CAPSTONE COMPANIES, INC. - Quarter Report: 2018 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, 2018

__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 3, 2018, there were 47,046,364 shares of the issuer's Common Stock, $0.0001 par value per share, issued and outstanding.

CAPSTONE COMPANIES, INC.

Quarterly Report on Form 10-Q

Three Months and Six Months Ended June 30, 2018

TABLE OF CONTENTS

 

CAPSTONE COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
		June 30,				December 31,
		2018				2017
Assets:		(Unaudited)
Current Assets:
Cash		$	2,760,994			$	3,668,196
Accounts receivable, net			2,023,474				4,367,721
Other receivables			78,250				-
Inventories			8,316				140,634
Prepaid expenses			787,165				239,150
Income tax refundable			346,912				-
Total Current Assets			6,005,111				8,415,701
Property and Equipment:
Computer equipment and software			52,649				9,895
Machinery and equipment			395,600				318,801
Furniture and fixtures			11,834				5,665
Less: Accumulated depreciation			(285,262	)			(266,997	)
Total Property & Equipment			174,821				67,364
Other Non-current Assets:
Deposit			14,312				13,616
Goodwill			1,936,020				1,936,020
Total Other Non-current Assets			1,950,332				1,949,636
Total Assets		$	8,130,264			$	10,432,701
Liabilities and Stockholders' Equity:
Current Liabilities:
Accounts payable and accrued liabilities		$	1,510,687			$	2,733,516
Income tax payable			11,694				624,782
Total Current Liabilities			1,522,381				3,358,298
Long Term Liabilities:
Deferred tax liabilities			269,000				251,000
Total Long Term Liabilities			269,000				251,000
Total Liabilities			1,791,381				3,609,298
Commitments and Contingencies (Note 4)
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 47,046,364 shares			4,704				4,704
Additional paid-in capital			7,063,302				7,005,553
Accumulated deficit			(729,123	)			(186,854	)
Total Stockholders' Equity			6,338,883				6,823,403
Total Liabilities and Stockholders' Equity		$	8,130,264			$	10,432,701
The accompanying notes are an integral part of these consolidated financial statements.

 

CAPSTONE COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
		For the Three Months Ended								For the Six Months Ended
		June 30,								June 30,
		2018				2017				2018				2017
Revenues, net		$	2,103,206			$	10,219,548			$	6,163,374			$	16,971,744
Cost of sales			1,742,486				7,576,685				4,783,384				12,749,413
Gross Profit			360,720				2,642,863				1,379,990				4,222,331
Operating Expenses:
Sales and marketing			115,547				564,519				478,608				941,275
Compensation			369,749				353,904				744,858				713,706
Professional fees			142,900				115,381				291,786				320,183
Product development			123,766				66,447				290,332				138,473
Other general and administrative			166,676				204,063				340,965				382,681
Total Operating Expenses			918,638				1,304,314				2,146,549				2,496,318
Operating  Income (Loss)			(557,918	)			1,338,549				(766,559	)			1,726,013
Other Income (Expense):
Miscellaneous income			147,290				-				147,290				-
Interest income			-				-				-				12,945
Interest expense			-				(35,186	)			-				(56,917	)
Total Other (Expense)			147,290				(35,186	)			147,290				(43,972	)
Income (Loss) Before Tax Provision (Benefit)			(410,628	)			1,303,363				(619,269	)			1,682,041
Provision (Benefit) for Income Tax			(59,000	)			402,000				(77,000	)			530,000
Net Income (Loss)		$	(351,628	)		$	901,363			$	(542,269	)		$	1,152,041
Net Income (Loss) per Common Share
Basic		$	(0.007	)		$	0.019			$	(0.012	)		$	0.024
Diluted		$	(0.007	)		$	0.019			$	(0.012	)		$	0.024
Weighted Average Shares Outstanding
Basic			47,046,364				46,694,058				47,046,364				47,155,592
Diluted			47,046,364				47,055,446				47,046,364				47,473,829
The accompanying notes are an integral part of these consolidated financial statements.

 

