NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
This summary of accounting policies for Capstone Companies, Inc. ("CAPC", "Capstone" or the "Company"), a Florida corporation (formerly,"CHDT Corporation") and its wholly-owned subsidiaries is
presented to assist in understanding the Company's consolidated financial statements. The accounting policies conform to accounting principles generally accepted in the United States of America ("U.S. GAAP") and have been consistently applied in the
preparation of the consolidated financial statements.
Organization and Basis of Presentation
The condensed consolidated financial statements contained in this report are unaudited. In the opinion of management, the condensed consolidated financial statements include all adjustments, which
are of a normal recurring nature, necessary to present fairly the Company’s financial position as of March 31, 2020 and results of operations, stockholders’ equity and cash flows for the three months ended March 31, 2020 and 2019. All material
intercompany accounts and transactions are eliminated in consolidation. These condensed consolidated financial statements and notes are presented in accordance with the rules and regulations of the United States Securities and Exchange Commission
(“SEC”) relating to interim financial statements and in conformity with U.S. GAAP. Certain information and note disclosures have been condensed or omitted in the condensed financial statements pursuant to SEC rules and regulations, although the
Company believes that the disclosures made herein are adequate to make the information not misleading. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes in the Company’s
Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Annual Report”).
The operating results for any interim period are not necessarily indicative of the operating results to be expected for any other interim period or the full fiscal year.
Effects of COVID-19
During the quarter ended March 31, 2020, the Company was negatively impacted by the effects of the worldwide COVID-19 pandemic. During the months of February and March 2020, the Company’s Hong Kong
office and Chinese suppliers were impacted by the closedown of facilities by local and regional authorities in their efforts to combat the spread of COVID-19. The CIHK staff worked remotely from home, however the factory closures delayed certain
orders from the first quarter of 2020 until the second and third quarter 2020. These factories are now functioning, and orders are being produced both in China and in Thailand.
On March 9, 2020, the State of Florida declared a state of emergency in order to combat the spread of the COVID-19 pandemic. The Company in 2019 had expanded its IT systems to allow for remote
operations and as of March 20, 2020, the Company’s U.S. staff have been working remotely from their homes.
Our business operations and financial performance for the three months ended March 31, 2020 were adversely impacted by the developments discussed above, including a significant decrease in net
revenue resulting in an approximate 73% increase in the net loss for the three months ended March 31, 2020 as compared to the prior year. The decrease in net sales was driven by the overseas governments mandated factory closures related to COVID-19
resulting in the unavailability of components and the shipment of finished orders.
Our business may continue to be adversely impacted by the resurgence of COVID-19. This disruption could have a continued negative impact on the retail business and consumers’ willingness to visit
retail stores, causing reduced consumer foot traffic and consumer spending which could negatively impact the demand for our products.
The Company reported a net loss of approximately $597 thousand for the three months ended March 31, 2020 compared to a net loss of approximately $345 thousand for the period ended March 31, 2019.
The cash generated from operations was negatively impacted and the Company utilized $679 thousand of cash.
With orders now shipping to customers in the second quarter 2020, we expect that the cash generated from operations will gradually improve in the second and future quarters in 2020.
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
At March 31, 2020, the Company remained debt free, had a cash balance of $2.5 million and an available credit facility of $7.5 million at Sterling National Bank, subject to eligible collateral.
This credit facility is up for renewal and is currently being negotiated, which Management expects to be finalized in the next couple of weeks.
As a result of the economic uncertainties caused by the COVID-19 pandemic, Management determined sufficient indicators existed to trigger the performance of an interim goodwill impairment analysis
as of March 31, 2020. The analysis concluded that the Company’s carrying value of its single reporting unit exceeded the fair value and the Company recognized $290,059 goodwill impairment charge in the quarter ended March 31, 2020.
With the continuing economic uncertainties caused by the COVID-19 pandemic, the capital markets may continue to have a downturn and adversely affect the Company’s stock price which will require the
Company to test its goodwill for impairment in future reporting periods.
On March 27, 2020, the current administration signed into law the Coronavirus Aid, Relief and Economic Security Act, which we refer to as the “CARES Act.” The CARES Act, among other things,
includes provisions related to net operating loss carryback periods. We were able to carryback the NOL to 2017 tax years and generate an estimated net refund of previously paid income taxes at an approximate 34% federal tax rate. This resulted in a
net tax benefit of $573,685 which has been recorded in the first quarter 2020.
We identified and had certified a factory in Thailand that started producing orders for the Company in 2020. This additional manufacturing capacity will provide the Company with more flexibility in
determining which factory location should produce goods for future orders, particularly if COVID-19 impacts Chinese manufacturing in a second wave pandemic.
With the United States now being impacted by a resurgence of COVID-19 pandemic, we believe the economic impact of the virus in the U.S. will continue through the third quarter and view this as a
major disruption but should not impact our long-term strategy and initiatives.
As the COVID 19 pandemic subsides and markets reopen, we intend to execute our organic growth strategy, which is designed to enhance our market presence and expand our customer base.
The continuing spread of COVID-19 could result in a further expansion of the public health crisis that could adversely affect the U.S. economy and financial markets, consumer spending and
confidence levels, resulting in a further economic downturn that could affect customer and consumer demand for our products. The overall impact of the COVID-19 pandemic to our business, financial condition, cash flow and results of operations,
therefore, remains uncertain. For example, if any of our major wholesale customers fail to return to normal operations, our revenue could decline, which could have a material adverse effect on our business, financial condition and results of
operations.
Liquidity and Going Concern
The accompanying condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities and
commitments in the normal course of business.
