CAPSTONE COMPANIES, INC. This Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and other parts of this Report contain forward-looking statements,that involve risks and uncertainties. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Forward-looking statements can also be identified by words such as "future," "anticipates," "believes," "estimates," "expects," "intends," "plans," "predicts," "will," "would," "could," "can," "may," and similar terms. Forward-looking statements are not guarantees of future performance and Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in this Report under the heading "Risk Factors," which are incorporated herein by reference. The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included in this Report. All information presented herein is based on CAPC's fiscal year 2022 results. Unless otherwise stated, references to particular years or quarters refer to the CAPC's fiscal years ended in December and the associated quarters of those fiscal years. Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law. 38 Executive Summary
COVID-19 has caused substantial disruption to travel, business activities, and global supply chains, significant volatility in global financial markets since the pandemic began in 2020. The pandemic has had and may continue to have a material impact on our business, results of operations, financial position and cash flow. In response to the COVID-19 pandemic, we took precautionary measures to maintain adequate liquidity by suspending share repurchases, temporarily deferring salaries of our executives by 50%-100%, significantly scaling back on non-essential operating expenses, and closing ourHong Kong operation, as we transferred manufacturing toThailand . Our goal was to preserve cash but to continue to invest where needed to support the relaunch of the Connected Surfaces program. Total net revenue for the year endedDecember 31, 2022 , decreased 50% to approximately$346 thousand as compared to$686 thousand in the same period of last year. The net loss was approximately$2.6 million for the year 2022 compared to a net loss of$1.9 million in 2021. The Company had an estimated net tax provision in 2022 and 2021 of$67.5thousand and$15.1 thousand , respectively. The following discussion is designed to provide a better understanding of our audited consolidated financial statements and notes thereto, including a brief overview of our business and products, key factors that impacted our performance and a summary of operating results. Overview
Capstone Companies, Inc. ("Company" or "CAPC") is a public holding company organized under the laws of theState of Florida . The Company is a leading designer, manufacturer and marketer of consumer inspired products that simplify daily living through technology. Over the past decade, the Company's various product lines have been distributed globally including consumer markets inAustralia ,Japan ,Korea ,North America ,South America , and theUnited Kingdom . The primary operating subsidiary isCapstone Industries, Inc. ("CAPI"), aFlorida corporation located at the principal executive offices of the Company.Capstone International Hong Kong, Ltd. , or "CIHK", was established to expand the Company's product development, engineering, and factory resource capabilities. With the 2021 shift of manufacturing toThailand fromChina , the CIHK operation was dormant. 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 Connected Surfaces Smart Mirrors internet connected and interactive mirror. The Company's focus through 2017 has been in the integration of LEDs into most commonly used consumer lighting products in today's home. Over the last few years there has been significant LED price erosion, which has commoditized LED consumer products. The LED category has matured and is no longer the innovative "must have" consumer product as in previous years. The Connected Surfaces is the Company's effort to establish business in an emerging segment that will allow for future revenue growth. The smart home segment is the umbrella category in which we will participate with the Connected Surfaces program. Capstone's success has been in its ability to identify emerging product categories where Capstone's management experience can be fully leveraged. Over the past decade, the Company's consistent low-cost manufacturing and operations have provided an advantage in delivering quality products at very competitive prices.
In late 2017, as management recognized that the LED category was maturing, it sought a business opportunity that would transition the Company's revenue streams to an emerging category. While we currently continue to supply LED products on a limited basis, our strategic plan to develop and launch new innovative product lines, like Smart Mirrors, is believed to be essential for sustaining or growing revenues. 39 The Company began its foray into the electronic industry in 2019 with its Connected Surfaces initiative. We entered the market as we identified the smart home category to be emerging with strong long-term growth potential. Our expectation is that the new Connected Surfaces portfolio advancing in 2022 appeals to a much larger audience than our traditional LED lighting product line. The new portfolio is designed to tap into consumer's ever-expanding connected lifestyles prevalent today. The Smart Mirrors have both touch screen, voice and remote control interfacing, internet access and an operating system capable of running downloadable applications. The average selling prices are comparable to that of tablets and smartphones, retailing between$799 -$999.00 per unit, with the goal to deliver cost-attractive product consumer value to mainstream America. Whereas, during the day your smartphone/tablet keeps you connected, whether it is work or personal, now when entering your home, Capstone's new Connected Surfaces products are intended to enable users the same level of connectivity in a more relaxed manner that does not require being tethered to these devices. The Company will require additional funding to build its marketing effort, inventory levels and service levels which funding must be timely and affordable to fund the desired marketing and product launch. The future growth will be directly impacted by the level of exposure, messaging and distribution capabilities. For the short term, Certain members of the Company's management ("Corporate Insiders and Directors") have provided short-term funding from time to time to support the Company's basic operational funding needs, but there is no guarantee that this funding will continue or be adequate to fund operations or Connected Surfaces program marketing and inventory