The net other income of $265 thousand as of September 30, 2022, comprised of $152 thousand employee retention tax credit received under Cares act 2020-2021 and $162 thousand freight claim recovery for the damaged Smart Mirror inventory that was written off December 31, 2021 approximately $50 thousand interest expense, accrued for note payable due related and unrelated parties and interest income of approximately $2 thousand.
41
Net Loss
For the three months ended September 30, 2022, the net loss was approximately $380 thousand compared to a net loss of $618 thousand in the same period 2021, a decreased loss of $238 thousand or 39%.
For the nine months ended September 30, 2022, the net loss was approximately $1.453 million compared to a net loss of $1.692 million in the same period 2021, a decrease in loss of $239 thousand or 14%.
Off-Balance Sheet Arrangements
The Company does not have material off-balance sheet arrangements that have or are reasonably likely to have a material future effect on our results of operations or financial condition.
Contractual Obligations
There were no material changes to contractual obligations for the nine months ended September30, 2022.
Cash flow from operations are primarily dependent on our net income adjusted for non-cash expenses and the timing of collections of receivables, level of inventory and payments to suppliers. Cash as of September 30, 2022, and December 31, 2021, was approximately $262 thousand and $1.277 million respectively, a decrease of approximately $1.015 million. The Company had an income tax refundable as of December 31, 2021, of approximately $285 thousand of which approximately $231 thousand was refunded on February 9, 2022 and approximately $54 thousand of income tax refundable was charged off during the three months period ended of June 30, 2022.
| Summary of Cash Flows | For the Nine Months ended September 30, | |||||||
| 2022 | 2021 | |||||||
| (In thousands) | ||||||||
| Net cash used in: | ||||||||
| Operating Activities | $ | (1,603 | ) | $ | (1,658 | ) | ||
| Investing Activities | — | (69 | ) | |||||
| Financing Activities | 588 | 1,436 | ||||||
| Net decrease in cash | $ | (1,015 | ) | $ | (291 | ) | ||
As of September30, 2022, the Company’s working capital was approximately $107 thousand. Current assets were approximately $1.498 million and current liabilities were approximately $1.391 million and include:
| ● | Accounts payable of approximately $59 thousand due vendors and service providers. |
| ● | Accrued expenses of approximately $165 thousand net of various services , allowances , deferred wages. |
| ● | Note payable related and unrelated parties with accrued interest of approximately $1.068 million. |
| ● | Warranty provision for estimated defective returns in the amount of approximately $43 thousand. |
| ● | Operating lease liability-current portion of approximately $56 thousand. |
Cash Flows used in Operating Activities
Cash used in operating activities in the nine months ended September 30, 2022, and 2021 was approximately $1.603 million and $1.658 million, respectively, a decrease of $55 thousand compared to last year. During the nine months ended September 30, 2022, cash used in operating activities resulted from the net loss of approximately $1.452 million and approximately $487 thousand increase of initial Smart Mirror inventories. The Company’s cash position was approximately $262 thousand at September 30, 2022 compared to $1.277 million at December 31, 2021.
Cash Flows used in Investing Activities
Cash used in investing activities in the nine months ended September30, 2022, and 2021 was $0 and $69 thousand, respectively.
42
Cash Flows provided by Financing Activities
Cash provided by financing activities for the nine months ended September 30, 2022, and 2021, was approximately $588 thousand and $1.436 million, respectively.
As of September 30, 2022, and 2021, the Company had outstanding note payable $1.681 million which includes accrued interest and $0 , respectively. As of September 30, 2022 and 2021, net proceeds from sale of common stock and stock option exercise was $0 and $1.436 million , respectively.
Directors and Officers Insurance
The Company currently has Directors and Officers liability insurance, and the Company believes the coverage is adequate to cover likely liabilities under such a policy.
Exchange Rates
We sell all of our products in U.S. dollars and pay for all of our manufacturing costs in U.S. dollars. Our factories are located in mainland China and Thailand. During 2022 the average exchange rate between the U.S. Dollar and Chinese Yuan have been relatively stable approximately RMB .7.12 to U.S. $1.00.
The average exchange rate between the U.S. Dollar and Thai Baht has been relatively stable at approximately Baht 38.00 to U.S. $1.00.