CAPSTONE COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
		For the Six Months Ended
		June 30,
		2018				2017
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)		$	(542,269	)		$	1,152,041
Adjustments necessary to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization			18,266				35,551
Accrued interest on note receivable			-				(12,945	)
Stock based compensation expense			57,750				40,950
Provision for deferred income tax			18,000				138,000
Increase (decrease) in accrued sales allowance			41,645				(20,848	)
(Increase) decrease in accounts receivable, net			2,302,602				(450,713	)
(Increase) other receivables			(78,250	)			-
Decrease in inventories			132,318				99,064
(Increase) in prepaid expenses			(548,017	)			(1,032,565	)
(Increase) in deposits			(696	)			-
Increase (decrease) in accounts payable and accrued liabilities			(1,222,828	)			111,954
(Decrease) in income tax payable			(613,088	)			-
(Increase) in income tax refundable			(346,912	)			-
(Decrease) in accrued interest on notes payable			-				(44,837	)
Net cash provided by (used in) operating activities			(781,479	)			15,652
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment			(125,723	)			(14,784	)
Net cash (used in) investing activities			(125,723	)			(14,784	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable			11,347,367				16,566,081
Repayments of notes payable			(11,347,367	)			(16,566,081	)
Repurchase of shares from Involve, LLC			-				(250,000	)
Repayments of notes and loans payable to related parties			-				(223,000	)
Net cash (used in) financing activities			-				(473,000	)
Net (Decrease) in Cash and Cash Equivalents			(907,202	)			(472,132	)
Cash and Cash Equivalents at Beginning of Period			3,668,196				1,646,128
Cash and Cash Equivalents at End of Period		$	2,760,994			$	1,173,996
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest		$	-			$	101,755
Income taxes		$	865,000			$	371,500
The accompanying notes are an integral part of these consolidated financial statements.

CAPSTONE COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	June 30,				December 31,
	2018				2017
Trade Accounts Receivables at period end		$	2,259,180			$	4,561,782
Reserve for estimated marketing allowances, cash discounts and other incentives			(235,706	)			(194,061	)
Total Accounts Receivable, net		$	2,023,474			$	4,367,721

		June 30,				December 31,
		2018				2017
Balance at beginning of the period		$	(194,061	)		$	(1,200,792	)
Accrued allowances			(62,280	)			(921,833	)
Reversal of prior year accrued allowances			1,749				58,867
Expenditures			18,886				1,869,697
Balance at period-end		$	(235,706	)		$	(194,061	)

		3 months ended				3 months ended
		June 30, 2018				June 30, 2017
Basic weighted average shares outstanding			47,046,364				46,694,058
Dilutive warrants			-				361,388
Diluted weighted average shares outstanding			47,046,364				47,055,446

		6 months ended				6 months ended
		June 30, 2018				June 30, 2017
Basic weighted average shares outstanding			47,046,364				47,155,592
Dilutive warrants			-				318,237
Diluted weighted average shares outstanding			47,046,364				47,473,829

	For the 3 Months Ended June 30, 2018												For the 3 Months Ended June 30, 2017
	Capstone Brand				License Brands				Total Consolidated				Capstone Brand				License Brands				Total Consolidated
Lighting Products- U.S.		$	1,693,480			$	264,472			$	1,957,952			$	2,597,529			$	7,125,295			$	9,722,824
Lighting Products-International			31,080				114,174				145,254				496,724				-				496,724
Total Revenue		$	1,724,560			$	378,646			$	2,103,206			$	3,094,253			$	7,125,295			$	10,219,548

	For the 6 Months Ended June 30, 2018												For the 6 Months Ended June 30, 2017
	Capstone Brand				License Brands				Total Consolidated				Capstone Brand				License Brands				Total Consolidated
Lighting Products- U.S.		$	1,841,781			$	3,859,253			$	5,701,034			$	3,304,724			$	12,586,213			$	15,890,937
Lighting Products-International			196,974				265,366				462,340				1,080,807				-				1,080,807
Total Revenue		$	2,038,755			$	4,124,619			$	6,163,374			$	4,385,531			$	12,586,213			$	16,971,744

		June 30,				December 31,
		2018				2017
Balance at the beginning of the period		$	328,279			$	294,122
Amount accrued			41,871				940,291
Amount expensed			(175,765	)			(906,134	)
Balance at period-end		$	194,385			$	328,279

		June 30,				December 31,
		2018				2017
Accounts payable		$	1,186,462			$	2,132,894
Accrued warranty reserve			194,385				328,279
Accrued compensation, benefits, commissions and other expenses			129,840				272,343
Total accrued liabilities			324,225				600,622
Total		$	1,510,687			$	2,733,516

		Net Revenue %							Net Accounts Receivable
		For the Six Months ended							As of				As of
		June 30,							June 30,				December 31,
		2018				2017			2018				2017
Customer A			51.6	%			50.2	%		$	2,232,854			$	2,259,769
Customer B			44.5	%			49.1	%			-				2,268,426
Total			96.1	%			99.3	%		$	2,232,854			$	4,528,195

		Purchases %							Accounts Payable
		For the Six Months ended							As of				As of
		June 30,							June 30,				December 31,
		2018				2017			2018				2017
Vendor A			92.3	%			97.1	%		$	1,115,720			$	922,310
Vendor B			-	%			-	%			-				768,164
Total			92.3	%			97.1	%		$	1,115,720			$	1,690,474

		2018				2017
Current:
Federal		$	(53,000	)		$	392,000
State			(15,000	)			-
Deferred:
Federal			8,500				10,000
State			500				-
Income Tax Provision (Benefit)		$	(59,000	)		$	402,000

		2018				2017
Current:
Federal		$	(74,000	)		$	392,000
State			(21,000	)			-
Deferred:
Federal			17,000				138,000
State			1,000				-
Income Tax Provision (Benefit)		$	(77,000	)		$	530,000

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 and with our annual report on Form 10-K for the fiscal year ended December 31, 2017. In addition to historical information, the following discussion contains certain forward-looking statements. 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 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. 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, 2017, 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 or current results. 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 3, 2018, the Common Stock was trading at $.21 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, the following terms have the stated meanings.