During the quarter ended March 31, 2020, the Company was negatively impacted by the effects of the worldwide COVID-19 pandemic. Our business operations and financial performance for the three
months ended March 31, 2020 were adversely impacted which resulted in a $2.8 million or 95% decrease in net revenue. The Company reported a net loss of approximately $597 thousand for the three months ended March 31, 2020 compared to a net loss of
approximately $345 thousand for the three months ended March 31, 2019, a net loss increase of approximately 73%.
The Company’s factory suppliers in Thailand and China are now fully functioning and shipping orders. However with the resurgence of the COVID-19 pandemic in the United States, the future impact on
the retail market place remains uncertain, which places doubt on the timing of the Company’s new retail programs that are planned to be introduced later in the year, which could result in further reduced revenue and continued losses.
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
As the Company relies on cash generated from operations to support its ongoing business, based on the Company’s expected rate of consumption, if the new programs are delayed or postponed the
Company will need additional working capital in the fourth quarter, 2020 and its prospects of obtaining that capital are uncertain at this time. The Company may be able to raise the required additional capital through debt or equity financing.
However, the Company can make no assurances that it will be able to raise the required capital, on acceptable terms or at all. Unless the Company succeeds in raising additional capital or successfully increases cash generated from operations,
Management believes there is substantial doubt about the Company’s ability to continue as a going concern for the next twelve months from the filing date of this report.
Management is closely monitoring its operations, liquidity, and capital resources and is actively working to minimize the current and future impact of this unprecedented situation. The Company has
taken some immediate steps to reduce operating costs in the second quarter, 2020 and to conserve cash including reductions in rent, travel expenses and staff reductions and plans to make further cost reductions to further conserve liquidity.
At March 31, 2020, the Company continued to remain debt free, had a cash balance of $2.5 million and an available credit facility of $7.5 million at Sterling National Bank. This credit facility,
which is subject to eligible collateral, is up for renewal and is currently being negotiated.
Nature of Business
Since the beginning of fiscal year 2007, the Company has been primarily engaged in the business of developing, marketing and selling home LED products through national and regional retailers in
North America and in certain overseas markets. The Company’s products are targeted for applications such as home indoor and outdoor lighting and have different functionalities to meet consumer’s needs. The Company has developed a smart interactive
mirror for residential use as a variant line for its lighting products, which was launched for market at the Consumer Electronics Show in early 2020. The development of the smart interactive mirror is part of the Company’s strategic effort to find
new product lines to replace or supplement existing products that are nearing or at the end of their product life cycle. These products are offered either under the Capstone brand or licensed brands.
The Company’s products are typically manufactured in China and Thailand by contract manufacturing companies.
The Company’s operations consist of one reportable segment for financial reporting purposes: Lighting Products.
Accounts Receivable
For product revenue, the Company invoices its customers at the time of shipment for the sales value of the product shipped. Accounts receivable are recognized at the amount expected to be collected
and are not subject to any interest or finance charges. The Company does not have any off-balance sheet credit exposure related to any of its customers. As of March 31, 2020 and December 31, 2019, accounts receivable serves as collateral when the
Company borrows against its credit facilities.
Allowance for Doubtful Accounts
The Company evaluates the collectability of accounts receivable based on a combination of factors. In cases where the Company becomes aware of circumstances that may impair a specific customer’s
ability to meet its financial obligations subsequent to the original sale, the Company will recognize an allowance against amounts due, and thereby reduce the net recognized receivable to the amount the Company reasonably believes will be collected.
For all other customers, the Company recognizes an allowance for doubtful accounts based on the length of time the receivables are past due and consideration of other factors such as industry conditions, the current business environment and the
Company’s historical payment experience. An allowance for doubtful accounts is established as losses are estimated to have occurred through a provision for bad debts charged to earnings. This evaluation is inherently subjective and requires estimates
that are susceptible to significant revisions as more information becomes available.
As of March 31, 2020 and December 31, 2019, management has determined that accounts receivable are fully collectible. As such, management has not recorded an allowance for doubtful accounts.
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The following table summarizes the components of Accounts Receivable, net:
Inventories
The Company's inventory, recorded at lower of cost (first-in, first-out) or net realizable value, consists of finished goods for resale by Capstone.
Prepaid Expenses
The Company’s prepaid expenses consist primarily of deposits on inventory purchases for future orders as well as prepaid insurance, trade show and subscription expense. As of March 31, 2020 and
December 31, 2019, prepaid expenses were $140,583 and $182,782, respectively.
Goodwill
On September 13, 2006, the Company entered into a Stock Purchase Agreement with Capstone Industries, Inc., a Florida corporation (“Capstone”). Capstone was incorporated in Florida on May 15, 1996
and is engaged primarily in the business of wholesaling technology inspired consumer products to distributors and retailers in the United States. Under the Stock Purchase Agreement, the Company acquired 100% of the issued and outstanding shares of
Capstone’s Common Stock, and recorded goodwill of $1,936,020.
Goodwill acquired in business combinations is initially computed as the amount paid by the acquiring company in excess of the fair value of the net assets acquired.
Goodwill is tested for impairment on December 31 of each year or more frequently if events or changes in circumstances indicate that the asset might be impaired. If the carrying amount exceeds its
fair value, an impairment loss is recognized. Goodwill is not amortized. The Company estimates the fair value of its single reporting unit relative to the Company's market capitalization.
Goodwill is subject to ongoing periodic impairments tests based on fair value of the reporting unit compared to its carrying amount, including goodwill. Impairment exists when a reporting unit’s
carrying amount exceeds its fair value. At December 31, 2019, the required annual impairment test of goodwill was performed, and no impairment existed as of the valuation date.
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
As a result of the economic uncertainties caused by the COVID-19 pandemic, we determined sufficient indicators existed to trigger the performance of an interim goodwill impairment analysis as of
March 31, 2020. The analysis concluded that the Company’s carrying value of its single reporting unit exceeded the fair value and the Company recognized $290,059 goodwill impairment charge in the quarter ended March 31, 2020 as shown in the
following table.
