CAPSTONE COMPANIES, INC. - Quarter Report: 2017 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

X     QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED June 30, 2017

__TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____________ to _____________

Commission File Number: 000-28831

(Exact name of Registrant as specified in its charter)

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. [X] Yes [__] No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web Site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X]     No [_]

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.

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.  [_]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  [_] Yes [X] No

State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practical date. As of August 2, 2017, there were 46,466,952 shares of the issuer's Common Stock, $0.0001 par value per share, issued and outstanding.

CAPSTONE COMPANIES, INC.

Quarterly Report of Form 10-Q

Three Months and Six Months Ended June 30, 2017

TABLE OF CONTENTS

 

CAPSTONE COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
		June 30,				December 31,
		2017				2016
		(Unaudited)
Assets:
Current Assets:
Cash		$	1,173,996			$	1,646,128
Accounts receivable, net			4,856,621				4,449,179
Inventory			267,266				366,330
Prepaid expenses			1,361,162				330,020
Total Current Assets			7,659,045				6,791,657
Property and Equipment:
Computer equipment and software			19,767				19,767
Machinery and equipment			340,534				325,750
Furniture and fixtures			5,665				5,665
Less: Accumulated depreciation			(286,016	)			(250,465	)
Total Property & Equipment			79,950				100,717
Other Non-current Assets:
Deposit			13,616				12,193
Note receivable			539,832				526,887
Goodwill			1,936,020				1,936,020
Total Other Non-current Assets			2,489,468				2,475,100
Total Assets		$	10,228,463			$	9,367,474
Liabilities and Stockholders' Equity:
Current Liabilities:
Accounts payable and accrued liabilities		$	2,705,144			$	2,678,210
Income tax payable			22,088				1,588
Notes and loans payable to related parties			1,053,883				1,321,721
Total Current Liabilities			3,781,115				4,001,519
Long Term Liabilities:
Deferred tax liabilities			354,000				216,000
Total Long Term Liabilities			354,000				216,000
Total Liabilities			4,135,115				4,217,519
Commitments and Contingencies (Note 6)
Stockholders' Equity:
Preferred Stock, Series A, par value $.001 per share, authorized 6,666,667 shares, issued -0- shares			-				-
Preferred Stock, Series B-1, par value $.0001 per share, authorized 3,333,333 shares, issued -0- shares			-				-
Preferred Stock, Series C, par value $1.00 per share, authorized 67 shares, issued -0- shares			-				-
Common Stock, par value $.0001 per share, authorized  56,666,667 shares, issued 46,466,952 shares and 48,132,664 shares			4,646				4,813
Additional paid-in capital			7,202,691				7,411,172
Accumulated deficit			(1,113,989	)			(2,266,030	)
Total Stockholders' Equity			6,093,348				5,149,955
Total Liabilities and Stockholders' Equity		$	10,228,463			$	9,367,474
The accompanying notes are an integral part of these financial statements.

 

CAPSTONE COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
		For the Three Months Ended								For the Six Months Ended
		June 30,								June 30,
		2017				2016				2017				2016
Revenues, net		$	10,219,548			$	8,902,189			$	16,971,744			$	10,980,403
Cost of sales			(7,576,685	)			(6,773,465	)			(12,749,413	)			(8,238,123	)
Gross Profit			2,642,863				2,128,724				4,222,331				2,742,280
Operating Expenses:
Sales and marketing			564,519				352,854				941,275				415,833
Compensation			353,904				316,011				713,706				624,469
Professional fees			115,381				71,057				320,183				175,342
Product development			66,447				63,908				138,473				100,182
Other general and administrative			204,063				163,656				382,681				306,411
Total Operating Expenses			1,304,314				967,486				2,496,318				1,622,237
Net Operating Income			1,338,549				1,161,238				1,726,013				1,120,043
Other Income (Expense):
Interest Income			-				-				12,945				-
Interest expense			(35,186	)			(66,424	)			(56,917	)			(124,159	)
Total Other Income (Expense)			(35,186	)			(66,424	)			(43,972	)			(124,159	)
Income Before Tax Provision			1,303,363				1,094,814				1,682,041				995,884
Provision for Income Tax			(402,000	)			(12,600	)			(530,000	)			(12,600	)
Net Income		$	901,363			$	1,082,214			$	1,152,041			$	983,284
Net Income per Common Share
Basic		$	0.019			$	0.022			$	0.024			$	0.020
Diluted		$	0.019			$	0.022			$	0.024			$	0.020
Weighted Average Common Shares Outstanding
Basic			46,694,058				48,132,664				47,155,592				48,132,664
Diluted			47,055,446				48,290,373				47,473,829				48,290,373
The accompanying notes are an integral part of these financial statements.

 

CAPSTONE COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
		For the Six Months Ended
		June 30,
		2017				2016
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	1,152,041			$	983,284
Adjustments necessary to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization			35,551				28,289
Accrued interest on note receivable			(12,945	)			-
Stock based compensation expense			40,950				28,500
Provision for deferred income tax			138,000				-
Accrued sales allowance			(20,848	)			65,630
(Increase) decrease in accounts receivable			(450,713	)			(2,406,176	)
(Increase) decrease in inventory			99,064				(413,287	)
(Increase) in prepaid expenses			(1,032,565	)			(142,000	)
Increase (decrease) in accounts payable and accrued liabilities			111,954				166,447
Increase (decrease) in accrued interest on notes payable			(44,837	)			70,511
Net cash provided by (used in) operating activities			15,652				(1,618,802	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment			(14,784	)			(4,701	)
Net cash (used in) investing activities			(14,784	)			(4,701	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable			16,566,081				9,860,252
Repayments of notes payable			(16,566,081	)			(8,142,198	)
Repurchase of shares from Involve, LLC			(250,000	)			-
Proceeds from notes and loans payable to related parties			-				860,000
Repayments of notes and loans payable to related parties			(223,000	)			(978,846	)
Net cash provided by (used in) financing activities			(473,000	)			1,599,208
Net (Decrease) in Cash and Cash Equivalents			(472,132	)			(24,295	)
Cash and Cash Equivalents at Beginning of Period			1,646,128				364,714
Cash and Cash Equivalents at End of Period		$	1,173,996			$	340,419
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest		$	101,755			$	97,494
Income taxes		$	371,500			$	7,500
Non-cash financing and investing activities:
Sale of Investment for Note receivable		$	-			$	500,000
The accompanying notes are an integral part of these financial statements.

