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, 2020

__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)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [__] No

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

Indicate by check mark whether the registrant is a large accelerated file, an accelerated filer, a non-accelerated filer, smaller reporting company, or emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act.

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

Securities registered pursuant to Section 12(b) of the 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

The number of shares outstanding of each of the issuer’s classes of common stock, as of August 11, 2020, is as follows: 46,296,364 shares of Common Stock, $0.0001 par value per share. The issuer’s common stock is quoted on the OTCQB Venture Market of the OTC Markets Group, Inc. under the trading symbol “CAPC.”

EXPLANATORY NOTE

As used in this Quarterly Report on Form 10-Q for the fiscal period ending June 30, 2020 (“Form 10-Q report”), “COVID-19” refers to Coronavirus/COVID 19, a highly contagious novel virus that was declared a global pandemic by the World Health Organization or “WHO” on March 11, 2020.  “COVID-19 pandemic” refers to “global pandemic” (as defined by WHO) by COVID-19. COVID-19 pandemic has had a significant, adverse economic disruption in the United States and China, especially the locality of the offices of Capstone Companies, Inc. and its subsidiaries and the Chinese original equipment manufacturers or “OEMs” of the products sold by Capstone Companies, Inc.  The products sold by Capstone Companies, Inc. are primarily sold by traditional brick-and-mortar retailers and COVID-19 pandemic significantly, adversely impacted those retailers and our sale of LED products.  We are developing a new product line on internet connected surfaces, like smart mirrors, (”Connected Surface”) for residential use, but this new product line has not been launched as of the second quarter of 2020. The impact of COVID-19 pandemic on the Company’s business and financial performance has been significant and ongoing and, coupled with the development of the Connected Surface product line, has placed a significant financial strain on Capstone Companies, Inc.

CAPSTONE COMPANIES, INC.

Quarterly Report on Form 10-Q

Three and Six Months Ended June 30, 2020

TABLE OF CONTENTS

CAPSTONE COMPANIES, INC., AND SUBSIDIARIES

NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

This summary of accounting policies for Capstone Companies, Inc. ("CAPC"or the "Company"), a Florida corporation and its wholly-owned subsidiaries is presented to assist in understanding the Company's consolidated financial statements. The accounting policies conform to accounting principles generally accepted in the United States of America ("U.S. GAAP") and have been consistently applied in the preparation of the consolidated financial statements.

Organization and Basis of Presentation

The condensed consolidated financial statements contained in this report are unaudited. In the opinion of management, the condensed consolidated financial statements include all adjustments, which are of a normal recurring nature, necessary to present fairly the Company’s financial position as of June 30, 2020 and results of operations, stockholders’ equity and cash flows for the three months and six months ended June 30, 2020 and 2019. All material intercompany accounts and transactions are eliminated in consolidation. These condensed consolidated financial statements and notes are presented in accordance with the rules and regulations of the United States Securities and Exchange Commission (“SEC”) relating to interim financial statements and in conformity with U.S. GAAP. Certain information and note disclosures have been condensed or omitted in the condensed financial statements pursuant to SEC rules and regulations, although the Company believes that the disclosures made herein are adequate to make the information not misleading. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Annual Report”).

The operating results for any interim period are not necessarily indicative of the operating results to be expected for any other interim period or the full fiscal year.

Effects of COVID-19

During the quarter ended June 30, 2020, the Company continued to be negatively impacted by the effects of the worldwide COVID-19 pandemic. During the end of March 2020, the Company’s Chinese suppliers that had been previously closed down by local and regional authorities in their efforts to combat the spread of COVID-19, started to gradually reopen their factories. Orders that had been previously delayed because of the close down started to ship. The newly certified Thailand factory also produced and shipped its first orders in the second quarter, 2020. These factories are now functioning, and orders are being produced both in Thailand and in China. Capstone International H.K. Ltd., (“CIHK”) staff have continued to work remotely from home.

On March 9, 2020, the State of Florida declared a state of emergency and issued a “stay at home” order to combat the spread of the COVID-19 pandemic. This order has since been lifted and during the second quarter 2020, many states enacted a phased reopening of their economies. The Company in 2019 had expanded its IT systems to allow for remote operations and as of March 20, 2020 the Company’s U.S. staff had been working remotely from their homes. With the State of Florida reopening, the Corporate office also opened, but staff are working on rotating schedules between the office and remotely from home.

With the initial phased reopening of many states, retailers experienced improving sales trends but with the resulting resurgence of the number of COVID-19 cases in those states, many phased reopenings have now been paused and other protective health measures are being considered. Our business operations and financial performance for the three and six months ended June 30, 2020 continued to be adversely impacted by the developments discussed above, including a further decrease in net revenue which resulted in an increase in the net loss for the three and six months ended June 30, 2020 as compared to the prior year. The decrease in net sales for this period was driven by the overseas governments mandated factory closures related to the COVID-19 pandemic, resulting in the unavailability of components and the shipment of finished orders and the uncertainty with the retail market felt by buyers as COVID-19 started to impact the U.S. economy.

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

The COVID-19 pandemic has adversely impacted general economic conditions in markets for our products.

The Company reported a net loss of approximately $657 thousand and $1.254 million for the three and six months ended June 30, 2020, respectively, compared to a net loss of approximately $11 thousand and $356 thousand for the three and six months ended June 30, 2019, respectively. With these losses the cash generated from operations was negatively impacted and the Company utilized $1.009 million of cash during the six months ended June 30, 2020.

As a result of the continuing economic uncertainties caused by the COVID-19 pandemic, management determined sufficient indicators remained to trigger the performance of a further interim goodwill impairment analysis as of June 30, 2020. The analysis concluded that the Company’s carrying value of its single reporting unit exceeded the fair value and the Company recognized an approximate $200.7 thousand goodwill impairment charge in the three months ended June 30, 2020. The total impairment charge for the six months ended June 30, 2020 was $490.8 thousand.

With the economic uncertainties caused by the COVID-19 pandemic, the capital markets may continue to have a downturn and adversely affect the Company’s stock price which will require the Company to further test its goodwill for impairment in future reporting periods.

On March 27, 2020, the current administration signed into law the Coronavirus Aid, Relief and Economic Security Act, which we refer to as the “CARES Act.” The CARES Act, among other things, includes provisions related to net operating loss carryback periods. The Company was able to carryback available net operating losses to the 2017 tax year and generate an estimated net refund of previously paid income taxes at an approximate 34% federal tax rate. This resulted in a net tax benefit of approximately $210.3 thousand which has been recorded in the three months ended June 30, 2020. A total net tax benefit of approximately $783.9 thousand has been recorded for the six months ended June 30, 2020.

The CARES Act also provided for the Paycheck Protection Program, (“PPP”). On May 11, 2020, the Company’s received a $89,600 loan under the PPP which was processed through Sterling National Bank.

At June 30, 2020, the Company’s had a loan balance of $89,600 under the PPP and had a cash balance of $2.1 million.

The Company’s factory in Thailand started producing and shipping orders in the second quarter of 2020. This additional manufacturing capacity will provide the Company with more flexibility in determining which factory location should produce goods for future orders, particularly if COVID-19 impacts Chinese manufacturing in a second wave pandemic.

With the resurgence of the COVID-19 pandemic in the U.S. many state governments could reinstate public health measures that could adversely affect the U.S. economy and financial markets, consumer spending and confidence levels, resulting in a further economic downturn that could affect customer and consumer demand for our products.

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.

As discussed above, the overall impact of the COVID-19 pandemic to our business, financial condition, cash flow and results of operations remains uncertain. For example, if any of our major wholesale customers fail to maintain normal operations, our revenue could decline, which could have a material adverse effect on our business, financial condition, results of operations and liquidity. Management believes the economic impact of the COVID-19 pandemic in the U.S. will continue through to the end of 2020 and views this as a major disruption to the 2020 forecast but ultimately should not impact our long-term strategy and initiatives.

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

The Company has had a recent history of losses and negative cash from operations and its cash balance has dropped by $1.0 million from $3.1million as of December 31, 2019 to $2.1 million as of June 30, 2020. The uncertainty and the continuing negative impact this disruption could have on the 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. As the Company relies on cash generated from operations to support its ongoing business, based on the Company’s expected rate of consumption, if the new programs are delayed or postponed the Company will need additional working capital in the fourth quarter of 2020 and its prospects of obtaining that capital are uncertain at this time. The Company may be able to raise the required additional capital through debt or equity financing. However, the Company can make no assurances that it will be able to raise the required capital, on acceptable terms or at all. Unless the Company succeeds in raising additional capital or successfully increases cash generated from operations, management believes there is substantial doubt about the Company’s ability to continue as a going concern and meet its obligations over the next twelve months from the filing date of this report. However, there are compensating factors and actions that are being taken to address these uncertainties, including the following:

•	The Company has  an $89,600 PPP loan  but no other debt or other outstanding obligations, outside of normal trade obligations.

•	The Company has no obligations or agreements containing financial covenants.

•	The Company has working capital of approximately $2.2 million consisting mostly of cash of $2.1 million.

•	The Company has income tax refundable of approximately $1.0 million of which approximately $800 thousand has already been applied for refund.

•	The Company is in discussions with an alternate funding source that offers more extensive programs that will service the Company’s future business model.

•	The Company’s plan has been to sell direct to consumers. The funding and cashflow requirements for this business model will require e-commerce funding. The Company is in discussions with a funding source that provides this option.

•	The Company has in place a mitigation plan that reduces discretionary expenses, executive managements compensation, and significantly reduces the cost of the Hong Kong operation and also reduces future travel, lodging and show expenses.

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. To conserve liquidity, the Company made some immediate steps to reduce operating costs in the second quarter of 2020 with other cost reductions effective later in the year. Disregarding the goodwill impairment charge that did not occur in 2019, the total operating expenses for the 3 months ended June 30, 2020 and 2019 were $701.5 thousand and $752.6 thousand, respectively, a reduction of $51.1 thousand. Disregarding the impairment charge in the first quarter 2020, the operating expenses are reduced to $915.2 thousand. When compared against the same calculated operating expenses in the second quarter 2020 of $701.5 thousand, expenses are down by $213.7 thousand since the first quarter 2020.

On July 31, 2020, the Company terminated its factoring agreement with Sterling National Bank. The Company will seek a new credit facility that will also provide funding options that are suitable to the e-commerce business model that the Company is transitioning into. 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.