With the continuing economic uncertainties caused by the COVID-19 pandemic, the capital markets may continue to have a downturn and adversely affect the Company’s stock price which will require the
Company to test its goodwill for impairment in future reporting periods.
Fair Value Measurement
The accounting guidance under Accounting Standards Codification 820-10, “Fair Value Measurements and Disclosures” (“ASC 820-10”) requires the Company to make disclosures about the fair value of
certain of its assets and liabilities. ASC 820-10 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the
information used to develop those assumptions. ASC 820-10 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The three levels of the hierarchy are as follows:
The input used in the goodwill fair value calculation falls within level 1 hierarchy.
Earnings Per Common Share
Basic earnings per common share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding for the reporting periods. Diluted earnings per share
reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. For calculation of the diluted earnings per share, the basic weighted average number of shares is
increased by the dilutive effect of stock options and warrants using the treasury stock method. In periods where losses are reported, the weighted average number of common shares outstanding excludes common stock equivalents because their inclusion
would be anti-dilutive. As of March 31, 2020 and 2019, the total number of potentially dilutive common stock equivalents excluded from the diluted earnings per share calculation was 900,000 and 870,001, respectively.
During the period ended March 31, 2020 a total of 100,000 stock options expired.
Basic weighted average shares outstanding is reconciled to diluted weighted shares outstanding as follows:
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Revenue Recognition
The Company generates revenue from developing, marketing and selling consumer lighting products through national and regional retailers. The Company’s products are targeted for applications such as
home indoor and outdoor lighting and have different functionalities Capstone currently operates in the consumer lighting products category in the United States and in certain overseas markets. These products may be offered either under the Capstone
brand or licensed brands.
A sales contract occurs when the customer-retailer submits a purchase order to buy a specific product, a specific quantity, at an agreed-fixed price, within a ship window, from a specific location
and on agreed payment terms.
The selling price in all of our customers’ orders has been previously negotiated and agreed to including any applicable discount prior to receiving the customer’s purchase order. The stated unit
price in the customer’s order has already been determined and is fixed at the time of invoicing.
The Company recognizes product revenue when the Company’s performance obligations as per the terms in the customers purchase order have been fully satisfied, specifically, when the specified
product and quantity ordered has been manufactured and shipped pursuant to the customers requested ship window, when the sales price as detailed in the purchase order is fixed, when the product title and risk of loss for that order has passed to the
customer, and collection of the invoice is reasonably assured. This means that the product ordered and to be shipped has gone through quality assurance inspection, customs and commercial documentation preparation, the goods have been delivered, title
transferred to the customer and confirmed by a signed cargo receipt or bill of lading. Only at the time of shipment when all performance obligations have been satisfied will the judgement be made to invoice the customer and complete the sales
contract.
The Company may enter into a licensing agreement with globally recognized companies, that allows the Company to market products under a licensed brand to retailers for a designated period of time,
and whereby the Company will pay a royalty fee, typically a percentage of licensed product revenue to the licensor in order to market the licensed product.
The Company expenses license royalty fees and sales commissions when incurred and these expenses are recognized during the period the related sale is recorded. These costs are recorded within sales
and marketing expense.
The following table disaggregates net revenue by brand and geographical area:
We provide our customers with limited rights of return for non-conforming product warranty claims. As a policy, the Company does not accept product returns from customers, however occasionally as
part of a customer's in store test for new product, we may receive back residual inventory.
Customer orders received are not long-term orders and are typically shipped within six months of the order receipt, but certainly within a one-year period.
Our payment terms may vary by the type of customer, the customer's credit standing, the location where the product will be picked up from and for international customers, which country their
corporate office is located. The term between invoicing date and when payment is due may vary between 30 days and 90 days depending on the customer type. In order to ensure there are no payment issues, overseas customers or new customers may be
required to provide a deposit or full payment before the order is delivered to the customer.
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
The Company selectively supports retailer's initiatives to maximize sales of the Company's products on the retail floor or to assist in developing consumer
awareness of new products launches, by providing marketing fund allowances to the customer. The Company recognizes these incentives at the time they are offered to the customers and records a credit to their account with an offsetting charge as
either a reduction to revenue, increase to cost of sales, or marketing expenses depending on the type of sales incentives. Sales reductions for anticipated discounts, allowances and other deductions are recognized during the period the related
revenue is recorded.
Warranties
The Company provides the end user with limited rights of return as a consumer assurance warranty on all products sold, stipulating that the product will function properly for the warranty period.
The warranty period for all products is one year from the date of consumer purchase.
Certain retail customers may receive an off-invoice based discount such as a defective/warranty allowance, that will automatically reduce the unit selling price at the time the order is invoiced.
This allowance will be used by the retail customer to defray the cost of
any returned units from consumers and therefore negate the need to ship defective units back to the Company. Such allowances are charged to cost of sales at the time the order is invoiced.
For those customers that do not receive a discount off-invoice, the Company recognizes a charge to cost of sales for anticipated non-conforming returns based upon an analysis of historical product
warranty claims and other relevant data. We evaluate our warranty reserves based on various factors including historical warranty claims assumptions about frequency of warranty claims, and assumptions about the frequency of product failures derived
from our reliability estimates. Actual product failure rates that materially differ from our estimates could have a significant impact on our operating results. Product warranty reserves are reviewed each quarter and recognized at the time we
recognize revenue.