		3 months ended June 30, 2017				3 months ended June 30, 2016
Basic weighted average shares outstanding			46,694,058				48,132,664
Dilutive warrants			361,388				157,709
Diluted weighted average shares outstanding			47,055,446				48,290,373

		6 months ended June 30, 2017				6 months ended June 30, 2016
Basic weighted average shares outstanding			47,155,592				48,132,664
Dilutive warrants			318,237				157,709
Diluted weighted average shares outstanding			47,473,829				48,290,373

		Gross Revenue %								Gross Accounts Receivable
		6 Month Periods Ended June 30,								As of June 30,
		2017				2016				2017				2016
Customer A			50.2	%			64.0	%		$	4,023,703			$	6,663,468
Customer B			49.1	%			35.0	%			1,028,734				1,457,417
			99.3	%			99.0	%		$	5,052,437			$	8,120,885

	Purchases %								Accounts Payable
	6 Month Periods Ended June 30,								As of June 30,
		2017				2016				2017				2016
Vendor A			97.1	%			97.4	%		$	1,868,111			$	1,407,617

Balance, December 31, 2016		$	526,887
Accrued interest income		$	12,945
Balance, June 30, 2017		$	539,832

		3 months ended June 30, 2017				3 months ended June 30, 2016
Current:
Federal		$	392,000			$	-
Deferred:
Federal			10,000				12,600
Income Tax Provision		$	402,000			$	12,600

		6 months ended June 30, 2017				6 months ended June 30, 2016
Current:
Federal		$	392,000			$	-
Deferred:
Federal			138,000				12,600
Income Tax Provision		$	530,000			$	12,600

The following management's discussion and analysis should be read in conjunction with our financial statements and the notes thereto and the other financial information appearing elsewhere in this Form 10-Q quarterly report. In addition to historical information, the following discussion contains certain forward-looking statements under the Private Securities Litigation Act of 1995, as amended. See "Special Note Regarding Forward Looking Statements" below for certain information concerning those forward- looking statements.  As used below, "our" and "we" refers to the Company and its subsidiaries.

Special Note Regarding Forward Looking Statements

This Form 10-Q quarterly report contains forward-looking statements that are contained principally in the sections describing our business as well as "Risk Factors," and this "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. These risks and uncertainties include, but are not limited to, the factors described in the section captioned "Risk Factors" in our latest annual report on Form 10-K for the fiscal year ended December 31, 2016, as filed with the SEC. 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) intended to identify forward-looking statements. 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 quarterly report should not place undue reliance on these forward-looking statements.

Forward-looking statements represent our estimates and assumptions only as of the date of this Form 10-Q quarterly report. One should read this Form 10-Q quarterly report and the documents that we reference herein and filed as exhibits to this Form 10-Q quarterly report completely and with the understanding that our actual future results may be materially different from what we expect. Except as required by law, we assume no obligation to update any forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, even if new information becomes available in the future.

The Company is a "penny stock" company under Commission rules and the public stock market price for its Common Stock has been depressed for several consecutive fiscal quarters.  The Company's Common Stock lacks sufficient or active primary market makers and institutional investor support in the public market and this lack of support means that any increase in the per share price of our Common Stock in the public market is usually eliminated by selling pressure from profit taking by investors.  As of August 2, 2017, the Common Stock was trading at $.59 on the Bid Investment in our Common Stock. 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. Investors should consider risk factors in this quarterly report on Form 10-Q and other SEC filings of the Company.  The Company completed a 1-for-15 reverse stock split for the Common Stock on July 25, 2016. The reverse stock split did not change the Company's status as a "penny stock" company.

Use of Certain Defined Terms. Except as otherwise indicated by the context, references in this quarterly report to:

(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 SAR registered Company.

(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.'s subsidiaries.

(5)	"China" or "PRC" means People's Republic of China.

(6)	References to "33 Act" or "Securities Act" means the Securities Act of 1933, as amended.

(7)	References to "34 Act" or "Exchange Act" means the Securities Exchange Act of 1934, as amended.

(8)	"SEC" or "Commission" means the U.S. Securities and Exchange Commission.

(9)	"Subsidiaries" means the following wholly owned subsidiaries of the Company:  Capstone Industries, Inc. ("CAPI"), Capstone International H.K Ltd., ("CIHK"), and Capstone Lighting Technologies, Inc. ("CLTL").

(10)	"LED" or "LED's" means a light-emitting diode component(s) which can be assembled into light bulbs or can be used in lighting fixtures.

Further, we may use "OEM" which means "original equipment manufacturer."

General.

Capstone Companies, Inc., a Florida corporation, ("CAPC," "Company," "we," or "our") is a public holding company with its Common Stock, $0.0001 par value per share, ("Common Stock") quoted on the OTC QB Venture Market exchange of The OTC Markets Group, Inc. and, since July 6, 2012, under the trading symbol "CAPC."  This discussion should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2016

Available Information.

The Company's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), are filed with the SEC. Such reports and other information filed by the Company with the SEC are available on the Company's website at http://www.capstonecompaniesinc.com/Investor Relations and on the SEC's website at http://www.sec.gov. The public may read and copy any materials filed by the Company with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Room 1580, Washington, D.C. 20549, or through the aforesaid website URL's. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. The contents of these websites are not incorporated into this report. Further, the Company's references to the URLs for these websites are intended to be inactive textual references only.

Introduction

The following discussion and analysis provides an introduction to our Company, its current strategy and customers and summarizes the significant factors affecting: (i) our consolidated results of operations for the three months and six months ended June 30, 2017 compared with the same period in 2016 and (ii) financial liquidity and capital resources.