(1)	"Capstone Lighting Technologies, L.L.C." or "CLTL" is a Florida limited liability company and a wholly owned subsidiary of Capstone Companies, Inc.

(2)	"Capstone International Hong Kong Ltd" or "CIHK" is a company organized under Hong Kong SAR laws and 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, unless the context indicates otherwise.

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

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

(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)	"Subsidiaries" means the above wholly owned subsidiaries of the Company.

(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.

General.

The Company 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, quoted 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, 2017, as filed with the Commission on March 28, 2018.

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, N.E., 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 or other websites referenced herein 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, 2018 compared with the same period in 2017 and (ii) financial liquidity and capital resources.

Capstone Companies, Inc. is a public holding company organized under the laws of the State of Florida.  The Company is engaged in the business of developing, marketing, manufacturing and selling consumer products through national and regional retailers in North America and in certain overseas 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 the Company's product development, engineering and factory resource capabilities in Hong Kong. Capstone's products have been to date targeted for applications such as home indoor and outdoor lighting.  The Company's current product portfolio consists of stylish, innovative and easy to use consumer LED lighting products.  The Company's products are currently sold under the CAPI brand name, Capstone Lighting®, as well as under nationally recognized licensed brands-named Hoover^® Home LED and Duracell^®.   LEDs are now mainstream in consumer lighting products, and, as such, the Company believes that the component and production costs of LED lighting products will continue to lower due to technological and production developments, which should allow the Company to compete through its innovations and branding that capitalize on products utilizing LED.  The Company's focus is the integration of LED into most commonly used lighting products in today's home. We continue to make key investments to ensure that we provide quality LED lighting products. The Company understands and strives to couple well made products with superior customer service.  Customer service is a vital part of consumer loyalty.  Capstone believes that it is positioned well to participate in these expanded product categories designed to fuel the Company's future 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 revenue growth to the Company's retail partners.  Whereas the Company's strengths have been demonstrated through the successful executions of its strategic initiatives which have focused on LED lighting products.  It believes it is well positioned to exploit categories outside LED lighting that also benefit from the proven strengths of the Company's management team.  Creating and exploiting niche consumer product categories, through advanced design and low-cost manufacturing are the core competencies of the Company.

The Company oversees and controls the manufacturing of its products, which are currently made in China by original equipment manufacturers ("OEM"), through three wholly-owned operating subsidiaries: CAPI, CIHK and CLTL.  Capstone believes it has commercially favorable payment terms with its OEM's which terms helps support the Company's growth.  The Company's direct import business model requires that product shipments meet minimum order quantity or "MOQ" full container loads from OEM's 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 typically 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.  The Company explores alternative manufacturing sources in China and elsewhere in the Pacific Rim as part of its ongoing supply chain strategic planning.

Strategy

Over the past ten years the global lighting market has undergone a transition driven by rapid advancements in the performance, efficiency and cost 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). As the cost of LEDs decreased, and while performance improvements were made, LED technology has expanded its share of the general illumination market.  The Company continues to explore other technologies that, like LED, could rapidly and effectively be integrated into traditional product categories providing users advantages in their daily life activities.

Target Markets:  Our objective is to become recognized as a leading-edge consumer products company, based on "Rapidly Integrating Technologies into Consumer Products."

·	As the LED lighting market begins to show signs of stabilizing and moderate growth, the Company plans to continue to strengthen its relationships and expand into other departments and other channels of distribution through its relationships and product line expansions.

·	We plan to continue to refine and improve our products portfolio and expand into other product segments through focused investment into the Company's research and development efforts.

·

By introducing new products and expanding sales of existing products and continuing to increase our sales volumes, we believe that we can continue to improve operational efficiency by further reducing cost of materials, components and manufacturing costs, allowing us to maintain very competitive price points in the market place.

Perceived or Essential Strengths

Capstone believes that the following competitive strengths have and will continue to serve as a foundation for its business strategy:

Capstone believes that the specialized nature of its existing product portfolio and its relative market share has provided a platform for successful introductions of future product segments.

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

Capstone's core executive team has been working together for over three decades and has built and managed other consumer product companies.  Operating Management's experience in hardline product manufacturing and marketing prepared the Company for its entry into the LED market.

