UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

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


__TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission File Number: 000-28831

CAPSTONE COMPANIES, INC.
(Exact name of Registrant as specified in its charter)

Florida
84-1047159
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

350 Jim Moran Boulevard, Suite 120, Deerfield Beach, Florida    33442
(Address of principal executive offices)

(954) 570-8889
(Issuer's Telephone Number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [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.

Large accelerated filer [_]
Accelerated filer [_]
Non-accelerated filer [_]
(Do not check if a smaller reporting company)
Smaller reporting company [x]
 Emerging Growth company [  ]
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  [_]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  [_] Yes [X] No
State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practical date. As of August 2, 2017, there were 46,466,952 shares of the issuer's Common Stock, $0.0001 par value per share, issued and outstanding.
1

CAPSTONE COMPANIES, INC.
Quarterly Report of Form 10-Q
Three Months and Six Months Ended June 30, 2017

TABLE OF CONTENTS


PART 1
FINANCIAL INFORMATION
 3
     
Item 1.
Financial Statements (Unaudited)
 3
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operation
 17
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
 32
Item 4.
Controls and Procedures
 33
     
PART II
Other Information
 33
     
Item 1.
Legal Proceedings
 33
Item 1A.
Risk Factors
 33
Item 2.
Unregistered Sale of Equity Securities and Use of Proceeds
 34
Item 3.
Defaults of Senior Securities
 34
Item 4.
Mine Safety Disclosures
 34
Item 5.
Other Information
 34
Item 6.
Exhibits
 34

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

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

 
CAPSTONE COMPANIES, INC. AND SUBSIDIARIES     
 
CONSOLIDATED STATEMENTS OF CASH FLOWS     
 
(Unaudited)     
 
             
   
For the Six Months Ended
 
   
June 30,   
 
   
2017
   
2016
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
             
   Net income
 
$
1,152,041
   
$
983,284
 
Adjustments necessary to reconcile net income to net cash provided by (used in) operating activities:
 
      Depreciation and amortization
   
35,551
     
28,289
 
      Accrued interest on note receivable
   
(12,945
)
   
-
 
      Stock based compensation expense
   
40,950
     
28,500
 
      Provision for deferred income tax
   
138,000
     
-
 
      Accrued sales allowance
   
(20,848
)
   
65,630
 
     (Increase) decrease in accounts receivable
   
(450,713
)
   
(2,406,176
)
     (Increase) decrease in inventory
   
99,064
     
(413,287
)
     (Increase) in prepaid expenses
   
(1,032,565
)
   
(142,000
)
      Increase (decrease) in accounts payable and accrued liabilities
   
111,954
     
166,447
 
      Increase (decrease) in accrued interest on notes payable
   
(44,837
)
   
70,511
 
  Net cash provided by (used in) operating activities
   
15,652
     
(1,618,802
)
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchase of property and equipment
   
(14,784
)    
(4,701
)
Net cash (used in) investing activities
   
(14,784
)
   
(4,701
)
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Proceeds from notes payable
   
16,566,081
     
9,860,252
 
Repayments of notes payable
   
(16,566,081
)
   
(8,142,198
)
Repurchase of shares from Involve, LLC
   
(250,000
)
   
-
 
Proceeds from notes and loans payable to related parties
   
-
     
860,000
 
Repayments of notes and loans payable to related parties
   
(223,000
)
   
(978,846
)
Net cash provided by (used in) financing activities
   
(473,000
)    
1,599,208
 
                 
Net (Decrease) in Cash and Cash Equivalents
   
(472,132
)    
(24,295
)
Cash and Cash Equivalents at Beginning of Period
   
1,646,128
     
364,714
 
Cash and Cash Equivalents at End of Period
 
$
1,173,996
   
$
340,419
 
                 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
               
Cash paid during the period for:
               
Interest
 
$
101,755
   
$
97,494
 
Income taxes
 
$
371,500
   
$
7,500
 
                 
Non-cash financing and investing activities:
               
Sale of Investment for Note receivable
 
$
-
   
$
500,000
 
                 
The accompanying notes are an integral part of these financial statements.    
 
5

NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

This summary of accounting policies for Capstone Companies, Inc. ("CAPC" or the "Company" or "Capstone"), 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.

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 June 30, 2017 and results of operations and cash flows for the three months and six months ended June 30, 2017 and 2016. All significant 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, 2016 (the "2016 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.

Nature of Business

Since the beginning of fiscal year 2007, the Company has been primarily engaged in the business of developing, marketing and selling consumer products through national and regional retailers and distributors in North America.  Capstone currently operates in eight primary product categories: Induction Charged Power Failure Lights; LED Night Lights and Power Failure Lights; Motion Sensor Lights; Wireless Remote-Control Outlets; Wireless Remote-Control Accent Lights; Dual Power Solar Lights; Outdoor Light Fixtures and Power Control Light Bulbs.  The Company's products are typically manufactured in China by third-party manufacturing companies.