The Company is a public holding company organized under the laws of the State of Florida.  The Company designs and markets consumer oriented LED lighting products for distribution globally with a primary focus on the North American markets.  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 its product development, engineering and factory resource capabilities in Hong Kong. Capstone's LED lighting portfolio consists of stylish, innovative and easy to use consumer LED lighting products, including power failure multi-function handheld lights, power failure multi-function nightlights, decorative nightlights, wireless motion sensor lights, remote control battery powered accent lights, remote control outlets, bath vanity lights, outdoor LED fixtures, dual powered solar lights and LED power controlled bulbs.  The Company's products are sold under CAPI's brand name, Capstone Lighting® as well as under two nationally recognized licensed brand names: Hoover^® Home LED and Duracell^Ò. The Company believes that LED is becoming increasingly more mainstream, and, as such, the Company believes that the component and production costs will continue to lower, which should allow a smaller innovative company like ourselves to capitalize on non-commodity products utilizing LED.  The Company's focus is the integration of LED into most commonly used lighting products in today's home. Capstone is positioned well to participate in these expanded product categories which will fuel the Company's further growth.

The Company seeks to deliver strong, consistent business results and increasing shareholder returns by providing innovative products on a global basis that make consumer's lives simpler and safer while delivering growth results to the Company's retail partners.

The Company oversees and controls the manufacturing of its products, which are currently made in China by OEM contract manufacturers, through three wholly-owned operating subsidiaries: CAPI, CIHK and CLTL.  Capstone believes it has commercially favorable payment terms with its contract manufacturers which supports the Company's growth.  The Company's direct import business model requires shipments meet minimum order quantity or "MOQ" full container loads from its factories directly to retail customers shipping brokers.   This business model avoids pitfalls resulting from slow moving and obsolete product inventories.  The Company's products are built to fill backlog orders and are not warehoused for domestic replenishment programming.  CIHK continually evaluates its contract manufacturers' ability to meet the Company's growing needs.  Additionally, all manufacturers must meet rigorous compliance, security and equipment evaluation audits to ensure competitive pricing for the highest quality products under applicable industry standards.  The Company continues to explore alternative manufacturing sources in China and elsewhere in the Pacific Rim as part of its ongoing supply chain strategic planning.

Strategy

The global LED lighting market is undergoing a perceived significant transition driven by rapid adoption of energy efficient LED lighting products.  LED lighting products offer numerous advantages for the user which are driving demand (improved light quality, durability, longer life, cooler temperatures, lower cost of operation). These advantages in addition to increased regulatory requirements banning inefficient lights have accelerated growth of LED products and are expected to continue to accelerate the adoption of energy efficient LED technologies going forward.  According to Allied Market Research, in a forecast in September 2014, the global LED market is forecasted to grow to $42 billion by 2020.

The Company entered the LED consumer market eight years ago. At that time, it was clear to management that there was a significant opportunity for an innovative low cost LED product supplier as the lighting industry was on its transition path from traditional lighting technologies to LED.

Capstone was an early integrator in the introduction of lower cost LED lighting solutions within its industry niche that have distinctive aspects to create greater appeal to consumers.  The Company's product lines consist of decorative lighting, outdoor fixtures, lighting with built-in power failure technology and safety and security.  The power failure lighting and security products were initially sold under its wholly – owned subsidiary Capstone Industries' brand name through 2015.

As the Company initially entered the market with products branded Capstone Lighting^Ò, the Company was able to stay under the radar and avoid direct competition with the larger brands that were focused on light bulbs and commercial lighting.  The strategy was to establish the Company's products in the marketplace, building on retail success and user satisfaction.

Moreover, in 2014, Capstone acquired the exclusive license and sub-license to an advanced power failure technology.  The Company's proprietary technology is referred to as Capstone Power Control or CPC.  It is a patented technology and the U.S. patents were issued August of 2016.  The CPC was developed over a two-year period by a group of MIT PhD Engineers operating as AC Kinetics, a private company. This technology can potentially be incorporated into a host of products.  The Company is exploring ways to commercialize this technology and whether it will result in any significant financial benefit is uncertain at the time of this report.

In the latter part of 2014, the Company concluded that conventional retail was going to undergo significant change in its LED product and vendor selections resulting from swift retail pricing adjustments.  Early LED products, particularly light bulbs, that were deemed early technologies were seen by the Company as too expensive and no longer appropriate for the market.  The early products did not look like light bulbs and were not marketed effectively in the opinion of the Company. As such, buying an LED light bulb was potentially confusing to the consumer.  Over the course of the next year, retail prices for early LED products plummeted and negatively impacted the supply chain.  Capstone forecasted this outcome and determined to focus its primary marketing approach towards the warehouse club channel where low retail mark-ups was deemed to have circumvented this market condition.  The Company was timely in this strategic market entry and benefited from the limited number of vendors competing in this arena.  The Company concluded that larger LED bulb suppliers were concerned with protecting retail price positions and they could not, as such, effectively market their brands in both conventional retail channels and warehouse club channels.

Commencing in 2014, Capstone explored and researched branding opportunities that would allow the Company to differentiate from its own Capstone Lighting^Ò brand.  The underlying strategy enabled Capstone to effectively provide product to competing retailers within the same channel.

Through product differentiation and a visibly recognized brand launched in 2015, Hoover^Ò Home LED became a Capstone success story.  The Company secured the North America trademark license for the Hoover^® brand for LED lighting products.  The Hoover^Ò name is a 100-year-old household iconic brand name. Hoover^® is a registered trademark of Techtronic Floor Care Technology Limited.

On January 9, 2017, the Company secured a license from Duracell^Ò for a specific product sold globally to a major warehouse club.  The first shipments of the branded product occurred in the first quarter 2017.