The following table summarizes the changes in the Company's product warranty liabilities which are included in accounts payable and accrued liabilities in the accompanying March 31, 2020 and
December 31, 2019 balance sheets:
Advertising and Promotion
Advertising and promotion costs, including advertising, public relations, and trade show expenses, are expensed as incurred and included in sales and marketing expenses. Advertising and promotion
expense was $188,808 and $171,457 for the three months ended March 31, 2020 and 2019, respectively.
Product Development
Our research and development team located in Hong Kong working with our designated factories, are responsible for the design, development, testing, and certification of new product releases. Our
engineering efforts support product development across all products, as well as product testing for specific overseas markets. All research and development costs are charged to results of operations as incurred.
For the three months ended March 31, 2020 and 2019, research and development expenses were $51,614 and $85,229, respectively.
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Shipping and Handling
The Company's shipping and handling costs are included in sales and marketing expenses and are recognized as an expense during the period in which they are incurred and amounted to $13,782 and
$7,866 for the three months ended March 31, 2020 and 2019, respectively.
Accounts Payable and Accrued Liabilities
The following table summarizes the components of accounts payable and accrued liabilities as of March 31, 2020 and December 31, 2019, respectively:
Income Taxes
The Company is subject to income taxes in the U.S. federal jurisdiction, various state jurisdictions and certain other jurisdictions.
The Company accounts for income taxes under the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) 740 Income
Taxes. ASC 740 requires recognition of deferred income tax assets and liabilities for the expected future income tax consequences, based on enacted tax laws, of temporary differences between the financial reporting and tax bases of assets
and liabilities. The Company and its U.S. subsidiaries file consolidated income tax returns.
The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the
technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement.
Tax regulations within each jurisdiction are subject to the interpretation of the relaxed tax laws and regulations and require significant judgement to apply. The Company is not subject to U.S.
federal, state and local tax examinations by tax authorities generally for a period of 3 years from the later of each return due date or date filed.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted into law. The CARES Act is a tax and spending package intended to provide economic relief to
address the impact of the COVID-19 pandemic. The CARES Act includes several significant income and other business tax provisions that, among other things, would eliminate the taxable income limit for certain net operating losses (“NOLs”) and allow
businesses to carry back NOLs arising in 2018, 2019, and 2020 to the five prior tax years.
If the Company were to subsequently record an unrecognized tax benefit, associated penalties and tax related interest expense would be recorded as a component of income tax expense.
Stock-Based Compensation
The Company accounts for stock-based compensation under the provisions of ASC 718 Compensation- Stock Compensation, which requires the measurement and
recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options, based on estimated fair values.
ASC 718 requires companies to estimate the fair value of share-based payment awards on the date of the grant using an option-pricing model. The value of the portion of the award that is ultimately
expected to vest is recognized as expenses over the requisite service periods in the Company's condensed consolidated statements of operations.
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period.
Stock-based compensation expense recognized during the periods ended March 31, 2020 and 2019 was $8,925 and $11,025, respectively.
In conjunction with the adoption of ASC 718, the Company adopted the straight-line single option method of attributing the value of stock-based compensation expense.
The Company accounts for forfeitures as they occur.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities,
revenue and expenses and the disclosure of contingent assets and liabilities. The Company evaluates its estimates on an ongoing basis, including those related to revenue recognition, product warranty obligations, valuation of inventories, tax related
contingencies, valuation of stock-based compensation, other contingencies and litigation, among others. The Company generally bases its estimates on historical experience, agreed obligations, and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis of making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Historically, past changes to these estimates have not
had a material impact on the Company’s financial statements. However, circumstances could change, and actual results could differ materially from those estimates.
Recent Accounting Standards
To be Adopted in a Future Period
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740) (“ASU 2019-12”). The amendments in ASU
2019-12 seek to simplify the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application and simplify GAAP in other areas of Topic 740. ASU 2019-12 is effective
for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. The Company is currently evaluating the impact ASU 2019-12 may have on the Company’s Consolidated Financial Statements.
Adoption of New Accounting Standards
In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment, which requires an entity to perform a one-step quantitative
impairment test, whereby a goodwill impairment loss will be measured as the excess of a reporting unit’s carrying amount over its fair value (not to exceed the total goodwill allocated to that reporting unit). It eliminates Step 2 of the current
two-step goodwill impairment test, under which a goodwill impairment loss is measured by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. ASU 2017-04 is effective for fiscal years beginning
after December 15, 2019. The adoption of ASU 2017-04 did not have a material effect on the Company’s consolidated financial statements.
In August 2018, the FASB issued Accounting Standards Update No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value
Measurement.” This new guidance removes certain disclosure requirements related to the fair value hierarchy, modifies existing disclosure requirements related to measurement uncertainty and adds new disclosure requirements. The new disclosure
requirements include disclosing the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average
of significant unobservable inputs used to develop Level 3 fair value measurements. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019. The adoption of ASU 2018-03 did not have a material effect on the Company’s consolidated
financial statements.
The Company continually assesses any new accounting pronouncements to determine their applicability to the Company. Where it is determined that a new accounting pronouncement affects the Company’s
financial reporting, the Company undertakes a study to determine the consequence of the change to its financial statements and assures that there are proper controls in place to ascertain that the Company’s financials properly reflect the change.
NOTE 2 - CONCENTRATIONS OF CREDIT RISK AND ECONOMIC DEPENDENCE
Financial instruments that potentially subject the Company to credit risk consist principally of cash and accounts receivable.
The Company has no significant off-balance-sheet concentrations of credit risk such as foreign exchange contracts, options contracts or other foreign hedging arrangements.
Cash
The Company at times has cash with its financial institution in excess of Federal Deposit Insurance Corporation ("FIDC") insurance limits. The Company places its cash with high credit quality
financial institutions which minimize these risks.