Inventory

The Company's inventory, recorded at lower of cost (first-in, first-out) or market, consists of finished goods for resale by Capstone, totaling $267,266 and $366,330 at June 30, 2017 and December 31, 2016, respectively.

Net Income (Loss) Per Common Share

Basic earnings per common share were computed by dividing net income or loss by the weighted average number of shares of common stock outstanding for the reporting period. 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 net income per share, the basic weighted average number of shares is increased by the dilutive effect of stock options 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.  At June 30, 2017 and 2016, the total number of potentially dilutive common stock equivalents excluded from the diluted earnings per share calculation was 1,516,670 and 5,908,701, respectively.

6

 
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Basic weighted average shares outstanding is reconciled to diluted weighted shares outstanding as follows:

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

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

Revenue Recognition

Product sales are recognized when an agreement of sale exists, product delivery has occurred, pricing is fixed or determinable, and collection is reasonably assured.

Allowances for sales returns, rebates and discounts are recorded as a component of net sales in the period the allowances are recognized.  In addition, accrued liabilities contained in the accompanying consolidated balance sheets include accruals for estimated amounts of credits to be issued in future years based on potentially defective product, other product returns and various allowances which are based on historical authorized returns.

On April 22, 2016, the Company received a credit of approximately $479,000 from its major vendor to cover customer returns of products from sales that occurred in 2015 and promotional allowances for 2016 sales. A credit of $126,000 was applied to invoices due to the vendor during the period ending June 30, 2016 leaving a balance of $353,000 to be applied during the remaining months of 2016.

During the six months ended June 30, 2017 and 2016, Capstone determined that $47,741 and $94,203, respectively of previously accrued allowances were no longer required. The reduction of accrued allowances is included in net revenues for the six-month ended June 30, 2017 and 2016.

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 $92,584 and $70,385 for the three months and $113,247 and $73,438 for the six months ended June 30, 2017 and 2016, respectively.

Shipping and Handling

The Company's shipping and handling costs are included in sales and marketing expenses and amounted to $29,866 and $31,142 for the three months and $46,786 and $57,397 for the six months ended June 30, 2017 and 2016, respectively.

7


NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Accrued Liabilities

Accrued liabilities contained in the accompanying consolidated balance sheets include accruals for estimated amounts of credits to be issued in future years based on potential product returns and various allowances.  These estimates could change significantly in the near term.

Income Taxes

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 intend to file consolidated income tax returns.

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 consolidated statements of income.

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 for the three-month period ended June 30, 2017 and 2016 totaled $20,475 and $14,250, respectively, and for the six-month period ended June 30, 2017 and 2016 totaled $40,950 and $28,500, respectively.

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 and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates, and the differences could be material.

Recent Accounting Standards

In May 2014, ASU 2014-09 was issued, Revenue from Contracts with Customers . Under this ASU and subsequently issued amendments, an entity is required to recognize the amount of revenue it expects to be entitled to for the transfer of promised goods or services to customers. The updated standard will replace most existing revenue recognition guidance in U.S. GAAP. This ASU provides alternative methods of transition, a full retrospective and a modified retrospective approach. The modified retrospective approach would result in recognition of the cumulative impact of a retrospective application as of the beginning of the period of initial application, which in our case is the interim period beginning January 1, 2018.

8


NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
 
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities ("ASU 2016-01"). ASU 2016-01 modifies how entities measure equity investments and present changes in the fair value of financial liabilities. Under the new guidance, entities will have to measure equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in fair value in net income unless the investments qualify for the new practicality exception. A practicality exception will apply to those equity investments that do not have a readily determinable fair value and do not qualify for the practical expedient to estimate fair value under ASC 820 , Fair Value Measurements , and as such these investments may be measured at cost. ASU 2016-01 will be effective for the Company's fiscal year beginning after December 15, 2017 and subsequent interim periods. The adoption of ASU 2016-01 is not expected to have a material effect on the Company's consolidated financial statements.

In March 2016, the FASB issued ASU 2016-02, Leases ("ASU 2016-02"), which provides guidance for accounting for leases. ASU 2016-02 requires lessees to classify leases as either finance or operating leases and to record a right-of-use asset and a lease liability for all leases with a term greater than 12 months regardless of the lease classification. The lease classification will determine whether the lease expense is recognized based on effective interest rate method or a straight-line basis over the term of the lease. Accounting for lessors remains largely unchanged from current GAAP. ASU 2016-02 will be effective for the Company's fiscal year beginning after December 15, 2018 and subsequent interim periods. The Company is currently evaluating the impact of the adaption of ASU 2016-02 will have on the Company's consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows   (Topic 230): Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15"). ASU 2016-015 reduces the existing diversity in practice in financial reporting across all industries by clarifying certain existing principles in ASC 230, Statement of Cash Flows, including providing additional guidance on how and what an entity should consider in determining the classification of certain cash flows. ASU 2016-15 will be effective for the Company's fiscal year beginning after December 15, 2017 and subsequent interim periods. The adoption of ASU 2016-15 will modify the Company's current disclosures and reclassifications within the consolidated statement of cash flows but is not expected to have a material effect on the Company's consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18, Cash Flows: Statement of Cash Flows (Topic 230) - Restricted Cash.  The update requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. This standard is effective at the beginning of our 2018 fiscal year. We are currently evaluating whether the adoption of this new guidance will have a significant impact on our consolidated financial statements and related disclosures

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 will be effective for the Company's fiscal year beginning after December 15, 2019, and subsequent interim periods. The Company is currently evaluating the impact of the adoption of ASU 2017-04 will have on the Company's consolidated financial statements.