Capstone believes that it has effectively positioned itself in this channel and posted successive revenue growth while delivering strong gross margins.  The Company is currently expanding its distribution into international home improvement centers that accept Capstone's direct import model.  The Company is distributing Capstone Lighting, Hoover^® Home LED and a Duracell^Ò  LED product and will, from time to time and in selected markets, offer private label programming to international accounts.

Capstone's 2013 investment in AC Kinetic Technologies, an Armonk, New York, private technology development company, allowed the Company to develop certain innovative concepts that the Company conceived and that are complex and has yielded intellectual property that we believe will further distinguish the Company's products from other off-the-shelf products commonly marketed at the retail level.  The Company intends to exploit the patented technologies developed and completed by AC Kinetic Technologies within the Company's own products, both labeled under "Capstone" and under the Hoover^® Home LED brand.

On June 8, 2016, the Board of Directors approved and accepted an offer from AC Kinetics to buy back their 100 shares of AC Kinetics Series A Preferred Stock for a $1,500,000 Note Receivable with an estimated fair market value of $500,000.  The Company may continue its technology development relationship with AC Kinetics despite the agreement to sell the 100 shares of AC Kinetics Series A Preferred Stock.

Perceived or Essential Strengths

Capstone's core executive team has been working together for over three decades in business and has successfully built and managed other consumer product companies.  CIHK resident management team has extensive experience with low cost off shore OEM manufacturing and is led by an industry leader that has provided sourcing and procurement services to such recognized companies as Circuit City and Dicks Sporting Goods.  Operating management's extensive experience in hardline product manufacturing and marketing prepared the Company for its entry into the LED market.

From a market perspective, Capstone's branding strategy is focused on establishing multiple trusted brands allowing for a broader reach into various channels.  Capstone Lighting® (2008), Hoover^® Home LED (2015) and Duracell^Ò, contribute to expanding the Company's retail position.  All three brands are currently available in the marketplace.

The Company's product characteristics are supposed to satisfy the following standards:

·

Designed to make everyday tasks or usage simpler and more enjoyable for consumers;

·

While continuing to focus on increased profit margins, the products must be affordable to win at the point of sale and deliver increased revenues for retail partners;

·

The products must represent significant value when compared with items produced or marketed by competitive consumer product companies; and

·

Wherever feasible, the products must be unique to the market whether this be accomplished though design techniques, added functionality or some proprietary innovation.

With respect to the Company's goal of sustained profitability, the challenge has been and remains to achieve greater profit margins from our product lines by either innovative product that induce consumers to pay a higher purchase price or increased efficiencies in producing and selling products that sustain attractive pricing.  This challenge confronts many consumer product companies. Capstone believes that appropriate use of OEM capabilities in innovation and production coupled with design that appeals to consumers are critical factors in meeting this challenge, especially for a smaller or niche competitor.

Due to the extensive, modern manufacturing, design and engineering capabilities with the Company's contract manufacturers, and the lower unit costs in China, Capstone believes that it is more economical and efficient to continue to manufacture certain products in China and have them shipped to the United States rather than to have such products produced in North America.  While this resource is available to and used by large numbers of U.S. companies, including our competitors, the Company believes this Chinese manufacturing resource gives the Company the level of innovation, production cost and quality that allows Capstone to be competitive with larger competitors in the United States.  However, as design technologies can influence the degree of hand labor in building its future products, the Company expects the advantages it has realized by manufacturing solely in China to be challenged.  The Company periodically evaluates alternative OEM manufacturing within and outside the Pacific Rim.

The Company's CIHK operations in Hong Kong, is staffed with personnel experienced in engineering and design, product development and testing, product sourcing, international logistics and quality control.  These associates work with our OEM factories to develop and prototype new product concepts and to ensure products meet consumer product regulations and rigorous quality control standards.  All products are tested before and during production by Company personnel.  This team also provides extensive product development, quality control and logistics support to our factory partners to ensure on time shipments.  In anticipation of the Company's growth, we have continued our investment in CIHK in an effort to ensure overseas factory performance meets stringent operational tolerances to maintain our competitiveness and operational excellence.

We have expanded our international sales by leveraging our relationships with our existing global retailers and by strengthening our international product offerings.  Our Hong Kong office assists us in placing more products into foreign market channels as well.  In 2016, we surpassed our initial expansion goal with product sales in Australia, Canada, Japan, South Korea, Taiwan and the United Kingdom. For the six- months ended June 30, 2017 and 2016, international sales were approximately $1,080,800 and $1,550,700 respectively or 6.4% and 14.1% of net revenue, respectively.

Products and Customers

The Company has expanded its product positioning through the introduction of more indoor and new outdoor lighting programs under the Capstone Lighting® brand, the Hoover^® Home LED brand and the Duracell^Ò  brand .  Capstone has also expanded hardwired solid state products to its programs in addition to the existing battery and induction powered product lines, through the expansion of bath vanity fixtures and outdoor LED Gooseneck Lanterns.  Such expansion involves the inherent risk of increased operating and marketing costs without a corresponding increase in operational revenues and profits.

The Company has established product distribution relationships with numerous leading international, national and regional retailers, including but not limited to: Amazon, Bunnings, Costco Wholesale, Home Depot, Home Pro, Sam's Club, The Container Store and Wal-Mart. These distribution channels may sell the Company's products through the Internet as well as through retail storefronts and catalogs/mail order.  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 markets and growing international market.  While Capstone has traditionally generated the majority of its sales in the domestic 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 expanded its international sales by leveraging relationships with our existing global retailers and by strengthening our international product offerings.  CIHK assists the Company in placing more products into foreign market channels as well.  The Company introduced Capstone brands to markets outside the U.S., including Australia, France, Iceland, Japan, Mexico, New Zealand, South Korea, Spain, Taiwan, Thailand and the United Kingdom.  This continues to be a promising distribution channel with international sales for the year ended December 31, 2016, increasing 100% up to $2.4 million from $1.2 million the same period in 2015 and representing 8% of net revenue in 2016 and 92% of net revenue originating in the United States.