Accounts Receivable
The Company grants credit to its customers, substantially all of whom are retail establishments located throughout the United States
and their international locations. The Company typically does not require collateral from customers. Credit risk is limited due to the financial strength of the customers comprising the Company's customer base and their dispersion across different
geographical regions. The Company monitors exposure of credit losses and maintains allowances for anticipated losses considered necessary under the circumstances.
Major Customers
The Company had two customers who comprised 82% and 18%, respectively, of net revenue during the three months ended March 31, 2020 and one customer who comprised 100% of net revenue during the
three months ended March 31, 2019. The loss of these customers would adversely impact the business of the Company.
For the three months ended March 31, 2020 and 2019, approximately 68% and 10%, respectively, of the Company's net revenue resulted from international sales.
As of March 31, 2020, approximately $43.6 thousand or 62% of accounts receivable was from one customer and approximately $26.4 thousand or 38% came from a second customer. As of December 31, 2019,
approximately $13.5 thousand or 100% of accounts receivable was from one customer.
Major Vendors
The Company had two vendors from which it purchased 66% and 18%, respectively, of merchandise during the three months ended March 31, 2020, and one vendor from which it purchased 100% of
merchandise during the three months ended March 31, 2019. The loss of these suppliers could adversely impact the business of the Company.
As of March 31, 2020, approximately $23.9 thousand or 100% of accounts payable was due to one vendor. As of December 31, 2019, approximately $100.7 thousand or 100% of accounts payable were due to
one vendor.
NOTE 3 – NOTES PAYABLE
Sterling National Bank
On September 8, 2010, in order to fund increasing accounts receivables and 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 is a base management fee equal to .30% of the gross invoice amount. The interest rate of the loan advance is .25% above Sterling National Bank's Base Rate which at time of closing was 7%. As
of March 31, 2020, and December 31, 2019, the interest rate on the loan was 5.25% and 6.75%, respectively. The amounts borrowed under this agreement are due on demand and collateralized by substantially all the
assets of Capstone.
For the periods ended March 31, 2020 and 2019, the processing fees associated with the agreement were $333 and $10,494 respectively.
NOTE 3 – NOTES PAYABLE (continued)
On July 18, 2019, Sterling National Bank renewed the credit line up to $7,500,000 to June 30, 2020. Additional expansion of the line will be reviewed as the need arises.
This credit facility is up for renewal and is currently being negotiated. In the unlikely event that the Company is unable to renew the credit agreement we will need to seek a new credit facility
to fund our operations and future growth. The borrowing costs associated with such financing, are dependent upon market conditions and our credit rating. We cannot assure that we will be able to negotiate competitive rates, which could increase our
cost of borrowing in the future.
As of March 31, 2020, and December 31, 2019, there was no balance due to Sterling National Bank.
The Company, through Sterling National Bank, applied under the Paycheck Protection Program (“PPP”). The PPP was enacted on March 27, 2020 as part of the Coronavirus Aid, Relief and Economic
Security Act (“CARES Act”) and provides for loans for amounts up to 2.5 times of the average monthly payroll expenses of the qualifying business. The loans and accrued interest are forgivable after eight weeks as long as the borrower uses the loan
proceeds for eligible purposes, including payroll, benefits, rent and utilities, and maintains its payroll levels. The amount of loan forgiveness will be reduced if the borrower terminates employees or reduces salaries during the eight-week period.
On May 11, 2020, the Company received loan proceeds in the amount of approximately $89,600.
The unforgiven portion of the PPP loan is payable over two years at an interest rate of 1%, with a deferral of payments for the first six months. The Company intends to use the proceeds for
purposes consistent with the PPP. The Company believes that its use of the loan proceeds will meet the conditions for forgiveness of the loan, we cannot be certain that we will not take actions that could cause the Company to be ineligible for
forgiveness of the loan. Under Small Business Administration and Treasury Department guidelines issued in May 2020, a borrower must apply for the forgiveness of the loans by filing SBA Form 3508, Paycheck Protection Program Loan Forgiveness
Application.
NOTE 4 – COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company has operating lease agreements for offices and showroom facilities in Fort Lauderdale, Florida and in Hong Kong, expiring at varying dates. The Company’s principal executive office is
located at 431 Fairway Drive, Suite 200, Deerfield Beach, Florida 33441.
Effective February 1, 2017, the Company renewed the lease for 3 years ending January 31, 2020, with a base annual rent of $92,256 and with a total rent expense of $281,711 through the term of the agreement. Under the
lease agreement, Capstone was responsible for a portion of common area maintenance charges and any other utility consumed in the leased premises.
On May 15, 2018, the Company entered into a lease agreement with the previous landlord to provide for a premise’s relocation, lease termination and new sublease agreement. Under the agreement the
Company relocated its principal executive offices located at 350 Jim Moran Blvd, Suite 120, Deerfield Beach, Florida 33442 to 4,694 square feet of office space on the second floor of 431 Fairway Drive, Suite 200, Deerfield Beach, Florida 33441. The
original lease terminated on the relocation date, being July 1, 2018, and the parties proceeded under the terms of the sublease which expired on January 31, 2020. The base annual rent in the sublease remained at the same rate as the previous
agreement until January 31, 2020. At the expiration of the sublease, the Company had the option to accept the prime lease with another 3 years renewal and with an option to renew for an additional 5-year period. If the Company decided to further
extend the sublease after January 31, 2020, the Company would be subject to the terms and conditions of the prime lease. The base monthly rent was $7,312 to January 31, 2019 and then base rent would be $7,514 until January 31, 2020 which includes an
estimate for portion of the common area maintenance.
As consideration for the lease amendment, the Company received a rate abatement from the landlord, effective May 1, 2018 and for four months to September 1, 2018. The landlord delivered the
relocation premises in a “turnkey” condition with requested renovations made at no expense to the Company. As further consideration, the existing landlord agreed to pay the Company a $150,000 incentive to vacate the existing premises on completion of
the relocation, which was fully paid as of December 31, 2018 and was being amortized over the life of the lease amendment and resulted in the recognition of lease incentive income of $870 per month.