Product Quality: We offer quality products allowing consumers to maximize the benefits of adopting LED products. We design, manufacture through OEM's and sell quality and reliable products across all of our brands with functional advantages that are deemed to be cost competitive. We achieve this, in part, through a combination of sourcing skills, stringent manufacturing quality control and conducting rigorous third-party product testing. To deliver cost-competitive products, we are investing in product advancements, leveraging purchasing volume, capitalizing on strategic vendor relationships and migrating high-volume products to our proprietary design.

The Company's product characteristics and design criteria are:

·	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.

Authoritative Knowledge: We emphasize employees and manufacturers with extensive knowledge, understanding and experience of technology, and regulatory environments that enables us to continue to provide superior quality products and service for our customers.  Our management team has demonstrated its ability to drive organic growth.

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 products 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 OEM 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's operation in Hong Kong, has 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 possible Company growth, we have continued our investment in CIHK by contracting additional engineering and software development services, expanding our relationships with testing and certification facilities and hiring additional operations support in an effort to ensure that the overseas factory performance meets our stringent operational tolerances to maintain our product quality, competitiveness and operational excellence.

Perceived Weaknesses.

Capstone believes that its competitive weaknesses are:  (1) it does not possess the business, marketing and financial resources of its larger competitors; (2) it does not have an extensive or aggressive Social Media marketing program or its own e-commerce capability; (3) it sells a niche consumer product that is sensitive to a drop in consumer discretionary spending and general economic conditions affecting consumer confidence; (4) its products lines are focused on a niche consumer LED lighting;  (5) profitability may be limited by attainable profit margins from consumer lighting products; (6) Capstone does not have the large internal research and development capability of its larger competitors; (7) Capstone operates with a limited number of employees who are dedicated to executive management, sales and marketing or administrative support; and (8) we rely on our OEM's for product production. As a smaller reporting company, we also face the challenges of a smaller enterprise competing in global markets and dependent on Chinese OEM's for production.

Products and Customers

The Company has expanded its product positioning through the introduction of more indoor and outdoor lighting programs under the "Capstone Lighting®", Hoover^® Home LED and Duracell^® brands and include the following products that are reported under one segment: Lighting Products:

·	Wireless Remote-Controlled LED Accent Lights

·	LED Under Cabinet Lights

·	LED Vanity Mirror

·	LED Gooseneck Lantern

·	LED Dual Mode Security Light

·	LED Solar Patio Lights

·	LED Motion Sensor Lights

·	LED Wall Utility Lights

·	CPC Power Failure Bulbs

·	Wireless Remote-Control Outlets

Such product 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, 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 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.  International sales for the six months ended June 30, 2018 were $462.3 thousand or 7.5% of net revenue as compared to $1.081 million or 6.4% in the same period 2017. 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 its segment of LED home lighting and security lighting segments. The Company's performance depends on a number of assumptions and factors.  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 products are subject to general economic conditions that impact discretionary consumer spending on non-essential items.

Tariffs. The Company is facing uncertainty relative to the ongoing competitive pricing position it has been recognized for.  The current U.S. administration has threatened and has implemented certain tariffs that directly affect the Company's competitiveness.  While all companies are affected equally, the appeal for these products to consumers may be negatively impacted when retail prices are increased due to higher duty rates.  The Company has seen promotional schedules cut back and retailers have expressed concerns for possible pricing adjustments that would not be known to them in advance to products being shipped.  Capstone's 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 or threatened by the current U.S. administration has provoked and may provoke future trade and tariff retaliation by other countries. A "trade war" 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.

With the Company's branded lighting categories, Capstone has a comprehensive product offering for its niche in the consumer lighting industry.  The Company believes that it will provide retailers with a broader and more diversified portfolio of consumer products across product categories, which should add diversity to the Company's revenues and cash flows sources.  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 ability to serve retailers with an 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

We continue to make investments to expand our sales, marketing, technical applications support and distribution capabilities to sell our products. We currently market and sell our LED products through our internal sales team and agency networks. Generally, our agencies are recruited, trained and monitored by us directly. We maintain a firm policy on the use of our name for branding our LED lighting products. 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 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.

The Company depends on Amazon.com and other retail e-commerce sites as they are the most cost efficient and effective approach for the Company. We maintain a Facebook¹ 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 promoters.  The growing importance of Social Media may require the Company to develop a more aggressive or extensive plan for using Social Media as a marketing tool.

¹ Facebook is a registered trademark of Facebook, Inc

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 consumer lighting product competitors in the U.S. are Energizer, Feit Electric and Jasco (GE).  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 consumer lighting products 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.  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.

Research, Product Development, and Manufacturing Activities

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 OEM manufacturing partners.  We outsource the manufacture and assembly of our products to a number of contract manufacturers overseas. CIHK's 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.