Operating expenses in Hong Kong are paid in either Hong Kong dollars or U.S. dollars. The exchange rate of the Hong Kong dollar to the U.S. dollar has been very stable at approximately HK $7.80 to U.S. $1.00 since 1983 and, accordingly, has not represented a currency exchange risk to the U.S. dollar. While exchange rates have been stable for several years, we cannot assure you that the exchange rate between the United States, Hong Kong, Chinese and Thailand currencies will continue to be stable and exchange rate fluctuations may have a material effect on our business, financial condition or results of operations.
Country Risks: Changes in foreign, cultural, political, and financial market conditions could impair the Company’s international manufacturing operations and financial performance.
The Company’s manufacturing is currently conducted in China and Thailand. Consequently, the Company is subject to a number of significant risks associated with manufacturing in overseas, including:
| ● | The possibility of expropriation, confiscatory taxation, or price controls. |
| ● | Adverse changes in local investment or exchange control regulations. |
| ● | Political or economic instability, government nationalization of business or industries, government corruption, and civil unrest. |
| ● | Legal and regulatory constraints. |
| ● | Tariffs and other trade barriers, including trade disputes between the U.S. and China. |
| ● | Political or military conflict between the U.S. and China, or between U.S. and North Korea, resulting in adverse or restricted access by U.S.-based companies to Chinese manufacturing and markets. |
Currency: Currency fluctuations may significantly increase our expenses and affect the results of operations, especially where the currency is subject to intense political and other outside pressures.
Interest Rate Risk: The Company does not have significant interest rate risk during the nine months period ended September 30, 2022. All outstanding loans have been disclosed including the agreed interest rates.
Credit Risk: The Company has not experienced significant credit risk, as most of our customers are long-term customers with superior payment records. Our managers monitor our receivables regularly and our Direct Import Programs are shipped to only the most financially stable customers or advance payments before shipment are required for those accounts less financially secure.
The new on-line business requires customer credit approval prior to shipment and the payment is received by the Company between 5 and 20 days after shipment depending on which ordering platform is used by the consumer. To date we have not experienced any credit risk issues, but we will closely monitor the process to assess that this trend continues.
43
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not applicable.
Item 4. Controls and Procedures
Evaluation of disclosure controls and procedures.
Because the Company is a smaller reporting company, this Form 10-Q Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Managements report was not subject to attestation by our independent registered public accounting firm
An evaluation was conducted under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) as principal executive officer and Chief Financial Officer (“CFO”) as principal financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of September 30, 2022. Based on that evaluation, the CEO and CFO concluded that the Company’s disclosure controls and procedures were effective as of such date to provide reasonable assurances that information required to be disclosed by the Company in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to the Company’s management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.
Changes in internal controls over financial reporting.
There are no changes to our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the three months ended September 30, 2022, that has materially affected or are reasonable likely to materially affect, our internal control over financial reporting.
The certifications of our Chief Executive Officer and Chief Financial Officer attached as Exhibits 31 and 32 and to this Form 10-Q Report include information concerning our disclosure controls and procedures and internal control over financial reporting.
Inherent Limitations on Effectiveness of Controls
Our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all errors and all fraud. Internal control over financial reporting, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of internal control are met. Further, the design of internal control must reflect the fact that there are resource constraints, and the benefits of the control must be considered relative to their costs. While our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable assurance of their effectiveness, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company, have been detected.
PART II — OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is not a party to any other pending or threatened legal proceedings and, to the best our knowledge, no such action by or against us has been threatened. From time to time, we are subject to legal proceedings and claims that arise in the ordinary course of our business. Although occasional adverse decisions or settlements may occur in such routine lawsuits, we believe that the final disposition of such routine lawsuits will not have material adverse effect on its financial position, results of operations or status as a going concern.
Other Legal Matters. To the best of our knowledge, none of our directors, officers, or owners of record of more than five percent (5%) of the securities of the Company, or any associate of any such director, officer or security holder is a party adverse to us or has a material interest adverse to us in reference to pending litigation.
Item 1A. Risk Factors.