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

Nature of Business

Since the beginning of fiscal year 2007, the Company has been primarily engaged in the business of developing, marketing, and selling home LED products (“Lighting Products”) through national and regional retailers in North America and in certain overseas markets. The Company’s products are targeted for applications such as home indoor and outdoor lighting and have different functionalities to meet consumer’s needs. The Company has developed a smart interactive mirror for residential use as a variant line for its lighting products, which was launched for market at the Consumer Electronics Show in early 2020. The development of the smart interactive mirror is part of the Company’s strategic effort to find new product lines to replace or supplement existing products that are nearing or at the end of their product life cycle. These products are offered either under the Capstone brand or licensed brands.

The Company’s products are typically manufactured in Thailand and China by contract manufacturing companies. As of the date of this Form 10-Q Report, the Company’s future product development effort is focused on Smart Mirrors because the Company believes, based on Company’s management understanding of the industry, the Smart Mirrors have the potential for greater profit margin than the Company’s historical LED consumer products.  Technological developments and changes in consumer tastes could alter the perceived potential and future viability of Smart Mirrors as a primary product.  The Company may change its product development strategies and plans as economic conditions and consumer tastes change, which condition and changes may be unforeseeable by the Company or may be beyond the ability of the Company to timely or at all adjust its strategic and product development plans.

The Company’s operations consist of one reportable segment for financial reporting purposes: Lighting Products.

Accounts Receivable

For product revenue, the Company invoices its customers at the time of shipment for the sales value of the product shipped. Accounts receivable are recognized at the amount expected to be collected and are not subject to any interest or finance charges. The Company does not have any off-balance sheet credit exposure related to any of its customers. As of June 30, 2020 and December 31, 2019, accounts receivable served as collateral when the Company borrowed against its credit facilities.

Allowance for Doubtful Accounts

The Company evaluates the collectability of accounts receivable based on a combination of factors. In cases where the Company becomes aware of circumstances that may impair a specific customer’s ability to meet its financial obligations subsequent to the original sale, the Company will recognize an allowance against amounts due, and thereby reduce the net recognized receivable to the amount the Company reasonably believes will be collected. For all other customers, the Company recognizes an allowance for doubtful accounts based on the length of time the receivables are past due and consideration of other factors such as industry conditions, the current business environment and the Company’s historical payment experience. An allowance for doubtful accounts is established as losses are estimated to have occurred through a provision for bad debts charged to earnings. This evaluation is inherently subjective and requires estimates that are susceptible to significant revisions as more information becomes available.

As of June 30, 2020 and December 31, 2019, management has determined that accounts receivable are fully collectible. As such, management has not recorded an allowance for doubtful accounts.

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

The following table summarizes the components of Accounts Receivable, net:

Inventories

The Company's inventory, recorded at lower of cost (first-in, first-out) or net realizable value, consists of finished goods for resale by Capstone.

Prepaid Expenses

The Company’s prepaid expenses consist primarily of deposits on inventory purchases for future orders as well as prepaid insurance, trade show and subscription expense. As of June 30, 2020 and December 31, 2019, prepaid expenses were $89,490 and $182,782, respectively.

Goodwill

On September 13, 2006, the Company entered into a Stock Purchase Agreement with Capstone Industries, Inc., a Florida corporation (“Capstone”). Capstone was incorporated in Florida on May 15, 1996 and is engaged primarily in the business of wholesaling technology inspired consumer products to distributors and retailers in the United States. Under the Stock Purchase Agreement, the Company acquired 100% of the issued and outstanding shares of Capstone’s Common Stock, and recorded goodwill of $1,936,020.

Goodwill acquired in business combinations is initially computed as the amount paid by the acquiring company in excess of the fair value of the net assets acquired.

Goodwill is tested for impairment on December 31 of each year or more frequently if events or changes in circumstances indicate that the asset might be impaired. If the carrying amount exceeds its fair value, an impairment loss is recognized. Goodwill is not amortized. The Company estimates the fair value of its single reporting unit relative to the Company's market capitalization.

As a result of the continuing economic uncertainties caused by the COVID-19 pandemic, management determined sufficient indicators existed to trigger the performance of an interim goodwill impairment analysis. For the three months and six months ended March 31, 2020 and June 30, 2020,  the Company recognized an impairment charge of $290,059 and $200,707, respectively.

The following table summarizes the changes in the Company’s goodwill asset which is included in the total assets in the accompanying condensed consolidated balance sheets:

With the continuing economic uncertainties caused by the COVID-19 pandemic, the capital markets may continue to have a downturn and adversely affect the Company’s stock price which will require the Company to test its goodwill for impairment in future reporting periods.

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

Fair Value Measurement

The accounting guidance under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), “Fair Value Measurements and Disclosures” (ASC 820-10) requires the Company to make disclosures about the fair value of certain of its assets and liabilities. ASC 820-10 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. ASC 820-10 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The three levels of the hierarchy are as follows:

•	Level 1: Observable inputs such as quoted prices in active markets for identical assets or liabilities.

•	Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly.

•	Level 3: Significant unobservable inputs.

The input used in the goodwill fair value calculation falls within the level 1 hierarchy.

Earnings Per Common Share

Basic earnings per common share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding for the reporting periods. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. For calculation of the diluted earnings per share, the basic weighted average number of shares is increased by the dilutive effect of stock options and warrants using the treasury stock method. In periods where losses are reported, the weighted average number of common shares outstanding excludes common stock equivalents because their inclusion would be anti-dilutive. As of June 30, 2020 and 2019, the total number of potentially dilutive common stock equivalents excluded from the diluted earnings per share calculation was 880,000 and 813,334, respectively.

During the six months ended June 30, 2020 a total of 120,000 stock options expired.

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

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

Revenue Recognition

The Company generates revenue from developing, marketing and selling consumer lighting products through national and regional retailers. The Company’s products are targeted for applications such as home indoor and outdoor lighting and have different functionalities. Capstone currently operates in the consumer lighting products category in the United States and in certain overseas markets. These products may be offered either under the Capstone brand or licensed brands.

A sales contract occurs when the customer-retailer submits a purchase order to buy a specific product, a specific quantity, at an agreed-fixed price, within a ship window, from a specific location and on agreed payment terms.

The selling price in all of our customers’ orders has been previously negotiated and agreed to including any applicable discount prior to receiving the customer’s purchase order. The stated unit price in the customer’s order has already been determined and is fixed at the time of invoicing.

The Company recognizes product revenue when the Company’s performance obligations as per the terms in the customers purchase order have been fully satisfied, specifically, when the specified product and quantity ordered has been manufactured and shipped pursuant to the customers requested ship window, when the sales price as detailed in the purchase order is fixed, when the product title and risk of loss for that order has passed to the customer, and collection of the invoice is reasonably assured. This means that the product ordered and to be shipped has gone through quality assurance inspection, customs and commercial documentation preparation, the goods have been delivered, title transferred to the customer and confirmed by a signed cargo receipt or bill of lading. Only at the time of shipment when all performance obligations have been satisfied will the judgement be made to invoice the customer and complete the sales contract.

The Company may enter into a licensing agreement with globally recognized companies, that allows the Company to market products under a licensed brand to retailers for a designated period of time, and whereby the Company will pay a royalty fee, typically a percentage of licensed product revenue to the licensor in order to market the licensed product.

The Company expenses license royalty fees and sales commissions when incurred and these expenses are recognized during the period the related sale is recorded. These costs are recorded within sales and marketing expense.

The following tables disaggregates net revenue by geographical area:

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

We provide our customers with limited rights of return for non-conforming product warranty claims. As a policy, the Company does not accept product returns from customers, however occasionally as part of a customer's in store test for new product, we may receive back residual inventory.

Customer orders received are not long-term orders and are typically shipped within six months of the order receipt, but certainly within a one-year period.

Our payment terms may vary by the type of customer, the customer's credit standing, the location where the product will be picked up from and for international customers, which country their corporate office is located. The term between invoicing date and when payment is due may vary between 30 days and 90 days depending on the customer type. In order to ensure there are no payment issues, overseas customers or new customers may be required to provide a deposit or full payment before the order is delivered to the customer.

The Company selectively supports retailer's initiatives to maximize sales of the Company's products on the retail floor or to assist in developing consumer awareness of new products launches, by providing marketing fund allowances to the customer. The Company recognizes these incentives at the time they are offered to the customers and records a credit to their account with an offsetting charge as either a reduction to revenue, increase to cost of sales, or marketing expenses depending on the type of sales incentives. Sales reductions for anticipated discounts, allowances and other deductions are recognized during the period the related revenue is recorded.

Warranties

The Company provides the end user with limited rights of return as a consumer assurance warranty on all products sold, stipulating that the product will function properly for the warranty period. The warranty period for all products is one year from the date of consumer purchase.

Certain retail customers may receive an off-invoice based discount such as a defective/warranty allowance, that will automatically reduce the unit selling price at the time the order is invoiced. This allowance will be used by the retail customer to defray the cost of any returned units from consumers and therefore negate the need to ship defective units back to the Company. Such allowances are charged to cost of sales at the time the order is invoiced.

For those customers that do not receive a discount off-invoice, the Company recognizes a charge to cost of sales for anticipated non-conforming returns based upon an analysis of historical product warranty claims and other relevant data. We evaluate our warranty reserves based on various factors including historical warranty claims assumptions about frequency of warranty claims, and assumptions about the frequency of product failures derived from our reliability estimates. Actual product failure rates that materially differ from our estimates could have a significant impact on our operating results. Product warranty reserves are reviewed each quarter and recognized at the time we recognize revenue.

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

The following table summarizes the changes in the Company's product warranty liabilities which are included in accounts payable and accrued liabilities in the accompanying June 30, 2020 and December 31, 2019 balance sheets:

Advertising and Promotion

Advertising and promotion costs, including advertising, public relations, and trade show expenses, are expensed as incurred and included in sales and marketing expenses. Advertising and promotion expense was $8,146 and $14,549 for the three months and $196,954 and $186,006 for the six months ended June 30, 2020 and 2019, respectively.

Product Development

Our research and development team located in Hong Kong working with our designated contractor factories, are responsible for the design, development, testing, and certification of new product releases. Our engineering efforts support product development across all products, as well as product testing for specific overseas markets. All research and development costs are charged to results of operations as incurred.

Product development expenses were $41,573 and $94,534, respectively for the three months and $93,186 and $179,763, respectively for the six months ended June 30, 2020 and 2019.

Shipping and Handling

The Company's shipping and handling costs are included in sales and marketing expenses and are recognized as an expense during the period in which they are incurred and amounted to $1,506 and $8,347 for the three months and $15,289 and $16,214, respectively for the six months ended June 30, 2020 and 2019.