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 lot testing is conducted at the contract manufacturers facility and also at 3^rd party testing laboratories overseas.

The Company'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, the Company 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 the Company'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.

To successfully implement the Company's business strategy, the Company must continually improve its current products and develop new product segments with innovative imbedded technologies to meet consumer's growing expectations.

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.  These costs are expensed when incurred and are included in the operating expenses.

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 distribution needs are provided by 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.

Royalties

We have, from time to time, entered into agreements whereby we have agreed to pay royalties for the use of nationally recognized licensed brands on Company product offerings. Royalty expense incurred under such agreements is expensed at the time of shipment.

Royalty expenses related to such agreements for the three months ended June 30, 2018 and 2017 were $17,074 and $296,215 respectively.

Royalty expenses for the six months ended June 30, 2018 and 2017 were $186,337 and $529,228 respectively.

Seasonality

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. Historically, the LED products had seasonally lower sales during the first quarter due to the Chinese New Year holiday as factories are closed and shipments are halted during this period.

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: 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, Spot Lights, 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.  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 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 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 these rights and determine whether to litigate to protect our intellectual property rights on a case by case basis. Enforcement of intellectual property rights in China is problematic.

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.

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. Our information technology systems are also vulnerable to damage or interruption from:

·	hurricanes, fire, flood and other natural disasters;

·	power outages; and

·	internet, telecommunications or data network failure.

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.

Working Capital Requirements and Financing

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 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 2017 and 2016, has increased working capital, provided the Company with liquidity and has allowed for the repayment of all outstanding bank notes and old related party loans.

Continued product expansion are critical requirements to ensure the Company's continued revenue 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.

On September 8, 2010, in order to support working capital needs, Capstone secured a Financing Agreement from Sterling Capital Funding (now called Sterling National Bank), located in New York, whereby Capstone receives funds for assigned retailer shipments. The assignments provide funding for an amount up to 85% of net invoices submitted.  There was a base management fee equal to .45% of the gross invoice amount. The interest rate of the loan advance is .25% above Sterling National Bank's Base Rate which at the time of closing was 5%.

As of June 30, 2018, the base management fee is now equal to .30% and the interest rate charged on a loan balance was 6.25%. The amounts borrowed under this agreement are due on demand and secured by a right to set-off on or against any of the following (collectively as "Collateral"): all accounts including those at risk, all reserves, instruments, documents, notes, bills and chattel paper, letter of credit rights, commercial tort claims, proceeds of insurance, other forms of obligations owing to Sterling National Bank,  bank and other deposit accounts whether or not reposed with affiliates, general intangibles (including without limitation all tax refunds, contract rights, trade names, trademarks, trade secrets, customer lists, software and all other licenses, rights, privileges and franchises), all balances, sums and other property at any time to our credit or in Sterling National Bank's possession or in the possession of any Sterling National Bank affiliates, together with all merchandise, the sale of which resulted in the creation of accounts receivable and in all such merchandise that may be returned by customers and all books and records relating to any of the foregoing, including the cash and non-cash proceeds of all of the foregoing.

The Sterling National Bank credit facility over the years has been a major contributing factor that has allowed the Company to increase its revenue and expand its account receivables.

As of both June 30, 2018 and December 31, 2017, the balance due to Sterling National Bank was $0.

As of June 30, 2018, the maximum amount that could be borrowed on this credit line was $7,000,000.

On July 20, 2018, in order to support the Company's future needs, Sterling National Bank expanded the credit line from $7,000,000 up to $10,000,000 of which $2,000,000 has been allocated as a working capital line to support Capstone's expansion.

The Company's liquidity and cash requirements are discussed more fully in the Management's Discussion and Analysis of Financial Condition and Results of Operations, below.

Critical Accounting Policies

We believe that there have been no significant changes to our critical accounting policies during the six months ended June 30, 2018 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, 2017.

CONSOLIDATED OVERVIEW OF RESULTS OF OPERATIONS

Net Revenues

Revenue is derived from sales of our residential LED 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 sales contractual arrangements. Each contract on acceptance will have a fixed unit price. The majority of our sales are to the U.S. market which in 2017 represented 95.1% of net revenue and 92.5 % in the six months ended June 30, 2018. We expect that the U.S. region will continue to be the major source of revenue for the Company. However, we also derive a portion of our revenue from overseas.  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, 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 licensed brands royalties, 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

Net Revenues

For the three months ended June 30, 2018 and 2017, net revenues were $2.1 million and $10.2 million, respectively, a decrease of $8.1 million.

For the six months ended June 30, 2018 and 2017, net revenues were $6.2 million and $17.0 million, a decrease of $10.8 million.