NOTE 4 – COMMITMENTS AND CONTINGENCIES (Continued)
On May 9, 2019, per the terms of the lease agreement, the current landlord was notified of the Company’s intent to take over the prime lease.
Effective November 1, 2019, the Company entered into a new prime operating lease with the landlord “431 Fairway Associates, LLC” ending June 30, 2023, for the Company’s executive offices located on
the second floor of 431 Fairway Drive, Suite 200, Deerfield Beach, Florida 33441 with an annualized base rent of $70,104 and with a base rental adjustment of 3% commencing July 1, 2020 and on July 1st of each subsequent year during the
term. Under the lease agreement, Capstone is also responsible for a portion of common area maintenance charges in the leased premises which has been estimated at $12.00 per square foot on an annualized basis of which the premises is approximately
4,694 square feet.
The Company's rent expense is recorded on a straight-line basis over the term of the lease. The rent expense for the periods ended
March 31, 2020 and 2019 amounted to $47,447 and $21,264, respectively. The rent increase in the quarter ended March 31, 2020 resulted from the expiry of a $8,383 monthly rent incentive that ended January 31, 2020. At the commencement date of the new
office lease, the Company recorded a right-of-use asset and lease liability under ASU 2016-02, Topic 842.
Supplemental balance sheet information related to leases as of March 31, 2020 is as follows:
Supplemental statement of operations information related to leases for the three months ended March 31, 2020 is as follows:
Supplemental cash flow information related to leases for the three months ended March 31, 2020 is as follows:
NOTE 4 – COMMITMENTS AND CONTINGENCIES (Continued)
Scheduled maturities of operating lease liabilities outstanding as of March 31, 2020 are as follows:
The Company has one short term lease with a duration of less than twelve months.
Capstone International Hong Kong Ltd, (CIHK), entered into a lease agreement for office space at 303 Hennessy Road, Wanchai, Hong Kong. The original agreement which was effective from February 17,
2014 has been extended various times. On August 17, 2019, the lease was further extended with a base monthly rate of $5,100 for six months until February 16, 2020. As the premises was no longer required as the employees were working remotely, the
Company decided not to renew and allowed this lease to expire.
CIHK entered into a six-month rental agreement effective from December 1, 2016 for a showroom space at 3F, Wing Kin Industrial Building, 4-6 Wing Kin Road, Kwai Chung, NT, Hong Kong. This agreement
has been extended various times. The lease with a base monthly rent of $1,290 expired August 16, 2019 and was further renewed for six-months expiring on February 16, 2020. Effective February 17, 2020, the Company entered into a new six-month lease
expiring on September 30, 2020, with a base rate of $1,285 per month and the space is available to renew as required.
Consulting Agreements
On July 1, 2015, the Company entered into a consulting agreement with George Wolf, whereby Mr. Wolf was paid $10,500 per month through December 31, 2015 increasing to $12,500 per month from January
1, 2016 through December 31, 2017.
On January 1, 2017, the agreement was amended, whereby Mr. Wolf was paid $13,750 per month from January 1, 2017 through December 31, 2017.
On January 1, 2018, the agreement was further amended, whereby Mr. Wolf was paid $13,750 per month from January 1, 2018 through December 31, 2018.
On January 1, 2019, the agreement was further amended, whereby Mr. Wolf was paid $13,750 per month from January 1, 2019 through December 31, 2020.
The agreement can be terminated upon 30 days' notice by either party. The Company may, in its sole discretion at any time convert Mr. Wolf to a full-time Executive status. The annual salary and
term of employment would be equal to that outlined in the consulting agreement.
Employment Agreements
On February 5, 2016, the Company entered into an Employment Agreement with Stewart Wallach, whereby Mr. Wallach was paid $301,521 per annum. As part of the agreement, the base salary would be
reviewed annually by the Compensation Committee for a potential increase, to at least reflect increases in the cost of living, but only if the Company shows a net profit for the year. The initial term of this agreement began February 5, 2016 and
ended February 5, 2018.
NOTE 4 – COMMITMENTS AND CONTINGENCIES (Continued)
On February 5, 2018, the Company entered into an Employment Agreement with Stewart Wallach, whereby Mr. Wallach was paid $301,521 per annum. The initial term of this agreement began February 5,
2018 and ended February 5, 2020. The parties may extend the employment period of this agreement by mutual consent with approval of the Company's Board of Directors, but the extension may not exceed two years in length.
On February 5, 2020, the Company entered into a new Employment Agreement with Stewart Wallach, whereby Mr. Wallach will be paid $301,521 per annum. The initial term of this new agreement began
February 5, 2020 and ends February 5, 2023. The parties may extend the employment period of this agreement by mutual consent with approval of the Company's Board of Directors, but the extension may not exceed two years in length.
On February 5, 2016, the Company entered into an Employment Agreement with James McClinton, whereby Mr. McClinton was paid $191,442 per annum. The term of this agreement began February 5, 2016 and
ended February 5, 2018.
On February 5, 2018, the Company renewed the Employment Agreement with James McClinton, whereby Mr. McClinton was paid $191,442 per annum. The term of this new agreement began February 5, 2018 and
ended February 5, 2020.
On February 5, 2020, the Company entered into a new Employment Agreement with James McClinton, whereby Mr. McClinton will be paid $191,442 per annum. The term of this new agreement began February
5, 2020 and ends February 5, 2022.