You should carefully consider the “Risk Factors” disclosed under “Item 1A. Risk Factors” in our 2021 Annual Report. You should be aware that these risk factors and other information may not describe every risk facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
44
Described below and throughout this Form 10-Q Report are certain risks that the Company’s management believes are applicable to the Company’s business and the industries in which it operates. If any of the described events occur, the Company’s business, results of operations, financial condition, liquidity, or access to the capital markets could be materially adversely affected. There may be additional risks that are not presently material or known and not discussed below. There are also risks within the economy, the industry, and the capital markets that could materially adversely affect the Company, including those associated with an economic recession, inflation, a global economic slowdown, political instability, government regulation (including tax regulation), employee attraction and retention, and customers inability or refusal to pay for the products and services provided by the Company. There are also risks associated with the occurrence of extraordinary events, such as COVID-19 pandemic, terrorist attacks or natural disasters (such as tsunamis, hurricanes, tornadoes, and floods). These factors affect businesses generally, including the Company, its customers and suppliers and, as a result, are not discussed in detail below, but are applicable to the Company. As a “penny stock without primary market maker support, and due to the decline in financial performance of the Company in 2020 and 2021 and continuing into 2022. An investment in our common stock involves a very high degree of risk. You should carefully consider the risks described below, together with all of the other information included in this Form 10-Q Report and other SEC filings, before making an investment decision. If any of the following risks actually occurs or continues to impact our business, our business, financial condition or results of operations could worsen. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment. You should read the section entitled “Cautionary Statement Regarding Forward-Looking Statements above for a discussion of what types of statements are forward-looking statements, as well as the significance of such statements in the context of this Form 10-Q Report. These risk factors are not the only risks that we may face. Additional risks and uncertainties not presently known to us or not currently believed to be important also may adversely affect our business.
Business and Operational Risks
The continuing COVID-19 pandemic mutations and measures intended to reduce its spread has, and may continue to, adversely affect our business, results of operations and financial condition and may hamper our ability to fund our operations without obtaining adequate, affordable funding, which funding may not be available as needed.
The outbreak of the COVID-19 pandemic and emergence of variants of COVID 19 continues to periodically impact worldwide economic activity, including Southern Florida where the Company offices are located and in China and Thailand where the Company has its products made. The COVID-19 pandemic has prevented our employees, suppliers, logistics services and other partners from conducting business activities at full capacity for a period of time, due to the community spread of the disease or due to shutdowns that were requested or mandated by governmental authorities or businesses. While it is not possible at this time to estimate the full impact that the COVID-19 pandemic has ultimately had on our business and its prospects as of the date of the filing of this Form 10-Q Report, the continued presence of COVID-19 pandemic, emergence of variant viruses and the measures taken by the governments and businesses in affected areas and in which we operate have disrupted in the past and may continue to disrupt our product development, manufacturing supply chain, the retail marketplace and overall consumer buying confidence. For example, despite the phased reopening of the economy in many U.S. states, the resurgence or persistence of COVID-19 pandemic has paused or delayed many phased re-openings. Due to social distancing and other mandates implemented by federal, state, and local governments at various times in 2021 and 2022, and despite the lifting of those mandates, many individuals are still working remotely and staying at home resulting in retail stores remaining closed or experiencing reduced traffic and demand for consumer goods like our goods remaining uncertain. As the COVID-19 pandemic continues to remain a serious health threat, the retail marketplace may have continued declines, which has reduced and may continue to reduce revenues and, as a result, could continue to adversely affect our operating results and financial condition, especially if our e-commerce initiative are ineffective or takes longer to succeed. The overall negative impact of the COVID-19 pandemic on the economy has also impacted, and may continue to impact, the number of potential retail customers for our LED and possibly Connected Surface “Smart Mirror” products. The COVID-19 pandemic outbreak and government and business mitigation measures have also had an adverse impact on global economic conditions, which has had and could continue to have an adverse effect on our business and financial condition and could impact our ability to access the capital markets on terms acceptable to us, if at all. China and Hong Kong continue to have periodic bans on travel or group gatherings. In addition, we have taken and may further take temporary precautionary measures intended to help minimize the risk of COVID-19 pandemic to our employees, including closing the corporate office for periods, temporarily requiring employees to work remotely, suspending all non-essential travel for our employees, which could negatively affect our business and promotion of the Connected Surfaces product line. The further spread of the COVID-19 pandemic or emergence of vaccine resistant strains of the virus and actions taken to limit and combat the spread will impact our ability to carry out our business as normal, and may materially adversely impact our business, operating results, and financial condition. The extent to which the COVID-19 pandemic outbreak impacts our results will depend on future developments that are highly uncertain and cannot be predicted, including new information that may emerge concerning the severity of the virus and the actions to contain its impact.