9


NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Adoption of New Accounting Standards

In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory which simplifies the subsequent measurement of inventory. The updated guidance requires that inventory measured using any method other than last-in, first-out (LIFO) or the retail inventory method (for example, inventory measured using first-in, first-out (FIFO) or average cost) be measured at the lower of cost and net realizable value. This update became effective at the beginning of our 2017 fiscal year. The adoption of this ASU did not have a significant impact on our consolidated financial statements and disclosures.

The Company adopted ASU 2015-17, Income Taxes (Topic 740): Balance sheet Classification of Deferred Taxes, which changed the classification requirements for deferred tax assets and liabilities, effective January 1, 2017. ASU 2015-17 requires long-term classification of all deferred tax assets and liabilities, rather than separately classifying deferred tax assets and liabilities based on their net current and non-current amounts, as was required under the previous guidance. The Company adopted ASU 2015-17 on a retrospective basis, therefore prior periods were adjusted to conform to the current period presentation. Consequently, $209,000 of current deferred tax assets previously reported as of December 31, 2016, have been reclassified to long-term deferred tax liabilities.

The Company adopted ASU 2016-09, Compensation - Stock Compensation (Topic 718) which simplified several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures, effective January 1, 2017. The new standard requires excess tax benefits or deficiencies for share-based payments to be recognized as income tax benefit or expense, rather than within additional paid-in capital, when the awards vest or are settled. Furthermore, cash flows related to excess tax benefits are required to be classified as operating activities in the statement of cash flows rather than financing activities. The adoption of ASU 2016-09 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 cash equivalents 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 and Cash Equivalents

The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents, to the extent the funds are not being held for investment purposes.

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.

10


NOTE 2 - CONCENTRATIONS OF CREDIT RISK AND ECONOMIC DEPENDENCE (continued)

Major Customers

The Company had two customers who comprised 50.2% and 49.1% of net revenue during the six-month period ended June 30, 2017, and 64.0% and 35.0% of net revenue during the six- month period ended June 30, 2016.  The loss of these customers would adversely impact the business of the Company.

Approximately 6.4% and 14.1% of the Company's net revenue for both periods ended June 30, 2017 and 2016, was from international sales.

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

Major Vendors

The Company had one vendor from which it purchased 97.1% of merchandise sold during the six-month period ended June 30, 2017, and 97.4% of merchandise sold during the six-month period ended June 30, 2016. The loss of this supplier could adversely impact the business of the Company.

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

NOTE 3 - NOTE RECEIVABLE

On January 15, 2013, the Company entered into an agreement with AC Kinetics, Inc. ("AC Kinetics") to purchase 100 shares of AC Kinetics Series A Preferred Stock for $500,000. These shares carried a liquidation preference in the amount of $500,000, were convertible at the Company's demand into 3% of the outstanding shares of AC Kinetics common stock and had anti-dilution protection.

On June 8, 2016, the Board of Directors approved a Resolution to accept an offer from AC Kinetics to sell back the 100 shares of AC Kinetics Series A Preferred Stock. For consideration, the Company received a note in the face amount of $1,500,000 that will be immediately paid to the Company on completion and funding of a Securities Purchase Agreement with a national company to purchase AC Kinetics.  The note is subject to a Subordination Agreement for loans made to AC Kinetics by the national company involved in the Securities Purchase Agreement.  As further consideration, the Company also received an option to repurchase 1,666,667 shares of Company common stock held by Involve L.L.C. at an exercise price of $.15. The Agreements were signed June 27, 2016. As the note is subject to a subordination agreement, and the Securities Purchase Agreement between the national company and AC Kinetics and has not been concluded, the Company has determined that the note falls under the Level three category of the fair value hierarchy and that the fair value of the note was determined to be $500,000 at the date of the
11

NOTE 3 - NOTE RECEIVABLE (continued)

transaction. The fair value of the note at June 30, 2017 was determined based on an analysis of AC Kinetics ability to repay the note. The significant unobservable inputs used in the fair value measurement of the Company's note receivable were the probability of default and the loss severity in the event of the default.

The table below sets forth a summary of changes in the fair value of the Level three note for the six-month period ended June 30, 2017:

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

NOTE 4 – 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 5%. As of June 30, 2017, and December 31, 2016, the interest rate on the loan was 5.25 % . The amounts borrowed under this agreement are due on demand and collateralized by substantially all the assets of Capstone.

As of both June 30, 2017 and December 31, 2016, there was no balance due to Sterling National Bank.

As of June 30, 2017, the maximum amount that can be borrowed on this credit line is $7,000,000.

NOTE 5 – NOTES AND LOANS PAYABLE TO RELATED PARTIES

As of June 30, 2017, and December 31, 2016, the Company had three notes and loans payable due to one officer, director and related party which totaled $1,053,883 and $1,321,721, respectively. These various notes and loans payable carry an 8% interest rate and mature on of January 2, 2018.

NOTE 6 – COMMITMENTS AND CONTINGENCIES

Operating Leases

On June 29, 2007, the Company relocated its principal executive offices and sole operations facility to 350 Jim Moran Blvd., Suite 120, Deerfield Beach, Florida 33442, which is located in Broward County.  This space consists of 4,000 square rentable feet and was leased on a month to month basis.

Capstone entered into a lease agreement for the same office space as currently located. The lease agreement dated January 17, 2014, and effective February 1, 2014, had a 3-year term with a base annual rent of $87,678 paid in equal monthly installments. The Company had the one-time option to renew the lease for three (3) years subject to a 3% increase per each year of the renewal term. 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 is responsible for a portion of common area maintenance charges and any other utility consumed in the leased premises.

12


NOTE 6 – COMMITMENTS AND CONTINGENCIES (continued)

CIHK entered into a lease agreement for office space at 303 Hennessy Road, Wanchai, Hong Kong.  The original agreement was for the period from February 17, 2014, to February 16, 2016, with a base annual rent of $48,000 (HK$ 372,000) paid in equal monthly installments. The lease was extended for three (3) months until May 16, 2016. The lease was renewed for (12) months ending May 16, 2017 with a base annual rate of $48,775 and was further extended for (12) months ending May 16, 2018 with a base annual rate of $54,193 paid in equal monthly installments. The Company entered into a six (6) month rental agreement from December 1, 2016 until May 31, 2017 for showroom space at 3F, Wing Kin Industrial Building, 4-6 Wing Kin Road, Kwai Chung, NT, Hong Kong. This agreement has been further extended until December 31, 2017.

The Company's rent expense amounted to $40,756 and $36,221 for the three-month period ended June 30, 2017 and 2016, respectively and $80,509 and $71,635 for the six-month period ended June 30, 2017 and 2016, respectively.

Consulting Agreements

On July 1, 2015, the Company entered into a consulting agreement with George Wolf, whereby Mr. Wolf will be paid $10,500 per month through December 31, 2015 and $12,500 per month from January 1, 2016 through December 31, 2017.

On January 1, 2017, the agreement was amended, whereby Mr. Wolf will be paid $13,750 per month from January 1, 2017 through December 31, 2017. A bonus compensation of $10,000 was paid in the month of January 2017.

The agreement can be terminated upon 30 days' notice by either party. The Company may, in its sole discretion at any time after December 31, 2015 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 will be paid $287,163 per annum.  As part of the agreement, the base salary will 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 new agreement began February 5, 2016 and ends February 5, 2018. 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 will be paid $191,442 per annum.  As part of the agreement, the base salary will 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 new agreement began February 5, 2016 and ends February 5, 2018. 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 one year in length.

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 12 months
13


NOTE 6 – COMMITMENTS AND CONTINGENCIES (continued)

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.

Licensing Agreements

On February 4, 2015, the Company finalized a Licensing Agreement with a globally recognized floorcare company that allows the Company to market home lighting products under the licensed brand, 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 is for 3 years. The agreement does not have a guaranteed royalty stipulation.

On December 29, 2016, the Company finalized the first amendment to the February 4 th , 2015 Licensing Agreement with the floorcare company in which the initial term was extended through February 3, 2020 if the Company reaches $10,000,000 of net sales in the initial term. The agreement was further extended out to a second extended term until February 3, 2022 and further extended out to a third extended term if specified sales goals are achieved. The license was also expanded to add an additional product category.

Royalty expense for this agreement was $206,141 and $154,315 for the three-month period ended June 30, 2017 and 2016, respectively, and $379,105 and $185,185 for the six-month period ended June 30, 2017 and 2016, respectively.

On January 9, 2017, the Company finalized a Licensing Agreement with a globally recognized battery company that will allow the Company to market under the licensed brand, a specific product to a specific retailer in the warehouse club distribution channel. This agreement will be effective until December 31, 2018. The agreement does not have a guaranteed royalty stipulation, but the Company must meet minimum net sales requirements of $5,000,000 for contract year 1 and $7,000,000 for contract year 2.

Royalty expense for this agreement was $90,074 and $0 for the three-month period ended June 30, 2017 and 2016, respectively, and $150,123 and $0 for the six-month period ended June 30, 2017 and 2016, respectively.

Investment Banking Agreement

On March 1, 2017, the Company executed an Investment Banking Agreement with Wilmington Capital Securities, LLC, ("Wilmington"), a registered broker-dealer under the Securities Exchange Act of 1934. The Company entered into the Agreement in order to obtain outside assistance in finding and considering possible opportunities to enhance Company shareholder value through significant corporate transactions or through funding expansion and/or diversification of the Company's primary business lines. The scope of such possible strategic transactions includes mergers and acquisitions, asset acquisition or sales and funding through the issuance of Company securities. The agreement has an initial six-month term and renews for an additional, consecutive six-month term if not terminated prior to the term renewal. Wilmington will receive a cash retainer fee up to $80,000, payable in monthly installments, in the first six-month term, and a reduced retainer fee of $45,000, payable in monthly installments, in the first renewal of the initial six-month term. Wilmington will also receive a transaction fee for any consummated strategic transaction introduced by Wilmington under the Agreement. The transaction fees are based on the Lehman Scale starting at 8% fee reducing to 4% on transactions from $5,000,000 to in excess of $20,000,000.

The retainer fee paid for this agreement was $30,000 and $0 for the three-month period ended June 30, 2017 and 2016, respectively, and $70,000 and $0 for the six-month period ended June 30, 2017 and 2016, respectively.

14


NOTE 7 - STOCK TRANSACTIONS

Warrants

During September and October 2007, the Company issued 2,121,569 shares of common stock for cash at $0.255 per share, or $541,000 total as part of a Private Placement under Rule 506 of Regulation D. Along with the stock, each investor also received a warrant to purchase 30% of the shares purchased in the Private Placement.  A total of 636,474 warrants were issued and remain outstanding at June 30, 2017. The warrants are ten-year warrants and have an exercise price of $0.255 per share.

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.

There were no stock options issued during the period ended June 30, 2017.

As of June 30, 2017, there were 1,516,670 stock options outstanding and 1,306,670 stock options vested. The stock options have a weighted average exercise price of $0.435.

For the three-month periods ended June 30, 2017 and 2016, the Company recognized stock based compensation expense of $20,475 and $14,250, respectively, related to these stock options.

For the six-month periods ended June 30, 2017 and 2016, the Company recognized stock based compensation expense of $40,950 and $28,500, respectively, related to these stock options. Such amounts are included in compensation expense in the accompanying consolidated statements of income. A further compensation expense expected to be $7,875 will be recognized for these options in 2017.

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.

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 as of June 30, 2017.
15


NOTE 8 - INCOME TAXES

As of June 30, 2017, the Company had utilized all net operating loss carry forwards for income tax reporting purposes that were previously available to be offset against future taxable income through 2034. The net deferred tax liability as of June 30, 2017 was $354,000 and is reflected in long-term liabilities in the accompanying balance sheet.

The Company is subject to income taxes in the U.S. federal jurisdiction, various state jurisdictions and certain other jurisdictions. 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 for the years 2013 and prior.

If the Company were to subsequently record an unrecognized tax benefit, associated penalties and tax related interest expense would be recorded as a component of income tax expense.

The provision for income taxes for the six- months ended June 30, 2017 and 2016 was calculated based on the estimated annual effective rate of 34% and 34 % for the full 2017 and 2016 calendar years respectively, adjusted for an income tax benefit from the expected utilization of net operating loss carryforwards.

The income tax provision for the three- month period ended June 30, 2017 and 2016 consists of:

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

The income tax provision for the six-month period ended June 30, 2017 and 2016 consists of:

   
6 months ended
June 30, 2017
   
6 months ended
June 30, 2016
 
  Current:
           
     Federal
 
$
392,000
   
$
-
 
  Deferred:
               
     Federal
   
138,000
     
12,600
 
  Income Tax Provision
 
$
530,000
   
$
12,600
 
 
16


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

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

Special Note Regarding Forward Looking Statements

This Form 10-Q quarterly report contains forward-looking statements that are contained principally in the sections describing our business as well as "Risk Factors," and this "Management's Discussion and Analysis of Financial Condition and Results of Operations." These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. These risks and uncertainties include, but are not limited to, the factors described in the section captioned "Risk Factors" in our latest annual report on Form 10-K for the fiscal year ended December 31, 2016, as filed with the SEC. In some cases, you can identify forward-looking statements by terms such as "anticipates," "believes," "could," "estimates," "expects," "intends," "may," "plans," "potential," "predicts," "projects," "should," "would" and similar expressions (including the negative and variants of such words) intended to identify forward-looking statements. Forward-looking statements reflect our current views with respect to future events and are based on assumptions and are subject to various risks and uncertainties. Given these uncertainties, a reader of this Form 10-Q quarterly report should not place undue reliance on these forward-looking statements.

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

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

17

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

(1)
"Capstone Lighting Technologies, L.L.C." or "CLTL" is a wholly owned subsidiary of Capstone Companies, Inc.
(2)
"Capstone International Hong Kong Ltd" or "CIHK" is a wholly owned subsidiary of Capstone Companies, Inc. and a Hong Kong SAR registered Company.
(3)
"Capstone Industries, Inc.", a Florida corporation and a wholly owned subsidiary of CAPC, may also be referred to as "CAPI" or "Capstone".
(4)
"Capstone Companies, Inc.," a Florida corporation, may also be referred to as "we," "us" "our," "Company," or "CAPC." Unless the context indicates otherwise, "Company" includes in its meaning all of Capstone Companies, Inc.'s subsidiaries.
(5)
"China" or "PRC" means People's Republic of China.
(6)
References to "33 Act" or "Securities Act" means the Securities Act of 1933, as amended.
(7)
References to "34 Act" or "Exchange Act" means the Securities Exchange Act of 1934, as amended.
(8)
"SEC" or "Commission" means the U.S. Securities and Exchange Commission.
(9)
"Subsidiaries" means the following wholly owned subsidiaries of the Company:  Capstone Industries, Inc. ("CAPI"), Capstone International H.K Ltd., ("CIHK"), and Capstone Lighting Technologies, Inc. ("CLTL").
(10)
"LED" or "LED's" means a light-emitting diode component(s) which can be assembled into light bulbs or can be used in lighting fixtures.

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

General .

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

Available Information.

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

Introduction

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

18

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

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

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

Strategy

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

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

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

19

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

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

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

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

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

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

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

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

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

Perceived or Essential Strengths

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

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

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

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Designed to make everyday tasks or usage simpler and more enjoyable for consumers;
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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;
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The products must represent significant value when compared with items produced or marketed by competitive consumer product companies; and
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Wherever feasible, the products must be unique to the market whether this be accomplished though design techniques, added functionality or some proprietary innovation.

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

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

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

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

Products and Customers

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

The Company has established product distribution relationships with numerous leading international, national and regional retailers, including but not limited to: Amazon, Bunnings, Costco Wholesale, Home Depot, Home Pro, Sam's Club, The Container Store and Wal-Mart. These distribution channels may sell the Company's products through the Internet as well as through retail storefronts and catalogs/mail order.  The Company believes it has developed the scale, manufacturing efficiencies, and design expertise that serves as the foundation for aggressive pursuit of niche product opportunities in our largest consumer markets and growing international market.  While Capstone has traditionally generated the majority of its sales in the domestic U.S. market, urbanization, rising family incomes and increased living standards abroad have spurred a perceived demand for small consumer appliances internationally. To capture this market opportunity, the Company has expanded its international sales by leveraging relationships with our existing global retailers and by strengthening our international product offerings.  CIHK assists the Company in placing more products into foreign market channels as well.  The Company introduced Capstone brands to markets outside the U.S., including Australia, France, Iceland, Japan, Mexico, New Zealand, South Korea, Spain, Taiwan, Thailand and the United Kingdom.  This continues to be a promising distribution channel with international sales for the year ended December 31, 2016, increasing 100% up to $2.4 million from $1.2 million the same period in 2015 and representing 8% of net revenue in 2016 and 92% of net revenue originating in the United States.

Based on Capstone's experience in the industry, the Company's Chinese contract manufacturing resources and focus on well designed, practical products, Capstone believes it is well positioned to become a leading manufacturer in the growing LED home lighting and security lighting segments.  The Company's efforts to achieve such a goal are ongoing.  Capstone believes it will maintain its revenue growth because of the ability to deliver unique products on time, the quality reputation of its products, business relationships with Capstone's retailers and the aggressive product expansion strategies currently in place.  Such continued progress depends on a number of assumptions and factors, including ones mentioned in "Risk Factors" below.  Critical to growth are economic conditions in the markets that foster greater consumer spending as well as success in the Company's initiatives to distinguish its brands from competitors by design, quality, and scope of functions and new technology or features.  The Company's ability to fund the pursuit of our goals remains a constant, significant factor.

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With the Company's branded lighting categories, Capstone has a comprehensive product offering for its niche in the industry.  The Company believes that it will provide retailers with a broad and diversified portfolio of consumer products across numerous product categories, which should add diversity to the Company's revenues and cash flows sources.  Within these categories, Capstone seeks to service the needs of a wide range of consumers by providing products to satisfy their different interests, preferences and budgets.

The Company believes in its ability to serve retailers with a broad array of branded products and quickly introduce new products to continue to allow Capstone to further penetrate its existing customer bases, while also attracting new customers. The Company's primary, perceived challenge is creating sustained consumer demand for its products in a growing number of markets and attaining sustained profitability, which challenge is complicated by the cost of new product development and costs of penetrating new markets.

Sales and Marketing

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

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

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

Working Capital Requirements

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

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

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

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

Competitive Conditions

The consumer LED products and small electronics businesses are highly competitive and rapidly evolving markets, both in the United States and on a global basis, as large manufacturers with global operations compete for consumer acceptance and, increasingly, limited retail shelf space.  Competition is influenced by brand perceptions, product performance and value perception, customer service and price.  The Company's principal lighting competitors in the U.S. are Amertac, Energizer, and Feit Electric.  The Company believes private-label sales by large retailers has some impact on the market in some parts of the world as many national retailers such as Costco, Home Depot, Target and Wal-Mart offer lighting as part of their private branded product lines.  Many of the Company's competitors have substantially greater resources and capabilities, including greater brand recognition, research and development budgets and broader geographical market reach.  Competitors with greater resources could undermine Capstone's expansion efforts by marketing campaigns targeting its expansion efforts or price competition.  Moreover, if one or more of the Company's competitors were to merge, the change in the competitive landscape could adversely affect our customer distribution channel.

With trends and technology continually changing, Capstone will continue to invest and rapidly develop new products that are competitively priced with consumer centric features and benefits easily articulated to influence point of sale decision making.  Success in the markets we serve depends upon product innovation, pricing, retailer support, responsiveness, and cost management.  The Company continues to invest in developing the technologies and design critical to competing in our markets as evidenced by our investment in Capstone Power Control (CPC) Technology.    Our ability to invest is limited by operational cash flow and funding from third parties, including members of management and the Board of Directors.

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

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

Research, Product Development, and Manufacturing Activities

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

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Capstone's research and development team ensures its proprietary manufacturing expertise by maintaining control over all outsourced production and critical production molds.  In order to ensure the quality and consistency of the Company's products manufactured in China, Capstone uses globally recognized certified testing laboratories such as United Laboratories (UL) or Intertek (ETL) to ensure all products are designed and tested to adhere to each country's individual regulatory standards.  The Company also employs quality control inspectors who examine and test products to Capstone's specification(s) before shipments are released.  CIHK office capabilities have now been expanded to include product development, project management, sourcing management, supply chain logistics, factory compliance auditing, and quality enforcement for all supplier factories located in Hong Kong and mainland China.

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

Raw Materials

The principal raw materials used by Capstone are sourced in China, as the Company orders product exclusively through contract manufacturers in the region. These contract manufacturers purchase components based on the Company's specifications and provide the necessary facilities and labor to manufacture the Company's products.  Capstone allocates the production of specific products to the contract manufacturer the Company believes is more experienced to produce the specific product.   In order to ensure the consistent quality of Capstone's products, quality control procedures have been incorporated at each stage of the manufacturing process, ranging from the inspection of raw materials through production and delivery to the customer.  These procedures are additional to the manufacturers internal quality control procedures and performed by Company staff.

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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.
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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.
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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.

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Distribution and Fulfillment

The Company's   U.S. domestic warehousing and fulfilment needs are performed by a third-party warehousing facility situated in Anaheim, California.  The warehouse distributor provides full inventory storage, packaging and logistics services including direct to store and direct to consumer shipping capabilities that electronically interface to our existing operations software.  The warehouse distributor provides full ERP (Enterprise Resource Planning), Inventory Control and Warehouse Management Systems.  These fulfillment services can be expanded to the east coast in Charleston, South Carolina, if we need to establish an east coast distribution point.  This relationship will allow us to fully expand our U.S. distribution capabilities and services as required

Seasonality

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

Intellectual Property

CAPC subsidiary, CAPI, owns a number of U.S. trademarks and patents which CAPC considers of substantial importance and which are used individually or in conjunction with other CAPC trademarks and patents.  These include the following trademarks: Timely Reader, Pathway Lights, Timely Reader Book lights with Timer and Auto Shut Off and 10 LED - Eco-i-Lite Power Failure Light, 5 LED - Eco-i-Lite Power Failure Light, 3 LED - Eco-i-Lite Power Failure Light, 3 LED Slim Line Eco-i-Lite Power Failure Light, LED Induction Charged Headlight.  We also have a number of patents pending on our Security Motion Activated Lights and Bathroom Vanity Light.  CAPC periodically prepares patent and trademark applications for filing in the United States and China.  CAPC will also pursue foreign patent protection in foreign countries if deemed necessary.  CAPC's ability to compete effectively in the power failure, portable lighting, and LED Home Lighting categories depends in part, on its ability to maintain the proprietary nature of its technology and manufacturing processes through a combination of patent and trade secret protection, non-disclosure agreements, licensing, and cross-licensing agreements.  CAPC owns a number of patents, trademarks, trademark and patent applications and other technology which CAPC believes are significant to its business. These relate primarily to lighting device improvements and manufacturing processes.

Value of Patents . The actual protection afforded by a patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage and the availability of legal remedies in the country. Issued patents or patents based on pending patent applications or any future patent applications may not exclude competitors or may not provide a competitive advantage to us. In addition, patents issued or licensed to us may not be held valid if subsequently challenged and others may claim rights in or ownership of such patents. The validity and breadth of claims in technology patents involve complex legal and factual questions and, therefore, the extent of their enforceability and protection is highly uncertain.

Reverse engineering, unauthorized copying or other misappropriation of our technologies could enable third parties to benefit from our technologies without paying us. We cannot assure shareholders that our competitors have not developed or will not develop similar products, will not duplicate our products, or will not design around any patents issued to or licensed by us.  We will assess any loss of these rights and determine whether to litigate to protect our intellectual property rights on a case by case basis.