Based on Capstone's experience in the industry, the Company's Chinese contract manufacturing resources and focus on well designed, practical products, Capstone believes it is well positioned to become a leading manufacturer in the growing LED home lighting and security lighting segments.  The Company's efforts to achieve such a goal are ongoing.  Capstone believes it will maintain its revenue growth because of the ability to deliver unique products on time, the quality reputation of its products, business relationships with Capstone's retailers and the aggressive product expansion strategies currently in place.  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 branded lighting categories, Capstone has a comprehensive product offering for its niche in the industry.  The Company believes that it will provide retailers with a broad and diversified portfolio of consumer products across numerous product categories, which should add diversity to the Company's revenues and cash flows sources.  Within these categories, 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 ability to serve retailers with a broad array of branded products and quickly introduce new products to continue to allow Capstone to further penetrate its existing customer bases, while also attracting new customers. The Company's primary, perceived challenge is creating sustained consumer demand for its products in a growing number of markets and attaining sustained profitability, which challenge is complicated by the cost of new product development and costs of penetrating new markets.

Sales and Marketing

The Company's products are marketed primarily through a direct independent sales force.  The sales force markets the Company's products through numerous retail locations worldwide, including larger retail warehouse clubs, hardware centers and e-commerce websites.  The Company actively promotes its products to retailers and distributors at North American trade shows, but relies on the retail sales channels to advertise its products directly to the end consumer.  All sales activities at major account levels involve direct executive management participation.

In order for continued sales growth in the retail market, the Company is focused on expanding its market share at existing accounts by expanding its portfolio of both branded and private label LED lighting products. The Company will also be targeting direct to retail clients through CIHK for products that fall outside Capstone's branded categories but are innovative and preferably exclusive to CIHK.  This should allow for quicker revenue expansion as time consuming product and brand development efforts are the responsibility of the retailer.

Capstone depends on e-commerce efforts of Amazon and other on-line retail customers in lieu of pursuing our own aggressive in-house e-commerce effort.  We believe this reliance on Amazon and other retail customer e-commerce is the most cost efficient and effective approach for the Company. We maintain a Facebook website at https://www.facebook.com/powerfailuresolutions/ and our sales staff may use Social Media from time to time to promote our products and brands.  We have not developed a specific Social Media campaign based on third party sponsors or promotors. Facebook is a registered trademark of Facebook, Inc.

Working Capital Requirements

In order to more effectively support retailers in the U.S. domestic markets, so that retailers can quickly replenish their stock and reduce the impact of lost sales as a result of stock outages, the Company, as needed, strategically increases its inventory levels held in its leased Anaheim, California warehouse. Combined with investment in new product molds, product testing and outside certifications, package design work, and further expansion of its design and engineering capabilities in CIHK, the Company may require additional working capital to fund these strategic projects.

The market price of CAPC Common Stock hinders the Company's ability to access capital markets, but the enhancement of Company's Common Stock's market price requires, in the Company's opinion, sustained profitability coupled with revenue growth.  Sustained profitability and revenue growth is deemed to be required to attract market maker and institutional support for CAPC Common Stock, which support the Company deems vital to any possible, sustained increase in the market price of our Common Stock.

The Company's ability to maintain sufficient working capital is highly dependent upon achieving expected operating results.  Failure to achieve expected operating results could have a material adverse effect on the Company's working capital, ability to obtain financing, and its operations in the future.  However, achieving expected results as accomplished in 2016, has increased working capital, provided the Company with liquidity and has allowed for the repayment of outstanding bank notes and some old related party loans.

Continued revenue growth and expanded product launches are critical requirements to ensure the Company's continued growth.  Such projects are never held back because of funding shortfalls.  The Company budgets for such projects and if necessary certain members of the Company's senior management and Board of Directors have supplemented the cash flow needs as required through short term loans.

Competitive Conditions

The consumer LED products and small electronics businesses are highly competitive and rapidly evolving markets, both in the United States and on a global basis, as large manufacturers with global operations compete for consumer acceptance and, increasingly, limited retail shelf space.  Competition is influenced by brand perceptions, product performance and value perception, customer service and price.  The Company's principal lighting competitors in the U.S. are Amertac, Energizer, and Feit Electric.  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 Wal-Mart offer lighting as part of their private branded product lines.  Many of the Company's competitors have substantially 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.  Moreover, if one or more of the Company's competitors were to merge, the change in the competitive landscape could adversely affect our customer distribution channel.

With trends and technology continually changing, Capstone will continue to invest and rapidly 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 as evidenced by our investment in Capstone Power Control (CPC) Technology.    Our ability to invest is limited by operational cash flow and funding from third parties, including members of management and the Board of Directors.

In North America, the Company is highly recognized in several product categories.  Capstone believes that the specialized nature of its existing niche categories, and the market share that it has provided has allowed us to introduce and launch its expanded LED Home Lighting programs.

The Company believes its multiple brand strategy is important in maintaining competitiveness in the marketplace. Capstone Lighting®, Hoover^® Home LED and Duracell^Ò  brands have proven successful in meeting Company's expectations at the point of sale.

Research, Product Development, and Manufacturing Activities

To successfully implement Capstone's business strategy, the Company must continually improve its current products and develop new LED products with additional functionality to meet consumer's expectations.  The Company's research and development department based in Hong Kong designs and engineers many of the Company's products, with collaboration from its third-party manufacturing partners.  Their focus is to introduce product with technology, increasing functionality, enhanced quality, efficient manufacturing processes and cost reductions.  CIHK also establishes strict engineering specifications and product testing protocols for the Company's contract manufacturers' factories and ensure the factories adhere to all Chinese Labor and Social Compliance Laws.  Under the current political regime in China, sudden and unexpected changes in such laws are possible and could impact the Company's business or financial performance by increasing the cost or ease of conducting business.

Capstone's research and development team ensures its proprietary manufacturing expertise by maintaining control over all outsourced production and critical production molds.  In order to ensure the quality and consistency of the Company's products manufactured in China, 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 employs quality control inspectors who examine and test products to Capstone's specification(s) before shipments are released.  CIHK office capabilities have now been expanded to include product development, project management, sourcing management, supply chain logistics, factory compliance auditing, and quality enforcement for all supplier factories located in Hong Kong and mainland China.