While the vaccination program has mitigated the impact of COVID-19 pandemic in the United States over the last nine months, the emergence of Delta variant and other variants, and the still significant percentage of unvaccinated Americans or Americans who have not received the most recent booster shots in certain parts of the United States and other regions outside the United States creates the specter of the emergence of vaccine resistant variants of COVID 19 that could impose economic disruption similar to the initial wave of COVID 19 in 2022 or 2023. This uncertainty makes COVID 19 pandemic an ongoing threat to and adverse factor in respect of the Company’s efforts to establish a new product line to stabilize the financial results of the Company. As such, the above-described risk factors remain relevant to the Company and its business despite an improving economy in the United States and possible return to pre-COVID 19 pandemic economic growth.
45
The adverse financial results from the COVID-19 pandemic on our business and financial performance coupled with our transition in new product focus on Connected Surfaces products and its inability to date to produce necessary revenues to support operational overhead and declining performance of the LED Lighting product lines places a significant financial strain on our Company.
Due to the limited number of employees and contractors who conduct Company operations, COVID-19 pandemic has a more significant and lasting impact on our company than larger competitor companies with significantly greater number of employees, contractors, facilities and overall resources.
We anticipate the available funding will sustain operations in the short-term, in 2022, but this assumption may prove to be incorrect. However, to sustain future operations and revenue growth we will also need either adequate and affordable additional working capital funding including purchase order funding or adequate cash flow from sales of products in fiscal year 2022. We can give no assurances that we will be able to secure affordable, adequate and timely funding as necessary in the future. The economic disruption resulting from the COVID-19 pandemic has had an adverse impact on the global freight shipping industry and on the cost of shipping our products. Continuation of current overall inflationary pressures coupled with any continuation or worsening of shipping problems and associated increased costs could severely impact our business and financial condition by decreasing consumer demand for Connected Surface products.
We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by governments, or that we determine are in the best interest of our employees, customers, partners, suppliers and shareholders. The extent of the adverse impact of the pandemic on the global economy and markets will depend, in part, on the length and severity of the measures taken to limit the spread of the virus and, in part, on the size and effectiveness of the compensating measures taken by governments. To the extent the COVID-19 pandemic continues to adversely affect the U.S. economy, or adversely affects our business, operations or financial performance, it may also have the effect of increasing the likelihood or magnitude of other risks described herein, including those risks related to market, credit, geopolitical and business operations and cyber, or risks described in our other filings with the SEC. In addition, the COVID-19 pandemic may also affect our business, operations or financial performance in a manner that is not presently known to us. The emergence of new, vaccine resistant strains of the virus could result in a reoccurrence of the economic disruption caused in 2020 by the first wave of COVID-19 pandemic. Further, if a significant portion of the U.S. population refuses to get vaccinated in response to new variants of the virus and the threats they may pose to the economy and consumer spending, and thereby sustain or expand the impact of the COVID-19 pandemic, the COVID-19 pandemic may continue to harm our business and financial performance in 2022 and 2023 as well as increase the possibility of new, vaccine resistant strains of the virus that perpetuate the COVID 19 pandemic.
Climate Change could adversely affect the Company’s ability to receive and deliver products. Global climate change is resulting in certain types of natural disasters occurring more frequently or with more intense effects. These events can possibly make it difficult for the Company’s OEM to manufacture and deliver products to the Company and for the Company to deliver products to its customers. Climate change can create delays and inefficiencies in the Company’s supply and manufacturing chain. For instance, China has experienced power outages in 2022 in certain regions due to prolonged drought. Following an interruption to its business, the Company’s efforts to establish the Connected Surface product line as a viable, primary business line could be severely delayed or undermined. The Company relies on limited number of sources for the supply and manufacture of its products and a business interruption affecting the Company’s OEM or Company would exacerbate any negative consequences to the Company.
We may experience labor problems that further our worsening business and financial condition. We operate with a small staff and rely on a limited number of contractors to provide the labor necessary to operate the company. The impact of the COVID 19 pandemic as well as the declining financial performance of the Company may cause reductions or loss of company personnel as well as an inability to find qualified replacements. Any inability to retain personnel or find qualified replacements would have a severe impact on the ability of the Company to efficiently operate. Further, the Company has transitioned some employees to independent contractor status, which transition may not provide the same benefits or efficiencies to the Company as having the personnel as full time employees.
With new variants of the virus posing new threats, the COVID-19 pandemic continues to be fluid and it is difficult to forecast the impact it could have on our future operations. Continued or sustained disruptions of our Thai OEM operations would have a severe impact on the ability of the Company to sustain efforts to establish Connected Surface product line as a primary, viable revenue source. The failure to establish the Connected Surface product line as a primary, viable revenue source in 2022 could be catastrophic to the prospects of the Company as a viable going concern.
