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 September 30, 20172018


__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)

Florida84-1047159
(State or other jurisdiction of incorporation or organization)(I.R.S. Employer Identification No.)

350 Jim Moran Boulevard,431 Fairway Drive, Suite 120,200, Deerfield Beach, Florida    3344233441
(Address of principal executive offices)

(954) 570-8889 extension 313
(Issuer's Telephone Number)

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

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

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

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  [_] Yes [X] No

State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practical date. As of September 30, 2017,November 5, 2018, there were 47,046,364 shares of the issuer's Common Stock, $0.0001 par value per share, issued and outstanding.



1



CAPSTONE COMPANIES, INC.
Quarterly Report ofon Form 10-Q
Three Months and Nine Months Ended September 30, 2017

2018
TABLE OF CONTENTS


PART 1FINANCIAL INFORMATION 3
   
Item 1.Financial Statements (Unaudited) 3
Item 2.Management's Discussion and Analysis of Financial Condition and Results of Operation 1723
Item 3.Quantitative and Qualitative Disclosures about Market Risk 3242
Item 4.Controls and Procedures 3342
   
PART IIOther Information 3344
   
Item 1.Legal Proceedings 3344
Item 1A.Risk Factors 3344
Item 2.Unregistered Sale of Equity Securities and Use of Proceeds 3444
Item 3.Defaults of Senior Securities 3444
Item 4.Mine Safety Disclosures 3445
Item 5.Other Information 3445
Item 6.Exhibits 3445



2


CAPSTONE COMPANIES, INC. AND SUBSIDIARIES      
CONSOLIDATED BALANCE SHEETS      
       
  September 30,  December 31, 
  2018  2017 
Assets: (Unaudited)    
Current Assets:      
   Cash $3,593,296  $3,668,196 
   Accounts receivable, net  2,387,590   4,367,721 
   Inventories  8,316   140,634 
   Prepaid expenses  164,345   239,150 
   Income tax refundable  354,912   - 
     Total Current Assets  6,508,459   8,415,701 
         
Property and Equipment:        
   Computer equipment and software  56,932   9,895 
   Machinery and equipment  395,601   318,801 
   Furniture and fixtures  12,493   5,665 
   Less: Accumulated depreciation  (299,454)  (266,997)
     Total Property & Equipment  165,572   67,364 
         
Other Non-current Assets:        
   Deposit  14,755   13,616 
   Goodwill  1,936,020   1,936,020 
      Total Other Non-current Assets  1,950,775   1,949,636 
         Total Assets $8,624,806  $10,432,701 
         
Liabilities and Stockholders' Equity:        
Current Liabilities:        
   Accounts payable and accrued liabilities $1,801,248  $2,733,516 
   Income tax payable  11,694   624,782 
     Total Current Liabilities  1,812,942   3,358,298 
         
Long Term Liabilities:        
   Deferred tax liabilities  283,000   251,000 
     Total Long Term Liabilities  283,000   251,000 
     Total Liabilities  2,095,942   3,609,298 
         
Commitments and Contingencies (Note 4)        
         
Stockholders' Equity:        
   Preferred Stock, Series A, par value $.001 per share, authorized 6,666,667 shares, issued -0- shares  -   - 
   Preferred Stock, Series B-1, par value $.0001 per share, authorized 3,333,333 shares, issued -0- shares  -   - 
   Preferred Stock, Series C, par value $1.00 per share, authorized 67 shares, issued -0- shares  -   - 
   Common Stock, par value $.0001 per share, authorized 56,666,667 shares, issued 47,046,364 shares  4,704   4,704 
   Additional paid-in capital  7,081,194   7,005,553 
   Accumulated deficit  (557,034)  (186,854)
     Total Stockholders' Equity  6,528,864   6,823,403 
     Total Liabilities and Stockholders' Equity $8,624,806  $10,432,701 
         
The accompanying notes are an integral part of these consolidated financial statements.     

 

CAPSTONE COMPANIES, INC. AND SUBSIDIARIES      
CONSOLIDATED BALANCE SHEETS      
       
  September 30,  December 31, 
  2017  2016 
  (Unaudited)    
Assets:      
Current Assets:      
   Cash $3,240,721  $1,646,128 
   Accounts receivable, net  4,660,203   4,449,179 
   Inventory  142,065   366,330 
   Prepaid expenses  349,410   330,020 
     Total Current Assets  8,392,399   6,791,657 
         
Property and Equipment:        
   Computer equipment and software  19,767   19,767 
   Machinery and equipment  371,323   325,750 
   Furniture and fixtures  5,665   5,665 
   Less: Accumulated depreciation  (304,176)  (250,465)
     Total Property & Equipment  92,579   100,717 
         
Other Non-current Assets:        
   Deposit  13,616   12,193 
   Note receivable  -   526,887 
   Goodwill  1,936,020   1,936,020 
      Total Other Non-current Assets  1,949,636   2,475,100 
         Total Assets $10,434,614  $9,367,474 
         
Liabilities and Stockholders' Equity:        
Current Liabilities:        
   Accounts payable and accrued liabilities $2,122,220  $2,678,210 
   Income tax payable  404,088   1,588 
   Notes and loans payable to related parties  688,384   1,321,721 
     Total Current Liabilities  3,214,692   4,001,519 
         
Long Term Liabilities:        
   Deferred tax liabilities  362,000   216,000 
     Total Long Term Liabilities  362,000   216,000 
     Total Liabilities  3,576,692   4,217,519 
         
Commitments and Contingencies (Note 6)        
         
Stockholders' Equity:        
   Preferred Stock, Series A, par value $.001 per share, authorized 6,666,667 shares, issued -0- shares  -   - 
   Preferred Stock, Series B-1, par value $.0001 per share, authorized 3,333,333 shares, issued -0- shares  -   - 
   Preferred Stock, Series C, par value $1.00 per share, authorized 67 shares, issued -0- shares  -   - 
   Common Stock, par value $.0001 per share, authorized  56,666,667 shares, issued 47,046,364 shares and 48,132,664 shares  4,704   4,813 
   Additional paid-in capital  6,976,678   7,411,172 
   Accumulated deficit  (123,460)  (2,266,030)
     Total Stockholders' Equity  6,857,922   5,149,955 
     Total Liabilities and Stockholders' Equity $10,434,614  $9,367,474 
         
The accompanying notes are an integral part of these financial statements.        

3

 
CAPSTONE COMPANIES, INC. AND SUBSIDIARIES CAPSTONE COMPANIES, INC. AND SUBSIDIARIES  CAPSTONE COMPANIES, INC. AND SUBSIDIARIES 
CONSOLIDATED STATEMENTS OF INCOME  
CONSOLIDATED STATEMENTS OF OPERATIONSCONSOLIDATED STATEMENTS OF OPERATIONS 
(Unaudited) (Unaudited)  (Unaudited)  
                        
 For the Three Months Ended  For the Nine Months Ended  For the Three Months Ended  For the Nine Months Ended 
 September 30,    September 30,     September 30,     September 30,    
 2017  2016  2017  2016  2018  2017  2018  2017 
                        
Revenues, net $13,817,909  $11,692,146  $30,789,653  $22,672,551  $5,726,145  $13,817,909  $11,889,520  $30,789,653 
Cost of sales  (10,707,657)  (8,841,148)  (23,457,070)  (17,079,271)  (4,395,761)  (10,707,657)  (9,179,145)  (23,457,070)
Gross Profit  3,110,252   2,850,998   7,332,583   5,593,280   1,330,384   3,110,252   2,710,375   7,332,583 
                                
Operating Expenses:                                
Sales and marketing  928,321   488,057   1,869,596   903,888   359,715   928,321   838,323   1,869,596 
Compensation  351,915   325,283   1,065,621   949,753   359,539   351,915   1,104,396   1,065,621 
Professional fees  109,257   111,339   429,440   286,681   102,532   109,257   394,320   429,440 
Product development  80,991   127,367   219,464   227,552   95,661   80,991   385,994   219,464 
Other general and administrative  189,780   195,046   572,461   501,458   232,888   189,780   573,852   572,461 
Total Operating Expenses  1,660,264   1,247,092   4,156,582   2,869,332   1,150,335   1,660,264   3,296,885   4,156,582 
                                
Net Operating Income  1,449,988   1,603,906   3,176,001   2,723,948 
Operating Income (Loss)  180,049   1,449,988   (586,510)  3,176,001 
                                
Other Income (Expense):                                
Interest Income  (12,945)  13,664   -   13,664 
Miscellaneous income (expense)  (1,960)  -   145,330   - 
Interest expense  (56,514)  (103,363)  (113,431)  (227,522)  -   (69,459)  -   (113,431)
Total Other Income (Expense)  (69,459)  (89,699)  (113,431)  (213,858)  (1,960)  (69,459)  145,330   (113,431)
                                
Income Before Tax Provision  1,380,529   1,514,207   3,062,570   2,510,090 
Income (Loss) Before Tax Provision (Benefit)  178,089   1,380,529   (441,180)  3,062,570 
                                
Provision for Income Tax  (390,000)  (24,412)  (920,000)  (37,012)
Provision (Benefit) for Income Tax  6,000   390,000   (71,000)  920,000 
                                
Net Income $990,529  $1,489,795  $2,142,570  $2,473,078 
Net Income (Loss) $172,089  $990,529  $(370,180) $2,142,570 
                                
Net Income per Common Share                
Net Income (Loss) per Common Share                
Basic $0.021  $0.031  $0.046  $0.051  $0.004  $0.021  $ (0.008) $0.046 
Diluted $0.021  $0.031  $0.045  $0.051  $0.004  $0.021  $ (0.008) $0.045 
                                
Weighted Average Common Shares Outstanding             
Weighted Average Shares Outstanding                
Basic  46,660,456   48,132,664   46,989,940   48,132,664   47,046,364   46,660,456   47,046,364   46,989,940 
Diluted  47,152,574   48,371,158   47,462,664   48,320,017   47,046,364   47,152,574   47,046,364   47,462,664 
                                
The accompanying notes are an integral part of these financial statements.  
The accompanying notes are an integral part of these consolidated financial statements.The accompanying notes are an integral part of these consolidated financial statements. 