Capstone will continue to invest in this area as the Company expands the number of products being developed and as it moves into more technical and innovative product categories.

Raw Materials

The principal raw materials used by Capstone are sourced in 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.   In order to ensure the consistent quality of Capstone's 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 Company staff.

·

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 team conducts quality control tests at different points during the product stages of our manufacturing process to ensure that quality integrity is maintained.

·

Finished Goods – Our team 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 lower and competitive in the last year as a result of lower oil prices and the strengthening U.S. dollar. 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.  CIHK is responsible for developing and sourcing finished products from Asia in order to grow and diversify our product portfolio.  Quality testing for these products is performed both by CIHK and by our globally recognized third party quality testing laboratories.

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

The Company's   U.S. domestic warehousing and fulfilment needs are performed by a third-party warehousing facility situated in Anaheim, California.  The warehouse distributor 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 distributor 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 we need to establish an east coast distribution point.  This relationship will allow us to fully expand our U.S. distribution capabilities and services as required

Seasonality

Sales for household products and electronics are seasonally influenced, with increased purchases by consumers during the key holiday winter season of the fourth fiscal quarter, which requires increases in retailer inventories during the third fiscal quarter.  In addition, natural disasters such as hurricanes and tornadoes can create conditions that drive increased needs for portable power and spike power failure light sales.  Many retailers now recognize a storm preparedness period and the Company believes that it is well positioned to gain market share in these sales periods.  The Company's "Power Failure Solutions" products support this growing awareness.   As is true for our lighting products, the Power Failure Solutions faces competition from domestic and international companies, which includes competitors with greater resources, market share and brand recognition.  Based on sales history, the LED Home Lighting product offerings are not as influenced by seasonal factors and will provide a more normalized revenue stream during the year.

Intellectual Property

CAPC subsidiary, CAPI, owns a number of U.S. trademarks and patents which CAPC considers of substantial importance and which are used individually or in conjunction with other CAPC trademarks and patents.  These include the following trademarks: Timely Reader, Pathway Lights, Timely Reader Book lights with Timer and Auto Shut Off 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 on our Security Motion Activated Lights 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.  CAPC's ability to compete effectively in the power failure, portable lighting, and LED 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 relate primarily to lighting device improvements and manufacturing processes.

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 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.

Critical Accounting Policies

We believe that there have been no significant changes to our critical accounting policies during the six months ended June 30, 2017 as compared to those we disclosed in Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K, for the fiscal year ended December 31, 2016.

CONSOLIDATED OVERVIEW OF OPERATIONS

Revenue, net

For the 3 months ended June 30, 2017 and 2016, total net sales were approximately $10,219,500 and $8,902,200, respectively, an increase of $1,317,300 or 14.8 % from the previous year. During the quarter ended June 30, 2017 the Company provided approximately $256,100 in consumer promotional allowances compared to $0 allowances in the same quarter 2016.

For the 6 months ended June 30, 2017 and 2016, total net sales were approximately $16,971,700 and $10,980,400, respectively, an increase of $5,991,300 or 54.6 % from the previous year. During the 6 months ended June 30, 2017 the Company provided approximately $453,300 in consumer promotional allowances compared to approximately $770,600 allowances in the same period 2016.

In the 3 months and 6 months ended June 30, 2017 the Company continued to have a very strong revenue performance in the Accent Light Category in all three-brands including Duracell^Ò , Capstone Lighting® and Hoover^Ò HOME LED.  The Company had strong sales with the new product launches including the Gooseneck LED Lantern, the LED Spotlight Accent Light, Dual Mode Motion Security Light, the LED CPC bulb and the swivel base LED Accent Lights.  The nearly $6 million revenue increase in the six months compared to 2016 was achieved after the Company provided approximately $454,300 of marketing allowances for new product promotions and transitional allowances.  For the 6 months ended June 30, 2017, and 2016 International sales were approximately $1,080,800 or 6.4% of net revenue as compared to $1,550,700 or 14.1% of net revenue for the same period in 2016.

Cost of Sales

For the 3 months ended June 30, 2017 and 2016, cost of sales were approximately $7,576,700 and $6,773,500, respectively, an increase of $803,200 or 11.9 % from the previous year. This cost represents 74.1 % and 76.0% respectively of total net revenue for the quarter.

For the 6 months ended June 30, 2017 and 2016, cost of sales were approximately $12,749,400 and $8,238,100, respectively, an increase of $4,511,300 or 54.8 % from the previous year. This cost represents 75.1% and 75.0% respectively of total net revenue.

Manufacturing unit costs continued to remain very stable in the period as a result of effective volume buying with overseas factories, the steady price of oil and the continuing strength of the U.S. Dollar. The cost of sales percent to net revenue in the second quarter of 74.1% was 2.0% lower than in second quarter 2016. For the 6 months ended June 30, 2017 the percent cost of sales to net revenue at 75.1 was .1% higher than 2016

Gross Profit

For the 3 months ended June 30, 2017 and 2016, gross profit was approximately $2,642,900 and $2,128,700 respectively, an increase of $514,200 or 24.2 % from the same period in 2016. Gross profit as a percentage of sales was 25.9 % in the quarter compared to 24.0% for the same period in 2016.

For the 6 months ended June 30, 2017 and 2016, gross profit was approximately $4,222,300 and $2,742,300 respectively, an increase of $1,480,000 or 54% from the same period in 2016. Gross profit as a percentage of sales was 24.9% in the 6 months compared to 25.0% for the same period in 2016.

Operating Expenses

For the 3 months ended June 30, 2017 and 2016, total operating expenses were approximately $1,304,300 and $967,500 respectively, an increase of $ 336,800 or 34.8% as compared to same period in 2016.

For the 6 months ended June 30, 2017 and 2016, total operating expenses were approximately $2,496,300 and $1,622,200 respectively, an increase of $874,100 or 53.9% as compared to same period in 2016.