as well as possible enhancements in functions demanded by the consumers. By working overseas with alternate manufacturers located outsideChina , particularly inThailand , we anticipated minimal impact to our selling prices and related margins of profit that could otherwise be impacted by an ongoing trade dispute betweenthe United States andChina . Political unrest inThailand in late 2020 and early 2021 did not affect our original equipment manufacturing ("OEM") activities, however the transportation/logistics costs have escalated as a result of the COVID-19 pandemic, but we are beginning to see more stability as we are able to book freight without the surcharges imposed by container shortages experience during 2021 and 2022. While the Company announced the plan to launch its ecommerce initiative inMarch 2021 , that effort was continually delayed because of COVID-19 forced closures overseas and inventories planned for Q3, 2021 sales were shipped inDecember 2021 , pushed the product launch intoJanuary 2022 The COVID-19 pandemic and transitioning to Thailand OEM's as well as to be expected delays in developing an acceptable new product essentially delayed our launch of the Smart Mirror product line by a year into 2022, which combined with declining LED product sales, has adversely impacted the Company's business and financial performance. The initial inventory that arrived in our fulfilment center inthe United States at the end of Q4 2021 was damaged by the logistics company. We filed an insurance claim and were compensated for the damaged inventory during 2022, however, incurred significant delays in our initial Smart Mirror product launch. During the twelve months endedDecember 31, 2022 , the generalU.S. economic indicators show signs of a slowdown caused by interest rate increases in order to reduce the impact of increasing inflationary pressures. While the unemployment rate decreased from 3.9% inDecember 2021 to 3.5% as ofDecember 2022 marking the lowest level in over 50 years, the consumer confidence index continued to drop falling from 70.6 inDecember 2021 to 59.7 inDecember 2022 . Retail sales increased 5.0% year over year fromDecember 2021 as consumers remained resilient despite inflation. But the impact of inflation on consumer prices and consumer buying patterns will be a factor through 2023. The slowing economy is likely to bring the yearly inflation rate down to 3.5%-4% by the end of 2023, however still higher than theFederal Reserve's target of 2%-2.5%. Management believes that the national vaccine inoculation program made major advances, and initially increased consumer confidence. However, the recent impact of the increased interest rates in response to inflation and higher energy costs have seriously eroded into consumers available spending or adversely impacted consumer confidence in the economy. Since our Connected Surface product line is not an essential product, but a discretionary purchase, consumer products that are discretionary purchases are generally adversely impacted by uncertain or negative economic news and downturn in consumer confidence. 40
Principal Factors Affecting Our Financial Performance
There are a number of industry factors that affect our financial performance which include, among others:
? Overall Demand for Products and Applications. Our potential for growth
depends on the successful introduction and consumer acceptance of theConnected Surfaces portfolio. The Company's products are characterized as
non-essential and economic conditions, especially consumer uncertainty or
worries over economic conditions and growth, affect consumer demand.
Uncertainty over global economic conditions that may affect the
economy is not conducive to consumer purchases of our category of
consumer products. These uncertainties make demand difficult to forecast
for us and our customers.
? Strong and Constantly Evolving Competitive Environment. While we havedemonstrated our abilities to compete successfully in the retail channels
since our inception, competition in the marketplace we serve is strong.
Many companies have made significant investments in product development,
production equipment and product marketing. Product pricing pressures
exist as market participants often initiate pricing strategies to gain or
protect market share. To remain competitive, market participants must
continuously increase product performance or functionality, reduce costs
and develop improved ways to support their customers. To address thesecompetitive measures, we invest in research and development activities to
support new product development, sustain low product costs and deliver
higher levels of performance and product functionality to differentiate
our products in the market.
? Profit Margins. The Company's product planning strategies are driven by
the need to deliver sustainable profit margins. This, in conjunction with
close management of related marketing costs, are required to sustain or
grow the Company's market presence.
? Technological Innovation and Advancement. Innovation and advancements in
consumer electronic categories continue to create expanded channel
opportunities. The smart home category is expected to grow to $139.8
billion by 2023, a CAGR of 18.2% since 2018. Household penetration ofsmart homes is expected to grow to 19.5% by 2022. Smart phone users in
by 2024. Through the Company's continual research and development
activities, differentiation of its smart home products and their related
value to the consumer, a consistent market share expansion is
anticipated.
? Affordable Funding. The Company needs to secure affordable funding
resources to support ongoing product development and new market
penetration.
Intellectual Property Issues. Market participants rely on patented and
non-patented proprietary information relating to product development and other
core competencies of their business. Protection of intellectual property is
important. Therefore, steps such as patent applications, confidentiality and
non-disclosure agreements, as well as other security measures are generally
taken. The Company has not created a litigation reserve for intellectual
property rights litigation. As a business judgment, the Company does not patent
or copyright or trademark all intellectual property due to a combination of
factors, including, in part, the cost of registration and maintenance of
registration, odds and cost of successful defense of the registration and
commercial value of the intellectual property rights. To enforce or protect
intellectual property rights, litigation or threatened litigation is common. The
Company has not sued any third parties over intellectual property rights.