4

 
CAPSTONE COMPANIES, INC. AND SUBSIDIARIES CAPSTONE COMPANIES, INC. AND SUBSIDIARIES        
CONSOLIDATED STATEMENTS OF CASH FLOWS CONSOLIDATED STATEMENTS OF CASH FLOWS        
(Unaudited) (Unaudited)        
            
 For the Nine Months Ended  For the Nine Months Ended 
 September 30,     September 30,    
 2017  2016  2018  2017 
CASH FLOWS FROM OPERATING ACTIVITIES:            
            
Net income $2,142,570  $2,473,078 
Adjustments necessary to reconcile net income to net cash provided by (used in) operating activities: 
Net income (loss) $(370,180) $2,142,570 
Adjustments necessary to reconcile net income (loss) to net cash provided by (used in) operating activities:        
Depreciation and amortization  55,725   44,400   32,457   55,725 
Accrued interest on note receivable  26,887   (13,654)  -   26,887 
Stock based compensation expense  66,594   46,581   75,641   66,594 
Provision for deferred income tax  146,000   -   32,000   146,000 
Accrued sales allowance  (831,731)  (94,203)
(Increase) decrease in accounts receivable  731,532   (6,755,174)
(Increase) decrease in inventory  224,265   (275,049)
Increase (decrease) in accrued sales allowance  153,025   (831,731)
Decrease in accounts receivable, net  1,827,100   731,532 
Decrease in inventories  132,318   224,265 
(Increase) decrease in prepaid expenses  (20,813)  43,764   74,805   (20,813)
Increase (decrease) in accounts payable and accrued liabilities  (263,912)  958,580 
(Increase) in deposits  (1,139)  - 
(Decrease) in accounts payable and accrued liabilities  (932,262)  (263,912)
(Decrease) in income tax payable  (613,088)  - 
(Increase) in income tax refundable  (354,912)  - 
(Decrease) in accrued interest on notes payable  (135,337)  (168,492)  -   (135,337)
Net cash provided by (used in) operating activities  2,141,780   (3,740,169)
Net cash provided by operating activities  55,765   2,141,780 
                
CASH FLOWS FROM INVESTING ACTIVITIES:                
Purchase of property and equipment  (47,587)  (15,501)  (130,665)  (47,587)
Net cash (used in) investing activities  (47,587)  (15,501)  (130,665)  (47,587)
                
CASH FLOWS FROM FINANCING ACTIVITIES:                
Proceeds from notes payable  30,559,312   19,393,834   18,352,018   30,559,312 
Repayments of notes payable  (30,559,312)  (15,049,345)  (18,352,018)  (30,559,312)
Repurchase of shares from Involve, LLC  (250,000)  -   -   (250,000)
Warrant issued  7,500   -   -   7,500 
Proceeds from notes and loans payable to related parties  -   860,000 
Repayments of notes and loans payable to related parties  (257,100)  (1,453,946)  -   (257,100)
Net cash provided by (used in) financing activities  (499,600)  3,750,543 
Net cash (used in) financing activities  -   (499,600)
                
Net Increase (decrease) in Cash and Cash Equivalents  1,594,593   (5,127)  (74,900)  1,594,593 
Cash and Cash Equivalents at Beginning of Period  1,646,128   364,714   3,668,196   1,646,128 
Cash and Cash Equivalents at End of Period $3,240,721  $359,587  $3,593,296  $3,240,721 
        
                
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                
Cash paid during the period for:                
Interest  221,881  $396,014  $-  $221,881 
Income taxes $371,500  $31,912  $865,000  $371,500 
                
Non-cash financing and investing activities:                
Sale of Investment for Note receivable $-  $500,000 
                
Shares issued in satisfaction of loan payable to related party $240,900  $-  $-  $240,900 
                
The accompanying notes are an integral part of these financial statements.  
The accompanying notes are an integral part of these consolidated financial statements.        



5


 
5

CAPSTONE COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

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 September 30, 20172018 and results of operations and cash flows for the three months and nine months ended September 30, 20172018 and 2016.2017. All significant intercompany accounts and transactions are eliminated in consolidation. These condensed consolidated financial statements and notes are presented in accordance with the rules and regulations of the United States Securities and Exchange Commission ("SEC") relating to interim financial statements and in conformity with U.S. GAAP. Certain information and note disclosures have been condensed or omitted in the condensed financial statements pursuant to SEC rules and regulations, although the Company believes that the disclosures made herein are adequate to make the information not misleading. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes in the Company's Annual Report on Form 10-K for the year ended December 31, 20162017 (the "2016"2017 Annual Report").

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

Nature of Business

Since the beginning of fiscal year 2007, the Company has been primarily engaged in the business of developing, marketing and selling consumerhome LED products through national and regional retailers and distributors in North America.America and in certain overseas markets. The Company's products are targeted for applications such as home indoor and outdoor lighting and will have different functionalities to meet consumer's needs.  These products may be offered either under the Capstone currently operates in eight primary product categories: Induction Charged Power Failure Lights; LED Night Lights and Power Failure Lights; Motion Sensor Lights; Wireless Remote-Control Outlets; Wireless Remote-Control Accent Lights; Dual Power Solar Lights; Outdoor Light Fixtures and Power Control Light Bulbs.  brand or licensed brands.

The Company's products are typically manufactured in China by third-partycontract manufacturing companies.

InventoryThe 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 invoiced amount 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 September 30, 2018 and December 31, 2017, accounts receivable serves as collateral for the Company's note payable.



6



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

The following table summarizes the components of accounts receivable, net:

 September 30, December 31, 
 2018 2017 
Trade accounts receivables at period end $2,734,676  $4,561,782 
Reserve for estimated marketing allowances, cash discounts and other incentives  (347,086)  (194,061)
Total Accounts Receivable, net $2,387,590  $4,367,721 

The following table summarizes the changes in the Company's reserve for marketing allowances, cash discounts and other incentives which is included in net accounts receivable:

  September 30,  December 31, 
  2018  2017 
Balance at beginning of the period $(194,061) $(1,200,792)
     Accrued allowances  (173,660)  (921,833)
     Reversal of prior year accrued allowances  1,749   58,867 
     Expenditures  18,886   1,869,697 
Balance at period-end $(347,086) $(194,061)

Marketing allowances include the cost of underwriting an in store instant rebate coupon or a target markdown allowance on a specific product. Cash discounts represent discounts offered to the retailer off outstanding accounts receivable in order to initiate early payment.

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, totaling $142,065$8,316 and $366,330$140,634 at September 30, 20172018 and December 31, 2016,2017, respectively.

Prepaid Expenses

The Company's prepaid expenses consist primarily of deposits on inventory purchases for future orders as well as prepaid advertising. As of September 30, 2017,insurance and December 31, 2016, the Company has $93,010 and $186,019, respectively, in prepaid advertising credits included in prepaid expenses on the consolidated balance sheets.trade show expense.

Net Income (Loss) Per Common Share

Basic earnings per common share wereare computed by dividing net income or loss by the weighted average number of shares of common stock outstanding for the reporting period. Diluted earnings per share reflects the potential dilution that couldwould occur if securities or other contracts to issue common stock were exercised or converted into common stock. For calculation of the diluted net income per share, the basic weighted average number of shares is increased by the dilutive effect of stock options 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.  At September 30, 20172018 and 2016,2017, the total number of potentially dilutive common stock equivalents excluded from the diluted earnings per share calculation was 0993,335 and 5,818,7000, respectively.

6

7



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

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

3 months ended3 months ended
 
3 months ended
September 30, 2017
  
3 months ended
September 30, 2016
 September 30, 2018September 30, 2017
Basic weighted average shares outstanding  46,660,456   48,132,664                 47,046,364                     46,660,456
Dilutive warrants  313,211   238,494                                  -                          313,211
Dilutive options  178,907   -                                  -
                          178,907
Diluted weighted average shares outstanding  47,152,574   48,371,158                 47,046,364                     47,152,574

9 months ended9 months ended
 
9 months ended
September 30, 2017
  
9 months ended
September 30, 2016
 September 30, 2018September 30, 2017
Basic weighted average shares outstanding  46,989,940   48,132,664                 47,046,364                     46,989,940
Dilutive warrants  308,219   187,353                                  -                          308,219
Dilutive options  164,505   -                                  -                          164,505
Diluted weighted average shares outstanding  47,462,664   48,320,017                 47,046,364                     47,462,664

Revenue Recognition

ProductThe 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 will have different functionalities.  Capstone currently operates in the consumer lighting products category in the Unites 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 when an agreement of sale exists, product delivery has occurred, pricing is fixed or determinable, and collection is reasonably assured.

Allowances for sales returns, rebates and discounts are recorded as a component of net sales induring the period the allowancesrelated sale is recorded. These costs are recognized.  In addition, accrued liabilities contained inrecorded within sales and marketing expenses.



8



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

The following table disaggregates net revenue by major source:

 For the 3 Months Ended September 30, 2018 For the 3 Months Ended September 30, 2017 
 Capstone Brand License Brands Total Consolidated Capstone Brand License Brands Total Consolidated 
             
Lighting Products- U.S. $2,697,694  $2,939,613  $5,637,307  $562,606  $13,038,136  $13,600,742 
Lighting Products-International  65,009   23,829   88,838   217,167   -   217,167 
     Total Revenue $2,762,703  $2,963,442  $5,726,145  $779,773  $13,038,136  $13,817,909 

 For the 9 Months Ended September 30, 2018 For the 9 Months Ended September 30, 2017 
 Capstone Brand License Brands Total Consolidated Capstone Brand License Brands Total Consolidated 
             
Lighting Products- U.S. $4,539,476  $6,798,866  $11,338,342  $3,855,504  $25,624,349  $29,479,853 
Lighting Products-International  261,983   289,195   551,178   1,309,800   -   1,309,800 
     Total Revenue $4,801,459  $7,088,061  $11,889,520  $5,165,304  $25,624,349  $30,789,653 

We provide our customers with limited rights of return for non-conforming product warranty claims. As a policy, the accompanying consolidated balance sheets include accruals for estimated amounts of credits to be issued in future years based on potentially defective product, otherCompany does not accept product returns and various allowances which are based on historical authorized returns.from customers, however occasionally as part of a customer's in store test for new product, we may receive back residual inventory.

On April 22, 2016,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 receivedselectively 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 approximately $479,000 from its major vendor to cover customer returnssales, or marketing expenses depending on the type of products from sales that occurred in 2015incentives.

Sales reductions for anticipated discounts, allowances and promotional allowances for 2016 sales. A credit of $126,000 was applied to invoices due to the vendorother deductions are recognized during the period ending June 30, 2016 and the remaining credit balance of $353,000 was applied to invoices due to the vendor during the period ended September 30, 2016.related revenue is recorded.

During the nine months ended September 30, 20172018 and 2016,2017, Capstone determined that $47,741$1,749 and $94,203,$47,741, respectively of previously accrued allowances were no longer required.


9



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

Warranties

The reductionCompany provides the end user with limited rights of accruedreturn 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 nonconforming returns based upon an analysis of historical product warranty claims and other relevant data. We evaluate our warranty reserves based on various factors including historical warranty claims assumptions about frequency of warranty claims, and assumptions about the frequency of product failures derived from our reliability estimates. Actual product failure rates that materially differ from our estimates could have a significant impact on our operating results. Product warranty reserves are reviewed each quarter and recognized at the time we recognize revenue.

The following table summarizes the changes in the Company's product warranty liabilities which are included in net revenues foraccounts payable and accrued liabilities in the nine-month periods endedaccompanying September 30, 2018 and December 31, 2017 and 2016.consolidated balance sheets:

  September 30,  December 31, 
  2018  2017 
Balance at the beginning of the period $328,279  $294,122 
     Amount accrued  64,060   940,291 
     Expenditures  (182,156)  (906,134)
Balance at period-end $210,183  $328,279 

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 werewas $0 and $67,497 and $65,406 for the three months and $180,743$77,650 and $138,846$180,743 for the nine months ended September 30, 2018 and 2017, respectively.

Product Development

Our research and 2016,development team located in Hong Kong working with our designated factories, are responsible for the design, development, testing, and certification of new product releases. Our engineering efforts support product development across all products, as well as product testing for specific overseas markets

Product development expenses were $95,661 and $80,991 for the three months and $385,994 and $219,464 for the nine months ended September 30, 2018 and 2017, respectively.



10



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

Shipping and Handling

The Company's shipping and handling costs are included in sales and marketing expenses and are recognized as an expense during the period in which they are incurred and amounted to $48,952$14,680 and $59,604$48,952 for the three months and $95,290$48,538 and $117,000$95,290 for the nine months ended September 30, 20172018 and 2016,2017, respectively.

Accounts Payable and Accrued Liabilities

AccruedAccounts payable and accrued liabilities contained in the accompanying consolidated balance sheets include accruals for estimated amounts of credits to be issued in future years based onfor potential product returnswarranty claims and various allowances, amounting to $369,061other expenses. As of September 30, 2018, and $1,200,792December 31, 2017, the Company has $437,915 and $600,622, respectively, in accrued liabilities.