The following is a summary of the major expense variances by category in the 2017 period compared to 2016.

Sales and Marketing Expenses

For the 3 months ended June 30, 2017 and 2016, sales and marketing expenses were approximately $564,500 and $352,900 respectively, an increase of $211,600 or 60.0%. The Company has continued to invest heavily in its brands of Duracell^Ò , Capstone Lighting® and Hoover^Ò HOME LED. With the launch of 5 new products in the period and the resulting increased retail presence, we continue to develop consumer awareness of our product lines and brands. During the quarter, the sales and marketing expense increase resulted mainly from royalty license payments of $141,900 for the branded licenses that did not incurred last year and distribution of representative commissions that increased by $38,600 in 2017 from the previous year.

For the 6 months ended June 30, 2017 and 2016, sales and marketing expenses were approximately $941,300 and $415,800 respectively, an increase of $525,500 or 126.4 %.  Investment in the branded licenses of Duracell^Ò and Hoover^Ò HOME LED amounted to $344,000 in royalty payments that did not occur last year. Sales representative commissions also increased by $136,000 in 2017 from the previous year.

Compensation Expense

For the 3 months ended June 30, 2017 and 2016, compensation expense was approximately $353,900 and $316,000 respectively, an increase of $37,900 or 12.00 %.

For the 6 months ended June 30, 2017 and 2016, compensation expense was approximately $713,700 and $624,500 respectively, an increase of $89,200 or 14.3%.

Compensation expense increased as a result of performance based salary adjustments during the period.

Professional Fees

For the 3 months ended June 30, 2017 and 2016, professional expenses were approximately $115,400 and $71,100 respectively, an increase of $44,300 or 62.3 %.

For the 6 months ended June 30, 2017 and 2016, professional expenses were approximately $320,200 and $175,300 respectively, an increase of $144,900 or 82.7%.

The increased expense in the period resulted from hiring of an investment banker, increased investor relations including managements' attendance at various investor shows, accounting fees and engaging the services of a sales consultant to support the U.S. sales office marketing effort.

Product Development Expenses

For the 3 months ended June 30, 2017 and 2016, product development expenses were approximately $66,400 and $63,900 respectively, an increase of $2,500 or 3.9 %.

For the 6 months ended June 30, 2017 and 2016, product development expenses were approximately $138,500 and $100,200 respectively, an increase of $38,300 or 38.2 %.

The expense increase resulted from new product prototype development including testing and certification costs related to expansion of our product categories. We also incurred additional costs related to artwork and package design and patent and trademark services.

Other General and Administrative

For the 3 months ended June 30, 2017 and 2016, other general and administrative expenses were approximately $204,100 and $163,700 respectively, an increase of $40,400 or 24.7%.

For the 6 months ended June 30, 2017 and 2016, other general and administrative expenses were approximately $382,700 and $306,400 respectively, an increase of $76,300 or 24.9%.

The expense increase is the result of increased Sterling Bank processing fees and general insurance liability premiums associated with the higher revenue levels and increased travel expenses related to sales activities during the period. We also incurred higher freight courier services resulting from the increase volume of new product samples coming from overseas.

Net Operating Income

For the 3 months ended June 30, 2017 the operating income was approximately $1,338,500 compared to $1,161,200 in 2016. This is an improved performance of $177,300 or 15.3% over the same period 2016.

For the 6 months ended June 30, 2017 the operating income was approximately $1,726,000 compared to $1,120,000 in 2016. This is an improved performance of $606,000 or 54.1% over the same period 2016.

Interest Expense

For the 3 months ended June 30, 2017 and 2016, interest expense was approximately $35,200 and $66,400, respectively, for a reduction of $31,200 or 47.0% as compared to the same period in 2016.

For the 6 months ended June 30, 2017 and 2016, interest expense was approximately $56,900 and $124,200, respectively, for a reduction of $67,300 or 54.3% as compared to the same period in 2016.

Despite having a substantial revenue growth during the quarter, we have been able to curtail the need for increased borrowing, through efficient daily cash management and by negotiating favorable payment terms with our overseas suppliers, which has substantially reduced the need and cost for purchase order funding. With the increased cash flow resulting from operational profits in 2017, we have also been able to substantially reduce old director loans which also reduced the interest expense.

Income Before Tax Provision

For the 3 months ended June 30, 2017, the Company had income before tax of approximately $1,303,400 as compared to an income of $1,094,800 in the same quarter last year.  That is an increase of $208,600 or 19.1%. Income before tax as a percentage of net sales was 12.8% in the quarter compared to 12.3% in the same quarter 2016.

For the 6 months ended June 30, 2017, the Company had income before tax of approximately $1,682,000 as compared to income of approximately $995,900 in the same period last year. That is an increase of $686,100 or 68.9%. Income before tax as a percentage of net sales was 9.9% in the period compared to 9.1% in the same period 2016.

Provision for Income Tax

For the 3 months ended June 30, 2017 and 2016, the provision for income tax was approximately $402,000 and $12,600, respectively, an increase of $389,400 compared to last year, As the Company has now offset its previous year's Net Operating Losses, the Company must now provide for future income tax expense.

For the 6 months ended June 30, 2017 and 2016, the provision for income tax was approximately $530,000 and $12,600, respectively, an increase of $517,400 compared to last year.

Net Income

For the 3 months ended June 30, 2017, the Company had a net income of approximately $901,363 as compared to a net income of $1,082,200 in the same period last year.

For the 6 months ended June 30, 2017, the Company had a net income of approximately $1,152,000 as compared to a net income of $983,300 in the same period last year.

The overall net income improvement for the 6 months ended June 30, 2017 of $168,700 or 17.2% as compared to 2016, was the result of the $5,991,300 increase in net revenue which resulted in an increased gross profit of $1,480,000 or 54%. This record performance was achieved after the Company provided for $454,300 of marketing and transitional allowances and increased operating expenses of $874,100 mainly resulting from the higher revenues. Approximately $344,000 of the increased operating expenses were invested for future revenue growth, by the marketing of our products through the expansion of our branded licenses. During the 6 months ended June 30, 2017, the Company also provided for an increased tax provision of $485,300 higher than in 2016 that also reduced the net income for the period.