There is a common provision in both Mr. Wallach and Mr. McClinton's employment agreements:
If the officer's employment is terminated by death or disability or without cause, the Company is obligated to pay to the officer's estate or the officer,
as the case may be an amount equal to accrued and unpaid base salary as well as all accrued but unused vacation days through the date of termination. The Company will also pay sum payments equal to (a) the sum of twelve (12) months base salary at the
rate the Executive was earning as of the date of termination and (b) the sum of "merit" based bonuses earned by the Executive during the prior calendar year of his termination. Any payments owed by the Company shall be paid from a normal payroll
account on a bi-weekly basis in accordance with the normal payroll policies of the Company. The amount owed by the Company to the Executive, from the effective Termination date, will be payout bi-weekly over the course of the year but at no time will
be no more than twenty (26) installments. The Company will also continue to pay the Executive's health and dental insurance benefits for 6 months starting at the Executives date of termination. If the Executive had family health coverage at the time
of termination, the additional family premium obligation would remain theirs and will be reduced against the Executive's severance package. The employment agreements have an anti-competition provision for 18 months after the end of employment.
Directors Compensation
On May 31, 2019 the Company approved that effective on June 1, 2019, each independent director, namely Jeffrey Guzy and Jeffrey Postal, would each receive $750 per calendar month, as a Form 1099
compensation, for their continued services as directors of the Company. This compensation would be additional to the stock option grants awarded for their participation on the Audit Committee and Compensation and Nominating Committee.
On May 31, 2019, the Company also approved that the independent directors would be offered effective from June 1, 2019, the opportunity to participate as a non-employee in the Company’s Health
Benefit Plan, subject to compliance with all plan participation requirements and on acceptance into the plan the director will be responsible to pay 100% of their plans participation cost.
On June 10, 2020 the Company approved that effective on August 1, 2020 until August 1, 2021, each independent director, namely Jeffrey Guzy and Jeffrey Postal, would each receive $750 per calendar
month, as a Form 1099 compensation, for their continued services as directors of the Company. This compensation would be additional to the stock option grants awarded for their participation on the Audit Committee and Compensation and Nominating
Committee.
NOTE 4 – COMMITMENTS AND CONTINGENCIES (Continued)
Licensing Agreements
Under a February 4, 2015 Licensing Agreement with a floorcare company, Company markets home lighting products under the licensed brand of the floorcare company, to discount retailers, warehouse
clubs, home centers, on-line retailers and other retail distribution channels in the U.S., Canada and Mexico. The initial term of the agreement was for 3 years. The Licensing Agreement did not have a guaranteed royalty stipulation.
On December 29, 2016, the Company finalized the first amendment to the February 4, 2015 Licensing Agreement with the floorcare company in which the initial term was extended through February 3,
2020 and additional renewal terms and periods were also finalized. During this initial extended period through February 3, 2020, if the Company achieves net sales of $5,000,000, then the Licensing Agreement would automatically be extended 2 years
until February 3, 2022 and if during this second extended period the Company achieves net sales of $5,000,000, then the Licensing Agreement would automatically be further extended 2 years until February 3, 2024. This license amendment also added an
additional product category.
On April 12, 2018, the Company finalized the second amendment to the February 4, 2015 Licensing Agreement in which the license was further expanded to add an additional product category.
As the Company did not achieve the stated net sales volume for the renewal period, the License expired on February 3, 2020.
Public Relations Agreement
On September 27, 2018, the Company executed a public relations services agreement with Max Borges Agency, (“MBA”), a full – service public relations and communications agency with offices in Miami
and San Francisco. The Company entered into the Agreement to obtain assistance from a nationally recognized firm, specializing in the development of product branding, marketing and launching of technology products. The agreement was effective on
October 1, 2018 with an initial 180-day term, which either party can cancel with 60 days advanced notice in writing on or after the 120th day of the effective date. MBA will receive a monthly fee of $11,250 and $476 subscription fee due on
the first of each month.
During 2019 both Companies agreed to temporarily pause the MBA agreement for specific months and restarted the engagement with the same statement of work and terms as originally agreed.
On January 21, 2020, the Company provided MBA with 60 days cancellation notice and the agreement ended March 31, 2020.
During the three months ended March 31, 2020, the Company incurred $33,750 of services fees and $952 of subscription fees.
NOTE 5 - STOCK TRANSACTIONS
Options
In 2005, the Company authorized the 2005 Equity Plan that made available shares of common stock for issuance through awards of options, restricted stock, stock bonuses, stock appreciation rights
and restricted stock units.
On May 2, 2017, the Company’s Board of Directors amended the Company’s 2005 Equity Incentive Plan to extend the Plan’s expiration date from December 31, 2016 to December 31, 2021.
On August 29, 2018, the Company granted 100,000 stock options each to two directors of the Company for their participation as members of the Audit Committee and Nominating and Compensation
Committee, and 10,000 stock options to the Company Secretary. The Director options have an exercise price of $.435 with an effective date of August 6, 2018 and vested on August 5, 2019 and have a term of 5 years. The Company Secretary options have an
exercise price of $.435 with an effective date of August 6, 2018 and vested on August 5, 2019 and have a term of 10 years.
NOTE 5 - STOCK TRANSACTIONS (Continued)
On May 31, 2019, the Company granted 100,000 stock options each to two directors of the Company for their participation as members of the Audit Committee and Nominating and Compensation Committee,
and 10,000 stock options to the Company Secretary. The Director options have a strike price of $.435 with an effective date of August 6, 2019 and will vest on August 5, 2020 and have a term of 5 years. The Company Secretary options have a strike
price of $.435 with an effective date of August 6, 2019 and will vest on August 5, 2020 and have a term of 10 years.