Results of operations
Net Revenues
Revenue is derived from sales of our residential lighting products and Connected
Surfaces Smart Mirrors. The residential products were directed towards consumer
home LED lighting for both indoor and outdoor applications while the Smart
Mirrors were sold directly to consumers via e-commerce efforts. 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. The majority of our sales are to the
U.S. market which in 2022 represented 87% of revenues and we expect to the U.S
Market to continue to be the major source of revenue for the Company. We derived
13%% of our revenue from overseas sales. Net revenue also includes the cost of
instant rebate coupons, promotional coupons, and product support allowances
provided to retailers to promote certain products. All of our revenue is
denominated in U.S. dollars.
41
Cost of Goods Sold
Our cost of goods sold consists primarily of purchased products from contract
manufacturers and when applicable associated duties and inbound freight. In
addition, our cost of goods sold also includes reserves for potential warranty
claims and freight allowances. We source our manufactured LED lighting products
based on customer orders. Beginning with the last quarter of 2021 in connection
with the launch of our Connected Surfaces Smart Mirror, we maintained inventory
on hand for direct to consumer shipment to fulfill sales 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 cost fluctuations in the cost of our
purchased components. See "Risk Factors" above in Item 1A.
Operating Expenses
Operating expenses include sales and marketing expenses, consisting of social
media advertising, sales representatives' commissions, advertising, show expense
and costs related to employee's compensation. In addition, operating expensed
includes charges relating to product development, office and warehousing,
accounting, legal, insurance and stock-based compensation.
CONSOLIDATED RESULTS OF OPERATIONS AND OUTLOOK
Year EndedDecember 31, 2022 Compared to the Year EndedDecember 31, 2021 (In Thousands) December 31, 2022 December 31, 2021 Dollars % of Revenue Dollars % of Revenue Revenue, Net$ 346 100.0 %$ 686 100.0 % Increase in inventory reserve and inventory write offs 692 (200.0 )% 155 23.6 % Cost of sales 257 (73.9 )% 484 69.5 % Gross Profit (Loss) (603 ) (173.9 )% 47 6.9 % Operating Expenses: Sales and marketing 360 103.8 % 29 4.2 % Compensation 817 235.9 % 1,276 186.0 % Professional fees 458 132.0 % 368 53.6 % Product development 204 58.8 % 309 45.0 %
Other general and administrative 480 138.8 %
421 61.4 % Total Operating Expenses 2,319 669.3 % 2,403 350.3 % Operating Loss (2,922 ) (843.2 )% (2,356 ) (343.4 )% Other Income (Expenses) Miscellaneous Income , net 395 114.0 % 456 66.42 % Interest expense, net (70 ) (20.1 )% (49 ) - % Total Other Income, net 325 93.9 % 407 59.3 % Loss Before Tax Benefit (2,597 ) (749.3 )% (1,949 ) (284.1 )% Income Tax Expense 67 19.5 % 15 (2.2 )% Net Loss$ (2,664 ) (768.8 )%$ (1,964 ) (286.3 )% 42 Net Revenues
For the year endedDecember 31, 2022 , net revenues were approximately$346 thousand , a decrease of approximately$340 thousand or 50% from$686 thousand in fiscal 2021. In 2022, the Company experience firsthand the alteration in consumer's buying habits. After stocking up on home goods, home improvements and electronics during the stay-at-home orders, once those orders were lifted, consumers chose to spend their money on things to do versus things to have. This change in consumer spending on activities versus goods negatively impacted the 2022 launch of the Smart Mirror significantly. Sales of the Smart Mirror severely underperformed management's expectations, generating approximately$74,000 in net sales for an approximate 105 units sold. In addition to the change in consumer spending, the Company changed its marketing course in late 2021 and 2022 by moving away from the Big Box retailers and put all of its marketing effort into the e-commerce marketing industry. The Company's first parlay into e-commerce proved to be very costly and a difficult market to secure customer acquisition with the Company spending approximately$285,000 in 2022 on social media, advertising and trade shows, and increase of$260,000 over the prior year. The Company has decided to re-focus their marketing strategy in 2023 and move back to brick and mortar and Big Box retailers, which was their core strength with the Lighting Products which they feel they can easily replicate with the Connected Surfaces product lines. Management has spent Q1 2023 actively marketing the Connected Surfaces product lines to brick-and-mortar retailers while maintaining their e-commerce presence. 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 product awareness, by providing marketing und allowances to the customer. The Company also provides promotional coupons for the Connected Surfaces Smart Mirror when determined necessary. Sales reductions for anticipated discounts, coupons, allowances and other deductions are recognized during the period the related revenue is recorded. The reduction of accrued allowances is included in net revenues and amounted to$26.7 thousand and$8.0 thousand for the years endedDecember 31, 2022 and 2021, respectively.