In the six months ended June 30, 2017, the Accent LED light category was at the height of its retail life cycle. Combined, the Capstone Lighting, Duracell and Hoover^Ò Home brands accent lights accounted for $10.9 million of net revenue in that period. The Duracell brand accounted for $6.4 million of those 2017 sales which was a limited one-year program as determined by the retailer. It was expected that if the Duracell branded product had achieved very strong product sell through at retail then the program would have been extended for an additional year. The Duracell brand did not perform as well at retail and as a result the program started to wind down in 2018 and subsequently generated $1.0 million of sales as of June 30, 2018. This represented a $5.4 million decrease in revenue compared to the same period in 2017.

During the six months ended June 30, 2017, the other Accent LED light brands accounted for $4.5 million of net revenue. With the ending of this product's life cycle that had been in the market for several years, net revenue during the six months ended June 30, 2018 was $100 thousand a reduction of $4.4 million from the same period in 2017.

The combined reduction in the Accent Light category accounted for $9.8 million of the $10.8 million revenue reduction in the period.

As the remaining on hand inventories at retail for these products was extensive, the transition into new product launches was delayed by the retail buyers in order to balance out their inventories.

During the first half 2018, the Company shipped 4 new product launches compared to 5 product launches in the same period 2017.

During the three months ended June 30, 2018 and 2017, the Company provided retailers with $417.5 thousand and $212.6 thousand, respectively, of product marketing funds and allowances.

During the six months ended June 30, 2018 and 2017, the Company provided retailers with $443.0 thousand and $473.8 thousand, respectively, of product marketing funds and allowances.

The following table disaggregates net revenue by major source:

Gross Profit and Cost of Sales

Gross profit for the three months ended June 30, 2018 and 2017, was approximately $360.7 thousand, and $2.643 million, respectively. With the reduced revenue, gross profit decreased by $2.282 million or 86.4% in the period. The gross margin percentage for Lighting Products decreased to 17.2% from 25.9 % in 2017.

Gross profit for the six months ended June 30, 2018 and 2017 was approximately $1.380 million and $4.222 million, a reduction of $2.842 million or 67.3% because of the revenue decrease in the period. The gross margin percentage for Lighting Products in the six months decreased to 22.4% compared to 24.9% in 2017.

Operating Expenses

Sales and Marketing Expenses

For the three months ended June 30, 2018, and 2017, sales and marketing expenses were $115.5 thousand and $564.5 thousand respectively, a reduction of $449 thousand or 79.5%. During the quarters with the reduced revenue resulting from the end of life cycle for specific Lighting products including Duracell^® and Hoover^® branded products, royalty payments to TTI Floor Care for the Hoover^® license for the three months were $14.3 thousand and $206.1 thousand, respectively, a reduction of $191.8 thousand or 93.1%. Duracell^® license royalties for the same period were $2.8 thousand and $90.1 thousand, respectively, a reduction of $87.3 thousand or 96.9%.  Sales Representative commission payments were also reduced in the period from $132.2 thousand in 2017 to $4.1 thousand in 2018 a reduction of $128.1 thousand or 96.9%.

For the six months ended June 30, 2018, and 2017, sales and marketing expenses were $478.6 thousand and $941.3 thousand respectively, a reduction of $462.7 thousand or 49.2%. During the six month periods with the reduced revenue, royalty payments to TTI Floor Care for the Hoover^® license were $156.5 thousand and $379.1 thousand, respectively, a reduction of $222.6 thousand or 58.7%. Duracell^® license royalties for the same period was $29.8 thousand and $150.1 thousand, respectively, a reduction of $120.3 thousand or 80.1%.  Sales Representative commission payments were $97.8 thousand and $229.0 thousand, a reduction of $131.2 thousand or 57.3%.

Compensation Expenses

For the 3 months ended June 30, 2018, and 2017, compensation expenses were approximately $369.7 thousand and $353.9 thousand respectively, an increase of $15.8 thousand or 4.5%. Compensation expense increased as a result of higher health insurance premiums, stock-based director compensation and salary increases in the period.

For the 6 months ended June 30, 2018, and 2017, compensation expenses were approximately $744.9 thousand and $713.7 thousand respectively, an increase of $31.2 thousand or 4.4%. Compensation expense increased as a result of $10.1 thousand higher health insurance premiums, $16.8 thousand increase in stock-based director compensation and $4.3 thousand of salary increases in the period.

Professional Fees

For the 3 months ended June 30, 2018, and 2017, professional fees were approximately $142.9 thousand and $115.4 thousand respectively, an increase of $27.5 thousand or 23.8 %.  These expenses increased mainly as a result of legal fees related to the Cyberquest case.

For the 6 months ended June 30, 2018, and 2017, professional fees were approximately $291.8 thousand and $320.2 thousand respectively, a reduction of $28.4 thousand or 8.9%. In this period 2017, the Company had engaged the investment banking services of Wilmington Capital Securities, LLC and executive management had attended various investor conferences. These expenses have not reoccurred in 2018.