46
Impact of Inflationary Trends may adversely impact future product sales. U.S has experienced extensive price inflation in 2022. The impact of inflation on consumer prices and consumer buying patterns will be a factor through 2022. It is projected that the inflation rate will average 7.9% through 2022. Future volatility of general price inflation could affect consumer purchases of our products, which are a discretionary expense. Additionally, the impact of inflation on costs and availability of materials, costs for shipping and warehousing and other operational overhead, could adversely affect the Company’s future financial results.
A prolonged conflict in the Ukraine may have unintended consequences such as further increased inflation due to increases in fuel and transportation costs and economic uncertainty from prospect of expanded conflict between the U.S. and E.U., on one hand, and Russia, on the other hand.
Our operating results are substantially dependent on the acceptance of new products. The success of the Connected Surfaces product line in 2022 is critical to the ability of the Company to sustain the Company as a going concern beyond 2022. The Company will not be able to assess the results of the new Connected Surfaces product line until later in 2022. While the Company routinely considers significant corporate actions as part of regular strategic planning, the Company may have to consider and pursue a strategic corporate action, like a merger, sale of operating assets or new business line, in order to sustain operations beyond 2022. The failure of the Connected Surface products to become a viable primary revenue source in 2022 would impose severe financial strain on the Company in light of the decline in sales of the LED Lighting products and absence of readily available alternative product lines and limited resources for developing and promoting a new product line.
We face competition from numerous domestic and international competitors in smart mirror industry and we cannot match the business, financial and technological resources of many of those competitors, especially in terms of being able to withstand competitive pricing efforts by competitors designed to undermine the pricing appeal of our products or overcome the well-established brand recognition by consumers and consumer loyalty enjoyed by competitors. We are new to smart mirror industry and may lack the resources or effective marketing strategy to successfully penetrate that market. With limited resources, we cannot afford an extensive multi-level, sustained marketing-sales effort that is periodically adjusted or significantly expanded to entice consumer interest in the Connected Surface product line.
The shipment of the Connected Surface products and success of Connected Surface products are critical to stabilizing the financial condition and performance of the Company. The Company started shipment of those products to customers and distributors in the first quarter of 2022. Any further delays in shipping and order fulfillment for Connected Surfaces will only impose greater financial stress on the Company and adversely impact the transition from LED product line to Connected Surfaces product line as the primary product line of the Company. A resurgence of the COVID-19 pandemic in the United States could adversely impact the Company’s efforts to ship and establish the Connected Surface product line by causing economic disruption and decline in consumer willingness to purchase discretionary purchase products like a smart mirror. The Company does not yet have an alternative product line to the Smart Mirrors certified and ready for production, which increases the importance of a successful launch of the Smart Mirrors to sustainability of the Company.
We face risks associated with doing business in non-US jurisdictions. Our products are manufactured in and distributed from facilities, located in Asia. We are highly dependent on our foreign affiliates for their production capabilities. As a result, our exposure to the risks described above may be greater in the future. The likelihood of such occurrences and their potential impact on is unpredictable under current worldwide political tensions and inflationary pressures.
International operations are subject to certain risks inherent in doing business abroad, including exposure to political, social and economic instability; expropriation and nationalization; withholding and other taxes on remittances and other payments by subsidiaries; difficulties in enforcement of contract and intellectual property rights; exposure to foreign current exchange rates, interest rates and inflation; investment restrictions or requirements; and export and import restrictions.
Our business and financial performance may be adversely affected if our information technology systems fail to perform adequately or if they are the subject of a security breach or cyberattack. We rely on a variety of information technology systems in the ordinary course of business to manage business data, communications, supply chain, order entry and fulfilment, customer support, billing and payments. Our system and processes are potentially vulnerable to cybersecurity incidents, such as terrorist or hacker attacks, the introduction of malicious computer viruses, ransomware, falsification of banking and other information, insider risk, or other security breaches, including individual or advanced persistent cyber-attacks on our information technology infrastructure and attempts by others to gain access to our proprietary or sensitive information regarding our employees, suppliers and customers.