For the years ended
43
The following table disaggregates net revenue by major source:
For the Year Ended For the Year Ended
December 31, 2022 December 31, 2021
Capstone Brand % of Revenue Capstone Brand % of RevenueLighting Products- U.S.$ 228,680 66 %$ 340,896 49 % Smart Mirror Products- U.S. 73,154 13 % 3,795 1 % Lighting Products-International 44,640 21 %
341,163 50 %
Total Revenue $ 346,474 100 % $ 685,854 100 %
Gross Profit and Cost of Sales
Gross
loss for the year endedDecember 31, 2022 , was approximately ($603 thousand ), or (173.9%) of net revenues, as compared to$47 thousand or 6.9% of net revenues, for fiscal 2021. For the years endedDecember 31, 2022 and 2021, cost of sales were approximately$949 thousand and$639 thousand , respectively, an increase of$310 thousand or 32.7% from the previous year. The gross profit reduction was the direct result of the reduced revenue in the year, relating to the low sales of the Smart Mirror and reduction in sales of the LED lighting products. Costs represented 274% and 93% of net revenues for 2022 and 2021, respectively. This increased cost was primarily due to allowances recorded for slow moving Smart Mirror inventory and a write off of prepaid inventory. Management considered the need for a reserve for slow moving inventory due to sales not meeting projected forecasts during 2022. Management estimated a 50% reserve of inventory held in domestic warehouses, a 100% reserve on inventory held in international warehouses, and a write off of prepaid inventory deposit for Smart Mirrors that we do not anticipate completing the manufacturing on. The allowances and prepaid inventory write off approximated a cumulative$692 thousand corresponding increase in cost of goods sold with a reduction in inventory on hand of$533 thousand and expensing of$159 thousand in prepaid inventory deposits. Operating Expenses Sales and Marketing Expenses In fiscal 2022 and 2021, sales and marketing expenses were approximately$360 thousand and$29 thousand respectively, an increase of$331 thousand or 1158%. As a percent to revenue, 2022 expenses were 103.8% as compared to 4.2% in 2021. Social Media expense in 2022 was$146 thousand , an increase of$125.5 thousand or 612% from$20.5 thousand in 2021. The increase in social media expenses were in connection with the launch of the Company's e-commerce efforts for Connected Surfaces Smart Mirror with direct to consumer marketing, hiring of influencers, targeted add on media platforms such as Facebook and$24.9 thousand in 2022 as compared to$2.2 thousand in 2021, an increase of$22.6 thousand or 996% due to the launch of e-commerce activities during 2022. Trade Show expense was$113 thousand in 2022 as compared to$0.4 thousand in 2021, an increase of$112.8 thousand related to the attendance of the 2022 CES trade show which was not attended in 2021. Compensation Expenses For the years endedDecember 31, 2022 and 2021 compensation expenses were approximately$817.4 million and$1.3 million , respectively, a reduction of$459 thousand or 36.0%. As a percent of net revenues, 2022 expenses were 235.90% as compared to 186.1% in 2021. With the reduced revenue and the transition of production intoThailand , the Company eliminated all positions from theHong Kong office and reduced administrative and sales positions in the corporate
office during 2022. Professional Fees For fiscal 2022, professional fees were approximately$457.5 thousand compared to$368 thousand in 2021, an increase of$89 thousand or 24.2 %. As a percent of net revenue 2022 expenses were 132.0% as compared to 53.7% in 2021. In 2022, consulting fees were approximately$260 thousand compared to$165 for 2021. Accounting, legal and other expenses were$197.6 thousand , a decrease of$5 thousand from$203 thousand in the prior year.