Product Development Expenses

For the 3 months ended June 30, 2018, product development expenses were approximately $123.8 thousand as compared to $66.4 thousand, in 2017, an increase of $57.4 thousand or 86.4%. This expense increase resulted from a $39.1 thousand investment in software and hardware development for a new product category being developed which also resulted in increased prototype and sample development expenses during the period.

For the 6 months ended June 30, 2018, product development expenses were approximately $290.3 thousand as compared to $138.4 thousand, in 2017, an increase of $151.8 thousand or 109.6%.  This expense increase resulted from a large investment in software and hardware development for a new product category being developed which also resulted in increased prototype and sample development expenses during the period.

Other General and Administrative Expenses

For the 3 months ended June 30, 2018, other general and administrative expenses were approximately $166.7 thousand as compared to $204.1 thousand, in 2017, a reduction of $37.4 thousand or 18.3%. In the second quarter 2018, bank charges were only $4.6 thousand compared to $56.5 thousand a reduction of $51.9 thousand, a result of our positive cash position and reduced processing fees. Insurance liability expense increased by $15.5 thousand in the quarter as a result of an insurance premium adjustment for the higher sales volumes in 2017.

For the 6 months ended June 30, 2018, other general and administrative expenses were approximately $341.0 thousand as compared to $382.7 thousand, in 2017, a reduction of $41.7 thousand or 10.9%. For the six months 2018, bank charges were $25.1 thousand compared to $86.9 thousand a reduction of $61.8 thousand or 71.1%, a result of reduced processing fees in the period. Insurance liability expense increased by $18.3 thousand in the period as a result of the insurance premium adjustment for the higher sales volumes in 2017.

Total Operating Expenses

For the 3 months ended June 30, 2018 total operating expenses were $918.6 thousand or 43.7% of revenue as compared to $1.304 million or 12.8 % of revenue in 2017.

For the 6 months ended June 30, 2018 total operating expenses were $2.147 million or 34.8% of revenue as compared to $ 2.496 million or 14.7% of revenue in 2017.

Operating Income (Loss)

For the 3 months ended June 30, 2018 the operating (loss) was $(557.9) thousand compared to $1.339 million profit in 2017.

For the 6 months ended June 30, 2018 the operating (loss) was $(766.6) thousand compared to $1.726 million profit in 2017.

Other Income (Expense)

For the 3 months ended June 30, 2018, and 2017, Other Income (Expense) was $147.3 and $(35.2) thousand respectively

For the 6 months ended June 30, 2018, and 2017, Other Income (Expense) was $147.3 and $(44.0) thousand respectively.

During the second quarter of 2018 as consideration for relocating offices to a new location, the existing landlord agreed to pay the Company $150,000 which is reported as other income net of expenses, of which $78,250 was outstanding as other receivables as of June 30, 2018.

During the six months 2018, the Company had zero debt and incurred zero interest expense compared to $44.0 thousand in 2017.

Provision (Benefit) for Income Tax

For the 3 months ended June 30, 2018 the (benefit) for income tax was estimated at $(59.0) thousand compared to a provision of $402.0 thousand in the same period 2017.  The (benefit) was a result of the net loss incurred during the period.

For the 6 months ended June 30, 2018 and 2017 the (benefit) for income tax was estimated at $(77.0) thousand compared to a provision of $530.0 thousand in the same period 2017. The (benefit) was a result of the net loss incurred during the period.

Net Income (Loss)

For the 3 months ended June 30, 2018 the net (loss) was $(351.6) thousand compared to a net income of $901.4 thousand in the same period 2017.

For the 6 months ended June 30, 2018 the net (loss) was $(542.3) thousand compared to a net income of $1.152 million in the same period 2017.

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, 2018.

LIQUIDITY AND CAPITAL RESOURCES

Our cash balances as of June 30, 2018 and December 31, 2017 was $2.8 million and $3.7 million, respectively. The Company also had available borrowing capacity under the Sterling National Bank financing agreement of approximately $1.7 million and $3.7 million, respectively.

The Sterling National Bank credit facility which was expanded on July 20, 2018, which allows the Company to borrow up to $10.0 million, of which $2.0 million has been allocated as a Capstone expansion credit line, available as needed to support the expansion of Capstone's new product development and is not subject to the bank's collateral conditions as required for the remaining $8.0 million trade receivable line. As of June 30, 2018, and December 31, 2017 the Sterling Bank loan balance for both periods was $0.

Historically, our Directors have been a significant source of financing and continue to support our operations as necessary. With the strong operational cash flows achieved during 2017, the Company was able to pay off all Director debt and accumulated interest. As of both June 30, 2018 and December 31, 2017, the Company had notes payable to related parties of $0.

Our expanded 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 operations and reinvest in our business.