If there is a cybersecurity incident, we may suffer interruptions to our business and service, loss of assets or data, or reduced functionality, which could materially adversely affect our financial condition, business and results of operations. Many of our systems are not redundant, and our disaster recovery planning is not sufficient for every eventuality a cybersecurity incident could cause. Security breaches of our systems which allow inappropriate access to or inadvertent transfer of information and misappropriation or unauthorized disclosure of confidential information belonging to us or to our employees, customers, or suppliers could have an adverse impact on our results of operation. If a customer, supplier or employee alleges that a cyberattack caused or contributed to a loss or compromise of critical information, we could face significant harm to our reputation and financial condition. Any remedial costs or other liabilities related to information security system failures and cybersecurity incidents may not be fully insured or indemnified by other means.
47
We may be exposed to potential risks relating to our internal controls over financial reporting and our ability to have those controls attested to by our independent auditors. As directed by Section 404 of the Sarbanes-Oxley Act of 2002, or SOX 404, the SEC adopted rules requiring public companies to include a report of management on the company’s internal controls over financial reporting in their periodic SEC financial reports. We have evaluated our internal control systems in order to allow our management to meet these requirements. We can provide no assurance that we will comply with all of the requirements imposed thereby in the future. In the event that we ever identify significant deficiencies or material weaknesses in our internal controls that we cannot remediate in a timely manner, investors and others may lose confidence in the reliability of our financial statements.
Risk Factors for our Common Stock
Penny Stock and Volatile Market Price.
As a matter of policy, the Company never recommends any investment in its common stock to public investors.
Due to the factors described below, the Company’s Common Stock is subject to possible volatile trading, including rapid increases and decreases in market price due to trading in the open market. Company’s declining business and financial condition has depressed the already low market price of the Company’s Common Stock in 2022. The Company’s Common Stock lacks the primary market makers and institutional investors who can protect the market price from volatility in trading and market price. Company does not have any research analyst issuing recommendations. The common stock is also a “penny stock under SEC rules and suffers the limitations and burdens in trading of penny stocks. This lack of market support and penny stock status means that trading, especially by day traders, can cause a rapid increase or decrease in market price of the common stock and makes any investment in the common stock extremely risky and unsuitable for investors who cannot withstand the loss of their entire investment and require liquidity in the investment.
In March 2021, our Common Stock was approved for DWAC/Fast electronic transfer, which will enhance trading of our Common Stock, but will not eliminate the issues imposed by the lack of market support for the Common Stock or the “penny stock status of our Common Stock and, as such, will not lessen the volatility in trading and market price of our Common Stock. Further, restricted stock cannot be DWAC/Fast transferred. Many brokerage houses do not want or readily accept “penny stocks” in trading accounts.
We are also a former shell company under current SEC rules and interpretations thereof. As such, our stock transfer agent requires a legal opinion as well as other paperwork to lift restrictive legends from stock certificates for non-affiliated as well as affiliated shareholders. The restrictive legends can only be lifted for at most a 90-day period for sales under Rule 144 for affiliated and non-affiliated shareholders. Further, our stock transfer agent will not permanently remove restrictive legends on stock certificates held by shareholders. absent registration of the shareholders shares of common stock under the Securities Act. This status may make our common stock even more unappealing to investors and potential purchasers and more difficult to sell or trade. “Affiliated shareholders are generally Company officers, directors, and holders of more than 10% of the issued shares of the Common Stock.
Further, our common stock is quoted on The OTC Markets Group, Inc. QB venture market. Many brokerage houses will not accept OTC stocks for deposit or for trading due to the compliance burdens and reduced financial benefits of trading in OTC stocks. This difficulty further decreases the appeal of our common stock to investors.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
The Company did not issue any unregistered securities in the fiscal quarter ended September 30, 2022.
The Company repurchased 66,167 shares of Common Stock during the nine months of 2022 under its repurchase plan.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not Applicable.
Item 5. Other Information
The Company has no information to disclose that was required to be in a report on Form 8-K during the period covered by this report but was not reported. There have been no material changes to the procedures by which security holders may recommend nominees to our board of directors or make shareholder proposals.
48
Item 6. Exhibits
The following exhibits are filed as part of this Report on Form 10-Q or are incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Capstone Companies, Inc.
Dated: November 14, 2022
| /s/ Stewart Wallach | ||
| Stewart Wallach | Chief Executive Officer | |
| Principal Executive Officer |
| /s/James G. McClinton | ||
| James G. McClinton | Chief Financial Officer and Chief Operating Officer | |
| Principal Financial Executive and Accounting Officer |
49