Accounts Payable and Accrued Liabilities

The following table summarizes the components of accounts payable and accrued liabilities as of June 30, 2020 and December 31, 2019, respectively:

Income Taxes

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

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

The Company accounts for income taxes under the provisions of ASC 740 Income Taxes. ASC 740 requires recognition of deferred income tax assets and liabilities for the expected future income tax consequences, based on enacted tax laws, of temporary differences between the financial reporting and tax bases of assets and liabilities. The Company and its U.S. subsidiaries file consolidated income tax returns.

The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement.

Tax regulations within each jurisdiction are subject to the interpretation of the relaxed tax laws and regulations and require significant judgement to apply. The Company is not subject to U.S. federal, state and local tax examinations by tax authorities generally for a period of 3 years from the later of each return due date or date filed.

On March 27, 2020, the CARES Act was enacted into law. The CARES Act is a tax and spending package intended to provide economic relief to address the impact of the COVID-19 pandemic. The CARES Act includes several significant income and other business tax provisions that, among other things, would eliminate the taxable income limit for certain net operating losses (“NOLs”) and allow businesses to carry back NOLs arising in 2018, 2019, and 2020 to the five prior tax years.

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

Stock-Based Compensation

The Company accounts for stock-based compensation under the provisions of ASC 718 Compensation- Stock Compensation, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options, based on estimated fair values. ASC 718 requires companies to estimate the fair value of share-based payment awards on the date of the grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expenses over the requisite service periods in the Company's condensed consolidated statements of operations.

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. In conjunction with the adoption of ASC 718, the Company adopted the straight-line single option method of attributing the value of stock-based compensation expense. The Company accounts for forfeitures as they occur.

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses and the disclosure of contingent assets and liabilities. The Company evaluates its estimates on an ongoing basis, including those related to revenue recognition, periodic impairment tests, product warranty obligations, valuation of inventories, tax related contingencies, valuation of stock-based compensation, other contingencies and litigation, among others. The Company generally bases its estimates on historical experience, agreed obligations, and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis of making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Historically, past changes to these estimates have not had a material impact on the Company’s financial statements. However, circumstances could change, and actual results could differ materially from those estimates.

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

Recent Accounting Standards

To be Adopted in a Future Period

In June 2016, the FASB issued  Accounting Standards Update (“ASU”) 2016-13, “Financial Instruments – Credit Losses.” This ASU sets forth a current expected credit loss model which requires the Company to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions, and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. In November 2019, the effective date of this ASU was deferred until fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, with early adoption permitted. The Company is in the process of determining the potential impact of adopting this guidance on its consolidated financial statements.

In December 2019, the FASB issued ASU 2019-12, "Income Taxes (Topic 740)". The amendments in ASU 2019-12 seek to simplify the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application and simplify GAAP in other areas of Topic 740. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. The Company is currently evaluating the impact ASU 2019-12 may have on the Company’s consolidated financial statements.

Adoption of New Accounting Standards

In January 2017, the FASB issued ASU 2017-04, "Simplifying the Test for Goodwill Impairment", which requires an entity to perform a one-step quantitative impairment test, whereby a goodwill impairment loss will be measured as the excess of a reporting unit’s carrying amount over its fair value (not to exceed the total goodwill allocated to that reporting unit). It eliminates Step 2 of the current two-step goodwill impairment test, under which a goodwill impairment loss is measured by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. ASU 2017-04 is effective for fiscal years beginning after December 15, 2019. The adoption of ASU 2017-04 did not have a material effect on the Company’s consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – “Changes to the Disclosure Requirements for Fair Value Measurement.” This new guidance removes certain disclosure requirements related to the fair value hierarchy, modifies existing disclosure requirements related to measurement uncertainty and adds new disclosure requirements. The new disclosure requirements include disclosing the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019. The adoption of ASU 2018-03 did not have a material effect on the Company’s consolidated financial statements.

The Company continually assesses any new accounting pronouncements to determine their applicability to the Company. Where it is determined that a new accounting pronouncement affects the Company’s consolidated 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 consolidated financial statements properly reflect the change.

NOTE 2 - CONCENTRATIONS OF CREDIT RISK AND ECONOMIC DEPENDENCE

Financial instruments that potentially subject the Company to credit risk consist principally of cash and accounts receivable.

The Company has no significant off-balance-sheet concentrations of credit risk such as foreign exchange contracts, options contracts or other foreign hedging arrangements.

Cash

The Company at times has cash with its financial institution in excess of Federal Deposit Insurance Corporation ("FIDC") insurance limits. The Company places its cash with high credit quality financial institutions which minimize risk of loss.

Accounts Receivable

The Company grants credit to its customers, substantially all of whom are retail establishments located throughout the United States and their international locations. The Company typically does not require collateral from customers. Credit risk is limited due to the financial strength of the customers comprising the Company's customer base and their dispersion across different geographical regions. The Company monitors exposure of credit losses and maintains allowances for anticipated losses considered necessary under the circumstances.

Major Customers

The Company had two customers who comprised 65% and 24%, respectively, of net revenue during the six months ended June 30, 2020 and one customer who comprised 95% of net revenue during the six months ended June 30, 2019. The loss of these customers would adversely impact the business of the Company.

For the six months ended June 30, 2020 and 2019, approximately 22% and 6%, respectively, of the Company's net revenue resulted from international sales.

As of June 30, 2020, approximately $69.3 thousand or 100% of accounts receivable was from one customer. As of December 31, 2019, approximately $13.5 thousand or 100% of accounts receivable was from one customer.

Major Vendors

The Company had two vendors from which it purchased 72% and 17%, respectively, of merchandise during the six months ended June 30, 2020, and one vendor from which it purchased 98% of merchandise during the six months ended June 30, 2019. The loss of these suppliers could adversely impact the business of the Company.

As of June 30, 2020, approximately $330.9 thousand or 54% of accounts payable was due to two vendors. As of December 31, 2019, approximately $100.7 thousand or 100% of accounts payable were due to one vendor.

NOTE 3 – NOTES PAYABLE

Sterling National Bank

On September 8, 2010, in order to fund increasing accounts receivables and support working capital needs, Capstone secured a Financing Agreement from Sterling Capital Funding (now called Sterling National Bank), located in New York, whereby Capstone receives funds for assigned retailer shipments. The assignments provide funding for an amount up to 85% of net invoices submitted.

There is a base management fee equal to .30% of the gross invoice amount. The interest rate of the loan advance is .25% above Sterling National Bank's Base Rate which at time of closing was 7%. As of June 30, 2020, and December 31, 2019, the interest rate on the loan was 5.25% and 6.75%, respectively. The amounts borrowed under this agreement are due on demand and collateralized by substantially all the assets of Capstone.

NOTE 3 – NOTES PAYABLE (continued)

For the three months ended June 30, 2020 and 2019, the processing fees associated with the agreement were $2,974 and $9,732, respectively.

For the six months ended June 30, 2020 and 2019, the processing fees associated with the agreement were $3,307 and $20,228 respectively.

On July 18, 2019, Sterling National Bank renewed the credit line up to $7,500,000 to June 30, 2020.

The credit facility at Sterling National Bank was up for renewal. On July 16, 2020, the Company received a Termination of Factoring Agreement letter advising that the Factoring Agreement would be terminated effective September 30, 2020. The bank advised that as the existing facility had not been used in recent years and with the uncertainties associated with the resurgence of the COVID-19 pandemic and its potential impact on the retail sector, the bank decided not to renew the Factoring Agreement. The Company requested to terminate the Agreement on July 31, 2020 which was agreed to by the bank.

The Company will seek a new credit facility that will also provide funding options that are suitable to the e-commerce business model that the Company is transitioning into. The borrowing costs associated with such financing, are dependent upon market conditions and our credit rating. We cannot assure that we will be able to negotiate competitive rates, which could increase our cost of borrowing in the future.

As of June 30, 2020, and December 31, 2019, there was no balance due to Sterling National Bank.

The Company, through Sterling National Bank, applied for a loan under the Paycheck Protection Program (“PPP”). The PPP was enacted on March 27, 2020 as part of the CARES Act and provides for loans for amounts up to 2.5 times of the average monthly payroll expenses of the qualifying business. The loans and accrued interest are forgivable after eight weeks as long as the borrower uses the loan proceeds for eligible purposes, including payroll, benefits, rent and utilities, and maintains its payroll levels. The amount of loan forgiveness will be reduced if the borrower terminates employees or reduces salaries during the eight-week period. On May 11, 2020, the Company received loan proceeds in the amount of $89,600.

The unforgiven portion of the PPP loan is payable over two years at an interest rate of 1%, with a deferral of payments for the first six months. As of June 30, 2020, the Company has accrued $133 of interest expense for this PPP loan. The Company intends to use the proceeds for purposes consistent with the PPP. The Company believes that its use of the loan proceeds will meet the conditions for forgiveness of the loan,  however we cannot be certain that we will not take actions that could cause the Company to be ineligible for forgiveness of the loan. Under Small Business Administration (“SBA”) and  U.S. Treasury Department guidelines issued in May 2020, a borrower must apply for the forgiveness of the loans by filing SBA Form 3508, Paycheck Protection Program Loan Forgiveness Application.

NOTE 4 – COMMITMENTS AND CONTINGENCIES

Operating Leases

The Company has operating lease agreements for offices and showroom facilities in Fort Lauderdale, Florida and in Hong Kong, expiring at varying dates. The Company’s principal executive office is located at 431 Fairway Drive, Suite 200, Deerfield Beach, Florida 33441.

Effective February 1, 2017, the Company renewed the lease for 3 years ending January 31, 2020, with a base annual rent of $92,256 and with a total rent expense of $281,711 through the term of the agreement. Under the lease agreement, Capstone was responsible for a portion of common area maintenance charges and any other utility consumed in the leased premises.

NOTE 4 – COMMITMENTS AND CONTINGENCIES (Continued)

On May 15, 2018, the Company entered into a lease agreement with the previous landlord to provide for a premise’s relocation, lease termination and new sublease agreement. Under the agreement the Company relocated its principal executive offices located at 350 Jim Moran Blvd, Suite 120, Deerfield Beach, Florida 33442 to 4,694 square feet of office space on the second floor of 431 Fairway Drive, Suite 200, Deerfield Beach, Florida 33441. The original lease terminated on the relocation date, being July 1, 2018, and the parties proceeded under the terms of the sublease which expired on January 31, 2020. The base annual rent in the sublease remained at the same rate as the previous agreement until January 31, 2020. At the expiration of the sublease, the Company had the option to accept the prime lease with another 3 years renewal and with an option to renew for an additional 5-year period. If the Company decided to further extend the sublease after January 31, 2020, the Company would be subject to the terms and conditions of the prime lease. The base monthly rent was $7,312 to January 31, 2019 and then base rent would be $7,514 until January 31, 2020 which includes an estimate for portion of the common area maintenance.

As consideration for the lease amendment, the Company received a rate abatement from the landlord, effective May 1, 2018 and for four months to September 1, 2018. The landlord delivered the relocation premises in a “turnkey” condition with requested renovations made at no expense to the Company. As further consideration, the existing landlord agreed to pay the Company a $150,000 incentive to vacate the existing premises on completion of the relocation, which was fully paid as of December 31, 2018 and was being amortized over the life of the lease amendment and resulted in the recognition of lease incentive income of $870 per month.

On May 9, 2019, per the terms of the lease agreement, the current landlord was notified of the Company’s intent to take over the prime lease.

Effective November 1, 2019, the Company entered into a new prime operating lease with the landlord “431 Fairway Associates, LLC” ending June 30, 2023, for the Company’s executive offices located on the second floor of 431 Fairway Drive, Suite 200, Deerfield Beach, Florida 33441 with an annualized base rent of $70,104 and with a base rental adjustment of 3% commencing July 1, 2020 and on July 1^st of each subsequent year during the term. Under the lease agreement, Capstone is also responsible for a portion of common area maintenance charges in the leased premises which has been estimated at $12.00 per square foot on an annualized basis of which the premises is approximately 4,694 square feet.

The Company's rent expense is recorded on a straight-line basis over the term of the lease. The rent expense for the six months ended June 30, 2020 and 2019 amounted to $88,432 and $42,774, respectively. The rent increase in the six months ended June 30, 2020 resulted from the expiry of a $8,383 monthly rent incentive that ended January 31, 2020. At the commencement date of the new office lease, the Company recorded a right-of-use asset and lease liability under ASU 2016-02, Topic 842.

Supplemental balance sheet information related to leases as of June 30, 2020 is as follows:

Supplemental statement of operations information related to leases for the six months ended June 30, 2020 is as follows:

NOTE 4 – COMMITMENTS AND CONTINGENCIES (Continued)

Supplemental cash flow information related to leases for the six months ended June 30, 2020 is as follows:

Scheduled maturities of operating lease liabilities outstanding as of June 30, 2020 are as follows:

The Company has one short term lease with a duration of less than twelve months.

Capstone International Hong Kong Ltd, (CIHK), entered into a lease agreement for office space at 303 Hennessy Road, Wanchai, Hong Kong. The original agreement which was effective from February 17, 2014 has been extended various times. On August 17, 2019, the lease was further extended with a base monthly rate of $5,100 for six months until February 16, 2020. As the premises was no longer required as the employees were working remotely, the Company decided not to renew and allowed this lease to expire.

CIHK entered into a six-month rental agreement effective from December 1, 2016 for a showroom space at 3F, Wing Kin Industrial Building, 4-6 Wing Kin Road, Kwai Chung, NT, Hong Kong. This agreement has been extended various times. The lease with a base monthly rent of $1,290 expired August 16, 2019 and was further renewed for six-months expiring on February 16, 2020. Effective February 17, 2020, the Company entered into a new six-month lease expiring on September 30, 2020, with a base rate of $1,285 per month and the space is available to renew as required.

Consulting Agreements

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

On January 1, 2017, the agreement was amended, whereby Mr. Wolf was paid $13,750 per month from January 1, 2017 through December 31, 2017.

On January 1, 2018, the agreement was further amended, whereby Mr. Wolf was paid $13,750 per month from January 1, 2018 through December 31, 2018.

On January 1, 2019, the agreement was further amended, whereby Mr. Wolf was paid $13,750 per month from January 1, 2019 through December 31, 2020.

NOTE 4 – COMMITMENTS AND CONTINGENCIES (Continued)

The agreement can be terminated upon 30 days' notice by either party. The Company may, in its sole discretion at any time convert Mr. Wolf to a full-time Executive status. The annual salary and term of employment would be equal to that outlined in the consulting agreement.

Employment Agreements

On February 5, 2016, the Company entered into an Employment Agreement with Stewart Wallach, whereby Mr. Wallach was paid $301,521 per annum. As part of the agreement, the base salary would be reviewed annually by the Compensation Committee for a potential increase, to at least reflect increases in the cost of living, but only if the Company shows a net profit for the year. The initial term of this agreement began February 5, 2016 and ended February 5, 2018.

On February 5, 2018, the Company entered into an Employment Agreement with Stewart Wallach, whereby Mr. Wallach was paid $301,521 per annum. The initial term of this agreement began February 5, 2018 and ended February 5, 2020. The parties may extend the employment period of this agreement by mutual consent with approval of the Company's Board of Directors, but the extension may not exceed two years in length.

On February 5, 2020, the Company entered into a new Employment Agreement with Stewart Wallach, whereby Mr. Wallach will be paid $301,521 per annum. The initial term of this new agreement began February 5, 2020 and ends February 5, 2023. The parties may extend the employment period of this agreement by mutual consent with approval of the Company's Board of Directors, but the extension may not exceed two years in length.

On February 5, 2016, the Company entered into an Employment Agreement with James McClinton, whereby Mr. McClinton was paid $191,442 per annum. The term of this agreement began February 5, 2016 and ended February 5, 2018.

On February 5, 2018, the Company renewed the Employment Agreement with James McClinton, whereby Mr. McClinton was paid $191,442 per annum. The term of this new agreement began February 5, 2018 and ended February 5, 2020.

On February 5, 2020, the Company entered into a new Employment Agreement with James McClinton, whereby Mr. McClinton will be paid $191,442 per annum. The term of this new agreement began February 5, 2020 and ends February 5, 2022.

There is a common provision in both Mr. Wallach and Mr. McClinton's employment agreements:

If the officer's employment is terminated by death or disability or without cause, the Company is obligated to pay to the officer's estate or the officer, as the case may be an amount equal to accrued and unpaid base salary as well as all accrued but unused vacation days through the date of termination. The Company will also pay sum payments equal to (a) the sum of twelve (12) months base salary at the rate the Executive was earning as of the date of termination and (b) the sum of "merit" based bonuses earned by the Executive during the prior calendar year of his termination. Any payments owed by the Company shall be paid from a normal payroll account on a bi-weekly basis in accordance with the normal payroll policies of the Company. The amount owed by the Company to the Executive, from the effective Termination date, will be payout bi-weekly over the course of the year but at no time will be no more than twenty (26) installments. The Company will also continue to pay the Executive's health and dental insurance benefits for 6 months starting at the Executives date of termination. If the Executive had family health coverage at the time of termination, the additional family premium obligation would remain theirs and will be reduced against the Executive's severance package. The employment agreements have an anti-competition provision for 18 months after the end of employment.

NOTE 4 – COMMITMENTS AND CONTINGENCIES (Continued)

Directors Compensation

On May 31, 2019 the Company approved that effective on June 1, 2019, each independent director, namely Jeffrey Guzy and Jeffrey Postal, would each receive $750 per calendar month, as a Form 1099 compensation, for their continued services as directors of the Company. This compensation would be additional to the stock option grants awarded for their participation on the Audit Committee and Compensation and Nominating Committee.

On May 31, 2019, the Company also approved that the independent directors would be offered effective from June 1, 2019, the opportunity to participate as a non-employee in the Company’s Health Benefit Plan, subject to compliance with all plan participation requirements and on acceptance into the plan the director will be responsible to pay 100% of their plans participation cost.

On June 10, 2020 the Company approved that effective on August 1, 2020 until August 1, 2021, each independent director, namely Jeffrey Guzy and Jeffrey Postal, would each receive $750 per calendar month, as a Form 1099 compensation, for their continued services as directors of the Company. This compensation would be additional to the stock option grants awarded for their participation on the Audit Committee and Compensation and Nominating Committee.

Licensing Agreements

Under a February 4, 2015 Licensing Agreement with a floorcare company, Company markets home lighting products under the licensed brand of the floorcare company, to discount retailers, warehouse clubs, home centers, on-line retailers and other retail distribution channels in the U.S., Canada and Mexico. The initial term of the agreement was for 3 years. The Licensing Agreement did not have a guaranteed royalty stipulation.

On December 29, 2016, the Company finalized the first amendment to the February 4, 2015 Licensing Agreement with the floorcare company in which the initial term was extended through February 3, 2020 and additional renewal terms and periods were also finalized. During this initial extended period through February 3, 2020, if the Company achieved net sales of $5,000,000, then the Licensing Agreement would automatically be extended 2 years until February 3, 2022 and if during this second extended period the Company achieved net sales of $5,000,000, then the Licensing Agreement would automatically be further extended 2 years until February 3, 2024. This license amendment also added an additional product category.

On April 12, 2018, the Company finalized the second amendment to the February 4, 2015 Licensing Agreement in which the license was further expanded to add an additional product category.

As the Company did not achieve the stated net sales volume for the renewal period, the License expired on February 3, 2020.

Public Relations Agreement

On September 27, 2018, the Company executed a public relations services agreement with Max Borges Agency, (“MBA”), a full – service public relations and communications agency with offices in Miami and San Francisco. The Company entered into the Agreement to obtain assistance from a nationally recognized firm, specializing in the development of product branding, marketing and launching of technology products. The agreement was effective on October 1, 2018 with an initial 180-day term, which either party can cancel with 60 days advanced notice in writing on or after the 120^th day of the effective date. MBA will receive a monthly fee of $11,250 and $476 subscription fee due on the first of each month.

During 2019 both Companies agreed to temporarily pause the MBA agreement for specific months and restarted the engagement with the same statement of work and terms as originally agreed.

On January 21, 2020, the Company provided MBA with 60 days cancellation notice and the agreement ended March 31, 2020.

NOTE 4 – COMMITMENTS AND CONTINGENCIES (Continued)

During the three months ended March 31, 2020, the Company incurred $33,750 of services fees and $952 of subscription fees. As the agreement has been cancelled there will be no further charges for this project.

NOTE 5 - STOCK TRANSACTIONS

Options

In 2005, the Company authorized the 2005 Equity Plan that made available shares of common stock for issuance through awards of options, restricted stock, stock bonuses, stock appreciation rights and restricted stock units.

On May 2, 2017, the Company’s Board of Directors amended the Company’s 2005 Equity Incentive Plan to extend the Plan’s expiration date from December 31, 2016 to December 31, 2021.

On August 29, 2018, the Company granted 100,000 stock options each to two directors of the Company for their participation as members of the Audit Committee and Nominating and Compensation Committee, and 10,000 stock options to the Company Secretary. The Director options have an exercise price of $.435 with an effective date of August 6, 2018 and vested on August 5, 2019 and have a term of 5 years. The Company Secretary options have an exercise price of $.435 with an effective date of August 6, 2018 and vested on August 5, 2019 and have a term of 10 years.

On May 31, 2019, the Company granted 100,000 stock options each to two directors of the Company for their participation as members of the Audit Committee and Nominating and Compensation Committee, and 10,000 stock options to the Company Secretary. The Director options have a strike price of $.435 with an effective date of August 6, 2019 and will vest on August 5, 2020 and have a term of 5 years. The Company Secretary options have a strike price of $.435 with an effective date of August 6, 2019 and will vest on August 5, 2020 and have a term of 10 years.

On June 10, 2020, the Company granted 100,000 stock options each to two directors of the Company for their participation as members of the Audit Committee and Nominating and Compensation Committee, and 10,000 stock options to the Company Secretary. The Director options have a strike price of $.435 with an effective date of August 6, 2020 and will vest on August 5, 2021 and have a term of 5 years. The Company Secretary options have a strike price of $.435 with an effective date of August 6, 2020 and will vest on August 5, 2021 and have a term of 10 years.

As of June 30, 2020, there were 880,000 stock options outstanding and 670,000 stock options vested. The stock options have a weighted average expense price of $0.435.

Stock options were issued under Section 4(a)(2) and Rule 506(b) of Regulation D under the Securities Act of 1933.

For the three months ended June 30, 2020 and 2019, the Company recognized stock-based compensation expense of $8,925 and $11,025 respectively.

For the six months ended June 30, 2020 and 2019, the Company recognized stock-based compensation expense of $17,850 and $22,050 respectively.

Such amounts are included in compensation expense in the accompanying consolidated statements of operations. A further compensation expense expected to be $3,433 will be recognized for these options in 2020.

NOTE 5 - STOCK TRANSACTIONS (Continued)

Adoption of Stock Repurchase Plan

On August 23, 2016, the Company's Board of Directors authorized the Company to implement a stock repurchase plan for up to $750,000 worth of shares of the Company's outstanding common stock. The stock purchases can be made in the open market, structured repurchase programs, or in privately negotiated transactions. The Company has no obligation to repurchase shares under the authorization, and the timing, actual number and value of the shares which are repurchased will be at the discretion of management and will depend on a number of factors including the price of the Company's common stock, market conditions, corporate developments and the Company's financial condition. The repurchase plan may be discontinued at any time at the Company's discretion.

On December 21, 2016, the Company's Board of Directors approved an extension of the Company's stock repurchase plan through December 31, 2017, subject to an earlier termination at the discretion of the Company's Board of Directors.

On February 13, 2017, as authorized under the Company's stock repurchase plan, the Company repurchased 1,000,000 shares of Company common stock from Involve, LLC., under the Option Agreement dated June 27, 2016, at an exercise price of $.15 per share.

On May 1, 2017, as authorized under the Company's stock repurchase plan, the Company repurchased 666,667 shares of Company common stock from Involve, LLC., under the Option Agreement dated June 27, 2016, at an exercise price of $.15 per share.

On May 2, 2017, the Company's Board of Directors authorized at the Company's discretion to either retain repurchased shares in the treasury or to retire the repurchased shares and these shares were retired on June 1, 2017.

On December 15, 2017, the Company's Board of Directors approved an extension of the Company's stock repurchase plan for up to $750,000 through June 30, 2018.

On August 29, 2018, the Company’s Board of Directors approved a further extension of the Company’s stock repurchase plan through August 31, 2019. The Board of Directors also approved an increase of the maximum amount of aggregate funding available for possible stock repurchases under the stock repurchase program from $750,000 to $1,000,000 during the renewal period.

On August 29, 2018, the Company’s Board of Directors authorized and directed the Company’s management to establish a trading account at a brokerage firm for the Company to conduct open market purchases of the Company’s Common Stock in accordance with the terms and conditions of the Company’s current stock repurchase program and to fund said account from available cash of the Company but not to exceed such amount that would cause the Company to be unable to pay its bona fide debts.

On December 19, 2018, Company entered into a Purchase Plan pursuant to Rule 10b5-1 under the Exchange Act, with Wilson Davis & Co., Inc., a registered broker-dealer. Under the Purchase Plan, Wilson Davis & Co., Inc will make periodic purchases of up to an aggregate of 750,000 shares at prevailing market prices, subject to the terms of the Purchase Plan.

On May 31, 2019, the Company’s Board of Directors approved a further extension of the Company’s stock repurchase plan through August 31, 2020. The Board of Directors also approved that the maximum amount of aggregate funding available for possible stock repurchases under the stock repurchase program remained at $1,000,000 during the renewal period.

On September 23, 2019 the Company signed a revised stock Purchase Plan to reflect an extension of the plan to repurchase up to an aggregate of 750,000 shares at prevailing market prices, subject to the terms of the Purchase Plan.

On March 30, 2020, Wilson Davis & CO., Inc., advised the Company that 750,000 of the Company’s Common Stock had been repurchased to complete the authorized Purchase Plan.

NOTE 5 - STOCK TRANSACTIONS (Continued)

On June 10, 2020, the Company’s Board of Directors approved a further extension of the Company’s stock repurchase plan through August 31, 2021.

During the quarter ended March 31, 2020 a total of 283,383 of the Company’s Common Stock has been repurchased at a total cost of $36,333.

As of March 31, 2020, since the start of the program, a total of 750,000 of the Company’s Common Stock has been repurchased at a total cost of $107,740.

As of June 30, 2020, there have been no further repurchase of the Company’s Common Stock in the quarter and further Stock repurchases have been placed on hold in order to conserve cash during the COVID-19 pandemic.

NOTE 6 - INCOME TAXES

As of December 31, 2019, the Company had net operating loss carry forwards of approximately $1,654,000, available to the Company indefinitely and up to 80% of the operating loss can be used against future taxable income.

As of  June 30, 2020, the Company had $186,022 net operating loss carry forward available to the Company.

On March 27, 2020, the CARES Act was enacted into law. The CARES Act is a tax and spending package intended to provide economic relief to address the impact of the COVID-19 pandemic. The CARES Act includes several significant income and other business tax provisions that, among other things, would eliminate the taxable income limit for certain net operating losses (“NOLs”) and allow businesses to carry back NOLs arising in 2018, 2019, and 2020 to the five prior tax years. The Company was able to carryback the NOL to 2017 tax years and generate an estimated refund of previously paid income taxes at an approximate 34% federal tax rate. This resulted in a net benefit of $573,685 which has been recorded in the first quarter 2020.

The Company has recorded a further net benefit of $210,253 in the second quarter 2020. For the six months ended June 30, 2020 the Company has recorded $783,938 in net tax benefits.

The effective tax rate as of June 30, 2020 was 38.5% and 3.3% as of June 30, 2019 and the statutory tax rate was 25.3% in 2020 and 24.5% in 2019.

The income tax (benefit) for the three months ended June 30, 2020 and 2019 consists of:

NOTE 6 - INCOME TAXES (Continued)

The income tax (benefit) for the six months ended June 30, 2020 and 2019 consists of:

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, 2019, as filed with the Commission on March 30, 2020.

Cautionary Statement Regarding Forward-Looking Statements

This Form 10-Q quarterly report contains forward-looking statements that are contained principally in the sections describing our business as well as in "Risk Factors," and in "Management's Discussion and Analysis of Financial Condition and Results of Operations." These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. All statements other than statements of historical facts contained, or incorporated by reference, in this 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, 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 annual report on Form 10-K for the fiscal year ended December 31, 2019, as filed with the SEC on March 30, 2020, and in this Form 10-Q 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 quarterly report should not place undue reliance on 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 outbreak. Until an effective vaccine is developed for COVID-19 and is widely available, it is not possible to predict the future or ongoing impact of the COVID-19 pandemic on a consumer product company like us.  Economic chaos and uncertainty, and the significant reduction of consumer traffic to brick-and-mortar retailers, imposed by COVID-19 pandemic may continue by either continuing to spike in North American in waves or a seasonal basis.  The severity of the COVID-19 pandemic is also affected by the effectiveness or lack thereof by measures to combat the spread of COVID-19 by businesses and governments, whether foreign, national, state, provincial or local. 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 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.

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 leading designer, manufacturer and marketer of consumer inspired products that bridge technological innovations. The Company has global distribution including Australia, Iceland, Japan, Korea, Mexico, North America, South America, Spain, Taiwan and the United Kingdom. The primary operating subsidiary is Capstone Industries, Inc., a Florida corporation located in the principal executive offices of the Company ("CAPI"). Capstone International Hong Kong, Ltd., or "CIHK", was established to expand the Company's product development, engineering and factory resource capabilities. The Company has a history of exploiting 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 Capstone’s Smart Mirrors.

Effects of COVID-19

In March 2020, a novel strain of coronavirus (COVID-19) was declared a global pandemic by the World Health Organization. This pandemic has negatively affected the U.S. and global economies, disrupted global supply chains and financial markets, and led to significant travel and transportation restrictions, including mandatory closures and orders to “shelter-in-place”.

During this period, the Company has been focused on protecting the health and safety of our staff, managing supply chain issues that may arise and to minimize potential disruptions to our customers, while managing our business in response to a changing dynamic. To that end, on  January 2020 our Hong Kong office was closed and remains closed, and all the employees work remotely from home. In March 2020 with the implementation of the State of Florida “Stay at Home Order” in the U.S., the corporate office was closed, and the staff have worked remotely from home. Many retail customers have been negatively impacted by the pandemic with closed stores or operating in a reduced capacity and demand for consumer goods has declined significantly which has delayed the purchase of additional products from us or resulted in delayed or cancelled orders.

With the initial phased reopening of many states, retailers experienced improving trends but with the resulting resurgence of the number of COVID-19 cases in those states, many state reopening’s have now been paused and other protective health measures are being considered. Our business operations and financial performance for the three and six months ended June 30, 2020 continued to be adversely impacted by the developments discussed above, including a further decrease in net revenue resulting in an increase in the net loss for the three and six months ended June 30, 2020 as compared to the prior year. The decrease in net sales for this period was driven by the overseas governments mandated factory closures related to the COVID-19 pandemic, resulting in the unavailability of components and the shipment of finished orders and the uncertainty felt by retail buyers of the impact of the COVID-19 pandemic on the U.S. retail markets.

The Company reported a net loss of approximately $657 thousand and $1.254 million for the three and six months ended June 30, 2020 compared to a net loss of approximately $11 thousand and $356 thousand for the three and six months ended June 30, 2019. With these losses the cash generated from operations was negatively impacted and the Company utilized $1.009 million of cash during the six months ended June 30, 2020.

With the resurgence of COVID-19 in many states our business may continue to be adversely impacted. This disruption could have a continued negative impact on the retail business and consumers’ willingness to visit retail stores, causing reduced consumer foot traffic and consumer spending which could negatively impact the demand for our products.

The Company’s available credit facility at Sterling National Bank, was up for renewal. With the current uncertainty in the retail sector resulting from the recent upsurge of COVID-19 cases, combined with the Company’s lack of utilizing the previous available credit facilities and the recent down trending of revenues, Sterling National Bank decided not to renew the facility but agreed to $3.0 million facility expiring on September 30, 2020. As the Company was not utilizing the line, the Company requested to terminate the facility on July 31, 2020 which Sterling National Bank agreed to accommodate.

The Company is in discussions with an alternate funding source that offers extensive programs that are more in line with the Company’s future business model but no firm commitments of funding have been made as of the date of the filing of this Form 10-Q report.

As of June 30, 2020, the Company had an $89,600 PPP loan but no other debt or other outstanding obligations, outside of normal trade obligations and had a cash balance of $2.1 million.

As a result of the continuing economic uncertainties caused by the COVID-19 pandemic, management determined sufficient indicators remained to trigger the performance of a further interim goodwill impairment analysis as of June 30, 2020. The analysis concluded that the Company’s carrying value of its single reporting unit exceeded the fair value and the Company recognized approximately $200.7 thousand goodwill impairment charge in the three months ended June 30, 2020. The total impairment charge for the six months ended June 30, 2020 is approximately $490.8 thousand.

With the economic uncertainties caused by the COVID-19 pandemic, the capital markets may continue to have a downturn and adversely affect the Company’s stock price which will require the Company to test its goodwill for impairment in future reporting periods.

In addition to the impact on our sales outlined above, this pandemic has also impacted the operations of our third-party logistics providers and our manufacturing and supplier partners, including through the closure or reduced capacity of facilities and operational changes to accommodate social distancing. In recent weeks the logistics situation has been improving but it is not yet up to full capacity as ocean vessels are in the process of being repositioned to accommodate demand. In addition, as the pandemic progresses, throughout our supply chain we may face further disruptions or increased operational and logistics costs.

The COVID-19 pandemic has also resulted in the Company considering possible changes in its strategic plan as a prudent measure to prepare for the impact of any possible continued or worsening of the COVID-19 pandemic on Company’s business and financial condition. The consideration of possible changes in the strategic plan is in the evaluation phase and the Company has not decided to make any specific changes in its current strategic plan, but the COVID-19 pandemic’s impact on the Company may require changes in the strategic plan.  The Company has a concern about its ability to cover operational overhead if it does not raise capital or improve cash flow from operations. See “Liquidity and Going Concern” below.

On March 27, 2020, the current administration signed into law the Coronavirus Aid, Relief and Economic Security Act, which we refer to as the “CARES Act.” The CARES Act, among other things, includes provisions related to net operating loss carryback periods. The Company was able to carryback the NOL to 2017 tax years and generate an estimated net refund of previously paid income taxes at an approximate 34% federal tax rate. This resulted in a net tax benefit of approximately $210.3 thousand which has been recorded in the three months ended June 30, 2020. A total net tax benefit of approximately $783.9 thousand has been recorded for the six months ended June 30, 2020.

The Company’s factory in Thailand started producing and shipping orders in the second quarter of 2020. This additional manufacturing capacity will provide the Company with more flexibility in determining which factory location should produce goods for future orders, particularly if COVID-19 impacts Chinese manufacturing in a second wave pandemic.

With the United States now being impacted by a resurgence of the COVID-19 pandemic, state governments could reinstate public health measures that could adversely affect the U.S. economy and financial markets, consumer spending and confidence levels, resulting in a further economic downturn that could affect customer and consumer demand for our products.

Goodwill Impairment

With the continuing economic uncertainties caused by the COVID-19 pandemic, we determined sufficient indicators existed to trigger the performance of a second interim goodwill impairment analysis as of June 30, 2020. In the first quarter 2020, the Company recognized an impairment charge of $290,059. The analysis for the second quarter 2020 concluded that the Company’s carrying value of its single reporting unit exceeded the fair value and the Company recognized a further $200,707 goodwill impairment charge was recorded. The total impairment charge for the six months ended June 30, 2020 was $490,766.

With the continuing economic uncertainties caused by the COVID-19 pandemic, the capital markets may continue to have a downturn and adversely affect the Company’s stock price which will require the Company to test its goodwill for impairment in future reporting periods. The Company estimates the fair value of its single reporting unit relative to the Company's market capitalization.

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.

As discussed in the effects of the COVID-19 pandemic disclosure, the overall impact of the COVID-19 pandemic to our business, financial condition, cash flow and results of operations remains uncertain. For example, if any of our major wholesale customers fail to maintain normal operations, our revenue could decline, which could have a material adverse effect on our business, financial condition, results of operations and liquidity. Management believe the economic impact of the virus in the U.S. will continue through to the end of 2020 and view this as a major disruption to the 2020 forecast but ultimately should not impact our long-term strategy and initiatives.

The Company has had a recent history of losses and negative cash from operations and its cash balance has dropped by $1.0 million from $3.1million as of December 31, 2019 to $2.1 million as of June 30, 2020. The uncertainty and the continuing negative impact this disruption could have on the 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. As the Company relies on cash generated from operations to support its ongoing business, based on the Company’s expected rate of consumption, if the new programs are delayed or postponed the Company will need additional working capital in the fourth quarter of 2020 and its prospects of obtaining that capital are uncertain at this time. The Company may be able to raise the required additional capital through debt or equity financing. However, the Company can make no assurances that it will be able to raise the required capital, on acceptable terms or at all. Unless the Company succeeds in raising additional capital or successfully increases cash generated from operations, management believes there is substantial doubt about the Company’s ability to continue as a going concern and meet its obligations over the next twelve months from the filing date of this Form 10-Q report. The inability of the Company to meet those obligations may require the Company to consider and pursue a significant, remedial corporate transaction. However, there are compensating factors and actions that are being taken to address these uncertainties, including the following:

•	The Company has  an $89,600 PPP loan  but no other debt or other outstanding obligations, outside of normal trade obligations.

•	The Company has no obligations or agreements containing financial covenants.

•	The Company has working capital of approximately $2.2 million consisting mostly of cash of $2.1 million.

•	The Company has an income tax refundable of approximately $1.0 million which approximately $800 thousand has already been applied for refund.

•	The Company is in discussions with an alternate funding source that offers more extensive programs that will service the Company’s future business model.

•	The Company’s plan has been to sell direct to consumers. The funding and cashflow requirements for this business model will require e-commerce funding. The Company is in discussions with a funding source that provides this funding option.

•	The Company has in place a mitigation plan that reduces discretionary expenses, executive managements compensation, and significantly reduces the cost of the Hong Kong operation and reduces travel, lodging and show expenses.

The above compensating factors may not provide the remedial benefit anticipated by the Company and may not counter the adverse, ongoing impact of the COVID-19 pandemic on the Company’s business and financial condition.  Even if the launch of more aggressive e-commerce program for selling products directly to the consumers is launched, consumer response may not counterbalance the adverse impact on sale of products through brick-and-mortar retail stores. Further, the Company may be unable to obtain adequate and affordable financing for operations.  While the above compensating factors and actions may mitigate the adverse impact of COVID-19 pandemic on the Company’s business and financial condition, those compensating factors may not provide the intended benefits or may fail to materialize in time or at all.  There can be no assurances that the Company’s business and financial condition will not be further deteriorated by the impact of the COVID-19 pandemic on consumer demand and purchases of our products, regardless of measures taken by the Company or impact of above compensating factors and actions.

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. To conserve liquidity, the Company made some immediate steps to reduce operating costs in the second of 2020 and other cost reductions effective later in the year. Disregarding the goodwill impairment charge that did not occur in 2019, the total operating expenses for the 3 months ended June 30, 2020 and 2019 were $701.5 thousand and $752.6 thousand, respectively, a reduction of $51.1 thousand. If we compare the second quarter 2020 total operating expenses of approximately $701.5 thousand against the first quarter 2020 operating expenses of $915.2 thousand, this equates to an expense reduction of $213.7 thousand during the quarter.

With the factoring agreement terminated at Sterling National Bank, the Company is in discussions with an alternate funding source that offers extensive programs that are more in line with the Company’s future business model particularly a facility that provides funding options that are suitable for the e-commerce business that the Company is transitioning into. 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.

In addition, we would 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. Although we believe we will have adequate sources of liquidity over the long-term, an economic recession or a slow recovery could adversely affect our business and liquidity.

Refer to our “Risk Factors” section included in Part II, Item 1A of this Quarterly Report on Form 10-Q for a further discussion of risks related to our indebtedness. Additionally, as discussed in the "Overview", as we navigate these unprecedented circumstances, we are focused on preserving our liquidity and managing our cash flows through certain preemptive actions designed to enhance our ability to meet our short-term liquidity needs. These actions include those noted above.

Our Growth Strategy

The Company's focus in recent years has been in the integration of LEDs into most commonly used lighting products in today's home. The LED markets are now mainstream in consumer lighting products. The Company believes that the component and production costs of LED lighting products will continue to lower due to technological and production developments.

Over the last few years there has been significant LED price erosion, which has substantially driven unit sales, as homeowner’s convert to LED, but at the same time has commoditized other LED consumer products. The LED category is maturing and is no longer the innovative “must have” consumer product as in previous years.

Capstone’s success has been in its ability to identify emerging product categories where Capstone’s 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 Company’s low-cost manufacturing and operations have provided an advantage in delivering great products affordably.

As management recognized that the growth of the LED category was maturing, we sought a business opportunity that would prove equal to or greater than the LED business. While we currently continue to develop new LED products, the revenue potential has been lessened and our new looking forward strategy to develop new product lines, like Smart Mirrors, is believed to be necessary and timely for sustaining or growing revenues.

Our expectation is that the new portfolio appeals to a much larger audience than our traditional LED lighting product line, with more relevant products that will hopefully benefit from management’s proven abilities in the areas of low-cost production and operations. The new Connected Surfaces or “Smart Mirror” portfolio is designed to tap into consumer’s ever-expanding connected lifestyles prevalent today. The products will 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 retails to start at $500.00 per unit, with the goal to deliver consumer value for middle income homes, which is our target market. Whereas, during the day your smartphone/tablet keeps you connected, whether it is work or personal, now when entering your home, Capstone’s 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. If we seek to compete in the upscale market for more expensive smart mirrors with varied and enhanced features, we perceive that we would be directly competing with larger competitors and their significantly greater resources. Retail pricing for upscale smart mirrors typically ranges from $900 to $2,000.

The Company competes in 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 Company’s products is highly dependent on economic drivers such as consumer spending and discretionary income. While we believe that the markets for LED home products will remain competitive during fiscal 2020, we are confident in maintaining our revenue stream in the lighting business segment by continuing to introduce new innovative LED products. By working diligently overseas with alternate manufacturers located in Thailand, we anticipate minimal impact to our selling prices and related margins of profit that could otherwise be impacted by ongoing trade disputes between the United States and China. Although the overseas factories are fully functioning at this time, a resurgence of the Global COVID-19 pandemic could impact the overseas factories again and could delay shipments of products from Thailand and China, which produces all of our products. The Company’s new factory in Thailand produced and shipped its first orders for the Company in the second quarter 2020. This facility will provide the Company with more flexibility in determining which location should produce goods for future orders. With the United States now being impacted by the resurgence of the COVID-19 pandemic we believe the impact of the virus in the U.S. will continue to the end of 2020, but this disruption should not impact our long-term strategy and initiatives.

We are not able to determine the long-term impact of any future reliance on or expanded reliance on production of products in Thailand as of the date of the filing of this Form 10-Q Report due to a lack of a sufficient period of operational experience under the expansion and the unknown extent to which we may have to rely more on production in Thailand in the future.

We continue to make investments to ensure that we provide quality, useful products. Additionally, the Company continues to enhance its customer service support. During 2020, the Company has substantially expanded its investment and commitment to social media marketing. With the growing importance of on-line commerce and social media to consumers, this marketing should play a vital role in expanding our lifestyle brands and will also serve to establish credibility with the Company’s growing consumer base. This effort will focus on creating a more extensive and aggressive social media presence through use of third-party social media like Facebook, Twitter, YouTube and Instagram as well as measures to increase our “ranking” in search engines.

The Company oversees and controls the manufacturing of its products, which are currently made in Thailand and China by OEM contract manufacturers, through three wholly owned operating subsidiaries: CAPI, CIHK and CLTL. The Company's direct import business model requires that 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 typically not warehoused for domestic replenishment programming. CIHK 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. Capstone’s business practices have allowed development of excellent relationships with its OEM contract manufacturers and has resulted in commercially favorable payment terms, which over the years has greatly contributed to the Company's growth.

The Company’s 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 seek new revenue opportunities through the introduction of its “Connected Surfaces” portfolio into expanded channels of distribution including e-commerce and others that the Company has not previously focused on. The Company also intends to leverage our existing valuable customer base and strong relationships to achieve organic growth initiatives with this new category.

Organic Growth Strategy

As the COVID 19 pandemic subsides and markets reopen, we intend to execute our organic growth strategy, which is designed to enhance our market presence, expand our customer base and be 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. Critical to this strategy, the Company developed and introduced in January 2019 at the Consumer Electronics Show (CES), a new concept line of “Connected Surfaces” products. The new category was officially launched in January 2020 at CES.

The Company intends to expand the new line of “Connected Products” for the next several years. Our current product roadmap outlines plans for product introductions through 2021 and this will continue to expand as consumer product acceptance validates our innovations. We believe this program will leverage existing relationships with our current retail partners and contribute organic growth for the Company.

The Company believes that smart homes will become more mainstream over the next several years and will present growth opportunities for our 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, smart mirrors are emerging in fitness industry for interactive workouts at home and at gyms. The automobile industry is also an emerging potential industry for smart mirrors, especially with emerging self-drive, self-park technologies and growing use of interactive surfaces in vehicles. As of the date of this Form 10-Q-Report, the Company’s focus is in Connected Surfaces products for the smart home industry. Any expansion into other industries will require establishing a profitable operation in smart home industry for Connected Surfaces portfolio or adequate, affordable funding.

Perceived or Essential Strengths

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

In North America, the Company is recognized as an innovator and highly efficient, low-cost manufacturer in product niches. Capstone believes that its personal relationships with retail customers combined with its innovative product offerings, strong marketing support and the high level of integrity embedded within the company, will allow the Company to expand its “Connected Surfaces” portfolio into the Home Lighting category.

The Company believes its multiple brand strategy is important in maintaining differentiation in the marketplace and maybe considered in future Connected Surfaces products. Capstone Lighting®, Hoover^® Home LED and Duracell^® have proven successful in the past in meeting expectations at point of sale and licensing, and once again, within the Connected Surfaces program may be part of our looking forward strategy.

Capstone's core executive team has been working together for over three decades and has successfully built and managed other consumer product companies. Operating Management's experience in hardline product manufacturing and marketing prepared the Company for its entry into the LED market. From a market perspective, Capstone's branding strategy was focused on establishing multiple trusted brands allowing for a broader reach into various channels. Capstone Lighting^® (2008), Hoover^® Home LED (2015) and Duracell^® (2017) have contributed to expanding the Company's retail position.

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

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

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

With respect to the Company's goal of sustained profitability, the challenge has been and remains to achieve greater profit margins from our product lines by either innovative products that induce consumers to pay a higher purchase price or increased efficiencies in producing and selling products that sustain attractive pricing. This challenge confronts many consumer products’ companies. Due to changing consumer tastes, available disposable income and economic conditions and new technologies, consumer products face an endless challenge of product line maturing and no longer providing reliable or sufficient revenues. The Company’s development of Connected Surfaces products is an effort to diversify into an emerging consumer product line and seek to hedge against maturing LED product lines. 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 through the Company's OEM contract manufacturers, and the lower unit costs in Thailand and China, Capstone believes that it is more economical and efficient to continue to manufacture certain products in Thailand and 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 and Thailand to be challenged.

The economic impact of a pandemic like COVID-19 reveals how an unexpected event in China can potentially disrupt or adversely impact the integrated global economy product supply chain and the need for companies to diversify or provide for alternative product supply. Due to reliance on China, many product companies face the dilemma of unanticipated distributions in key product and component supply chains. The Company faces this challenge and has been reviewing in the past ways to supplement or provide back-up production sources to China. The Company has now transitioned its primary source of products from China to Thailand. The Company intends to continue its analysis of developing a more diverse product sourcing strategy. As a small reporting company, the Company has limited resources for independent diversification of production sources and must rely on subcontracting production to existing OEM’s.

The U.S federal government has imposed tariffs on certain Chinese imports. During 2019, the Company’s products were sourced in China and were impacted by the imposed tariffs. Future U.S. policy changes that may be implemented, including further increased tariffs could have a negative consequence on the Company’s financial performance depending how the changes influence many factors, including business and consumer sentiment. While developments in 2020 indicate a possible resolution or partial resolution of existing Chinese American trade dispute, there is no assurance that a comprehensive or lasting resolution will occur in 2020.

Management’s efforts to mitigate the impact of these added costs included the transition of alternative OEM manufacturing into Thailand.

The Company’s CIHK's operations in Hong Kong with personnel experienced in engineering and design, product development and testing, product sourcing, international logistics and quality control, 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.

As a result of the COVID-19 pandemic, CIHK being located in Hong Kong, the personnel have been working remotely from home, but the full extent and impact of the pandemic in China and Hong Kong remains uncertain as of the date of this Report.

Perceived Weaknesses

Capstone believes that its competitive weaknesses are: (1) it does not possess the business, marketing and financial resources of larger competitors; (2) the Company is actively building its new Social Media marketing programming and its e-commerce development but does not yet have a prominent social media presence and the impact of the Social Media campaign on future sales of our products is not certain as of the date of this Form 10-Q report; (3) it sells a niche consumer product that is sensitive to a drop in consumer discretionary spending and general economic conditions affecting consumer confidence; (4) its current products lines are focused on consumer LED lighting and long-term revenue prospects of the recent diversification into Connected Surfaces products is uncertain as of the date of this Form 10-Q report; (5) profitability may be limited by attainable profit margins from consumer lighting products as markets mature; (6) Capstone does not have the large internal research and development capability of its larger competitors; (7) Capstone operates with a limited number of employees who are dedicated to executive management, sales and marketing or administrative support; (8) we rely on OEM's for product production and these OEM’s are primarily located in Thailand and China, which have been impacted by the COVID-19 pandemic and the full economic impact of the COVID-19 pandemic is uncertain as of the date of this Report; (9) our international purchases can become more expensive if the U.S. Dollar weakens against the foreign currencies; (10) as we still or may manufacture our products in China, the increased U.S. tariffs imposed on Chinese manufactured goods may negatively impact demand and/or increase the cost for our products at retail, which could negatively impact our business and (11) while we have established new production capability in Thailand, the lack of a resolution of the U.S.-China trade dispute presents the risk of more tariffs or retaliatory actions by U.S. or China and additional adverse impact on our ability to produce, ship or sell any products still made in China, if any; (12) the ongoing and severe impact of the COVID-19 pandemic on our business and financial performance will strain our ability to withstand continued losses and may force the Company into significant corporate transaction, including, without limitation,  possible merger and acquisition transaction or reorganization, to protect the core operations from the ongoing impact of the COVID-19 pandemic; and (13)  we are focused on affordable consumer products in LED lighting and smart home connected mirrors and this product focus may not provide profitability on a long-term basis or at sufficient levels to fund future product development and diversification – both of which may be vital to long-term success of the Company.

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

Connected Surfaces – Smart Mirror

LED Puck Lights

LED Vanity Mirror

LED Gooseneck Lantern

LED Dual Mode Security Light

LED Solar Patio Lights

LED Undercabinet Light Bars

LED Motion Sensor Lights

LED Motion Sensor Light with Air Purifier

LED Wall Utility Lights

Eco-i-Lites

Wireless Remote-Control Outlets

Wireless Remote-Controlled LED Accent Lights

These product offerings have been focused on solutions for various residential lighting applications for interior and outdoor use.

Such product expansion involves the inherent risk of increased operating and marketing costs without a corresponding increase in operational revenues and profits. Further, some product lines may fall out of favor with consumers before we can recoup product and market development costs. While the Company makes significant investments into the Connected Surfaces portfolio, it is reasonable to expect to post losses while building the market for a new category of products which were formally launched at the 2020 CES. Expense categories including molds, prototyping, engineering, advertising, public relations, tradeshows and social media platforms will continue to be incurred for six to nine months before shipments and related revenues occur.

The Company has established product distribution relationships with numerous leading international, national and regional retailers, including but not limited to: Amazon, Costco Wholesale, Sam's Club-Walmart, the Container Store and Firefly Buys. 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 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. CIHK assists the Company in placing more products into foreign market channels as well. The Company introduced Capstone brands to markets outside the U.S., including Australia, France, Iceland, Japan, Mexico, New Zealand, South Korea, Spain, Taiwan, Thailand and the United Kingdom. International sales for the six months ended June 30, 2020 and 2019 were $227 thousand or 22% of net revenue and $402 a thousand or 6% of net revenue, respectively. The Company's 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 Company's 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 short term by the COVID-19 pandemic.

The Company's products are subject to general economic conditions that impact discretionary consumer spending on non-essential items. Capstone believes it will maintain its presence in the lighting category because of its proven abilities in operational excellence, the quality reputation of its products, business relationships with Capstone's retailers and the aggressive product development 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.

The Company believes that it will provide retailers with a broader and more diversified portfolio of consumer products across product categories, which should add diversity to the Company's revenues and cash flows sources. Within the selection of products offered, Capstone seeks to service the needs of a wide range of consumers by providing products to satisfy their different interests, preferences and budgets. The Company believes in its ability to serve retailers with an array of branded products and quickly introduce new products to continue to allow Capstone to further penetrate its existing customer bases, while also attracting new customers. The Company's primary, perceived challenge is creating sustained consumer demand for its products in a growing number of markets and attaining sustained profitability, which challenge is complicated by the cost of new product development and costs of penetrating new markets. An extensive product line, especially new product line, increases the investment in product development and, as such, increases operating overhead.

With the Company's lighting products and recently launched “Connected Surfaces” category, Capstone has developed a comprehensive product offering for its niche in the retail industry. Within the selection of products offered, Capstone seeks to service the needs of a wide range of consumers by providing products to satisfy their different interests, preferences and budgets. The Company believes in its ability to serve retailers with a broad array of innovative connected products and quickly introduce new products to continue to allow Capstone to further penetrate this developing market.

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

Tariffs and trade restrictions imposed or threatened by the current U.S. administration has provoked and may provoke future trade and tariff retaliation by other countries. A "trade 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 Report, there has not been a resolution of the Chinese American trade dispute.

Sales and Marketing

Our products, heretofore, are sold nationally and internationally through a direct 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. Our sales 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 further expanded in the future.

Direct Import Sales. We currently 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. In order 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.

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. Other international sales are made by our Hong-Kong based CIHK office staff. The Company actively promotes 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.

In six months ended June 30, 2020, the Company had two customers who comprised approximately 65% and 24% of net revenue and one customer who comprised of 95% of net revenues in the same period in 2019. 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.

In order for continued sales growth in the retail market to continue , the Company is focused on expanding the product portfolio currently offered into new innovative electronic categories that will also allow the Company to expand into different retail departments and channels of distribution.

The Company is also focused on establishing an on-line presence in order to support retail customers requirements and to further support the introduction of the “Connected Surfaces” launch with the ability to ship direct to consumer.

We enter 2020 with an expanded social media department and enhanced social media campaign strategy. We currently have a 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

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

The social media campaign is not fully implemented and has not operated for sufficient time to judge its effectiveness. The Company believes that the impact of  the COVID-19 pandemic on traditional brick-and-mortar retailing requires migration of marketing of products to e-commerce/on-line approach.

Competitive Conditions

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 just 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 that pandemic is uncertain as of the date of the filing of this Form 10-Q Report due to the lack of an effective, available vaccine.

The consumer lighting products and small electronics businesses are highly competitive, 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 technological innovation, brand perceptions, product quality and performance, value perception and customer service and price. The Company's principal lighting competitors in the U.S. are Energizer, Feit Electric and Jasco (GE). The Company believes private-label sales by large retailers has some impact on the market in some parts of the world as many national retailers such as Costco, Home Depot, Target and Sam’s/Wal-Mart offer lighting as part of their private branded product lines. Many of the Company's competitors have greater resources and capabilities, including greater brand recognition, research and development budgets and broader geographical market reach. Competitors with greater resources could undermine Capstone's expansion efforts by marketing campaigns targeting its expansion efforts or price competition. Moreover, if one or more of the Company's competitors were to merge, the change in the competitive landscape could adversely affect our customer distribution channel.

With trends and technology continually evolving, 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. 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 ongoing impact of  the COVID-19 pandemic on our business and financial performance.

Research, Product Development, and Manufacturing Activities

The Company's research and development department based in Hong Kong designs and engineers many of the Company's products, with collaboration from its third-party manufacturing partners and software developers. The Company outsources the manufacture and assembly of our products to a number of contract manufacturers overseas. Our research and development focus includes efforts to:

CIHK establishes strict engineering specifications and product testing protocols with the Company's 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 also at 3^rd party testing laboratories overseas.

Capstone's research and development team enforces 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 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 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 include product development, project management, sourcing management, supply chain logistics, factory compliance auditing, and quality enforcement for all supplier factories located in Hong Kong, China and Thailand.

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

Capstone will invest in more technical and innovative product categories. These costs are expensed when incurred and are included in the operating expenses.

Raw Materials

The principal raw materials 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 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 the 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 as a result of stable oil prices and the strengthening U.S. dollar. CAPC believes that adequate supplies of raw materials required for its operations are available at the present time. CAPC, cannot predict the future availability or prices of such materials. These raw materials are generally available from a number of different sources, and the prices of those raw materials are susceptible to currency fluctuations and price fluctuations due to transportation, government regulations, price controls, economic climate, or other unforeseen circumstances. In the past, CAPC has not experienced any significant interruption in availability of raw materials. We believe we have extensive experience in manufacturing and have taken positions to assure supply and to protect margins on anticipated sales volume. CIHK is responsible for developing and sourcing finished products from Asia in order to grow and diversify our product portfolio. Quality testing for these products is performed both by CIHK and by our globally recognized third party quality testing laboratories.

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

Distribution and Fulfillment

Since January 2015, the Company has transferred 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 moves 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 is also in discussions with a national fulfilment company to launch the online Smart Mirror program.

Royalties

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

In 2019 it was the Company’s marketing objective to transition existing product lines from licensed product into Capstone Lighting brand which was successfully achieved.

As the Company did not achieve the stated net sales volumes for the renewal period, the remaining Royalty license expired on February 3, 2020.

Seasonality

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

Intellectual Property

CAPC subsidiary, CAPI, owns a number of U.S. trademarks and patents which CAPC considers of substantial importance and which are used individually or in conjunction with other CAPC trademarks and patents. These include the following trademarks: Exclusive license and sub-license to Power Failure Technology; Capstone Power Control, Timely Reader, Pathway Lights, and 10 LED - Eco-i-Lite Power Failure Light, 5 LED - Eco-i-Lite Power Failure Light, 3 LED - Eco-i-Lite Power Failure Light, 3 LED Slim Line Eco-i-Lite Power Failure Light, LED Induction Charged Headlight. We also have a number of patents pending; Puck Light (cookie), Puck Light Base, Multi-Color Puck Lights, LED Dual Mode Solar Light, Integrated Light Bulb (Coach Light), LED Gooseneck Lantern, Spot Lights, Security Motion Activated Lights, Under Cabinet Lighting and Bathroom Vanity Light. CAPC periodically prepares patent and trademark applications for filing in the United States and China. CAPC will also pursue foreign patent protection in foreign countries if deemed necessary to protect a patent and to the extent that we have the available cash to do so. CAPC's 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 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.

Working Capital Requirements and Financing

In order to more effectively support retailers in the U.S. domestic markets and to support the Company’s new online shopping cart, sufficient inventory must be available to support immediate customer demand and reduce the impact of lost sales as a result of stock outages. The Company will be required to strategically increase its inventory levels held either at its leased Anaheim, California warehouse or at the distribution centers of a national fulfilment company. Combined with investment in new product molds, product testing and outside certifications, package design work, the Company will require additional working capital to fund these strategic projects.

The Company's ability to maintain sufficient working capital is highly dependent upon achieving expected operating results. Failure to achieve expected operating results could have a material adverse effect on the Company's working capital, ability to obtain financing, and its operations in the future. However, achieving expected results as accomplished in 2017 and 2016, increased working capital and provided the Company with liquidity to transition into a new innovative category without creating debt.

Continued investment in product development is a critical requirement to ensure the Company's future revenue growth. The Company allocates funds for such projects and if necessary certain members of the Company's senior management and Board of Directors have historically supplemented the cash flow needs as required through short-term, unsecured loans.

The Company’s credit facility at Sterling National Bank was up for renewal. On July 16, 2020, the Company received a Termination of Factoring Agreement letter advising that the Factoring Agreement would be terminated effective September 30, 2020. The bank advised that as the existing facility had not been used in recent years and with the uncertainties associated with the resurgence of the  COVID-19 pandemic and its potential impact on the retail sector, the bank decided not to renew the Factoring Agreement. The Company requested to terminate the Agreement on July 31, 2020 which was agreed to by Sterling National Bank.

For the three months ended June 30, 2020 and 2019, the processing fees associated with this agreement were $2,974 and $ 9,732, respectively.

For the six months ended June 30, 2020 and 2019, the processing fees associated with this agreement were $3,307 and $20,228, respectively.

As of June 30, 2020, and December 31, 2019, there was no balance due to Sterling National Bank.

The Company is in discussions with an alternate funding source that offers extensive programs that are more in line with the Company’s future business model particularly a facility that provides funding options that are suitable for the e-commerce business that the Company is transitioning into. 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.

The Company has an income tax refundable of approximately $1.0 million of which approximately $800 thousand has already been applied for refund and should be received within the next few months.

In addition, we would 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 Company’s business and financial performance will affect the Company’s ability to obtain funding.

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

Critical Accounting Policies

We believe that there have been no significant changes to our critical accounting policies during the three months and six months ended June 30, 2020 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, 2019.

CONSOLIDATED OVERVIEW OF RESULTS OF OPERATIONS

Net Revenues

Revenue is derived from sales of our residential LED lighting products. These products are directed towards consumer home LED lighting for both indoor and outdoor applications. Revenue is subject to both quarterly and annual fluctuations and is impacted by the timing of individually large orders as well as delays or sometimes advancements to the timing of shipments or deliveries. We recognize revenue upon shipment of the order to the customer, when all performance obligations have been completed and title has transferred to the customer and in accordance with the respective sale’s contractual arrangements. Each contract on acceptance will have a fixed unit price. We have not realized any revenues from our Connected Surfaces initiative for the quarter ended June 30, 2020.

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 licensed brand royalties, sales representatives’ commissions, advertising and trade show expense and costs related to employee's compensation. In addition, operating expense include charges relating to accounting, legal, insurance and stock-based compensation.

CONSOLIDATED RESULTS OF OPERATIONS AND OUTLOOK