Cash Flows provided by Operating Activities

Cash used in operating activities in the six months ended June 30, 2018 was approximately $781 thousand compared with approximately $16 thousand provided by operating activities in the same period 2017.  In the period $2.4 million of cash was generated by the collection of accounts receivables and a further $132 thousand by a reduction in on hand inventories.  This cash was used in underwriting the $542 thousand loss in the period, nearly $1.2 million reduction of accounts payable and accrued expenses, $548 thousand reduction in prepaid expenses and $266 thousand net reduction in tax liabilities.

Cash Flows used in Investing Activities

During the six months ended June 30, 2018, the Company has invested $126 thousand in property and equipment including new product molds and updated Corporate computer systems. During the six months ended June 30, 2017, the Company had cash outflows of $15 thousand for the purchase of new product tooling in the period.

Cash Flows used in Financing Activities

During the six months ended June 30, 2018 and 2017 cash used in financing activities was $0 and $(473) thousand, respectively. The cash outflow for last year was the result of the Company repurchasing $250 thousand of Company shares from Involve LLC and the Company paid off $223 thousand of Directors loans outstanding from 2010 and 2013.

At June 30, 2018, the Company was in compliance with all of the terms pursuant to existing credit facilities.  Management believes that our cash flow from operations, continued support from Sterling National Bank and support of our Directors as needed will provide sufficient financial resources for the Company in 2018.

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. Although labor costs are starting 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 2018.

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.

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, 2018.

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.

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2018. As of the date of this Report, Stewart Wallach is our Chief Executive Officer and James Gerald McClinton is our Chief Financial Officer and Chief Operating Officer.

The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on management's evaluation of our disclosure controls and procedures as of June 30, 2018, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, the Company's principal executive and principal financial officers and effected by the Company's Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

·	Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company.

·

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

·	Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.

·

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Company's management assessed the effectiveness of the Company's internal control over financial reporting as of June 30, 2018. In making this assessment, the Company's management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) 2013 Internal Control-Integrated Framework. Based on their assessment, management concluded that, as of June 30, 2018, the Company's internal control over financial reporting is effective based on those criteria. Based on that evaluation, our management concluded that our internal control over financial reporting, as of June 30, 2018, was effective.

Because the Company is a smaller reporting company, this annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our independent registered public accounting firm.

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 June 30, 2018 that has materially affected or are reasonable likely to materially affect, our internal control over financial reporting.

The Chairman of our Audit Committee has reviewed the internal control reports in detail and has spoken to the external auditors in depth about the audit, the internal controls and the auditors' findings. The Chairman has had detailed discussions with the auditors about these matters, prior to, during, and on completion of the audit.

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 incorporated by reference to our annual report on Form 10-K for the fiscal year ended December 31, 2017, for a more complete understanding of the matters covered by such certifications.

PART II — OTHER INFORMATION

Cyberquest, Inc.  Capstone received a letter in July 2017 from a purported holder of 70,000 shares of a series of preferred stock issued by CBQ, Inc., a predecessor of the Company, in the 1998 acquisition of Cyberquest, Inc., a company that ceased operations by 2002.  The letter was a request to inspect Capstone corporate records.   Capstone investigated these claims and, due to perceived deficiencies in the stock certificate, our inability to substantiate the purported ownership of said preferred stock to date and absence of validation that shares of the series of preferred stock are still outstanding, Capstone refused the purported holder's request to inspect corporate records per a September 1, 2017 letter to the purported holder.  Capstone did not receive any responsive communications from the purported holder after September 1, 2017, until the purported holder filed a declaratory judgement action in Dallas County, Texas state court on March 21, 2018 seeking validation of purported holder's ownership of the preferred stock and to compel inspection of Capstone corporate records.  Capstone received notice of the state declaratory action on April 3, 2018.  The Company has retained local Dallas, Texas legal counsel and has answered the suit, filed a counter claim to recover attorney's fees, and removed litigation to the U.S. District Court in Texas.  The Company intends to contest this declaratory judgment action for the reasons stated above for denial of the July 2017 request to inspect corporate records.

The Company and the claimant in the declaratory action agreed to pursue court-sponsored mediation as a possible resolution of this dispute.  The mediation may not result in a resolution of the dispute.  The mediation has not commenced as of the date of this quarterly report on Form 10-Q but should be conducted in 2018.

As previously reported in filings with the Commission by Capstone, the purported holder of the preferred stock made the same letter request in 2006 and, after receiving a denial of the request, the purported holder of the preferred stock made no further communications or demands to Capstone in the matter.

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.

There have been no material changes in reported risk factors from the information reported in our Annual Report on Form 10-K for the year ended December 31, 2017, except as described in this quarterly report on Form 10-Q.

There were no unregistered issuances of Company securities in the fiscal quarter ending June 30, 2018.

None.

Not Applicable.

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.

 

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, 2018

 

 

 

 

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