Product Development Expenses
For the years endedDecember 31, 2022 and 2021, product development expenses were approximately$204 and$309 thousand , respectively, a decrease of$105 thousand or 34%. In 2021 the Company invested$237 thousand in the Smart Mirror development and continued the investment with an approximate$93 thousand in Smart Mirror development in 2022, a decrease of$144 thousand or 154%. During 2022, the Company invested approximately$54 thousand in software, hardware development, certifications, patent and trademarks and quality control audits for the Smart Mirror project compared to$70 thousand in the same period in 2021 which resulted in an expense reduction of approximately$16 thousand . In 2022 the Company also invested approximately$56 thousand for the development of new Connected Surfaces product lines for the Connected Chef kitchen utility smart device, compared to$0 in expenses during 2021. Due to these aforementioned investments, Management determined the initial investment in tooling manufacturing equipment purchased in 2021 for the Smart Mirror was impaired as of the year endDecember 31, 2022 as recent innovations to the Smart Mirror have rendered the tooling machinery unusable for the redesigned Smart Mirror mold. As such, Management recorded an impairment of long lived assets with a net book value of$51 thousand as of the year endedDecember 31, 2022 , recognized as a reduction in property and equipment and increase in product development expenses. 44
Other General and Administrative Expenses
For fiscal 2022 and 2021, other general and administration expenses were approximately$481 thousand and$421 thousand , respectively, an increase of$60 thousand or 14.2%. As a percent to revenue 2022 expenses were 138.8% as compared to 61.4% in 2021. The Directors insurance increased in 2022 from$100 thousand in 2021 to$124 thousand a$24 thousand or 20% increase. The Company's liability insurance also increased in 2022 from a rebate of$15 thousand to an expense of$32 thousand , an increase of$46 thousand or 146%. Lodging fees increased$22 thousand from$18 thousand in 2021 to$41 thousand in 2022 for an electronic consultant working on Connected Surfaces product lines. Total Operating Expenses For the years endedDecember 31, 2022 and 2021, total operating expenses were$2.3 million and$2.4 million , respectively. This represents an$84 thousand or 3.5% decrease over fiscal year 2021. Operating Loss
For the year endedDecember 31, 2022 , the operating loss was approximately$2.9 million as compared to$2.4 million in 2021, a loss increase of$566 thousand over 2021. Other Income (Expense)
For fiscal 2022 other income was approximately$395 thousand compared to a$456 thousand in 2021, a decrease of$61 thousand over 2021. The other income for the year endedDecember 31, 2022 resulted from$152 thousand in employee retention tax credit received under Cares act 2020-2021 and$162 thousand freight claim recovery for the damaged Smart Mirror inventory that was written off inDecember 31, 2021 . In addition, other income includes a reversal of approximately$61 thousand of accrued marketing and promotional allowances and warranty reserves against previous sales that is no longer required as ofDecember 31, 2022 . Marketing allowances include the cost of underwriting an in store instant rebate coupon or a targeted markdown allowance on specific products. The Company accrues and retains these allowances for a period of 3 to 5 years in the event the customer charges back a promotional allowance against future open invoices or submits to us an invoice. These allowances are also evaluated when our relationship with a customer is terminated, or we cease selling a specific product to a customer. We evaluated certain allowances and were satisfied that these allowances were no longer required based on the age of the allowance and sale of the products for which these allowances relate being significantly reduced. These allowances were charged to other income during the year endedDecember 31, 2022 .
Interest expense for 2022 amounted to$70 thousand compared to$49 thousand in 2021, an increase of$21 thousand or 42%, due to the increase of$700 thousand in notes payable held by the Company, accruing interest at 5% per annum.
For the years ended
The effective tax rate for the years ended
45 Net Loss
For fiscal 2022 and 2021 net loss was approximately
RESULTS OF OPERATIONS AND BUSINESS OUTLOOK
Our goal is that the new Connected Surfaces portfolio advancing in 2023 appeals to a much larger audience than our traditional LED lighting product line. Approximately 46% of domestic households have one smart device in their home. Our Connected Surfaces portfolio falls in line with the average user of internet-of-things home devices. Management believes that the execution of the Company's strategy and development of the Connected Surfaces category will provide attractive opportunities for profitable growth over the long term. The Company will require additional funding to build its marketing effort, inventory levels and service levels once the revised marketing back to retail phase validates the Company's strategic initiatives. The future growth will be directly impacted by the level of exposure, messaging and distribution capabilities. By working diligently overseas with alternate manufacturers located outsideChina , particularly inThailand , we anticipate minimal impact to our selling prices and related margins of profit that could otherwise be impacted by an ongoing trade dispute betweenthe United States andChina . Other factors, like inflation and its impact on consumer confidence and willingness to purchase discretionary purchases like our Smart Mirrors, may impact selling prices and related margins of profit.
With the impact of COVID-19, Management was even more focused on the following priorities:
? to protect the safety and wellbeing of the Capstone team. ? to expand the Company's social media platforms and online visibility. ? to revamp the Company's website to support online business.
? to build the logistics and fulfilment structure to support online orders.
? to transfer Smart Mirror production capability toThailand fromChina . ? to design, enhance and build the Smart Mirror product portfolio with the advancement of research and development efforts of the Connected Chef kitchen utility device. During 2022 we were able to complete the above priorities and are now preparing for the re-launch of the Smart Mirror program to home good retailers and the Big Box retailers in 2023. Contractual Obligations The following table represents contractual obligations as ofDecember 31, 2022 . Payments Due by Period Total 2023 2024 2025 After 2026 Accounts payable and accrued liabilities$ 309,439 $ 309,439 $ - $ - $ - Short-Term Debt - related parties 413,425 413,425 - - - Short-Term Debt 206,712 206,712 - - - Long-Term Debt - related parties 821,647 - 821,647 - - Long-Term Debt 360,446 - 360,446 - - Operating and Short Term Leases 37,535 - 37,533 - - Total Contractual Obligations$ 2,149,204 $ 967,111 $ 1,182,093 $ - $ - 46
Notes to Contractual Obligations Table
Accounts payable and accrued liabilities -Comprised of the Company's liability for goods and services in the normal course of business as well as deferred compensation for management.
Short Term Debt - notes payable with related parties - Related to working capital funding.
Short Term Debt - note payable with unrelated parties - Related to working capital funding.
Long Term Debt - related parties - Related to working capital and purchase order funding.
Long Term Debt - note payable unrelated parties - Related to purchase order funding.
Operating Leases -Related to facility leases for our operations in theU.S.
LIQUIDITY AND CAPITAL RESOURCES
Operational cash flow is significantly influenced by the timing and launch of new products as well as favorable payment terms negotiated with overseas suppliers. With ourThailand operational presence, we have built an operational structure that, through relationships with factory-suppliers both inThailand andChina combined with our expertise, that under normal operating circumstances, can develop and release quality, innovative products to the marketplace substantially quicker than in previous years. Our historical ability to generate cash from operations has been one of our fundamental strengths and has provided us with flexibility in meeting our operating, financing and investing needs in the past. However, the Company has not achieved sufficient sales of Smart Mirror products, whether online or by brick-and-mortar retail sales, to compensate for the drop in LED Lighting Product sales. During the year endedDecember 31, 2022 , the Company used cash in operations of approximately$1.9 million and generated net operating losses of$2.6 million . As ofDecember 31, 2022 , the Company had working capital deficit of$448 thousand and an accumulated deficit of$9.1 million . The Company's cash balance decreased by approximately$1.2 million from$1.3 million as ofDecember 31, 2021 to$61 thousand as ofDecember 31, 2022 . With the reduced revenues in 2022 and to conserve cash, the Company initiated an expense mitigation plan that reduced discretionary spending including travel, lodging and trade show expenses, deferred executive management compensation, and closed theHong Kong operation. These efforts assisted the Company in conserving cash and allowing for expenditures to move the re-launch of the Connected Surfaces Smart Mirror forward and continued research and development efforts in additional Connected Surfaces product lines such as the Connected Chef kitchen utility device. The Company has decided to re-focus their marketing strategy in 2023 and move back to brick and mortar and Big Box retailers, which was their core strength with the Lighting Products which they feel they can easily replicate with the Connected Surfaces product lines. The Company has a recent history of losses and negative cash from operations. The uncertainty and the continuing negative impact of a slowing economy, rising inflation and COVID-19 disruption could negatively impact the demand for our products or delay future planned promotional opportunities. With the Smart Mirror portfolio and potential for additional Connected Surface devices, the Company requires an inventory credit facility to support increasedU.S. domestic inventory to facilitate revenue growth in the online business. OnJanuary 4, 2021 , the Company entered a$750,000 working capital loan agreement with Directors,Stewart Wallach andJeffrey Postal . The short-term facility endedJune 30, 2021 ("Initial Period'). The Company had the option to extend the Initial Period for an additional six consecutive months, endingDecember 31, 2021 , but decided not to renew. 47 OnApril 5, 2021 , the Company entered into five separate securities purchase agreements ("SPAs") whereby the Company privately placed an aggregate of 2,496,667 shares of Common Stock for an aggregate purchase price$1,498,000 (transactions being referred to as the "Private Placement"). The five investors in the Private Placement consisted of four private equity funds and one individual - all being "accredited investors" (under Rule 501(a) of Regulation D under the Securities Act of 1933, as amended, ("Securities Act"). The$1,498,000 in proceeds from the Private Placement was used mostly to purchase start up inventory for the Company's new Smart Mirror product line, for a major online e-commerce fulfilment company, and the remainder for advertising and working capital.
OnJuly 2, 2021 , the Board of Directors ("Board") resolved that the Company required a purchase order funding facility to procure additional inventory to support the online Smart Mirror product. The Board resolved that certain Directors could negotiate the terms of a Purchase Order Funding Agreement for up to$1,020,000 with DirectorsS. Wallach andJ. Postal andE. Fleisig , a natural person. OnOctober 18, 2021 , the Company received the$1,020,000 funding under this agreement. The term of the agreement is 30 months with principal accruing a simple interest rate of 5 percent per annum. These loans may be prepaid in full or partially without any penalty. OnMay 1, 2022 , the Company negotiated three$200,000 working capital funding agreements, to provide$600,000 in funding for daily operations. The Board resolved that certain Directors could negotiate the terms of a Working Capital Funding Agreement for up to a total of$600,000 , with DirectorsS. Wallach (through Group Nexus, a company controlled byMr. Wallach ),J. Postal and Mouhaned Khoury, a natural person. OnMay 1st the three individual agreements became effective. The term of each agreement is 18 months with principal accruing a simple interest rate of 5 percent per annum. These loans may be prepaid in full or partially without any penalty. OnOctober 13, 2022 , the Company negotiated a$50,000 Working Capital Funding agreement withJeffrey Postal , a director, to provide funding for daily operations (the "Working Capital Funding Agreement"). The term of this agreement is 18 months and principal accrues simple interest at a rate of 5 percent per annum. The loan may be prepaid in full or partially without any penalty. OnDecember 1, 2022 , the Company negotiated a$50,000 Working Capital Funding agreement withJeffrey Postal , a director, to provide funding for daily operations (the "Working Capital Funding Agreement"). The term of this agreement is 18 months and principal accrues simple interest at a rate of 5 percent per annum. The loan may be prepaid in full or partially without any penalty.