On June 10, 2020, the Company granted 100,000 stock options each to two directors of the Company for their participation as members of the Audit Committee and Nominating and Compensation Committee,
and 10,000 stock options to the Company Secretary. The Director options have a strike price of $.435 with an effective date of August 6, 2020 and will vest on August 5, 2021 and have a term of 5 years. The Company Secretary options have a strike
price of $.435 with an effective date of August 6, 2020 and will vest on August 5, 2021 and have a term of 10 years.
As of March 31, 2020, there were 900,000 stock options outstanding and 690,000 stock options vested. The stock options have a weighted average expense price of $0.435.
Stock options were issued under Section 4(a)(2) and Rule 506(b) of Regulation D under the Securities Act of 1933.
For the three-month period ended March 31, 2020 and 2019, the Company recognized stock-based compensation expense of $8,925 and $11,025, respectively.
Such amounts are included in compensation expense in the accompanying consolidated statements of operations. A further compensation expense expected to be
$12,358 will be recognized for these options in 2020.
Adoption of Stock Repurchase Plan
On August 23, 2016, the Company's Board of Directors authorized the Company to implement a stock repurchase plan for up to $750,000 worth of shares of the Company's outstanding common stock. The
stock purchases can be made in the open market, structured repurchase programs, or in privately negotiated transactions. The Company has no obligation to repurchase shares under the authorization, and the timing, actual number and value of the shares
which are repurchased will be at the discretion of management and will depend on a number of factors including the price of the Company's common stock, market conditions, corporate developments and the Company's financial condition. The repurchase
plan may be discontinued at any time at the Company's discretion.
On December 21, 2016, the Company's Board of Directors approved an extension of the Company's stock repurchase plan through December 31, 2017, subject to an earlier termination at the discretion of
the Company's Board of Directors.
On February 13, 2017, as authorized under the Company's stock repurchase plan, the Company repurchased 1,000,000 shares of Company common stock from Involve, LLC., under the Option Agreement dated
June 27, 2016, at an exercise price of $.15 per share.
On May 1, 2017, as authorized under the Company's stock repurchase plan, the Company repurchased 666,667 shares of Company common stock from Involve, LLC., under the Option Agreement dated June 27,
2016, at an exercise price of $.15 per share.
On May 2, 2017, the Company's Board of Directors authorized at the Company's discretion to either retain repurchased shares in the treasury or to retire the repurchased shares and these shares were
retired on June 1, 2017.
On December 15, 2017, the Company's Board of Directors approved an extension of the Company's stock repurchase plan for up to $750,000 through June 30, 2018.
On August 29, 2018, the Company’s Board of Directors approved a further extension of the Company’s stock repurchase plan through August 31, 2019. The Board of Directors also approved an increase of
the maximum amount of aggregate funding available for possible stock repurchases under the stock repurchase program from $750,000 to $1,000,000 during the renewal period.
NOTE 5 - STOCK TRANSACTIONS (Continued)
On August 29, 2018, the Company’s Board of Directors authorized and directed the Company’s management to establish a trading account at a brokerage firm for the Company to conduct open market
purchases of the Company’s Common Stock in accordance with the terms and conditions of the Company’s current stock repurchase program and to fund said account from available cash of the Company but not to exceed such amount that would cause the
Company to be unable to pay its bona fide debts.
On December 19, 2018, Company entered into a Purchase Plan pursuant to Rule 10b5-1 under the Exchange Act, with Wilson Davis & Co., Inc., a registered broker-dealer. Under the Purchase Plan,
Wilson Davis & Co., Inc will make periodic purchases of up to an aggregate of 750,000 shares at prevailing market prices, subject to the terms of the Purchase Plan.
On May 31, 2019, the Company’s Board of Directors approved a further extension of the Company’s stock repurchase plan through August 31, 2020. The Board of Directors also approved that the maximum
amount of aggregate funding available for possible stock repurchases under the stock repurchase program remained at $1,000,000 during the renewal period.
On September 23, 2019 the Company signed a revised stock Purchase Plan to reflect an extension of the plan to repurchase up to an aggregate of 750,000 shares at prevailing market prices, subject to
the terms of the Purchase Plan.
On March 30, 2020, Wilson Davis & CO., Inc., advised the Company that 750,000 of the Company’s Common Stock had been repurchased to complete the authorized Purchase Plan.
On June 10, 2020, the Company’s Board of Directors approved a further extension of the Company’s stock repurchase plan through August 31, 2021.
During the quarter ended March 31, 2020 a total of 283,383 of the Company’s Common Stock has been repurchased at a total cost of $36,333.
As of March 31, 2020, since the start of the program, a total of 750,000 of the Company’s Common Stock has been repurchased at a total cost of $107,740.
NOTE 6 - INCOME TAXES
As of December 31, 2019, the Company had net operating loss carry forwards of approximately $1,654,000, available to the Company indefinitely and up to 80% of the operating loss can be used against
future taxable income.
As of March 31, 2020, the Company had $0 net operating loss carry forward available to the Company.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted into law. The CARES Act is a tax and spending package intended to provide economic relief to
address the impact of the COVID-19 pandemic. The CARES Act includes several significant income and other business tax provisions that, among other things, would eliminate the taxable income limit for certain net operating losses (“NOLs”) and allow
businesses to carry back NOLs arising in 2018, 2019, and 2020 to the five prior tax years. The Company was able to carryback the NOL to 2017 tax years and generate an estimated refund of previously paid income taxes at an approximate 34% federal tax
rate. This resulted in a net benefit of $573,685 which has been recorded in the first quarter 2020.
The effective tax rate as of March 31, 2020 was 49.0% and 3.4% as of March 31, 2019 and the statutory tax rate was 25.2% in 2020 and 24.4% in 2019.
NOTE 6 - INCOME TAXES (Continue)
The income tax (benefit) for the three months ended March 31, 2020 and 2019 consists of: