CAPC Capstone Companies Inc (QB)

Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.

This discussion should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations in the Companys 2021 Annual Report.

Cautionary Statement Regarding Forward-Looking Statements

This Form 10-Q Report contains forward-looking statements that are contained principally in the sections describing our business as well as in “Risk Factors, and in “Managements Discussion and Analysis of Financial Condition and Results of Operations. These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance, or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. All statements other than statements of historical facts contained, or incorporated by reference, in this Form 10-Q Report, including, without limitation, those regarding our business strategy, financial position, results of operations, plans, prospects, actions taken or strategies being considered with respect to our liquidity position, valuation and appraisals of our assets and objectives of management for future operations, our ability to weather the impacts of the COVID-19 pandemic (including variant viruses), financing opportunities, and future cost mitigation and cash conservation efforts and efforts to reduce operating expenses and capital expenditures are forward-looking statements. These risks and uncertainties include, but are not limited to, the factors described in the section captioned “Risk Factors in our latest 2021 Annual Report. In some cases, you can identify forward-looking statements by terms such as “anticipates, “believes, “could, “estimates, “expects, “intends, “may, “plans, “potential, “predicts, “projects, “should, “would and similar expressions (including the negative and variants of such words). Forward-looking statements reflect our current views with respect to future events and are based on assumptions and are subject to various risks and uncertainties. Given these uncertainties, a reader of this Form 10-Q Report should not place undue reliance on these forward-looking statements. The forward-looking statements contained in this Form 10-Q Report are made as of the date of filing this Form 10-Q Report. You should not rely upon forward-looking statements as predictions of future events. In addition, neither we nor any other person assumes responsibility for the accuracy and completeness of any of these forward-looking statements. Examples of these risks, uncertainties and other factors include, but are not limited, to the impact of:

Additionally, many of these risks and uncertainties are currently amplified by and will continue to be amplified by, or in the future may be amplified by, the COVID-19 pandemic outbreak and emergence of new variant viruses. It is not possible to predict or identify all such risks. There may be additional risks that we consider immaterial, or which are unknown.

The challenge facing the Company is to establish a new profitable product line, the Connected Surfaces, before the poor performance of Companys traditional LED product line and economic disruptions imposed by COVID-19 pandemic and variant viruses and cost of marketing and penetrating a new product market company impose unsustainable financial burdens and losses on the Company. The Company is a “penny stock company under Commission rules and the public stock market price for our common stock is impacted by the lack of significant institutional investor and primary market maker support. Investment in our common stock is highly risky and should only be considered by investors who can afford to lose their investment and do not require on demand liquidity. Potential investors should carefully consider risk factors in our SEC filings. Increases in the public market price of the common stock in first fiscal quarter of 2021 is not indicative of potential performance of the common stock in the public market.

The Companys common stock lacks the primary market maker and institutional investor support to protect the public market from being unpredictable and volatile.

The above examples are not exhaustive and new risks emerge from time to time. Such forward-looking statements are based on our current beliefs, assumptions, expectations, estimates and projections regarding our present and future business strategies and the environment in which we expect to operate in the future. These forward-looking statements speak only as of the date made. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statement to reflect any change in our expectations with regard thereto or any change of events, conditions, or circumstances on which any such statement was based, except as required by law.

Use of Certain Defined Terms. Except as otherwise indicated by the context, the following terms have the stated meanings.

We may use “FY to mean “fiscal year and “Q to mean fiscal quarter in this Report

Overview of Our Business

Capstone Companies, Inc. (“Company or “CAPC) is a public holding company organized under the laws of the State of Florida. The Company is a designer, manufacturer and marketer of consumer inspired products that bridge technological innovations. The primary operating subsidiary is Capstone Industries, Inc., a Florida corporation located in the principal executive offices of the Company (“CAPI). Capstone International Hong Kong, Ltd., or “CIHK, was established to expand the Companys product development, engineering, and factory resource capabilities. With the 2021 shift of manufacturing to Thailand from China, the CIHK operation was downsized and closed in March 2022.

The Company has exploited technologies in areas of induction charging, power failure control, security and home LED lighting products and most recently has entered the electronics market with its introduction of Capstones Smart Mirrors. The Companys focus through 2017 was the integration of LEDs into most commonly used consumer lighting products in todays home. Over the last few years there has been significant LED price erosion, which has commoditized LED consumer products. The LED category has matured and is no longer the innovative “must have consumer product as in previous years. The Connected Surfaces is the Companys effort to establish business in an emerging segment that will allow for future revenue growth. The smart home segment is the umbrella category in which we will participate with the Connected Surfaces program.

 In late 2017, as management recognized that the LED category was maturing, it sought a business opportunity that would transition the Companys revenue streams to an emerging new product category. While we currently continue to supply LED products on a limited basis, our strategic plan to develop and launch new innovative product lines, like Connected Surfaces Smart Mirrors, is believed to be essential for sustaining or growing revenues.

The Company began its foray into the electronics industry in 2019 with its Connected Surfaces initiative. We decided to enter the market as we identified the smart home category to be emerging with strong long term growth potential. This strategy would require the Company to adopt a different short term business model as a way of building awareness and revenues. The business model is consumer direct through e-commerce marketing including a company webstore as well as third party resellers like Amazon, Wayfair and other recognized, available e-commerce platforms. The smart mirror business requires maintenance of inventory in order to be responsive to e-commerce and retail sales orders and lessen the impact of logistical problems with the delivery of products from Asia. The e-commerce platform is designed to build product awareness among consumers but will also allow the Company to potentially exploit and promote sales of products in brick-and-mortar retailers stores.

The Companys financial initiatives are driven by its entry into new distribution channels and calls for an increased emphasis on an e-commerce business model. As a result of the COVID-19 pandemic, retail foot traffic has diminished and e-commerce platforms have advanced with consumers across all product lines. The COVID-19 pandemic accelerated an existing trend of consumers purchasing more products online. The Connected Surfaces category is intended to find its way to retail shelves after it has been established through its direct-to-consumer e-commerce platform. The Company does not have prior experience in operating and promoting its own e-commerce website. The Companys e-commerce marketing and sales strategy will shift its historic reliance on ‘Big Box, brick and mortar retailers to an emphasis on e-commerce marketing and sales. If Connected Surfaces is successful, the gross margins generated by the e-commerce model should be greater than LED consumer lighting products. The Company will require additional funding to build its marketing effort, inventory levels and service levels, which funding must be timely and affordable to fund the desired marketing and product launch. The future growth will be directly impacted by the level of exposure, messaging and distribution capabilities. Certain members of the Companys management (“Corporate Insiders and Directors) have provided funding from time to time to support the Companys basic operational funding needs, but there is no guarantee that this funding will continue or be adequate to fund operations or Smart Mirror program marketing and inventory as well as possible enhancements or an expansion of the portfolio with additional items.

During the three months ended June 30, 2022, the general U.S. economic indicators show signs of a slowdown caused by interest rate increases in order to reduce the impact of increasing inflationary pressures. Although the unemployment rate remained at 3.6% and unemployment dropped in June 2022 by 372 thousand, the consumer confidence index in June was at its lowest point in one year. Retail sales in June 2022 increased 1.0% higher than May as consumers remained resilient despite inflation. But the impact of inflation on consumer prices and consumer buying patterns will be a factor through 2022. It is projected that the inflation rate will average 7.9% through 2022. Management believes that the national vaccine inoculation program made major advances, and initially increased consumer confidence, however the recent impact of the increased interest rates and energy costs have seriously eroded into consumers available spending or adversely impacted consumer confidence in the economy. Since our Connected Surface product line is not an essential product, but a discretionary purchase, consumer products that are discretionary purchases are generally adversely impacted by uncertain or negative economic news and downturn in consumer confidence. The Company anticipates that the States will continue to open their economies and consumer foot traffic will increase in brick-and-mortar retailers in 2022 but the volume of spending may be greatly reduced. Additionally during 2022 if the Omnicron variant of COVID 19 or a new variant proves to be vaccine resistant or causes a surge in severe illness and death among a significant percentage of unvaccinated Americans and to others in other nations the negative impact to consumer confidence will be significant.

Future economic indicators are trending that the U.S. economy will slowdown in 2022-23 but narrowly avoid a recession. Reducing inflation and providing price stability will protect real incomes and help sustain growth over the medium term, however, as our wholesale business revenue is dependent on customer orders issued many months in advance, the revenue shortfall during the period continued to be driven by the uncertainty felt by retail buyers as to the short and long-term impact on the retail market of COVID-19 and its overall long-term impact on the U.S. economy and in-store retail foot traffic. Management actively monitors the impact of the global pandemic on the Companys financial condition, liquidity, operations, suppliers, industry, and workforce. Given the evolution of the COVID-19 pandemic, emergence of variants and uncertainty about future variants, and the global response to curb its spread, the Company is not able to estimate the effects of the COVID-19 pandemic on its results of operations, financial condition, or liquidity for fiscal year 2022.

Effects of COVID-19

During the three and six months ended June 30, 2022, the continued outbreak and global spread of COVID-19 pandemic caused significant global economic volatility, uncertainty and disruption in our operating environment.

In response to the COVID-19 and various state and local orders, the Company instituted the following actions in March 2020:

As of the filing of this Form 10-Q Report, the Company continues to adhere to the same practices. With government mandated restrictions in Thailand and parts of China resulting from the upsurge in the Omicron variant, the Company restrictions on business travel remains in effect. While all the above-referenced steps are appropriate considering COVID-19 pandemic, they have impacted the Companys ability to operate the business in its ordinary and traditional course. The Company does not have a vaccination mandate for its employees.

Our business operations and financial performance for the period ended June 30, 2022, continued to be adversely impacted by COVID-19, which also contributed to the poor performance of our traditional LED product line in 2021 and the lack of revenues from the new Connected Surface products. In Thailand, the Omnicron variant of COVID-19 has recently surged which disrupted our overseas OEMs and delayed some of the Smart Mirror certification testing. This resulted in shipment delays of the company critical Connected Surface devices. The Company reported a net loss of approximately $611.3 thousand for the three months ended June 30, 2022, compared to a net loss of approximately $574.6 thousand for the three months ended June 30, 2021, respectively and a net loss of $1.072.6 and $1.073.6 million for the six months ended June 30, 2022, and 2021, respectively

During the three months ended June 30, 2022, the general U.S. economic indicators show signs of a slowdown caused by interest rate increases in order to reduce the impact of increasing inflationary pressures. The consumer confidence index in June was at its lowest point in one year. Management believes that the national vaccine inoculation program made major advances, and initially increased consumer confidence, however the recent impact of the increased interest rates and energy costs should seriously erode into consumers available spending. Company anticipates that the States will continue to open their economies and consumer foot traffic will increase in brick-and-mortar retailers in 2022 but the volume of spending maybe greatly reduced. Additionally during 2022 if the Omnicron variant of COVID 19 or a new variant proves to be vaccine resistant or continues to cause a surge in severe illness and death among a significant percentage of unvaccinated Americans and others in other nations the negative impact to consumer confidence will be significant.

The Company has been building its infrastructure to transition into the online retail business by developing an e-commerce website and has invested in developing a social media presence over the last year and these systems are ready to launch and ship its Smart Mirror product.

During the quarter ended March 31, 2022, the Company introduced the Smart Mirror on its Capstone Connected website. Prior to 2021, the Companys wholesale business relied on brick-and-mortar retail for sale of its products to consumers and sought to piggyback off retailers e-commerce websites as well as dedicated online retailers like Amazon. As the Company focuses its effort on social media driven e-commerce, the Companys online strategy is projected to deliver future growth and reduce reliance on Big Box retail. The Company believes that the gross margin is more favorable on the e-commerce business which then should translates to better returns on lower revenues. The Company does not have operational experience in running its own e-commerce site for Connected Surfaces products to substantiate this expectation of better returns on lower revenues. If the Company cannot operate an effective e-commerce site or effectively market in the e-commerce marketplace, the launch of the Connected Surfaces product line may not be successful.

Further, the market for Connected Surfaces products may not materialize as anticipated and to the extent necessary to generate sufficient revenues to fund Company operations. Since the Connected Surface products are intended to be the core business line of the Company, the failure of the Connected Surface products to gain consumer acceptance and generate sufficient revenues to sustain Company operations would leave the Company without a viable business line. It is possible that the interactive smart mirror market does not have the anticipated potential for a niche market competitor like the Company or that the Connected Surface products do not match then current consumer demand in the smart mirror market.

Further reliance on brick-and-mortar retailers may not provide the necessary financial benefits to address the Companys current financial problems. COVID-19 pandemic may have substantially altered the consumer product distribution environment. The extent to which COVID-19 pandemic will continue to impact the Companys results will depend primarily on future developments, including the severity and duration of the crisis, the acceptance and effectiveness of the national vaccine inoculation program, potential mutations of COVID-19 pandemic, and the impact of future actions that will be taken to contain COVID-19 pandemic or treat its impact. These future developments are highly uncertain and cannot be predicted with confidence, especially if mutations of the COVID-19 virus become widespread and prove resistant to vaccines. The Delta and Micron variant of COVID-19 for the last few months had a major surge in Thailand which necessitated sporadic regional lockdowns and s resulted in delays in finalizing certain Smart Mirror certifications, production of the initial Smart Mirror inventory and a major logistics backlog. The Company placed orders for the initial inventory rollout and has received shipments in the U.S. warehouse and has other shipments in transit.as part of the domestic inventory buildup.

As a result of the continuing economic uncertainties caused by the COVID-19 pandemic and the reduced revenue during the period, Management determined sufficient indicators existed to trigger the performance of an interim goodwill impairment analysis as of June 30, 2022. The analysis concluded that the Companys fair value of its single reporting unit exceeded the carrying value and a goodwill impairment charge was not required in the quarter ended June 30, 2022.

On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act, which we refer to as the “CARES Act. was enacted into law. The CARES Act includes several significant income and other business tax provisions that, among other things, would eliminate the taxable income limit for certain net operating losses (“NOLs) and allow businesses to carry back NOLs arising in 2018, 2019, and 2020 to the five prior tax years. The Company was able to carryback the 2018 and the 2019 NOLs to 2017 tax year and generate an estimated refund of previously paid income taxes at an approximate 34% federal tax rate. As of December 31, 2020, the Company had an income tax refundable of approximately $862 thousand of which approximately $576 thousand of income tax was refunded on February 3, 2021 and approximately $232 thousand tax was refunded on February 9, 2022 . The remaining balance of approximately $54.5 thousand was charged off in the three month period ended June 30, 2022 as the refund had been previously over estimated. leaving $0 remaining balance to be refunded as of June 30, 2022.

Goodwill Impairment

As a result of the economic uncertainties caused by the resurgence of the COVID-19 pandemic, management determined sufficient indicators existed to trigger the performance of interim goodwill impairment analysis for the three months ended June 30, 2022. The analysis concluded that the Companys fair value exceeded the carrying value of its single reporting unit and a goodwill impairment charge was not required. For the three months and six months ended June 30, 2022, and 2021, the Company recognized a goodwill impairment charge of $0 for both periods.

With the continuing economic uncertainties caused by the COVID-19 pandemic including variant viruses and the increasing inflationary impact, the capital markets may have a downturn and adversely affect the Companys stock price which will require the Company to test its goodwill for impairment in future reporting periods.

Liquidity and Going Concern

The accompanying condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business.

The uncertainty and the continuing negative impact that the COVID-19 disruption and inflationary policies could have on the future retail business and consumers willingness to visit retail stores, causing reduced consumer foot traffic and consumer spending, could negatively impact the demand for our products or delay future planned promotional opportunities. However, with the launch of the Smart Mirror portfolio using the online retail platform, the Company secured an additional working capital credit line of $600 thousand to support the Companys working capital needs during the period needed to facilitate revenue growth in that category.

Our business operations and financial performance for the six months ended June 30, 2022 continued to be adversely impacted by the developments discussed above. For the six months ended June 30 2022 and 2021, the Company reported a $155 thousand or 35.4% decrease in net revenue from $438 thousand in 2021 to $283 thousand in 2022. The net loss for the six months ended June 30, 2022 and 2021 was approximately $1.073 million as compared to approximately $1.074 million in 2021. During the six months ended June 30, 2022 and 2021 the Company used in operating activities approximately $1.140 million of cash in 2022 and $744 thousand in 2021. The net loss in the period accounted for cash usage of $1.073 million, inventory increased by $517 thousand as we started building inventory for the Smart Mirror program. The cash usage was partially offset by $287 thousand decrease in prepaid expenses and $285 thousand decrease in income tax refundable.

As of June 30, 2022, the Company has working capital of approximately $469 thousand and an accumulated deficit of $7.5 million. The Companys cash balance decreased by approximately $551.8 thousand from $1.277 million as of December 31, 2021 to $725.6 thousand as of June 30, 2022. These conditions raise substantial doubt about the Companys ability to continue as a going concern,

As discussed above, the overall impact of the COVID-19 pandemic to our business, financial condition, cash flow and results of operations remains uncertain. If any of our major wholesale customers fail to maintain normal operations or the Connected Surfaces program is not accepted by consumers, then the revenue could further decline, which could have a material adverse effect on our business, financial condition, results of operations and liquidity. Management believes that with the ongoing national distribution of vaccines, the economic impact of the COVID-19 pandemic in the U.S. will continue through 2022, but ultimately should not impact the Companys long-term strategy and initiatives.

We will seek alternative sources of liquidity, including but not limited to accessing the capital markets, or other alternative financing measures. However, instability in, or tightening of the capital markets, could adversely affect our ability to access the capital markets on terms acceptable to us. An economic recession or a slow recovery could adversely affect our business and liquidity. The ongoing impact of the COVID-19 pandemic on the Companys business and financial performance may also affect the Companys ability to obtain funding.

 The Company has been in discussions with alternate funding sources that offer programs that are more in line with the Companys future business model, particularly a facility that provides funding options that are more suitable for the e-commerce business. The borrowing costs associated with such financing are dependent upon market conditions and our credit rating. We cannot assure that we will be able to negotiate competitive rates, which could increase our cost of borrowing in the future. Based on past performances and current expectations, Management believes that with the $1,393,000 equity investment and the recent $1,020,000 purchase order funding and the $600,000 working capital loans, provides adequate liquidity to meet the Companys cash needs for our daily operations, capital expenditures and procurement of the Smart Mirror inventory for the short-term. However, we will need to continue seeking additional funding through either debt or equity to continue meeting our financial obligations which consist approximately of $376 thousands of accounts payable and accrued expenses as well as a $1,660,000 note payable with related parties and accrued interest that becomes due approximately $1,055,000 in April 2023 and $605,000 thousand in November 2023 until we are able to generate sufficient cash flows from the sale of the Smart Mirror inventory. Company may be unable to secure future necessary long term funding in adequate amounts, on affordable terms and conditions or in a timely manner.

The COVID-19 pandemic resurgence in many states or emergence of new vaccine-resistant strains of the virus could have a continuing negative impact on the brick-and-mortar retail sector, with consumers unwilling to visit retail stores, causing reduced consumer foot traffic and consumer spending. However, with a successful relaunch of the Smart Mirror portfolio using the online retail platform, the Company will not be as dependent on Big Box retailers for our revenue streams as in previous years.

On April 5, 2021, the Company entered into five separate security purchase agreements (“SPAs) whereby the Company privately placed an aggregate of 2,496,667 shares of Company common stock for an aggregate purchase price $1.498,000 (transactions being referred to as the “Private Placement). The five investors in the Private Placement consisted of four private equity funds and one individual – all being “accredited investors (under Rule 501(a) of Regulation D under the Securities Act of 1933, as amended, (“Securities Act). The $1,393,140 in net proceeds from the Private Placement will be used mostly to purchase start up inventory for the Companys new Smart Mirror product line, for a major online e-commerce fulfilment company, and the remainder for advertising and working capital (See Note 6).

On July 2, 2021, the Board of Directors (“Board) resolved that the Company required a purchase order funding facility to procure additional inventory to support the online Smart Mirror business. The Board resolved that certain Directors could negotiate the terms of a Purchase Order Funding Agreement for up to $1.020 million with Directors S. Wallach, and J. Postal and E. Fleisig, a natural person who is not affiliated with the Company other than as a lender. This agreement was finalized, and the Company received the $1.020 million, funding under this agreement on October 18, 2021. As of June 30, 2022, the loan balance $1,055,630 includes an accrued interest of $35,630.

On May 1, 2022 the Company negotiated three $200,000 each, working capital funding agreements, to provide funding for daily operations. The Board resolved that certain Directors could negotiate the terms of a Working Capital Funding Agreement for up to a total of $600,000, with Directors S. Wallach (Group Nexus), J. Postal and Mouhaned Khoury, a natural person. On May 1^st the three individual agreements became effective. The terms are for 18 months with a simple interest rate of 5 percent per annum. The loans may be prepaid in full or partially without any penalty The Company has received the $600,000 funding under these agreements. As of June 30, 2022, the notes balance $605,013 includes an accrued interest of $5.013.

With the global resurgence of the Omicron variant of COVID-19, the Companys manufacturers both in Thailand and China experienced sporadic regional lockdowns which caused production delays for Connected Surface products. With the same virus now becoming the dominant variant in the United States, the future impact on the retail marketplace remains uncertain, which places uncertainty on the timing of the Companys new retail programs that are planned to be introduced during 2022. Further delays in the shipment of Connected Surface products to consumers and distributors could have a significant impact on the ability of the Company to continue to withstand the multiple challenges of a declining LED product line, delay in shipping the new product line and the ongoing impact of COVID-19 pandemic.

As part of its traditional strategic planning, the Company reviews alternatives to its current business approach, including, without limitation, development of a new product line, sale of the public company or merger of the Company with a private operating company and other common strategic alternatives to a company facing business and financial challenges and uncertainties.

Management is closely monitoring its operations, liquidity, and capital resources and is actively working to minimize the current and future impact of this unprecedented situation. Those efforts may not successfully remediate or combat in all instances the adverse impact of COVID-19 pandemic and the affected efforts to launch the Connected Surfaces product line.

Our Growth Strategy

The Companys looking forward strategy requires continued expansion of its product development and engineering, manufacturing base marketing and distribution of a broadened portfolio of consumer electronic products. The Company will pursue new revenue opportunities through the introduction and expansion of its “Connected Surfaces portfolio into alternate distribution channels including e-commerce and others that the Company has not previously focused on. The Company also intends to leverage its existing valuable customer base and strong relationships to achieve organic growth initiatives within this new category.

Capstones past success has been in its ability to identify emerging product categories where Capstones management experience can be fully leveraged. We demonstrated this when the Company entered the LED lighting category. Our branding and product strategies delivered the Company to a well-respected market position. The Companys low-cost OEM manufacturing and operations have typically, in the past, provided an advantage in delivering great products affordably.

Our expectation is that the new product portfolio appeals to a much larger audience than our traditional LED lighting product line. The new Connected Surfaces portfolio is designed to tap into consumers ever-expanding connected lifestyles prevalent today. The products have both touch screen and voice interfacing, internet access and an operating system capable of running downloadable applications. The average selling prices will be comparable to that of tablets and smartphones, expected MSRP retail to start at $899.00, with the goal to deliver exceptional consumer value to mainstream America. Whereas, during the day your smartphone/tablet keeps you connected, whether it is work or personal, now when entering your home, Capstones new Connected Surfaces products will enable users the same level of connectivity in a more relaxed manner that does not require being tethered to these devices.

The Company competes in emerging, highly competitive consumer market channels that can be affected by volatility from a number of general business and economic factors such as, consumer confidence, employment levels, credit availability and commodity costs. Demand for the Companys products is highly dependent on economic drivers such as consumer spending and discretionary income.

Although the overseas factories have previously been fully functioning, a resurgence of the Omnicron variant of COVID-19 caused sporadic regional lockdowns with certain overseas factories that could delay shipments of products from Thailand and China, which produces all of our products. With the United States now being impacted by the Omnicron variant of the COVID-19 pandemic, we believe the impact of the virus in the U.S. will continue through 2022, but this disruption has not impacted our long-term strategy and initiatives as of the date of the filing of this Form 10-Q Report.

Last year, the Company expanded its investment and commitment in social media marketing. With our Companys plan to shift its focus to on-line commerce in the first half of 2022 and thereafter, its social media presence will be key to the Companys growth initiatives. The analytics derived from testing various messaging on social media platforms (i.e., Facebook Ads, Google Ads) has validated consumer interest in the Smart Mirror program. Based on the results from the Smart Mirrors product rollout, the Companys social media marketing efforts may be revised or expanded. Additional capital may be required to fully exploit an effective social media and e-commerce effort to support the company-critical Smart Mirrors product launch. As stated, the Company is new to social media and ecommerce marketing on the current contemplated scale and no assurances can be given, due to the lack of operational experience, on the success of those efforts, which are critical to our future financial performance and condition.

Organic Growth Strategy

Subject to adequate funding, the Company intends to pursue various initiatives to execute its organic growth strategy, which is designed to enhance its market presence, expand its customer base and maintain its recognition as an industry leader in new product development. Key elements of our organic growth strategy include:

Connected Surfaces. Historically LED lighting products have been our core business. The Capstone Lighting and Hoover Home LED brands combined, have sold millions of LED lighting products over the recent years and consequently the Company holds a well-respected position in the retail lighting category. While consistently launching successful lighting programs, the Company has determined that it needs to diversify and expand its core focus in order to continue to meet revenue growth initiatives. The Company has refocused its development and marketing initiatives and is determined to build on its success with a broader product portfolio beyond lighting products only. The new category “Connected Surfaces was officially launched in January 2020 at CES. The Company intends to expand the new line of “Connected Products for the next several years. The Companys product roadmap outlines plan for product introductions through 2022 and this will continue to expand as consumer product acceptance validates its innovations. The Company believes this program will leverage existing relationships with its current retail partners, deliver on its e-commerce initiatives and collectively contribute organic growth for the Company.

The Company acknowledges that smart homes will become more mainstream over the next several years and will present significant growth opportunities for the Company and its Connected Surfaces portfolio.

While our focus of Connected Surface products is the smart home market, smart mirrors are being employed by retailers like Ralph Lauren and Neiman Marcus to allow customers to compare outfits on fitting room smart mirrors. Further, single application smart mirrors are emerging in the fitness industry for interactive workouts at home as a result of the global pandemic.

 Perceived or Essential Strengths

Capstone believes that the following competitive strengths serve to support its business strategies.

In North America, the Company has been recognized for more than a decade as an innovator and highly efficient, low-cost manufacturer in several product niches. Capstone believes that its insight into the needs of retail programming and its proven execution track record with noted retailers globally positions it well for future growth.

Capstones core executive team has been working together for over three decades and has successfully built and managed other consumer product companies.

Operating Managements experience in hardline product manufacturing has prepared the Company for successful entries into various consumer product markets, especially its experience in using foreign OEMs to provide capabilities not possessed internally by our company.

Product Quality: Through a combination of sourcing quality components, stringent manufacturing quality control and conducting rigorous third-party testing, product experiences by consumers are of the highest ranking. To deliver cost-competitive products without compromising quality standards, we leverage purchasing volume and capitalize on strategic vendor relationships.

Perceived Weaknesses : The Company does not possess the business, marketing, and financial resources of larger competitors or the brand recognition or international markets of some of the larger competitors. The declining financial performance of the Company due to declining sales and appeal of its LED lighting product line has placed the Company in a weakened financial position, which in turn increases the need for working capital funding from investors or lenders. The Company lacks the hard assets for affordable, sufficient debt financing and the low market price of its Common Stock makes equity funding difficult in terms of finding suitable investors who will provide adequate, affordable, timely working capital funding.

The Companys previous core products lines were focused on consumer LED lighting, which is a declining revenue source with relatively low profit margins, and long-term revenue prospects of the recent diversification into Connected Surfaces products is uncertain as of the date of this Form 10-K report. As a mature product line, LED business is a declining business line and revenue source and is not deemed as sufficient to sustain the Company as a revenue source through 2022 and into 2023.

The Company does not have the large internal research and development capability of its larger competitors. Capstone operates with a limited number of employees whose functions are dedicated to executive management, sales and marketing or administrative support. The limited number of employees may hinder or delay the ability of the Company to identify or respond to consumer preferences or new technology developments in a product line. Hiring may be required with any growth and qualified personnel may not be readily available. We cannot match the compensation packages to prospective employees that many larger competitors may offer, and we lack the funding and other resources to change our operational model and its reliance on contractors for many functions and capabilities, including development, production, shipping, warehousing and distribution of products.

As a smaller reporting company, we are more vulnerable to events like COVID-19 pandemic, production and shipping delays, travel and operational disruptions and restrictions and an accelerated shift to e-commerce from reliance on brick-and-mortar retail sales. We lack, the staff, money, internal capabilities and resources and operational experience to significantly or timely respond to significant challenges and adverse changes in business and financial requirements.

COVID-19 pandemic closures of companies and shipping-distribution channels produced a delay in shipping and receipt of products from abroad and in the United States. The problems include a lack of sufficient drivers for trucking industry. The Company relies on OEMs located in Thailand and China, which have been impacted by the COVID-19 pandemic in meeting development, production and shipping deadlines. The extent of the continuing economic impact of the COVID-19 pandemic and resulting logistical delays is uncertain as of the date of this Form 10-Q report. The Company is actively exploring production capabilities in Mexico as an alternative product development and production source in order to eliminate shipping delays from Asia, but a Mexican source has not been identified as of the date of the filing of this Form 10-K and the Company may not be able to locate a Mexican source. Even if identified, a Mexican production source for products would not be in place prior to 2023, if then.

Capstones international purchases can become more expensive if the U.S. Dollar weakens against the foreign currencies.

Should the increased U.S. tariffs imposed on Chinese manufactured goods remain it may increase the cost of electronic components used in our products.

 While we have established new production capacity in Thailand, there is no final resolution of the U.S. / China trade dispute from which specific components are sourced. Developing a new, efficient OEM relationship in a new country takes time and effort to reach acceptable production efficiencies. We have only a short operational experience with Thai OEMs and cannot predict long term effectiveness of the relationship.

If the COVID-19 pandemic and increasing inflationary pressures continues to adversely impact operations and consumer confidence in 2022, it could have a detrimental impact on our ability to maintain operations by depressing consumer purchase of our products, whether online or in retail stores. Withstanding continued losses could cause the Company to consider significant corporate transaction, including, without limitation, a possible merger and acquisition transaction or reorganization to protect the core operations from the ongoing impact of the COVID-19 pandemic. Like many companies, the Company conducts periodic strategic reviews where the feasibility of significant corporate transactions are considered, including mergers, asset purchases or sales and diversification or change in business lines. The Company lacks the financial resources of larger companies to withstand adverse, significant and sustained changes in business and financial condition. This vulnerability necessitates an ongoing consideration of alternatives to current operations. Due to the decline in financial performance of the Company since 2021, and the Company being in transition from a declining product line and not yet establishing a profitable product line, as well as the Company having its shares of Common Stock quoted on The OTC Markets Group, Inc. QB Venture Market, the Company may be unable to consummate a corporate transaction that sustains operations.

Products and Customers

While the Company is expanding its product portfolio through the introduction of the Capstone Connected Surfaces program, it still develops and offers a select number of LED lighting products under the “Capstone Lighting brand for both the U.S. and overseas market. The product lines available as of the date of this 10-Q report are as follows:

Connected Surfaces – Smart Mirrors

Standard Rectangular

Wardrobe/Fitness Mirror

LED Puck Lights

LED Undercabinet Light Bars

LED Motion Sensor Lights

The plan to expand the Companys product portfolio through Connected Surfaces involves the inherent risk of increased operating and marketing costs without a corresponding increase in operational revenues and profits.. Expense categories including molds, prototyping, engineering, advertising, public relations, tradeshows and social media platforms will continue to be incurred for a period before revenues occur.

Over the past ten years, the Company has established product distribution relationships with numerous leading international, national and regional retailers, including but not limited to: Amazon, Costco Wholesale, Sams Club-Walmart, the Container Store and Firefly Buys. These distribution channels may sell the Companys products through the internet as well as through retail storefronts and catalogs/mail order. In a post-COVID-19 pandemic environment, these distribution channels may be less valuable as distribution channels, especially for the Smart Mirrors product line and if our e-commerce initiative succeeds and expands. The effective development of an e-commerce-based approach to distribution of products may be critical to the future performance of the Company. The Company believes it has developed the scale, manufacturing efficiencies, and design expertise that serves as the foundation for aggressive pursuit of niche product opportunities in our largest consumer domestic and international markets. While Capstone has traditionally generated the majority of its sales in the U.S. market, urbanization, rising family incomes and increased living standards abroad have spurred a perceived demand for small consumer appliances internationally. To capture this market opportunity, the Company has continued its international sales by leveraging relationships with our existing global retailers and by strengthening our international product offerings. The Company has sold Capstone brand products to markets outside the U.S., including Australia, Japan, South Korea, and the United Kingdom. International sales for the six months ended June 30, 2022, were approximately $44.6 thousand or 16 % of net revenue as compared to $296.5thousand or 68% in the same period 2021. The Companys performance depends on a number of assumptions and factors. Critical to growth are the economic conditions in the markets that we serve, as well as success in the Companys initiatives to distinguish its brands from competitors by design, quality, and scope of functions and new technology or features. Efforts to expand into new international markets may be adversely impacted in the near term by COVID-19 pandemic.

The Companys products are subject to general economic conditions that impact discretionary consumer spending on non-essential items. Such continued progress depends on a number of assumptions and factors, including ones mentioned in “Risk Factors below. Critical to growth are economic conditions in the markets that foster greater consumer spending as well as success in the Companys initiatives to distinguish its brands from competitors by design, quality, and scope of functions and new technology or features. The Companys ability to fund the pursuit of our goals remains a constant, significant factor.

With the Companys “Connected Surfaces category, Capstone has developed a comprehensive product offering. Within the selection of products offered, Capstone seeks to service the needs of a wide range of consumers by providing products to satisfy their different interests, preferences, and budgets. The Company believes in its strategy to offer consumers with an array of innovative connected products and quickly introduce additional products to continue to allow Capstone to further penetrate this developing market.

Tariffs. The previous U.S. administration implemented certain tariffs that directly affected the Companys competitiveness. While all companies in certain industries are affected equally, the appeal for these products to consumers was negatively impacted when retail prices increased due to higher duty rates. The Company has seen promotional schedules cut back and retailers have requested pricing adjustments that would not be known to them in advance to products being shipped. Capstones business model insulates the Company from paying duties as its retail partners are the importers of record. The obvious unknown is the final impact of tariffs to the landed costs. Accordingly, retailers have demonstrated caution in their promotional planning schedules and will continue to do so until the administration has clarified its position enabling importers to calculate estimated landed costs.

Tariffs and trade restrictions imposed by the previous U.S. administration provoked trade and tariff retaliation by other countries. A “trade dispute of this nature or other governmental action related to tariffs or international trade agreements or policies has the potential to adversely impact demand for our products, our costs, customers, suppliers and/or the U.S. economy or certain sectors thereof and, thus, to adversely impact our businesses. As of the date of this Form 10-Q Report, the new U.S. administration is currently reviewing its future position on this issue and there has not been a resolution of the Chinese American trade dispute.

Sales and Marketing

Our LED products have been sold nationally and internationally through a direct sales force. The sales force markets the Companys LED products through numerous retail locations worldwide, including larger retail warehouse clubs, hardware centers and e-commerce websites. Our business model has been designed to support “direct import sales made directly to the retail customer. However, we also offer “domestic sales programs which will be expanded in the future as a result of the Capstone Connected Surfaces program becomes available. As we shift to Connected Surfaces products, the LED products will become a secondary product line.

Direct Import Sales. We ship finished products directly to our retail customer from Thailand and China. The sales transaction and title of goods are completed by delivering products to the customers overseas shipping point. The customer takes title of the goods at that point and is responsible for inbound ocean freight and import duties. Direct import sales are made in larger quantities (generally container sized lots) to customers worldwide.

Domestic Sales. The strategy of selling products from a U.S. domestic warehouse enables the Company to provide timely delivery and serve as a domestic supplier of imported goods. With this model the Company imports goods from overseas and is responsible for all related costs including ocean freight, insurance, customs clearance, duties, storage, and distribution charges related to such products and therefore such sales command higher sales prices than direct sales. Domestic orders are for a much smaller size and could be as low as a single unit directly to the end consumer if ordered through an online website. To support an effective e-commerce business model, we will be required to warehouse adequate inventory levels enabling the Company to ship orders directly to the end consumer expediently.

To the extent permitted by our current financial condition, we continue to make investments to expand our sales, marketing, technical applications support and distribution capabilities to sell our product portfolio. We also continue to make investments to promote and build market awareness of the products and brands we offer. Our sales within the U.S. are primarily made by our in-house sales team and our independent sales agencies. Our independent sales agencies are paid a commission based upon sales made in their respective territories. Our sales agencies are recruited, trained, and monitored by us directly. We will utilize an agency as needed to help us provide service to our retail customers as required. The sales agency agreements are generally one (1) year agreements, which automatically renew on an annual basis, unless terminated by either party on 30 days prior notice. Our international sales to divisions of U.S. based retailers are made by our in-house sales team.

The Company has actively promoted its products to retailers and distributors at North American trade shows, such as the Consumer Electronics Show (“CES) or the International Hardware Show, but also relies on the retail sales channels to advertise its products directly to the end user consumers through various promotional activities. This marketing effort will continue as a complement to the social media and e-commerce initiatives.

In the six months ended June 30, 2022, and 2021, the Company had two customers who comprised approximately 87 % and 79%, respectively, of net revenue. Although we have long established relationships with our customers, we do not have contractual arrangements to purchase a fixed quantity of product annually. A decrease of business or a loss of any of our major customers could have a material adverse effect on our results of operations and financial condition.

The Company has been focused on establishing an on-line e-commerce presence to support the introduction of the “Connected Surfaces program and deliver direct to consumer.

 In 2021, we utilized social media platforms and online advertising campaigns to further grow the Companys online presence. In addition to Facebook, Instagram, Pinterest and LinkedIn, Capstone has launched a You Tube channel Smart Mirror videos and established a Twitter account. The Company has a social media presence on the following social media platforms:

FACEBOOK¹: https://www.facebook.com/capstoneindustries and https://www.facebook.com/capstoneconnected

INSTAGRAM²: https://www.instagram.com/capstoneconnected

PINTEREST³: https://www.pinterest.com/capstoneconnected/

LINKEDIN⁴: https://www.linkedin.com/company/6251882

TWITTER⁵https://twitter.com/capc capstone

YOUTUBE⁶ https://www.youtube.com/channel/UCMX5W8PV0Q59qoAdMxKcAig

¹ Facebook is a registered trademark of Facebook, Inc.

² Instagram is a registered trademark of Instagram.

³ Pinterest is a registered trademark of Pinterest.

⁴ LinkedIn is a registered trademark of LinkedIn Corporation.

⁵ Twitter is a registered trademark of Twitter Corporation.

⁶YouTube is a registered trademark of YouTube Corporation.

Competitive Conditions

The Company operates in a highly competitive environment, both in the United States and internationally, in the lighting and smart mirror segments. The Company competes with large multinationals with global operations as well as numerous other smaller, specialized competitors who generally focus on narrower markets, products, or particular categories.

Competition is influenced by technological innovation, brand perceptions, product quality, value perception, customer service and price. Over the past several years while the Companys focus has been on LED lighting, principal competitors include Energizer, Feit Electric and Jasco Products Co. (an exclusive licensee of General Electric Company). The Company believes private-label sales by large retailers has some impact on the market in some parts of the world as many national retailers such as Costco, Home Depot, Target and Sams/Wal-Mart offer lighting as part of their private branded product lines. Many of the Companys competitors have greater resources and capabilities, including greater brand recognition, research and development budgets and broader geographical market reach. Competitors with greater resources could undermine Capstones expansion efforts by marketing campaigns targeting its expansion efforts or price competition.

Other competitive factors include rapid technological changes, product availability, credit availability, speed of delivery, ability to tailor solutions to customer needs, quality and depth of product lines and training, as well as service and support provided by the distributor to the customer. Smart mirrors and other connected surface products are an emerging industry, and the Company may be unable to develop or license emerging new technologies that are dominant.

The COVID-19 pandemic has accelerated the decrease in consumer reliance on traditional brick-and-mortar retailing and heightened the importance of e-commerce and online marketing and sales. We have started our social media marketing. Many competitors have more established, widespread and effective e-commerce and social media campaigns than we do. We may not be able to effectively compete in e-commerce and social media marketing and sales. The COVID-19 pandemic has dramatically impacted marketing and sales of many products and the long-term impact of the pandemic remains uncertain as of the date of the filing of this Form 10-Q report.

With trends and technology continually evolving, and subject to adequate and affordable funding, Capstone will continue to invest and develop new products that are competitively priced with consumer centric features and benefits easily articulated to influence point of sale decision making. Success in the markets we serve depends upon product innovation, pricing, retailer support, responsiveness, and cost management. The Company continues to invest in developing the technologies and design critical to competing in our markets. Our ability to invest is limited by operational cash flow and funding from third parties, including members of management and the Board of Directors, and by the ongoing impact of the COVID-19 pandemic on our business and financial performance. Subject to adequate and affordable funding, absence of unexpected competition or technological developments in connected surface devices, and a curbing of the impact of the COVID-19 pandemic, the Company believes that it can effectively pursue and exploit product market niches because of managements proven track record in delivering innovation to the market and cost-effective and timely manner.

Research, Product Development, and Manufacturing Activities

The Companys research and development operations based in Florida and Thailand design and engineer many of the Companys products, with collaboration from its third-party manufacturing partners, software developers and Capstone U.S. engineering advisers. The Company outsources the manufacture and assembly of our products to a select group of OEM manufacturers overseas. Our research and development focus includes efforts to:

The Company establishes strict engineering specifications and product testing protocols with the Companys contract manufacturers and ensure that their factories adhere to all Regional Labor and Social Compliance Laws. These contract manufacturers purchase components that we specify and provide the necessary facilities and labor to manufacture our products. We leverage the strength of the contract manufacturers and allocate the manufacturing of specific products to the contract manufacturer best suited to the task. Quality control and product testing is conducted at the contract manufacturers facility and at their 3^rd party testing laboratories overseas.

Capstones research and development team enforces its proprietary manufacturing expertise by maintaining control over all outsourced production and critical production molds. To ensure the quality and consistency of the Companys products manufactured overseas, Capstone uses globally recognized certified testing laboratories such as United Laboratories (UL) or Intertek (ETL) to ensure all products are designed and tested to adhere to each countrys individual regulatory standards. The Company also hires quality control inspectors who examine and test products to Capstones specification(s) before shipments are released.

To successfully implement Capstones business strategy, the Company must continually improve its current products and develop new product segments with innovative imbedded technologies to meet consumers growing expectations. The Connected Surfaces product development is our current effort to achieve those expectations.

Investments in technical and product development are expensed when incurred and are included in the operating expenses.

Raw Materials

The principal raw materials currently used by Capstone are sourced in Thailand and China, as the Company orders product exclusively through contract manufacturers in the region. These contract manufacturers purchase components based on the Companys specifications and provide the necessary facilities and labor to manufacture the Companys products. Capstone allocates the production of specific products to the contract manufacturer the Company believes is more experienced to produce the specific product and whose facility is located in the country that most benefits from the U.S. Tariff regulations. To ensure the consistent quality of Capstones products, quality control procedures have been incorporated at each stage of the manufacturing process, ranging from the inspection of raw materials through production and delivery to the customer. These procedures are additional to the manufacturers internal quality control procedures and performed by Quality Assurance personnel.

Raw materials used in manufacturing include plastic resin, copper, led bulbs, batteries, and corrugated paper. Prices of materials have remained competitive in the last year. CAPC believes that adequate supplies of raw materials required for its operations are available at the present time. CAPC, cannot predict the future availability or prices of such materials. These raw materials are generally available from a number of different sources, and the prices of those raw materials are susceptible to currency fluctuations and price fluctuations due to transportation, government regulations, price controls, economic climate, or other unforeseen circumstances. In the past, CAPC has not experienced any significant interruption in availability of raw materials. We believe we have extensive experience in manufacturing and have taken positions to assure supply and to protect margins on anticipated sales volume.

Section 1502 of Title XV of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires SEC-reporting companies to disclose annually whether any conflict minerals are necessary to the functionality or production of a product. Based on our inquiries to our manufacturers, we do not believe as of the date of such inquiries that any conflict minerals are used in making our products.

Distribution and Fulfillment

Since January 2015, the Company has outsourced its U.S. domestic warehousing and distribution needs to a third-party warehousing facility situated in Anaheim, California. The warehouse operator provides full inventory storage, packaging and logistics services including direct to store and direct to consumer shipping capabilities that electronically interface to our existing operations software. The warehouse operator provides full ERP (Enterprise Resource Planning), Inventory Control and Warehouse Management Systems. These fulfillment services can be expanded to the east coast in Charleston, South Carolina, if the Company needed to establish an east coast distribution point. This relationship, if required, will allow us to fully expand our U.S. distribution capabilities and services. As the Company transitions into the e-commerce and direct to consumer marketplace, the Company has developed a new website with full shopping cart capabilities. To complete this project the Company has negotiated contracts for secured credit card processing capability, state sales tax compliance services and order fulfillment and logistics services, at a very competitive rate. The Company will also warehouse and supply its Smart Mirror program through Amazon fulfilment and Wayfair.

Seasonality

In general, sales for household products and electronics are seasonally influenced. Certain gift products cause consumers to increase purchases during key holiday winter season of the fourth quarter, which requires increases in retailer inventories during the third quarter. In addition, natural disasters such as hurricanes and tornadoes can create conditions that drive increased needs for portable power and power failure light sales. Climate change may increase the number and severity of hurricanes, tornadoes and flooding. Historically, the lighting products had lower sales during the first quarter due to the Chinese New Year holiday as factories are closed and shipments are halted during this period. Our transition to Thailand manufacturers may reduce the impact of Chinese New Year holiday.

We do not have sufficient operational experience with Connected Surfaces to predict the seasonality of Connected Surfaces.

Intellectual Property

CAPC subsidiary, CAPI, has filed a number of U.S. trademarks and patents over the past decade. These include the following trademarks: Exclusive license and sub-license to Power Failure Technology; Capstone Power Control, Timely Reader, Pathway Lights, and 10 LED - Eco-i-Lite Power Failure Light, 5 LED - Eco-i-Lite Power Failure Light, 3 LED - Eco-i-Lite Power Failure Light, 3 LED Slim Line Eco-i-Lite Power Failure Light, LED Induction Charged Headlight. We also have a number of patents pending; Puck Light (cookie), Puck Light Base, Multi-Color Puck Lights, LED Dual Mode Solar Light, Integrated Light Bulb (Coach Light), LED Gooseneck Lantern, Spotlights, Security Motion Activated Lights, Under Cabinet Lighting and Bathroom Vanity Light. CAPC periodically prepares patent and trademark applications for filing in the United States and China. CAPC will also pursue foreign patent protection in foreign countries if deemed necessary to protect a patent and to the extent that we have the available cash to do so. CAPCs ability to compete effectively in the Home Lighting categories depends in part, on its ability to maintain the proprietary nature of its technology and manufacturing processes through a combination of patent and trade secret protection, non-disclosure agreements, licensing, and cross-licensing agreements. CAPC owns a number of patents, trademarks, trademark and patent applications and other technology which CAPC believes are significant to its business. These intellectual property rights relate primarily to lighting device improvements and manufacturing processes.

While the Company may license third party technologies for its products, or may rely on other companies, especially OEMs, for design, engineering and testing, the Company believes that its oversight of design and function of its products and its marketing capabilities are significant factors in the ability of the Company to sell its products.

Value of Patents.

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

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

We rely on trademark, trade secret, patent, and copyright laws to protect our intellectual property rights. We cannot be sure that these intellectual property rights will be effectively utilized or, if necessary, successfully asserted. There is a risk that we will not be able to obtain and perfect our own intellectual property rights, or, where appropriate, license intellectual property rights from others to support new product introductions. There can be no assurance that we can acquire licenses under patents belonging to others for technology potentially useful or necessary to us and there can be no assurance that such licenses will be available to us, if at all, on terms acceptable to us. Moreover, there can be no assurance that any patent issued to or licensed by us will not be infringed or circumvented by others or will not be successfully challenged by others in lawsuits. We do not have a reserve for litigation costs associated with intellectual property matters. The cost of litigating intellectual property rights claims may be beyond our financial ability to fund.

As is customary in the retail industry, many of our customer agreements requires us to indemnify our customers for third-party intellectual property infringement claims. Such claims could harm our relationships with customers and might deter future customers from doing business with us. With respect to any intellectual property rights claims against us or our customers, we may be required to cease manufacture of the infringing product, pay damages and expend significant Company resources to defend against the claim and or seek a license.

Information Technology

The efficient operation of our business is dependent on our information technology systems. We rely on those systems to manage our daily operations, communicate with our customers and maintain our financial and accounting records. In the normal course of business, we receive information regarding customers, associates, and vendors. Since we do not collect significant amounts of valuable personal data or sensitive business data from others, our internal computer systems are under a light to moderate level of risk from hackers or other individuals with malicious intent to gain unauthorized access to our computer systems. Cyberattacks are growing in number and sophistication and are an ongoing threat to business computer systems, which are used to operate the business on a day to day basis. Our computer systems could be vulnerable to security breaches, computer viruses, or other events. The failure of our information technology systems, our inability to successfully maintain our information or any compromise of the integrity or security of the data we generate from our systems or an event resulting in the unauthorized disclosure of confidential information or degradation of services provided by critical business systems, whether by us directly or our third-party service providers, could adversely affect our business operations, sales, reputation with current and potential customers, associates or vendors, results of operations, product development and make us unable or limit our ability to respond to customers demands.

We have incorporated into our data network various on and off-site data backup processes which should allow us to mitigate any data loss events, however our information technology systems are vulnerable to damage or interruption from:

Environmental Regulations

We believe that the Company is in compliance with environmental protection regulations and will not have a material impact on our financial position and results of operations.

The Company is not aware of any national, state or local environmental laws or regulations that will materially affect our earnings or competitive position or result in material capital expenditures. However, the Company cannot predict the effect on our operations due to possible future environmental legislation or regulations. During the first fiscal quarter of 2022, there were no material capital expenditures for environmental control facilities and no such material expenditures are anticipated.

Intellectual Property Issues. Market participants rely on patented and non-patented proprietary information relating to product development and other core competencies of their business. Protection of intellectual property is important. Therefore, steps such as patent applications, confidentiality and non-disclosure agreements, as well as other security measures are generally taken. The Company has not created a litigation reserve for intellectual property rights litigation. As a business judgment, the Company does not patent or copyright or trademark all intellectual property due to a combination of factors, including, in part, the cost of registration and maintenance of registration, odds and cost of successful defense of the registration and commercial value of the intellectual property rights. To enforce or protect intellectual property rights, litigation or threatened litigation is common. The Company has not sued any third parties over intellectual property rights.

Critical Accounting Policies

We believe that there have been no significant changes to our critical accounting policies during the three months ended June 30, 2022, as compared to those we disclosed in Managements Discussion and Analysis of Financial Condition and Results of Operations included in our 2021 Annual Report.

CONSOLIDATED OVERVIEW OF RESULTS OF OPERATIONS

Results of operations.

Net Revenues

Revenue is currently mainly derived from sales of our residential lighting products. These products are directed towards consumer home LED lighting for both indoor and outdoor applications. Revenue is subject to both quarterly and annual fluctuations and is impacted by the timing of individually large orders as well as delays or sometimes advancements to the timing of shipments or deliveries. We recognize revenue upon shipment of the order to the customer when all performance obligations have been completed and title has transferred to the customer and in accordance with the respective sales contractual arrangements. Each contract on acceptance will have a fixed unit price. Most of our sales are to the U.S. market which in the quarter ended June 30, 2022 represented 100% of revenues and we expect that region to continue to be the major source of revenue for the Company. We derived 0 % of our revenue from overseas sales. Net revenue also includes the cost of instant rebate coupons, and product support allowances provided to retailers and online orders to promote certain products. All of our revenue is denominated in U.S. dollars.

Cost of Goods Sold

Our cost of goods sold consists primarily of purchased products from contract manufacturers, associated duties and inbound freight. In addition, our cost of goods sold also include inventory adjustments, warranty claims/reserves and freight allowances. We source our manufactured products based on customer orders.

Gross Profit

Our gross profit has and will continue to be affected by a variety of factors, including average sales price for our products, product mix, promotional allowances, our ability to reduce product costs and fluctuations in the cost of our purchased components

Operating Expenses

Operating expenses include sales and marketing expenses, consisting of sales representatives commissions, advertising and trade show expense and costs related to employees compensation. In addition, operating expense include charges relating to accounting, legal, insurance and stock-based compensation.