As of
48
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.
In addition, we may seek alternative sources of liquidity, including but not
limited to accessing the capital markets, or the Company may be able to raise
the required additional capital through debt and or equity financing. However,
instability in, or tightening of the capital markets, could adversely affect our
ability to access the capital markets on terms acceptable to us. The Company can
make no assurances that it will be able to raise the required capital, on
acceptable terms or at all. Management believes that with the cash on hand, and
our availability will be adequate to meet the Company's cash needs for daily
operations for the short-term period, however the Company does not have
sufficient cash on hand to finance its plan of operations for the next 12 months
from the filing of this report and will need to seek additional capital through
debt and/or equity financing. These factors raise substantial doubt about the
Company's ability to continue as a going concern.
Summary of Cash Flows
Years ended December 31,
2022 2021
(In thousands)
Net cash provided by (used in):
Operating Activities $ (1,904 ) $ (2,371 )
Investing Activities - (32 )
Financing Activities 688 2,457
Net increase (decrease) in cash
As of
? Accounts payable of approximately$38 thousand for amounts due vendors and service providers.
? Accrued expenses of approximately
wages, and customer deposits.
? Operating lease - current portion of approximately
? Notes payable - related parties - current portion of approximately
thousand.
? Notes payable - unrelated parties - current portion of approximately
thousand.
Cash Flows provided by (used in) Operating Activities
Cash used in operating activities was approximately$1.9 million in 2022 compared with approximately$2.4 million in 2021. The cash used in operating activities in 2022 included the negative cash impact of the net loss, which was approximately$2.6 million , offset by a decrease of prepaid expenses of$463 thousand , a decrease in inventory of$97 thousand , a decrease in accounts payable of$229 thousand , netted against a decrease in tax refund for$284 thousand .
Cash Flows used in Investing Activities
Cash provided by in investing activities in 2021 was$0 compared to cash used in investing activities of$32 thousand in 2021. The Company continued to invest in new product molds and tooling. With the product expansion into the Smart Mirror categories, the Company's purchased tooling and product molds in 2021. In 2022, the Company began a re-engineering of the Smart Mirror for its next rollout for version two and decided the current tooling and product molds will not manufacture the mold for version two, and therefore removed the equipment from the balance sheet as it will not provide any future resources to the Company. Future capital requirements will increase to fund future mold and tooling as the Company expands the Connected Surfaces portfolio.
Cash Flows used in Financing Activities
Cash received and used in financing activities for the years endedDecember 31, 2022 and 2021, was approximately$688 thousand and$2.4 million , respectively. During 2022, the Company received$700,000 in working capital funding netted against a$12 thousand repurchase of common shares. In 2021, the Company received approximately$1.4 million from sales of common stock and approximately$1.0 million purchase order funding received from related party note payable during the year 2021.
The Company has negotiated beneficial payment terms with our main overseas
manufacturers including the new supplier in
49 Exchange Rates We sell all of our products inU.S. dollars and pay for all of our manufacturing costs inU.S. dollars. Our factories are located inThailand . During 2021 the average exchange rate between theU.S. Dollar and Chinese Yuan have been relatively stable approximatelyRMB 6.90 toU.S. $1.00 .
The average exchange rate between the
While exchange rates have been stable for several years, we cannot assure you that the exchange rate betweenthe United States , Chinese andThailand currencies will continue to be stable and exchange rate fluctuations may have a material effect on our business, financial condition or results of operations.
Off Balance Sheet Arrangements
We do not have material off-balance sheet arrangements that have or are reasonably likely to have a material future effect on our results of operations or financial condition.
DIVIDENDS We have not declared or paid any cash or other dividends on shares of our Common Stock in the last eight years and we presently have no intention of paying any cash dividends on shares of our Common Stock. RELATED-PARTY TRANSACTIONS
See Note 4 of the Consolidated Financial Statements at Item 15 of this Report.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 1 of the Consolidated Financial Statements at Item 15 of this Report.
CRITICAL ACCOUNTING POLICIES The preparation of consolidated financial statements in conformity with accounting principles generally accepted inthe United States of America ("U.S. GAAP") requires management to make certain estimates and assumptions regarding matters that are inherently uncertain and that ultimately affect the reported amounts of assets, liabilities, revenues and expense, and the disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition; inventory valuation; depreciation; amortization and the recovery of long-lived assets; including goodwill and intangible assets; shared base-based payment expense; product warranty; and other reserves and assumptions based on management's experience and understanding of current facts and circumstances, historical experience and other relevant factors. These estimates may differ from actual results. Certain of our accounting policies are considered critical as they are both important to reflect our financial position and results of operations and require significant or complex judgement on the part of management. The following is a summary of certain accounting policies considered critical by management. Revenue Recognition The Company generates revenue from developing, marketing and selling consumer electronic products through national and regional retailers. The Company's products are targeted for applications such as home indoor and outdoor lighting as well as Internet-of-Thing devices and will have different functionalities. Capstone currently operates in the consumer electronic products category in the Unites States and in specific overseas markets. These products may be offered either under the Capstone brand or a private brand. 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. 50 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 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. With the Company launching the Connected Surfaces Smart Mirror program, the direct-to-consumer orders are sold initially through e-commerce platforms. The Company also sells the Connected Surfaces Smart Mirror program through independent retailers. The Company will only bill the customer and recognize revenue upon the customer obtaining control of the Smart Mirror order which
will occur upon delivery. 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 may also enter into a private label agreement, whereby the Company produces and ships products to a customer that has been packaged and will be marketed under the customers own private label.
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 expenses.
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 retail customers, however occasionally as part of a customers 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, promotional and marketing allowances, defective warranty claims, and other deductions are recognized during the period the related revenue is recorded. The Company may be subject to chargebacks from customers for negotiated promotional allowances, that are deducted from open invoices and reduce collectability of open invoices. For the years endedDecember 31, 2022 and 2021, the Company had processed approximately$26.7 thousand and$8.0 thousand , respectively for such allowances. Accounts Receivable For product revenue, the Company invoices its customers at the time of shipment for the sales value of the product shipped. Accounts receivables 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.
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 both Decembers 31, 2022 and 2021, management determined that the accounts receivable is fully collectible. As such, management has not recorded an allowance for doubtful accounts.
51Goodwill
OnSeptember 13, 2006 , the Company entered into a Stock Purchase Agreement withCapstone Industries, Inc. , aFlorida corporation ("Capstone"). Capstone was incorporated inFlorida onMay 15, 1996 and is engaged primarily in the business of wholesaling technology inspired consumer products to distributors and retailers inthe 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 .
InJanuary 2017 , the FASB issued ASU 2017-04, Simplifying the Test forGoodwill 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). ASU 2017-04 was effective for the Company's fiscal year endedDecember 31, 2019 . The adoption of ASU 2017-04 did not have a material effect on the Company's consolidated financial statements.Goodwill is tested for impairment onDecember 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 economic uncertainties caused by the COVID-19 pandemic during the year endedDecember 31, 2021 , management determined sufficient indicators existed to trigger the performance of interim goodwill impairment analyses for each reporting quarter. The total impairment charge for the year endedDecember 31, 2022 and 2021 was$0 , respectively. With the continuing economic uncertainties caused by the COVID-19 pandemic, the capital markets may 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's stock is deemed a "penny stock" under Commission rules. Accrued Liabilities Accrued liabilities contained in the accompanying consolidated balance sheets include accruals for estimated amounts of credits to be issued in future years based on potential product warranties, compensation, benefits, marketing allowances and other liabilities. 52 Income Taxes The Company is subject to income taxes in theU.S. federal jurisdiction, various state jurisdictions and certain other jurisdictions. The Company accounts for income taxes under the provisions ofFinancial Accounting Standards Board ("FASB") Accounting Standard Codification ("ASC") 740 Income Taxes. ASC 740 requires recognition of deferred income tax assets and liabilities for the expected future income tax consequences, based on enacted tax laws, of temporary differences between the financial reporting and tax bases of assets and liabilities. The Company and itsU.S. subsidiaries file consolidated income
tax returns.
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 toU.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.
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.
As of
OnMarch 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, provided for the Employee Retention Tax Credit ("ERTC"), a refundable tax credit for businesses that continued to pay employees while shut down due to COVID-19 or had significant declines in gross receipts fromMarch 13, 2022 toDecember 31, 2021 . For the year endedDecember 31, 2022 and 2021, the Company recorded a net tax receivable of$0 and$284,876 , respectively, related to the ERTC. During 2022, the Company received a refund of$231,155 with the remaining receivable balance of$53,721 included as income tax expense on the consolidated statements of operations as ofDecember 31, 2022 .
The effective tax rate for the years ended
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. Deferred tax assets are to be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred assets will not be realized. The Company has evaluated the positive and negative evidence bearing upon its ability to realize the deferred tax assets. Management has considered the Company's history of cumulative net losses incurred and has concluded that it is more likely than not that the Company will not realize the benefits of the deferred tax assets. Accordingly, a full valuation allowance has been established against the deferred tax assets as ofDecember 31, 2022 and 2021. Since indefinite-lived assets cannot be used as a source of taxable income to support the realization of deferred tax asset, a valuation allowance was recorded against the deferred tax assets, and a net deferred tax liability or naked credit of approximately$285,000 and$274,000 is presented on the company's balance sheet, respectively. The Company's valuation allowance increased by$740,508 in 2022. The Company recognizes liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. While the Company believes that it has appropriate support for the positions taken on its tax returns, the Company regularly assesses the potential outcome of examinations by tax authorities in determining the adequacy of its provision for income taxes.
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