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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 w e can acquire licenses under patents belonging to others for technology potentially useful or necessary to us and there can be no assurance that such licenses will be available to us, if at all, on terms acceptable to us.  Moreover, there can be no assurance that any patent issued to or licensed by us will not be infringed or circumvented by others, or will not be successfully challenged by others in lawsuits.  We do not have a reserve for litigation costs associated with intellectual property matters.  The cost of litigating intellectual property rights claims may be beyond our financial ability to fund.

Critical Accounting Policies

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

CONSOLIDATED OVERVIEW OF OPERATIONS

Revenue, net

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

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

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

Cost of Sales

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

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

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

Gross Profit

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

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

Operating Expenses

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

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

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

Sales and Marketing Expenses

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

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

Compensation Expense

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

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

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

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Professional Fees

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

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

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

Product Development Expenses

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

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

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

Other General and Administrative

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

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

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

Net Operating Income

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

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

Interest Expense

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

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

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

Income Before Tax Provision

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

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

Provision for Income Tax

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

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

Net Income

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

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

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

Off-Balance Sheet Arrangements

The Company does not have material off-balance sheet arrangements that have or are reasonably likely to have a material future effect on our results of operations or financial condition.

Contractual Obligations

There were no material changes to contractual obligations for the 6 months ended June 30, 2017.

30

LIQUIDITY AND CAPITAL RESOURCES

   
For the Six Months Ended
 
(In thousands)
 
June 30, 2017
   
June 30, 2016
 
Net cash provided by (used in):
           
Operating Activities
 
$
16
   
$
(1,619
)
Investing Activities
 
$
(15
)
 
$
(5
)
Financing Activities
 
$
(473
)
 
$
1,599
 
Total
 
$
(472
)
 
$
(25
)

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

Operating Activities

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

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

Investing Activities

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

Financing Activities

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

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

31

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

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

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

Country Risks: Changes in foreign, cultural, political and financial market conditions could impair the Company's international manufacturing operations and financial performance.

The Company's manufacturing is currently conducted in China.  Consequently, the Company is subject to a number of significant risks associated with manufacturing in China, including:

·
The possibility of expropriation, confiscatory taxation or price controls;
·
Adverse changes in local investment or exchange control regulations;
·
Political or economic instability, government nationalization of business or industries, government corruption, and civil unrest;
·
Legal and regulatory constraints;
·
Tariffs and other trade barriers, including trade disputes between the U.S. and China;
·
Political or military conflict between the U.S. and China, or between U.S. and North Korea, resulting in adverse or restricted access by U.S.-based companies to Chinese manufacturing and markets; and

Currency: Currency fluctuations may significantly increase our expenses and affect the results of operations, especially where the currency is subject to intense political and other outside pressures.

Interest Rate Risk : The Company does not have significant interest rate risk during the period ended June 30, 2017.

Credit Risk : The Company has not experienced significant credit risk, as most of our customers are long-term customers with superior payment records.  Our managers monitor our receivables regularly and our Direct Import Programs are shipped to only the most financially stable customers or advance payments before shipment are required for those accounts less financially secure.

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Not applicable.

32

Item 4.  Controls and Procedures

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

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

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

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


PART II — OTHER INFORMATION

Item 1.  Legal Proceedings.

The Company is not a party to any material pending or threatened legal proceedings and, to the best our knowledge, no such action by or against us has been threatened.  From time to time, we are subject to legal proceedings and claims that arise in the ordinary course of our business.  Although occasional adverse decisions or settlements may occur in such routine lawsuits, we believe that the final disposition of such routine lawsuits will not have material adverse effect on its financial position, results of operations or status as a going concern.

Other Legal Matters .  To the best of our knowledge, none of our Directors, officers or owners of record of more than five percent (5%) of the securities of the Company, or any associate of any such director, officer or security holder is a party adverse to us or has a material interest adverse to us in reference to pending litigation.

Item 1A.  Risk Factors.

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

33

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

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

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

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.

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

Item 3.  Defaults Upon Senior Securities

None.

Item 4.  Mine Safety Disclosures

Not Applicable.

Item 5.  Other Information

None.

Item 6.  Exhibits

The following exhibits are filed as part of this Report on Form 10-Q or are incorporated herein by reference.

EXHIBIT #
EXHIBIT TITLE
   
31.1
Certifications of Principal Executive Officer filed pursuant to Section 302 of the Sarbanes Oxley Act of 2002 ^
31.2
Certifications of Principal Financial Officer filed pursuant to Section 302 of the Sarbanes Oxley Act of 2002 ^
32.1
Certification of Principal Executive Officer furnished pursuant to 18 U.S.C. Section 1350, ^
32.2
Certification of Principal Financial Officer furnished pursuant to 18 U.S.C. Section 1350, ^


34

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


Capstone Companies, Inc.
Dated:    August 14, 2017



/s/ Stewart Wallach
   
Stewart Wallach
Chief Executive Officer
 
Principal Executive Officer
   
     
     
/ s/James G. McClinton
   
James G. McClinton
Chief Financial Officer and
 
Principal Financial Executive and Accounting Officer
Chief Operating Officer
 


35
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