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 6 months ended June 30, 2017.

LIQUIDITY AND CAPITAL RESOURCES

The Company's borrowing capacity with Sterling National Bank, favorable payment terms with vendors, funding support from certain Company Directors and cash flow from operations provide the Company with the financial resources needed to run operation's and reinvest in our business.

Operating Activities

Cash flow provided by operating activities was approximately $15,700 in the 6 months ended June 30, 2017 compared with approximately $1,619,000 used in operating activities in the same period 2016.  In the six months, the Net income of approximately $1,152,000, and a $99,100 decrease in Inventory helped to offset cash usage resulting from a $1,032,600 increase in prepaid expenses.

The Company's cash flow from operations is 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.  Sales are influenced significantly by the timing and launch of new products into the marketplace. With the establishment of our Hong Kong operation we have built an operational structure that, through relationships with factory-suppliers combined with our internal expertise, can develop and release quality products to market substantially quicker than we have been able to accomplish in previous years

Investing Activities

Cash used for investing activities for the 6 months ended June 30, 2017 was approximately $14,800 compared to $4,700 in 2016.  The Company continues to invest in new product molds and tooling.  With the product expansion into new LED home lighting categories, the Company's future capital requirements will increase.  Our Hong Kong management team has the task of negotiating favorable payment terms with factories which will reduce the amounts of upfront cash required to have available when initiating a new project.  Management believes that our cash flow from operations and additional borrowing will provide for these necessary capital expenditures.

Financing Activities

Cash used in financing activities for the six-months ended June 30, 2017 was approximately $473,000 compared to $1,559,200 provided by financing activities in the same period 2016. During the period ended June 30, 2017, the Company repurchased and retired $250,000 of Company shares from Involve, LLC and paid off $223,000 of Directors loans outstanding since 2010 and 2013 including all accrued interest. The Company was also able to maintain the Sterling Bank loan at $0 balance despite the large sales volume increase. The cash balance at June 30, 2017 was approximately $1,174,000 which is a $472,100 reduction from December 31, 2016.

Our ability to maintain sufficient liquidity is highly dependent upon achieving expected operating results. Failure to achieve expected operating results could have a material adverse effect on our liquidity, our ability to obtain financing, and our operations in the future.

At June 30, 2017, the Company was in compliance with all agreements pursuant to existing credit facilities.  Management believes that our cash flow from operations, continued support from Sterling National Bank and support of certain of our Directors will provide sufficient financial resources for the Company during 2017.

Directors and Officers Insurance: The Company currently operates with Directors and Officers insurance and the Company believes the coverage is adequate to cover likely liabilities under such a policy.

Impact of Inflation: The Company's major expense has been the cost of selling and marketing product lines to customers in North America.  That effort involves mostly sales staff traveling to make direct marketing and sales pitches to customers and potential customers, trade shows around North America and visiting China to maintain and seek to expand distribution and manufacturing relationships and channels. With the current reduced price of world oil, although labor costs are continuing to increase, the Company expects costs to remain stable with the Chinese manufacturers. The Company generally has been able to reduce cost increases by negotiating volume purchases or re-engineering products. With our Hong Kong office firmly established, the Company expects that prices will remain steady through 2017.

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.  Consequently, the Company is subject to a number of significant risks associated with manufacturing in China, 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; and

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 period ended June 30, 2017.

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.

Not applicable.

Evaluation of disclosure controls and procedures.  The Company maintains "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act that are designed to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable assurance of achieving the desired control objectives, and we necessarily are required to apply our judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures.

Our management, including our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2016 and concluded that the disclosure controls and procedures were effective under Rules 13a-15(e) and 15d-15(e) under the Exchange Act and as of June  30, 2017, to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in Commission regulations and forms and (ii) accumulated and communicated to the Company's management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosures.

Changes in internal controls:  There were no changes in our internal controls over financial reporting that occurred during the three months covered by this quarterly report on Form 10-Q or "Report" that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

The certifications of our Chief Executive Officer and Chief Financial Officer attached as Exhibits 31 and 32 and to this Report include information concerning our disclosure controls and procedures and internal control over financial reporting. Such certifications should be read in conjunction with the information contained in Item 4, including the information incorporated by reference to our annual report on Form 10-K for the fiscal year ended December 31, 2016, for a more complete understanding of the matters covered by such certifications.

PART II — OTHER INFORMATION

The Company is not a party to any material 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.

The only material changes in the risk factors from our Form 10-K for the fiscal year ended December 31, 2016 are:

Economic conditions that impact the Company can also be impacted by labor strikes. Labor strikes at West Coast ports by longshoreman and truckers servicing those ports can adversely impact shipment of our products to the U.S.  Such West Coast port strikes occurred in 2015 with the International Longshore and Warehouse Union and in 2016 with truck drivers of companies that move goods out of the West Coast ports

Liquidity - Our ability to maintain sufficient liquidity is highly dependent upon achieving expected operating results. Failure to achieve expected operating results could have a material adverse effect on our liquidity, our ability to obtain financing and our operations in the future.  The Company's liquidity is expected to be sufficient through fiscal year 2017, resulting from the combination of our existing cash position, improved operational cash flow as a result of improvements to our operating results, the Company's borrowing capacity with Sterling National Bank and as needed, funding support from certain Company Directors (see Notes 4 and 5 to the financial statements contained in this report).

Potential Military Conflict between the U.S. and North Korea.  Such conflict could adversely impact U.S.-Chinese economic and trade relationships. As of the date of this report, it is uncertain as to the likelihood of such conflict and potential consequences if such conflict did occur.

There were no unregistered issuances of Company securities in the quarter ending June 30, 2017.

None.

Not Applicable.

None.

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:    August 14, 2017