The following table summarizes the components of accounts payable and accrued liabilities as of September 30, 20172018 and December 31, 2016, respectively. These estimates could change significantly in the near term.2017, respectively:

7


NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
  September30,  December 31, 
  2018  2017 
Accounts payable $1,363,333  $2,132,894 
Accrued warranty reserve  210,183   328,279 
Accrued compensation, benefits, commissions and other expenses  227,732   272,343 
                             Total accrued liabilities  437,915   600,622 
   Total $1,801,248  $2,733,516 

Income Taxes

The Company accounts for income taxes under the provisions of Financial Accounting Standards Board ("FASB") Accounting Standard Codification ("ASC") 740 Income Taxes. ASC 740 requires recognition of deferred income tax assets and liabilities for the expected future income tax consequences, based on enacted tax laws, of temporary differences between the financial reporting and tax bases of assets and liabilities. The Company and its U.S. subsidiaries intend to file consolidated income tax returns.

On December 22, 2017, President Trump signed into law the legislation generally known as Tax Cut and Jobs Act of 2017. The tax law includes significant changes to the U.S. corporate tax systems including a rate reduction from 35% to 21% beginning in January of 2018, a change in the treatment of foreign earnings going forward and a deemed repatriation transition tax. Refer to Note 6 for additional information on income taxes.

Stock-Based Compensation

The Company accounts for stock-based compensation under the provisions of ASC 718 Compensation- Stock Compensation, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options, based on estimated fair values.

ASC 718 requires companies to estimate the fair value of share-based payment awards on the date of the grant using an option-pricing model.  The value of the portion of the award that is ultimately expected to vest is recognized as expenses over the requisite service periods in the Company's consolidated statements of income.



11



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

Stock-based compensation expense recognized during the period is based on the value of the portion of share-based payment awards that is ultimately expected to vest during the period.

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 liabilitiesexpenses and the disclosure of contingent assets and liabilities. The Company evaluates its estimates on an ongoing basis, including those related to revenue recognition, product warranty obligations, valuation of inventories, tax related contingencies, valuation of stock-based compensation, other contingencies and litigation, among others. The Company generally bases its estimates on historical experience, agreed obligations, and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis of making judgments about the carrying value of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period.that are not readily apparent from other sources. Actual results could differ materially from those estimates, and the differences could be material.estimates.

Recent Accounting Standards

In May 2014, ASU 2014-09 was issued, Revenue from Contracts with Customers. Under this ASU and subsequently issued amendments, an entity is required to recognize the amount of revenue it expects toTo be entitled to for the transfer of promised goods or services to customers. The updated standard will replace most existing revenue recognition guidanceAdopted in U.S. GAAP. This ASU provides alternative methods of transition, a full retrospective and a modified retrospective approach. We expect to utilize the modified retrospective approach which would result in recognition of the cumulative impact of a retrospective application as of the beginning of the period of initial application, which in our case is the interim period beginning January 1, 2018. The adoption of ASU 2014-09 is not expected to have a material effect on the Company's consolidated financial statements.Future Period

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

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

8


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

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

In November 2016, the FASB issued ASU 2016-18, Cash Flows: Statement of Cash Flows (Topic 230) - Restricted Cash.  The update requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. This standard is effective at the beginning of our 2018 fiscal year. The adoption of ASU 2016-18 is not expected to have a material effect on the Company's consolidated financial statements.

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

Adoption of New Accounting Standards

 In May 2014, the FASB issued Accounting Standards Update ("ASU") 2014-09, which provided guidance for revenue recognition. The standard's core principle was that a company would recognize revenue when it transferred promised goods or services to customers in an amount that reflected the consideration to which the company expected to be entitled in exchange for those goods or services. In doing so, companies needed to use more judgment and make more estimates than under previous guidance. In August 2015, the FASB issued ASU 2015-14, which deferred the effective date of ASU 2014-09 for all entities by one year. Accordingly, public business entities applied the guidance in ASU 2014-09 to annual reporting periods (including interim periods within those periods) beginning after December 15, 2017.


12



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

ASC 606 established a principles-based approach for accounting for revenue arising from contracts with customers and superseded existing revenue recognition guidance. ASC 606 provided that an entity should apply a five-step approach for recognizing revenue, including (1) identify the contract with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, the entity satisfies a performance obligation. Also, the entity must provide various disclosures concerning the nature, amount and timing of revenue and cash flows arising from contracts with customers.

The Company completed its study on the impact that implementing this standard would have on its consolidated financial statements, related disclosures and our internal control over financial reporting as well as whether the effect would be material to our revenue. Based on the results of our study the standard did not have a material effect to our revenue. Changes were made to our internal control over financial reporting processes to ensure all contracts are reviewed for each of the five revenue recognition steps.  Additionally, the Company's revenue disclosures changed in fiscal 2018.  The new disclosures required more granularity into our sources of revenue, as well as the assumptions about recognition timing, and include our selection of certain practical expedients and policy elections. We used the modified retrospective approach upon adoption of this guidance effective January 1, 2018. We reviewed our current accounting policies and practices to identify potential differences resulting from the application of the new requirements to our sales contracts, including evaluation of performance obligations in the sales contract, the transaction price, allocating the transaction price to each separate performance obligation and accounting treatment of costs to obtain and fulfill contracts. In addition, we updated certain disclosures, as applicable, included in our consolidated financial statements to meet the requirements of the new guidance.

The adoption of ASC 606 did not have any impact on our operating cash flows.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities ("ASU 2016-01"). ASU 2016-01 modified how entities measure equity investments and present changes in the fair value of financial liabilities. Under the new guidance, entities have to measure equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in fair value in net income unless the investments qualify for the new practicality exception. A practicality exception applies to those equity investments that do not have a readily determinable fair value and do not qualify for the practical expedient to estimate fair value under ASC 820, Fair

Value Measurements, and as such these investments may be measured at cost. ASU 2016-01 was effective for the Company's fiscal year beginning after December 15, 2017 and subsequent interim periods. The adoption of ASU 2016-01 did not have a material effect on the Company's consolidated financial statements.

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

In November 2016, the FASB issued ASU 2016-18, Cash Flows: Statement of Cash Flows (Topic 230) - Restricted Cash.  The update required that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. This standard was effective at the beginning of our fiscal year and subsequent interim periods beginning after December 31, 2017. The adoption of ASU 2016-18 did not have a material effect on the Company's consolidated financial statements.


13



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

In May 2017, the FASB issued ASU No. 2017-09, "Compensation – Stock Compensation (Topic 718) – Scope of Modification Accounting" ("ASU 2017-09"), clarifying when a change to the terms or conditions of a share-based payment award must be accounted for as a modification. This new accounting standard requiresrequired modification accounting if the fair value, vesting condition or the classification of the award is not the same immediately before and after a change to the terms and conditions of the award. The new guidance is effective for us on a prospective basis beginning on January 1, 2018, with early adoption permitted.2018. We typically do not change either the terms or conditions of share-based payment awards once they are granted, therefore; this new guidance isdid not expected to have a material impact on our consolidated financial statements.

Adoption of New Accounting Standards

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

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

The Company adopted ASU 2016-09, Compensation - Stock Compensation (Topic 718) which simplified several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures, effective January 1, 2017. The new standard requires excess tax benefits or deficiencies for share-based payments to be recognized as income tax benefit or expense, rather than within additional paid-in capital, when the awards vest or are settled. Furthermore, cashflows related to excess tax benefits are required to be classified as operating activities in the statement of cash flows rather than financing activities. The adoption of ASU 2016-09 did not have a material effect on the Company's consolidated financial statements.

The Company continually assesses any new accounting pronouncements to determine their applicability to the Company. Where it is determined that a new accounting pronouncement affects the Company's financial reporting, the Company undertakes a study to determine the consequence of the change to its financial statements and assures that there are proper controls in place to ascertain that the Company's financials properly reflect the change.

9


NOTE 2 - CONCENTRATIONS OF CREDIT RISK AND ECONOMIC DEPENDENCE

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

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

Cash and Cash Equivalents

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

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

Accounts Receivable

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

Major Customers

The Company had two customers who comprised 55.5%61.1 % and 43.7%36.0% of net revenue during the nine-month periodnine months ended September 30, 2017,2018 and 62.8%55.5% and 35.8%43.7 % of net revenue during the nine-month periodnine months ended September 30, 2016.2017.  The loss of these customers would adversely impact the business of the Company.

ApproximatelyFor the nine months ended September 30, 2018 and 2017, approximately 4.6% and 4.3% and 8.1%, respectively, of the Company's net revenue for the nine-month periods ended September 30, 2017 and 2016, wasresulted from international sales.

  Revenue %  Gross Accounts Receivable 
  
9 Month Periods Ended
September 30,
  As of September 30,  As of December 31, 
  2017  2016  2017  2016 
Customer A  55.5%  62.8% $3,563,515  $3,760,755 
Customer B  43.7%  35.8%  1,447,171   1,823,785 
   99.2%  98.6% $5,010,686  $5,558,540 


14



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

Major Customers
  Net Revenue %     Net Accounts Receivable 
  For the Nine Months ended     As of  As of 
  September 30,     September 30,  December 31, 
             
  2018  2017  2018  2017 
Customer A  61.1%  55.5% $1,895,862  $2,259,769 
Customer B  36.0%  43.7%  839,808   2,268,426 
 Total  97.1%  99.2% $2,735,670  $4,528,195 

Major Vendors

The Company had one vendortwo vendors from which it purchased 90.8%77.5% and 98.1% of merchandise sold during the nine-month periodnine months ended September 30, 2018 and 2017, and 89.5% of merchandise sold during the nine-month period ended September 30, 2016.respectively. The loss of this supplierthese suppliers could adversely impact the business of the Company.

 Purchases % Accounts Payable 
 
9 Month Periods Ended
September 30,
 As of September 30, As of December 31, 
  2017  2016  2017  2016 
Vendor A  90.8%  89.5% $1,172,314  $1,507,671 
As of September 30, 2018 approximately 18.8% of accounts payable was due to two vendors. As of December 31, 2017 approximately 79.3% was due to two vendors.
  Purchases %     Accounts Payable 
  For the Nine Months ended     As of  As of 
  September 30,     September 30,  December 31, 
             
  2018  2017  2018  2017 
Vendor A  59.8%  90.8% $140,677  $922,310 
Vendor B  17.6%  7.3%  112,825   768,164 
 Total  77.4%  98.1% $253,202  $1,690,474 


10

15



NOTE 3 - NOTE RECEIVABLE

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

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

The significant unobservable inputs used in the fair value measurement of the Company's note receivable were the probability of default and the loss severity in the event of the default.

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.

With the purchase of all available options under the repurchase agreement, part of the collateral used to substantiate the value of the note receivable was no longer available and, consequently management has determined that the fair value of the note at September 30, 2017 was $0.

NOTE 4 – NOTES PAYABLE

Sterling National Bank

On September 8, 2010, in order to fund increasing accounts receivables and support working capital needs, Capstone secured a Financing Agreement from Sterling Capital Funding (now called Sterling National Bank), located in New York, whereby Capstone receives funds for assigned retailer shipments. The assignments provide funding for an amount up to 85% of net invoices submitted.submitted and 50% of inventory value.  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 the time of closing was 5%6.00%. As of September 30, 20172018 and December 31, 2016,2017, the interest rate on the loan was 5.256.25%. The amounts borrowed under this agreement are due on demand and collateralized by substantially all the assets of Capstone.

As of both September 30, 20172018 and December 31, 2016,2017, there was no balance due to Sterling National Bank.

On July 20, 2018, to support the Company's future needs, Sterling National Bank expanded the credit line up to $10,000,000 of which $2,000,000 has been allocated as a Capstone expansion working capital line.

As of September 30, 2017,2018, the maximum amount that can be borrowed on this credit line is $7,000,000.$10,000,000.

11


NOTE 5 – NOTES AND LOANS PAYABLE TO RELATED PARTIES

As of September 30, 2017, and December 31, 2016, the Company had notes payable due to one officer, director and related party which totaled $688,384 and $1,321,721, respectively. During the quarter ended September 30, 2017, this related party entered into a Conversion and Option Agreement that resulted in $217,500 of outstanding notes payable being satisfied as payment for exercised stock options and a further $23,400 of notes payable being satisfied as payment for the purchase of 50,000 of the Company's common shares.

On September 14, 2017, the remaining balance of that note payable, $138,418 was paid to this related party, resulting in the full and final payment of the note outstanding since 2012.

The remaining note payable carries an 8% interest rate and matures on of January 2, 2018.

NOTE 64 – COMMITMENTS AND CONTINGENCIES

Operating Leases

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

On January 17, 2014, and effective February 1, 2014, Capstone entered into a lease agreement for the same office space as currently located. The lease agreement dated January 17, 2014, and effective February 1, 2014, hadhaving a 3-year term with a base annual rent of $87,678 paid in equal monthly installments. The Company had the one-time option to renew the lease for three (3) years subject to a 3% increase per each year of the renewal term.

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

CIHKOn May 15, 2018, the Company entered into a lease amendment with the existing landlord to provide for a premise's relocation, lease termination and new sublease agreement. Under the agreement the Company relocated its current 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, Deerfield Beach, Florida 33441. The original lease terminated on the relocation date and the parties proceeded under the terms of the new sublease which expires on January 31, 2020. The base annual rent in the new sublease remains at the same rate as the previous agreement until January 31, 2020. At the expiration of the new sublease, the Company has 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 decides to further extend the



16



NOTE 4 – COMMITMENTS AND CONTINGENCIES (continued)

sublease after January 31, 2020, the Company will be subject to the terms and conditions of the prime lease. The base monthly rent will be $4,390 to January 31, 2019 and then a base rent of $4,522 until January 31, 2020. The Company is also responsible for portion of the common area maintenance, estimated to be $2,992 per month.

For consideration for the lease amendment, the Company received a rate abatement from the landlord, effective May 1, 2018 and for four months until September 1, 2018. The landlord also delivered the relocation premises in a "turn key" condition with requested renovations made at no expense to the Company.  As further consideration, the existing landlord agreed to pay the Company as an incentive to vacate the existing premises, a total of $150,000 on completion of the relocation. As of September 30, 2018 the $150,000 has been fully paid to the Company.

Capstone International Hong Kong Ltd, (CIHK), entered into a lease agreement for office space at 303 Hennessy Road, Wanchai, Hong Kong.  The original agreement was for the period from February 17, 2014, to February 16, 2016, with a base annual rent of $48,000 (HK$ 372,000) paid in equal monthly installments. The lease was extended for three (3) months until May 16, 2016. The lease was renewed for (12) months ending May 16, 2017 with a base annual rate of $48,775 and was further extended for (12) months ending May 16, 2018 with a base annual rate of $54,193 paid in equal monthly installments.  On April 24, 2018, the Company further extended the lease for (3) months ending August 16, 2018 with a base rate increase of $225 per month. On September 11, 2018, the Company further extended the lease for (6) months, with the term beginning August 17, 2008 and ending February 16, 2019 with a base monthly rent of $4,815 (HKD $ 37,800).  The Company entered into a six (6) month rental agreement from December 1, 2016 until May 31, 2017 and was extended until December 31, 2017 for showroom space at 3F, Wing Kin Industrial Building, 4-6 Wing Kin Road, Kwai Chung, NT, Hong Kong. This agreement has been further extended until December 31, 2017.2018.

The Company's rent expense amounted to $36,757 and $35,610 for the three-month periodthree months ended September 30, 2018 and 2017 was $30,976 and 2016,$36,757, respectively and $117,266$106,743 and $107,245$117,266 for the nine-month periodnine months ended September 30, 20172018 and 2016,2017, respectively.

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. A bonus compensation of $10,000 was paid in the month of January 2017 related to 2016 sales performance.

On January 1, 2017, the agreement was amended, whereby Mr. Wolf will bewas paid $13,750 per month from January 1, 2017 through December 31, 2017. A bonusBonus compensation of $10,000$15,000 was paid inon December 22, 2017 related to 2017 sales performance.

On January 1, 2018, the agreement was further amended, whereby Mr. Wolf will be paid $13,750 per month offrom January 2017. 1, 2018 through December 31, 2018.

The agreement can be terminated upon 30 days' notice by either party. The Company may, in its sole discretion at any time after December 31, 2015 convert Mr. Wolf to a full-time Executive status. The annual salary and term of employment would be equal to that outlined in the consulting agreement.

12

17



NOTE 64 – COMMITMENTS AND CONTINGENCIES (continued)

Employment Agreements

On February 5, 2016, the Company entered into an Employment Agreement with Stewart Wallach, whereby Mr. Wallach will bewas paid $287,163 per annum.  As part of the agreement, the base salary will bewas reviewed annually by the Compensation Committee for a potential increase, to at least reflect increases in the cost of living, but only if the Company shows a net profit for the year. The initial term of this new agreement began February 5, 2016 and ended February 5, 2018. On February 5, 2018, the Company renewed the 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, 2018 and ends February 5, 2018.2020. 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, 2016, the Company entered into an Employment Agreement with James McClinton, whereby Mr. McClinton will bewas paid $191,442 per annum.  As part of the agreement, the base salary will bewas reviewed annually by the Compensation Committee for a potential increase, to at least reflect increases in the cost of living, but only if the Company shows a net profit for the year. The initial term of this new agreement began February 5, 2016 and ended February 5, 2018. On February 5, 2018, the Company renewed the Employment Agreement with James McClinton, whereby Mr. McClinton will be paid $191,442 per annum. The initial term of this new agreement began February 5, 2018 and ends February 5, 2018.2020. 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 one year in length.

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

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

Executives date of termination.  If the Executive had family health coverage at the time of termination, the additional family premium obligation would remain theirs and will be reduced against the Executive's severance package. The employment agreements have an anti-competition provision for 18 months after the end of employment.

Licensing Agreements

On February 4, 2015, the Company finalized a Licensing Agreement with a globally recognized floorcare company that allows the Company to market home lighting products under the licensed brand, to discount retailers, warehouse clubs, home centers, on-line retailers and other retail distribution channels in the U.S., Canada and Mexico. The initial term of the agreement is for 3 years. The agreement does not have a guaranteed royalty stipulation.

On December 29, 2016, the Company finalized the first amendment to the February 4,th, 2015 Licensing Agreement with the floorcare company in which the initial term was extended through February 3, 2020 and additional renewal terms and periods were also finalized. During this initial extended period through February 3, 2020, if the Company reaches $10,000,000 ofachieves net sales inof $5,000,000, then the initial

term. The agreement was furtherwould automatically be extended out to a second extended term2 years until February 3, 2022 and if during this second extended period the Company achieves net sales of $5,000,000, then the agreement would automatically be further extended out to a third extended term if specified sales goals are achieved.2 years until February 3, 2024. The license 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 alsofurther expanded to add an additional product category.

Royalty expense forrelated to this agreement was $251,559$146,981 and $221,219$251,559 for the three-monththree month period ended September 30, 20172018 and 2016,2017, respectively, and $630,664$303,477 and $406,405$630,664 for the nine-monthnine month period ended September 30, 2018 and 2017, and 2016, respectively.

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

Royalty expense forrelated to this agreement was $715 and $262,466, for the three-monththree month period ended September 30, 2018 and 2017, respectively, and $30,555 and $412,589 for the nine-monthnine month period ended September 30, 2017.
2018 and 2017, respectively.

13

18



NOTE 64 – COMMITMENTS AND CONTINGENCIES (continued)

Investment Banking Agreement

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

The retainer fee paid for this agreement was $30,000 for the three-month periodyear ended September 30,December 31, 2017 and $100,000 forwas $120,000.  A further retainer fee of $5,000 that remained on the nine-month period ended September 30, 2017.agreement was paid in January 2018. The agreement has now expired.

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 days term, which either party can cancel with 60 days advanced notice in writing on or after the 120th day of the effective date. MBA will receive a monthly fee of $11,250 and $475.88 subscription fee due on the first of each month.

Legal Matters

Cyberquest, Inc.  Capstone received a letter in July 2017 from a purported holder of 70,000 shares of a series of preferred stock issued by CBQ, Inc., a predecessor of the Company, in the 1998 acquisition of Cyberquest, Inc., a company that ceased operations by 2002.  The letter was a request to inspect Capstone corporate records.  Capstone investigated these claims and, due to perceived deficiencies in the stock certificate, our inability to substantiate the purported ownership of said preferred stock to date and absence of validation that shares of the series of preferred stock are still outstanding, Capstone refused the purported holder's request to inspect corporate records per a September 1, 2017 letter to the purported holder.  Capstone did not receive any responsive communications from the purported holder after September 1, 2017, until the purported holder filed a declaratory judgement action in Dallas County, Texas state court on March 21, 2018 seeking validation of purported holder's ownership of the preferred stock and to compel inspection of Capstone corporate records.  Capstone received notice of the state declaratory action on April 3, 2018.  The Company retained local Dallas, Texas legal counsel and answered the suit, filed a counter claim to recover attorney's fees, and removed litigation from the State Court to the U.S. District Court in Texas.

The Company and the claimant in the declaratory action pursued court-sponsored mediation which was held on September 12, 2018 in Dallas, Texas and resulted in a settlement agreement dated September 19, 2018. Under this agreement all parties acknowledged and agreed that this matter was amicably resolved without any admission of liability.

On September 27, 2018 both parties to this action filed a Joint Stipulation and Order for Dismissal with Prejudice with the U.S. district Court in Dallas, Texas, thereby ending this dispute.


19



NOTE 75 - STOCK TRANSACTIONS

Warrants

During September and October 2007, the Company issued 2,121,569 shares of common stock for cash at $0.255 per share, or $541,000 total as part of a Private Placement under Rule 506 of Regulation D. Along with the stock, each investor also received a warrant to purchase 30% of the shares purchased in the Private Placement. In September 2017, an investor exercised a warrant option for 29,412 shares at the exercise price of $.255 per share. A total ofDuring October 2017 the remaining 607,062 issuedoutstanding warrants remain outstanding at September 30, 2017.  Such warrants expired during October 2017.expired.

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 August 6, 2017, the Company granted 200,000 stock options to two directors of the Company and 10,000 stock options to the Company Secretary. These options have a strike price of $.435 with an effective date of August 6, 2017 and will vest on August 5, 2018.

During the quarter ended September 30, 2017, Jeffrey Postal (Director) entered into a Conversion and Option Agreement with the Company and exercised his option to purchase 500,000 of his vested stock options at the grant price of $.435 per share and with a total value of $217,500.  As part of the Agreement, the $217,500 payment for these stock options resulted in the satisfaction of $217,500 of notes payable due Mr. Postal since 2012.

As of September 30, 2017, there were 1,026,670 stock options outstanding and 816,670 stock options vested. The stock options have a weighted average expense price of $0.435.

For the three-month periods ended September 30, 2017 and 2016, the Company recognized stock based compensation expense of $25,644 and $18,081, respectively, related to these stock options.

For the nine-month periods ended September 30, 2017 and 2016, the Company recognized stock based compensation expense of $66,594 and $46,581, respectively, related to these stock options. Such amounts are included in compensation expense in the accompanying consolidated statements of income. A further compensation expense expected to be $28,875 and $68,856 will be recognized for these options in 2017 and 2018 respectively.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.

14

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 a strike price of $.435 with an effective date of August 6, 2018 and will vest on August 5, 2019 and have a term of 5 years. The Company Secretary options have a strike price of $.435 with an effective date of August 6, 2018 and will vest on August 5, 2019 and have a term of 10 years.

NOTE 7 - STOCK TRANSACTIONS (continued)As of September 30, 2018, there were 993,335 stock options outstanding and 783,335 stock options vested. The stock options have a weighted average expense price of $0.435.

Stock Purchase

DuringFor the quarterthree-month period ended September 30, 2018 and 2017, Jeffrey Postal entered into a Conversionthe Company recognized stock-based compensation expense of $17,891and $25,644, respectively and Option Agreement with$75,641and $66,594 for the Company. As partnine-month period ended September 30, 2018 and 2017, respectively.

Such amounts are included in compensation expense in the accompanying consolidated statements of the Agreement, Jeffrey Postal purchased 50,000 shares of common stock at a price of $.468 per share being the 30-consecutive trading day average price with a 10% discount resulting in a total value of $23,400. As part of the Agreement, the paymentoperations. A further compensation expense expected to be $11,025 will be recognized for these shares resultedoptions in the satisfaction of $23,400 of notes payable due to Mr. Postal since 2012.2018 and $26,290 in 2019.

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.


20



NOTE 5 - STOCK TRANSACTIONS (continued)

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 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.

NOTE 86 - INCOME TAXES

As of September 30, 2017,2018, the Company had utilized all net operating loss carry forwards for income tax reporting purposes that were previously available to be offset against future taxable income through 2034. The net deferred tax liability as of September 30, 2018 and December 31, 2017 was $362,000$283,000 and $251,000, respectively, and is reflected in long-term liabilities in the accompanying consolidated balance sheet.sheets.

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

Tax regulations within each jurisdiction are subject to the interpretation of the relaxed tax laws and regulations and require significant judgement to apply. The Company is not subject to U.S. federal, state and local tax examinations by tax authorities for the years 20132014 and prior.

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

The provision (benefit) for income taxes for the nine-monthsnine months ended September 30, 20172018 and 20162017 was calculated based on the estimated annual effective rate of 25.35% and 34%, respectively for both the full 2018 and 2017 calendar years. Additionally, a true-up related to 2017 is included in the tax provision for the three and 2016 calendar years, adjusted for annine months ended September 30, 2018.

On December 22, 2017, President Trump signed into law the legislation generally known as Tax Cut and Jobs Act of 2017. The tax law includes significant changes to the U.S. corporate tax systems including a rate reduction from 35% to 21% beginning in January of 2018, a change in the treatment of foreign earnings going forward and a deemed repatriation transition tax. In accordance with ASC 740, the impact of a change in tax law is recorded in the period of enactment. During the fourth quarter of 2017, the Company recorded a non-cash change in its net deferred income tax benefit frombalances of approximately $120,000 related to the expected utilization of net operating loss carryforwards.tax rate change.

15

21



NOTE 86 - INCOME TAXES (continued)

The income tax provision for the three- month periodthree months ended September 30, 20172018 and 20162017 consists of:

 
3 months ended
September 30, 2017
  
3 months ended
September 30, 2016
  2018  2017 
Current:            
Federal $382,000  $-  $(19,000) $382,000 
State  11,000   - 
        
Deferred:                
Federal  8,000   24,412   13,000   8,000 
State  1,000   - 
Income Tax Provision $390,000  $24,412  $6,000  $390,000 

The income tax provision (benefit) for the nine-month periodnine months ended September 30, 20172018 and 20162017 consists of:

 
9 months ended
September 30, 2017
  
9 months ended
September 30, 2016
  2018  2017 
Current:            
Federal $774,000  $-  $(93,000) $774,000 
State  (10,000)  - 
        
Deferred:                
Federal  146,000   37,012   30,000   146,000 
Income Tax Provision $920,000  $37,012 
State  2,000   - 
Income Tax Provision (Benefit) $(71,000) $920,000 








1622

Item


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

The following management's discussion and analysis should be read in conjunction with our financial statements and the notes thereto and the other financial information appearing elsewhere in this Form 10-Q quarterly report and with our annual report on Form 10-K for the fiscal year ended December 31, 2016.2017. In addition to historical information, the following discussion contains certain forward-looking statements under the Private Securities Litigation Act of 1995, as amended.statements. See "Special Note Regarding Forward Looking Statements" below for certain information concerning those forward- looking statements.  As used below, "our" and "we" refers to the Company and its subsidiaries.

Special Note Regarding Forward Looking Statements

This Form 10-Q quarterly report contains forward-looking statements that are contained principally in the sections describing our business as well as in "Risk Factors," and thisin "Management's Discussion and Analysis of Financial Condition and Results of Operations." These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. These risks and uncertainties include, but are not limited to, the factors described in the section captioned "Risk Factors" in our latest annual report on Form 10-K for the fiscal year ended December 31, 2016,2017, as filed with the SEC. In some cases, you can identify forward-looking statements by terms such as "anticipates," "believes," "could," "estimates," "expects," "intends," "may," "plans," "potential," "predicts," "projects," "should," "would" and similar expressions (including the negative and variants of such words) intended to identify forward-looking statements. Forward-looking statements reflect our current views with respect to future events and are based on assumptions and are subject to various risks and uncertainties. Given these uncertainties, a reader of this Form 10-Q quarterly report should not place undue reliance on these forward-looking statements.

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

The Company is a "penny stock" company under Commission rules and the public stock market price for its Common Stock has been depressed for several consecutive fiscal quarters.  The Company's Common Stock lacks sufficient or active primary market makers and institutional investor support in the public market and this lack of support means that any increase in the per share price of our Common Stock in the public market is usually eliminated by selling pressure from profit taking by investors.  As of November 2, 2017,5, 2018, the Common Stock was trading at $.50$.1445 on the Bid Investment in our Common Stock. Investment in our Common Stock is highly risky and should only be considered by investors who can afford to lose their investment and do not require on demand liquidity. Investors should consider risk factors in this quarterly report on Form 10-Q and other SEC filings of the Company.  The Company completed a 1-for-15 reverse stock split for the Common Stock on July 25, 2016. The reverse stock split did not change the Company's status as a "penny stock" company.


1723


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

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

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

General.

Capstone Companies, Inc., a Florida corporation, ("CAPC," "Company," "we," or "our")The Company is a public holding company with its Common Stock, $0.0001 par value per share, ("Common Stock") quoted on the OTC QB Venture Market exchange of The OTC Markets Group, Inc. and, since July 6, 2012, quoted under the trading symbol "CAPC."  This discussion should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2016,2017, as filed with the Commission on March 27, 2017.28, 2018.

Available Information.

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

Introduction

The following discussion and analysis provides an introduction to our Company, its current strategy and customers and summarizes the significant factors affecting: (i) our consolidated results of operations for the three months and nine months ended September 30, 20172018 compared with the same periodsperiod in 20162017 and (ii) financial liquidity and capital resources.



1824




Capstone Companies, Inc. is a public holding company organized under the laws of the State of Florida.  The Company designsis engaged in the business of developing, marketing, manufacturing and marketsselling consumer oriented LED lighting products for distribution globally with a primary focus on thethrough national and regional retailers in North AmericanAmerica and in certain overseas markets. The primary operating subsidiary is Capstone Industries, Inc., a Florida corporation located in the principal executive offices of the Company ("CAPI"). Capstone International Hong Kong, Ltd., or "CIHK", was established to expand itsthe Company's product development, engineering and factory resource capabilities in Hong Kong. Capstone's LED lightingproducts have been to date targeted for applications such as home indoor and outdoor lighting.  The Company's current product portfolio consists of stylish, innovative and easy to use consumer LED lighting products, including power failure multi-function handheld lights, power failure multi-function nightlights, decorative nightlights, wireless motion sensor lights, remote control battery powered accent lights, remote control outlets, bath vanity lights, outdoor LED fixtures, dual powered solar lights and LED power controlled bulbs.products.  The Company's products are currently sold under CAPI'sthe CAPI brand name, Capstone Lighting®, as well as under two nationally recognized licensed brand names:brands-named Hoover® Home LED and DuracellÒ®.   The Company believes that LED is becoming increasingly moreLEDs are now mainstream in consumer lighting products, and, as such, the Company believes that the component and production costs of LED lighting products will continue to lower for the foreseeable future,due to technological and production developments, which should allow aninnovative smaller company like usthe Company to compete through its innovations and branding that capitalize on non-commodity products utilizing LED.  The Company's focus is the integration of LED into most commonly used lighting products in today's home. We continue to make key investments to ensure that we provide quality LED lighting products. The Company understands and strives to couple well made products with superior customer service.  Customer service is a vital part of consumer loyalty.  Capstone believes that it is positioned well to participate in these expanded product categories which are expecteddesigned to fuel the Company's furtherfuture growth.

The Company seeks to deliver strong, consistent business results and increasing shareholder returns by providing innovative products on a global basis that make consumer's lives simpler and safer while delivering revenue growth results to the Company's retail partners.  Whereas the Company's strengths have been demonstrated through the successful executions of its strategic initiatives which have focused on LED lighting products, it believes it is well positioned to exploit categories outside LED lighting that also benefit from these strengths of the Company's management team.  Creating and exploiting niche consumer product categories within our industry focus, through advanced design and low-cost manufacturing, are the core competencies of the Company.

The Company oversees and controls the manufacturing of its products, which are currently made in China by OEM contractoriginal equipment manufacturers ("OEM"), through three wholly-owned operating subsidiaries: CAPI, CIHK and CLTL.  Capstone believes it has commercially favorable payment terms with its contract manufacturers,OEM's, which terms helps supports any instances of the Company's growth.  The Company's direct import business model requires that product shipments to meet minimum order quantity or "MOQ" full container loads from itsOEM's factories directly to retail customerscustomers' 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 continually evaluates its contract manufacturers' ability to meet the Company's growing needs. Additionally, all manufacturers must meet rigorous compliance, security and equipment evaluation audits to ensure competitive pricing for the highest quality products under applicable industry standards.products.  The Company continues to exploreexplores alternative manufacturing sources in China and elsewhere in the Pacific Rim as part of its ongoing supply chain strategic planning.planning, but the Company has not allocated as of the date of this Form 10-Q report any production to such alternative manufacturing sources.

Strategy

TheOver the past ten years the global LED lighting market is undergoinghas undergone a perceived significant transition driven by rapid adoptionadvancements in the performance, efficiency and cost of energy efficientenergy-efficient LED lighting products.  LED lighting products offer numerous advantages for the user which are driving demand (improved light quality, durability, longer life, cooler temperatures, lower cost of operation). TheseAs the cost of LEDs decreased, and while performance improvements were made, LED technology has expanded its share of the general illumination market.  The Company continues to explore other technologies that, like LED, could rapidly and effectively be integrated into traditional product categories providing users advantages in addition to increased regulatory requirements banning inefficient lights have accelerated growth of LED products and are expected to continue to accelerate the adoption of energy efficient LED technologies going forward.  According to Allied Market Research, in a forecast in September 2014, the global LED market is forecasted to grow to $42 billion by 2020.

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

The Company's product lines consist of decorative lighting, outdoor fixtures, lighting with built-in power failure technology and safety and security.  The power failure lighting and security products were initially sold under its wholly – owned subsidiary Capstone Industries' brand name through 2015.

their daily life activities.



1925

Target Markets:  Our objective is to become recognized as a leading-edge consumer products company, based on "Rapidly Integrating Technologies into Consumer Products."


·As the LED lighting market begins to show signs of stabilizing and moderate growth, the Company plans to continue to strengthen its relationships and expand into other departments and other channels of distribution through its relationships and product line expansions.
·We plan to continue to refine and improve our products portfolio and expand into other product segments through focused investment into the Company's research and development efforts.
·By introducing new products and expanding sales of existing products and continuing to increase our sales volumes, we believe that we can continue to improve operational efficiency by further reducing cost of materials, components and manufacturing costs, allowing us to maintain very competitive price points in the market place.

AsPursuit and achievement of all of these objectives are subject to adequate cash flow from operations and available, affordable funding as well as putting the Company initially entered the market withdemands of existing operations ahead of efforts at expansion of products branded Capstone LightingÒ, the Company was able to stay under the radar and avoid direct competition with the larger brands that were focused on light bulbs and commercial lighting.  The strategy was to establish the Company's products in the marketplace, building on retail success and user satisfaction.or exploitation of new technologies.

Moreover, in 2014, Capstone acquired the exclusive license and sub-license to an advanced power failure technology.  The Company's proprietary technology is referred to as Capstone Power ControlPerceived or CPC.  It is a patented technology and the U.S. patents were issued August of 2016.  The CPC was developed over a two-year period by a group of MIT PhD Engineers operating as AC Kinetics, a private company. This technology can potentially be incorporated into a host of products.  The Company is exploring ways to commercialize this technology, but has not commercially exploited this technology as of the date of this Quarterly Report on Form 10-Q. Whether it will result in any significant financial benefit is uncertain at the time of this report.

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

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

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

On January 9, 2017, the Company secured a license from DuracellÒ for a major warehouse club.  The first shipments of the branded product occurred in the first quarter 2017.Essential Strengths

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

Capstone believes that the specialized nature of its existing product portfolio and its relative market share has effectively positioned itself in this channel and posted successive revenue growth while delivering strong gross margins.  provided a platform for successful introductions of future product segments, either updated versions of existing models or variant products.

The Company believes its multiple brand strategy is currently expanding its distribution into international home improvement centers that accept Capstone's direct import model.  The Company is distributingimportant in maintaining competitiveness in the marketplace. Capstone Lighting,Lighting® and Hoover® Home LED and a DuracellÒ LED product and will, from time to time andhave proven successful in selected markets, offer private label programming to international accounts.

Capstone's 2013 investment in AC Kinetic Technologies, an Armonk, New York, private technology development company, allowed the Company to develop certain innovative concepts that the Company conceived and that are complex and has yielded intellectual property that we believe will further distinguish themeeting Company's products from other off-the-shelf products commonly marketedexpectations at the retail level.  The Company intends to exploit, but has not commercially exploited aspoint of the date of this Quarterly Report on Form 10-Q, the patented technologies developed and completed by AC Kinetic Technologies within the Company's own products, both labeled under "Capstone" and under the Hoover® Home LED brand.


20

On June 8, 2016, the Board of Directors approved and accepted an offer from AC Kinetics to buy back their 100 shares of AC Kinetics Series A Preferred Stock for a $1,500,000 Note Receivable with an estimated fair market value of $500,000.
As further consideration, the Company also received an option to repurchase 1,666,667 shares of Company common stock held by Involve L.L.C. at an exercise price of $.15. The Agreements were signed June 27, 2016, at an exercise price of $.15 per share.
On February 13, 2017 and May 1, 2017 as authorized under the Company's stock repurchase plan, the Company repurchased 1,000,000 shares and 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.
With the purchase of all available options under the repurchase agreement, part of the collateral used to substantiate the value of the note receivable was no longer available and, consequently management has determined that the fair value of the note at September 30, 2017 was $0.
Perceived or Essential Strengthssale.

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

FromProduct Quality: We offer quality products allowing consumers to maximize the benefits of adopting LED products. We design, manufacture through OEM's and sell quality and reliable products across all of our brands with functional advantages that are deemed to be cost competitive. We achieve this, in part, through a market perspective, Capstone's branding strategy is focusedcombination of sourcing skills, 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 establishing multiple trusted brands allowing for a broader reach into various channels.  Capstone Lighting® (2008), Hoover® Home LED (2015)strategic vendor relationships and DuracellÒ, contributemigrating high-volume products to expanding the Company's retail position.  All three brands are currently available in the marketplace.our proprietary design.

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

·Designed to make everyday tasks or usage simpler and more enjoyable for consumers;
·While continuing to focus on increased profit margins, the products must be affordable to win at the point of sale and deliver increased revenues for retail partners;
·The products must represent significant value when compared with items produced or marketed by competitive consumeconsumer product companies; and
·Wherever feasible, the products must be unique to the market whether this be accomplished though design techniques, added functionality or some proprietary innovation.

Authoritative Knowledge: We emphasize 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.



26

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 productproducts that induce consumers to pay a higher purchase price or increased efficiencies in producing and selling products that sustain attractive pricing.  This challenge confronts many consumer product companies. Capstone believes that appropriate use of OEM capabilities in innovation and production coupled with design that appeals to consumers are critical factors in meeting this challenge, especially for a smaller or niche competitor.

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


21


Rim (in the event that non-Chinese OEM's become more efficient or profitable than Chinese OEM's).

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

WePerceived Weaknesses.

Capstone believes that its competitive weaknesses are:  (1) it does not possess the business, marketing and financial resources of its larger competitors; (2) it does not have expandedan extensive or aggressive Social Media marketing program or its own e-commerce capability; (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 products lines are focused on a niche consumer LED lighting;  (5) profitability may be limited by attainable profit margins from consumer lighting products; (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; and (8) we rely on our international sales by leveraging our relationships with our existingOEM's for product production. As a smaller reporting company, we face the challenges of a smaller enterprise competing in global retailersmarkets and by strengthening our international product offerings.  Our Hong Kong office assists us in placing more products into foreign market channels as well.  In 2017, we have product sales in Australia, Canada, Japan, South Korea, Taiwan, Thailand and the United Kingdom. For the nine-months ended September 30, 2017 and 2016, international sales were approximately $1,309,800 and $1,847,300 respectively or 4.3% and 8.1% of revenue, respectively. This continues to be a growing distribution channeldependent on Chinese OEM's for the Company.production.



27

Products and Customers

The Company has expanded its product positioning through the introduction of more indoor and new outdoor lighting programs under the Capstone"Capstone Lighting® brand, the", Hoover® Home LED brand and Duracell® brands and include the DuracellÒbrand.  Capstone has also expanded hardwired solid-statefollowing products to its programs in addition to the existing battery and induction poweredthat are reported under one segment: Lighting Products:

·Wireless Remote-Controlled LED Accent Lights
·LED Under Cabinet Lights
·LED Vanity Mirror
·LED Gooseneck Lantern
·LED Dual Mode Security Light
·LED Solar Patio Lights
·LED Motion Sensor Lights
·LED Motion Sensor Light with Air Purifier
·LED Wall Utility Lights
·CPC Power Failure Bulbs
·Wireless Remote-Control Outlets

Such product lines, through the introduction of vanity fixtures and outdoor LED Gooseneck Lanterns.  Such expansion involves the inherent risk of increased operating and marketing costs without a corresponding increase in operational revenues and profits.  Further, some product lines may fall out of favor with consumers before we can recoup product and market development costs.

The Company has established product distribution relationships with numerous leading international, national and regional retailers, including but not limited to: Amazon, Bunnings, Costco Wholesale, Home Depot, Home Pro, Sam's Club and The Container Store and Wal-Mart.Store. These distribution channels may sell the Company's products through the Internetinternet as well as through retail storefronts and catalogs/mail order.  The Company believes it has developed the scale, manufacturing efficiencies, and design expertise that serves as the foundation for aggressive pursuit of niche product opportunities in our largest consumer markets and in a growing international market. 

While Capstone has traditionally generated the majority of its sales in the domestic U.S. market, urbanization, rising family incomes and increased living standards abroad have spurred a perceived demand for small consumer appliances internationally. To capture this market opportunity, the Company has 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 nine months ended September 30, 2018 were $551.2 thousand or 4.6% of net revenue as compared to $1.310 million or 4.3% in the same period 2017. Based on Capstone's experience in the industry, the Company's Chinese contract manufacturing resources and focus on well designed, practical products, Capstone believes it is well positioned to become a leading manufacturer in the growingits segment of LED home lighting and security lighting segments. The Company's efforts to achieve such a goal are ongoing.  Capstone believes it will maintain its revenue growth because of the ability to deliver quality, well designed products on time, the quality reputation of its products, business relationships with Capstone's retailers and the aggressive product expansion strategies currently in place.  Such continued progressperformance depends on a number of assumptions and factors, including ones mentioned in "Risk Factors" below.factors.  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. Company products are also sensitivesubject to consumer demand and consumer concerns overgeneral economic conditions becausethat impact discretionary consumer spending on non-essential items.

Tariffs. The Company is facing uncertainty relative to the ongoing competitive pricing position it has been recognized for.  The current U.S. administration has threatened and has implemented certain tariffs that directly affect the Company's competitiveness.  While all companies 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.



28

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 war" 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, are a discretionary purchase by consumers.our costs, customers, suppliers and/or the U.S. economy or certain sectors thereof and, thus, to adversely impact our businesses.

With the Company's branded lighting categories, Capstone has a comprehensive product offering for its niche in the consumer lighting industry.  The Company believes that it will provide retailers with a broadbroader and more diversified portfolio of consumer products across numerous product categories, which should add diversity to the Company's revenues and cash flows sources.  Within these categories,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.

22




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

Sales and Marketing

We continue to make investments to expand our sales, marketing, technical applications support and distribution capabilities to sell our products. We currently market and sell our LED products through our internal sales team and agency networks. Generally, our agencies are recruited, trained and monitored by us directly. We maintain a firm policy on the use of our name for branding our LED lighting products. The Company's products are marketed primarily through a direct independent sales force.  The sales force markets the Company's products through numerous retail locations worldwide, including larger retail warehouse clubs, hardware centers and e-commerce websites.  The Company actively promotes its products to retailers and distributors at North American trade shows but relies on the retail sales channels to advertise its products directly to the end consumer.  All sales activities at major account levels involve direct executive management participation.

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

CapstoneThe Company depends on e-commerce efforts of Amazon and other on-line retail customers in lieu of pursuing our own aggressive in-house e-commerce effort.  We believe this reliance on AmazonAmazon.com and other retail customer e-commerce issites as they are the most cost efficient and effective e-commerce approach for the Company. We maintain a Facebook1 website at https://www.facebook.com /powerfailuresolutions/www.facebook.com/powerfailuresolutions/ and our sales staff may use Social Media from time to time to promote our products and brands.  We have not developed or aggressively pursued a specific Social Media campaign based on third party sponsors or promotors. promoters.  The growing importance of Social Media will eventually require the Company to develop a more aggressive or extensive plan for using Social Media as a marketing tool.



1Facebook is a registered trademark of Facebook, Inc. Social Media marketing may become more important in launching and sustaining market demand for products and the Company may have to develop a more aggressive Social Media marketing campaign and presence.Inc


Working Capital Requirements

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

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

The Company's ability to maintain sufficient working capital is highly dependent upon achieving expected operating results.  Failure to achieve expected operating results could have a material adverse effect on the Company's working capital, ability to obtain financing, and its operations in the future.  However, achieving expected results as accomplished in 2016 and through the first three quarters of 2017, has increased working capital, provided the Company with liquidity and has allowed for the repayment of outstanding bank notes and some old related party loans.


2329



Continued revenue growth and expanded product launches are critical requirements to ensure the Company's continued growth.  Such projects are never delayed because of funding shortfalls.  The Company budgets for such projects and if necessary certain members of the Company's senior management and Board of Directors have supplemented the cash flow needs as required through short term loans.  There is no assurance that senior management and certain directors can supplement the cash flow needs of the Company in all instances or completely.

Competitive Conditions

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

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

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

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

Research, Product Development, and Manufacturing Activities

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


24
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 lot testing is conducted at the contract manufacturers facility and also at 3rd party testing laboratories overseas.



Capstone'sThe Company's research and development team ensures its proprietary manufacturing expertise by maintaining control over all outsourced production and critical production molds.  In order to ensure the quality and consistency of the Company's products manufactured in China, Capstonethe Company 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'sthe Company's specification(s) before shipments are released.  CIHK office capabilities have now been expanded to include product development, project management, sourcing management, supply chain logistics, factory compliance auditing, and quality enforcement for all our products' supplier factories located in Hong Kong and mainland China.

To successfully implement the Company's business strategy, the Company must periodically improve its current products and develop new product segments with innovative imbedded technologies to meet consumer's growing expectations.

Capstone will continue to invest in this area as the Company expands the number of products being developed and as it moves into more technical and innovative product categories.  The Company may explore strategic partnerships with others to assistThese costs are expensed when incurred and are included in development of more technical and innovative product categories.the operating expenses.



30

Raw Materials

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

·Raw Materials – Components and supplies are subject to sample inspections upon arrival at the contract manufacturer, to ensure the correct specified components are being used in production.
·Work in Process – Our quality control team conducts quality control tests at different points during the product stages of our manufacturing process to ensure that quality integrity is maintained.
·Finished Goods – Our team performs tests on finished and packaged products to assess product safety, integrity and package compliance.

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

Section 1502 of Title XV of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires SEC-reporting companies to disclose annually whether any "conflict minerals"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.


25



Distribution and Fulfillment

The Company's U.S. domestic warehousing and fulfilmentdistribution needs are performedprovided by a third-party warehousing facility situated in Anaheim, California.  The warehouse distributoroperator 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 distributoroperator provides full ERP (Enterprise Resource Planning), Inventory Control and Warehouse Management Systems.  These fulfillment services can be expanded to the east coast in Charleston, South Carolina, if we needthe 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 requiredservices.

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.

Royalty expenses related to such agreements for the three months ended September 30, 2018 and 2017 were $147,696 and $514,025 respectively. Royalty expenses for the nine months ended September 30, 2018 and 2017 were $334,032 and $1,043,253 respectively.



31

Seasonality

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

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, Timely Reader Book lights with Timer and Auto Shut Off and 10 LED - Eco-i-Lite Power Failure Light, 5 LED - Eco-i-Lite Power Failure Light, 3 LED - Eco-i-Lite Power Failure Light, 3 LED Slim Line Eco-i-Lite Power Failure Light, LED Induction Charged Headlight.  We also have a number of patents pending on ourpending; 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.  CAPC's ability to compete effectively in the power failure, portable lighting, and LED Home Lighting categories depends in part, on its ability to maintain the proprietary nature of its technology and manufacturing processes through a combination of patent and trade secret protection, non-disclosure agreements, licensing, and cross-licensing agreements.  CAPC owns a number of patents, trademarks, trademark and patent applications and other technology which CAPC believes are significant to its business. These 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. Enforcement of intellectual property rights in China is problematic.



2632



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.

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. Our information technology systems are also vulnerable to damage or interruption from:

·hurricanes, fire, flood and other natural disasters;
·power outages; and
·internet, telecommunications or data network failure.

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

The 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, has increased working capital, provided the Company with liquidity and has allowed for the repayment of all outstanding bank notes and old related party loans.



33

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

On September 8,2010, in order to 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 was a base management fee equal to .45% of the gross invoice amount. The interest rate of the loan advance is .25% above Sterling National Bank's Base Rate which at the time of closing was 5%.

As of September 30, 2018, the base management fee is now equal to .30% and the interest rate charged on a loan balance was 6.25%. The amounts borrowed under this agreement are due on demand and secured by a right to set-off on or against any of the following (collectively as "Collateral"): all accounts including those at risk, all reserves, instruments, documents, notes, bills and chattel paper, letter of credit rights, commercial tort claims, proceeds of insurance, other forms of obligations owing to Sterling National Bank,  bank and other deposit accounts whether or not reposed with affiliates, general intangibles (including without limitation all tax refunds, contract rights, trade names, trademarks, trade secrets, customer lists, software and all other licenses, rights, privileges and franchises), all balances, sums and other property at any time to our credit or in Sterling National Bank's possession or in the possession of any Sterling National Bank affiliates, together with all merchandise, the sale of which resulted in the creation of accounts receivable and in all such merchandise that may be returned by customers and all books and records relating to any of the foregoing, including the cash and non-cash proceeds of all of the foregoing.

The Sterling National Bank credit facility over the years has been a major contributing factor that has allowed the Company to increase its revenue and expand its account receivables.

As of both September 30, 2018 and December 31, 2017, the balance due to Sterling National Bank was $0.

On July 20, 2018, in order to support the Company's future needs, Sterling National Bank expanded the credit line from $7,000,000 up to $10,000,000 of which $2,000,000 has been allocated as a working capital line to support Capstone's expansion plans.

As of September 30, 2018, the maximum amount that could be borrowed on this credit line was $10,000,000.

The Company's liquidity and cash requirements are discussed more fully in the Management's Discussion and 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 nine months ended September 30, 20172018 as compared to those we disclosed in Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K, for the fiscal year ended December 31, 2016.2017.



34

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. The majority of our sales are to the U.S. market which in 2017 represented 95.1% of net revenue and 95.4% in the nine months ended September 30, 2018. We expect that the U.S. region will continue to be the major source of revenue for the Company. However, we also derive a portion of our revenue from overseas.  All of our revenue is denominated in U.S. dollars.

Cost of Goods Sold

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

Gross Profit

Our gross profit has and will continue to be affected by a variety of factors, including average sales price for our products, product mix, 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 brands royalties, sales representative's 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.



35

CONSOLIDATED RESULTS OF OPERATIONS AND OUTLOOK

Three Months Ended September 30, 2018 Compared to the Three Months Ended September 30, 2017 
(In Thousands) 
  September 30, 2018  September 30, 2017 
             
  Dollars  % of Revenue  Dollars  % of Revenue 
Revenue, net $5,726.1   100.0% $13,818.0   100.0%
Cost of sales  4,395.7   76.8%  10,707.7   77.5%
Gross Profit  1,330.4   23.2%  3,110.3   22.5%
Operating Expenses:                
Sales and marketing  359.7   6.3%  928.3   6.7%
Compensation  359.5   6.3%  351.9   2.5%
Professional fees  102.5   1.8%  109.3   .8%
Product development  95.7   1.6%  81.0   .6%
Other general and administrative  232.9   4.1%  189.8   1.4%
Total Operating Expenses  1,150.3   20.1%  1,660.3   12.0%
Operating Income  180.1   3.1%  1,450.0   10.5%
Other (Expense)                
Miscellaneous expense  (2.0)  -%  (12.9)  (.1)%
Interest expense  -   -%  (56.6)  (.4)%
Total Other (Expense)  (2.0)  -%  (69.5)  (.5)%
Income Before Tax Provision  178.1   3.1%  1,380.5   10.0%
Provision for Income Tax  6.0   0.1%  390.0   2.8%
Net Income $172.1   3.0% $990.5   7.2%

Nine Months Ended September 30, 2018 Compared to the Nine Months Ended September30, 2017 
(In Thousands) 
  September 30, 2018  September 30, 2017 
             
  Dollars  % of Revenue  Dollars  % of Revenue 
Revenue, net $11,889.5   100.0% $30,789.7   100.0%
Cost of sales  9,179.1   77.2%  23,457.1   76.2%
Gross Profit  2,710.4   22.8%  7,332.6   23.8%
Operating Expenses:                
Sales and marketing  838.3   7.1%  1,869.6   6.1%
Compensation  1,104.4   9.3%  1,065.6   3.4%
Professional fees  394.3   3.3%  429.4   1.4%
Product development  386.0   3.2%  219.5   .7%
Other general and administrative  573.9   4.8%  572.5   1.9%
Total Operating Expenses  3,296.9   27.7%  4,156.6   13.5%
Operating Income (Loss)  (586.5)  (4.9)%  3,176.0   10.3%
Other Income (Expense)                
Miscellaneous income  145.3   1.2%  -   -%
Interest expense  -   -%  (113.4)  (.4)%
Total Other Income (Expense)  145.3   1.2%  (113.4)  (.4)%
Income (Loss) Before Tax Provision (Benefit)  (441.2)  (3.7)%  3,062.6   9.9%
Provision (Benefit) for Income Tax  (71.0)  (.6) %  920.0   3.0%
Net Income (Loss) $(370.2)  (3.1)% $2,142.6   6.9%



36

Net Revenues

For the 3three months ended September 30, 2018 and 2017, and 2016, net salesrevenues were approximately $13,817,900$5.7 million and $11,692,100$13.8 million, respectively, an increasea decrease of $2,125,800 or 18.2% from the previous year. During the quarter ended September 30, 2017 the Company provided approximately $1,376,700 in consumer promotional allowances compared to $699,100 in the same quarter 2016, an increase of $677,600 or 96.9% during the quarter.$8.1 million.

For the 9nine months ended September 30, 2018 and 2017, and 2016, net salesrevenues were approximately $30,789,700$11.9 million and $22,672,600$30.8 million, respectively, an increasea decrease of $8,117,100 or 35.8% from the previous year. During the 9 months ended September 30, 2017 and 2016, the Company provided approximately $1,831,000 and $1,478,600, respectively of consumer promotional allowances, an increase of $352,400 or 23.8% over 2016.$18.9 million.

In the 9nine months ended September 30, 2017, the Company continued to have a very strong revenue performance inAccent LED light category was at the Accent Light Category in all three-brands includingheight of its retail life cycle. Combined, the Capstone Lighting, DuracellÒ, Capstone Lighting® and HooverÒ HOME LED. Home brands accent lights accounted for $22.3 million of net revenue or 72.3% of net revenue in that period. The Company alsoDuracell brand accounted for approximately $12.6 million of those 2017 sales which was a limited one-year program as determined by the retailer. It was expected that if the Duracell branded product had newachieved very strong product launches includingsell through at retail then the Gooseneck LED Lantern,program would have been extended for an additional year. The Duracell brand did not perform as well at retail and as a result the LED Spotlight Accent Light, Dual Mode Motion Security Light, the LED CPC bulbprogram started to wind down in 2018 and the swivel base LED Accent Lights.  The $8.1subsequently generated $1.1 million revenue increaseof sales as of September 30, 2018. This represented a $11.5 million decrease in the periodrevenue compared to 2016 was achieved after the Company provided approximately $1.8 million of marketing allowances for new product promotions and transitional allowances.  Forsame period in 2017.

During the 9nine months ended September 30, 2017, and 2016 International sales werethe other Accent LED light brands accounted for approximately $1,309,800 or 4.3%$9.7 million of net revenue. With the ending of this product's life cycle that had been in the market for several years, net revenue for this category during the nine months ended September 30, 2018 was approximately $2.3 million, a reduction of $7.4 million from the same period in 2017.

In 2018, the combined reduction in the Accent Light category of $18.9 million as compared to $1,847,300 or 8.1%2017 is the main reason for the revenue decrease in 2018.

At the beginning and through the first half of 2018, the remaining on hand inventories at retail for these products was very extensive. As a result, the transition into new product launches was delayed by retailers in order to balance out their inventories. These product launch delays also had the impact of reducing revenue in 2016.the third quarter 2018.

During the three months ended September 30, 2018 and 2017, the Company provided retailers with $123.4 thousand and $1.377 million, respectively, of product marketing funds and allowances.

During the nine months ended September 30, 2018 and 2017, the Company provided retailers with $559.2 thousand and $1.831 million, respectively, of product marketing funds and allowances.

The following table disaggregates net revenue by major source:

 For the 3 Months Ended September 30, 2018 For the 3 Months Ended September 30, 2017 
 Capstone Brand License Brands Total Consolidated Capstone Brand License Brands Total Consolidated 
             
Lighting Products- U.S. $2,697,694  $2,939,613  $5,637,307  $562,606  $13,038,136  $13,600,742 
Lighting Products-International  65,009   23,289   88,838   217,167   -   217,167 
     Total Revenue $2,762,703  $2,963,442  $5,726,145  $779,773  $13,038,136  $13,817,909 



37


 For the 9 Months Ended September 30, 2018 For the 9 Months Ended September 30, 2017 
 Capstone Brand License Brands Total Consolidated Capstone Brand License Brands Total Consolidated 
             
Lighting Products- U.S. $4,539,476  $6,798,866  $11,338,342  $3,855,504  $25,624,349  $29,479,853, 
Lighting Products-International  261,983   289,195   551,178   1,309,800   -   1,309,800 
     Total Revenue $4,801,459  $7,088,061  $11,889,520  $5,165,304  $25,624,349  $30,789,653 

Gross Profit and Cost of Sales

ForGross profit for the 3three months ended September 30, 2018 and 2017, was approximately $1.330 million, and 2016, cost of sales were approximately $10,707,700 and $8,841,100, respectively, an increase of $1,866,600$3.110 million, respectively. With the reduced revenue, gross profit decreased by $1.780 million or 21.1% from the previous year. This cost equates to 77.5% and 75.6% respectively of net revenues57.2% in the quarter.period. The gross margin percentage for Lighting Products increased to net revenues increased by 1.9%23.2% from 22.5% in 2017 resulting from a reduction of marketing allowances provided to retailers during the period as compared to the same period in 2017.

Gross profit for the nine months ended September 30, 2018 and 2017 was approximately $2.710 million and $7.333 million, a reduction of $4.623 million or 63.0% resulting from the $677,600 additional promotion allowances providedrevenue decrease in the quarterperiod. The gross margin percentage for Lighting Products in the nine months decreased to 22.8% compared to 2016.23.8 % in 2017. This decrease resulted from inactive inventory being sold off at reduced margins combined with the blended margin of 5 new products that were launched during the period.

Operating Expenses

Sales and Marketing Expenses

For the 9three months ended September 30, 2018, and 2017, sales and 2016, costmarketing expenses were $359.7 thousand and $928.3 thousand respectively, a reduction of sales$568.6 thousand or 61.3%. During the quarter with the reduced revenue for Duracell® and Hoover® branded products, royalty payments to TTI Floor Care for the Hoover® license for the three months were approximately $23,457,100$147.0 thousand and $17,079,300,$251.6 thousand, respectively, an increasea reduction of $6,377,800$104.6 thousand or 37.3% from41.5%. Duracell® license royalties for the previous year. This cost equates to 76.2%same period were $.7 thousand and 75.3%$262.5 thousand, respectively, a reduction of net revenues. The percentage to net revenues increased by .9% resulting from $352,400 additional promotion allowances provided in the 9 months compared to 2016.


27
Manufacturing unit costs continued to remain very stable$261.8 thousand or 99.7%.  Sales Representative commission payments were also reduced in the period asfrom $157.5 thousand in 2017 to $125.9 thousand in 2018 a resultreduction of effective volume buying with overseas factories, the steady price of oil and the stable U.S. Dollar exchange rates.

Gross Profit$31.6 thousand or 20.1 %.

For the 3nine months ended September 30, 2018, and 2017, sales and 2016, gross profit was approximately $3,110,300marketing expenses were $838.3 thousand and $2,851,000$1.869 million respectively, an increasea reduction of $259,300$1.031 million or 9.1% from55.2%. During the nine month period with the reduced revenue, royalty payments to TTI Floor Care for the Hoover® license were $303.5 thousand and $630.7 thousand, respectively, a reduction of $327.2 thousand or 51.9%. Duracell® license royalties for the same period in 2016. Gross profit aswas $30.6 thousand and $412.6 thousand, respectively, a percentagereduction of sales was 22.5 % in the quarter compared to 24.4 % in 2016.

For the 9 months ended September 30, 2017 and 2016, gross profit was approximately $7,332,600 and $5,593,300 respectively, an increase of $1,739,300$382.0 thousand or 31.1% from92.6%.  Sales Representative commission payments for the same period in 2016. Gross profit aswere $223.7 thousand and $386.5 thousand, a percentagereduction of sales was 23.8 % in the 9 months compared to 24.7% in 2016.$162.8 thousand or 42.1%.

The increased gross profit for the period was caused mainly by the 35.8% increase in revenue. The slight reduction of gross profit to sales percentage resulted from the additional transitional allowances provided to retailers.

OperatingCompensation Expenses

For the 3 months ended September 30, 2018, and 2017, and 2016, total operatingcompensation expenses were approximately $1,660,300$359.5 thousand and $1,247,100$351.9 thousand respectively, an increase of $413,200$7.6 thousand or 33.1%2.2%. Compensation expense increased as a result salary increases in the period.

For the 9 months ended September 30, 2018, and 2017, and 2016, total operatingcompensation expenses were approximately $4,156,600$1.104 million and $2,869,300$1.065 million respectively, an increase of $1,287,300$38.8 thousand or 44.9% as compared to same period in 2016.

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

Sales and Marketing Expenses

For the 3 months ended September 30, 2017 and 2016, sales and marketing expenses were approximately $928,300 and $488,100 respectively, an increase of $440,200 or 90.2%3.6%. The Company continued to invest heavily in its brands of DuracellÒ, Capstone Lighting® and HooverÒ HOME LED. With the launch of 5 new products in the period and revenue increase, the sales and marketing expense increased mainly from royalty license payments of $514,000 for the branded licenses which was $292,800 higher than 2016. Representative commissions also increased by $22,900. The Company also expensed $93,000 of prepaid media credits and invested $36,300 for in store displays setup to promote new products.

For the 9 months ended September 30, 2017 and 2016, sales and marketing expenses were approximately $1,869,600 and $903,900 respectively, an increase of $965,700 or 106.8%. Many of the expense increases resulted from the $8,117,100 revenue increase. Royalty license payments of $1,043,300 for the branded licenses were $636,800 higher than in 2016. Representative commissions of $386,500 increased by $159,900 over 2016. The Company also expensed $93,000 of prepaid media credits, invested $36,300 for in store display setups and $180,700 for advertising and trade show expense which increased by $41,900 over 2016.

Compensation Expense

For the 3 months ended September 30, 2017 and 2016, compensation expense was approximately $351,900 and $325,300 respectively, an increase of $26,600 or 8.2%.

For the 9 months ended September 30, 2017 and 2016, compensation expense was approximately $1,065,600 and $949,800 respectively, an increase of $115,800 or 12.2%.

Compensation expense increased as a result of performance basedhigher health insurance premiums and salary adjustments duringincreases in the period and stock based compensation paid to certain directors.period.



2838

Professional Fees

For the 3 months ended September 30, 2018, and 2017, and 2016, professional expensesfees were approximately $109,300$102.5 thousand and $111,300$109.3 thousand respectively, a decrease of $2,000$6.8 thousand or 1.9%6.2%. In this period 2017, the Company had engaged the investment banking services of Wilmington Capital Securities, LLC and executive management had attended various investor conferences. These expenses have not reoccurred in 2018.


For the 9 months ended September 30, 2018, and 2017, and 2016, professional expensesfees were approximately $429,400$394.3 thousand and $286,700$429.4 thousand respectively, an increasea reduction of $142,700$35.1 thousand or 49.8%8.2%.

The increased expense in In this period 2017, the period resulted from hiringCompany had engaged the investment banking services of an investment banker, increased investor relations
including managements' attendance atWilmington Capital Securities, LLC and executive management had attended various investor shows, and engaging the services of a sales consultant to support the U.S. sales office marketing effort.conferences. These expenses have not reoccurred in 2018.

Product Development Expenses

For the 3 months ended September 30, 2017 and 2016,2018, product development expenses were approximately $81,000$95.7 thousand as compared to $81.0 thousand, in 2017, an increase of $14.7 thousand or 18.1%. During the quarter the Company invested $63.6 thousand in software and $127,400 respectively,hardware development for a decrease of $46,400 or 36.4 %.new product category being developed which also resulted in increased prototype and sample development expenses during the period.

For the 9 months ended September 30, 2017 and 2016,2018, product development expenses were approximately $219,500$386.0 thousand as compared to $219.5 thousand, in 2017, an increase of $166.5 thousand or 75.9%.  During the quarter the Company invested $63.6 thousand in software and $227,600 respectively,hardware development for a decrease of $8,100 or 3.6 %.

The Company has continued to invest in new product category being developed which also resulted in increased prototype and sample development including testing and product certification. To reduceexpenses during the initial cost of new product investment, we have been able to negotiate with our factory partners to absorb some of the costs of new product development.period.

Other General and Administrative Expenses

For the 3 months ended September 30, 2017 and 2016,2018, other general and administrative expenses were approximately $189,800$232.9 thousand as compared to $189.8 thousand, in 2017, an increase of $43.1 thousand or 22.7%. In the third quarter 2018, bank charges were $25.1 thousand compared to $50 thousand in 2017, a reduction of $24.9 thousand, a result of our positive cash position and $195,000 respectively,reduced processing fees. In the third quarter 2018, we also incurred a decrease of $5,200 or 2.7%."once-off" settlement charge related to a lawsuit which was the main reason for the increased expenses in the period.

For the 9 months ended September 30, 2017 and 2016,2018, other general and administrative expenses were approximately $572,500 and $501,500 respectively,$573.9 thousand as compared to $572.5 thousand, in 2017, an increase of $71,000$1.4 thousand or 14.2%.24%.

The expense increased is the result of higher Sterling Bank processing fees and increased general insurance liability premiums associated with the higher revenue levels and increased travel expenses related to sales activities during the period.

NetTotal Operating IncomeExpenses

For the 3 months ended September 30, 2017 the2018 total operating income was approximately $1,450,000expenses were $1.150 million or 20.1% of revenue as compared to $1,603,900$1.660 million or 12.0% of revenue in 2016. This is a reduction of $153,900 or 9.6% compared to 2016.2017.

For the 9 months ended September 30, 20172018 total operating expenses were $3.297 million or 27.7% of revenue as compared to $4.157 million or 13.5% of revenue in 2017.

Operating Income (Loss)

For the 3 months ended September 30, 2018 the operating income was approximately $3,176,000$180.1 thousand compared to $2,723,900$1.450 million in 2016. This is an improved performance of $452,100 or 16.6%2017.

For the 9 months ended September 30, 2018 the operating income (loss) was $(586.5) thousand compared to 2016.$3.176 million in 2017.

Total Other Income (Expense)

For the 3 months ended September 30, 2018, and 2017, Other Income (Expense) was $(2.0) and 2016, other expense was approximately $69,500 and $89,700,$(69.5) thousand respectively for a reduction of $20,200 or 22.6% as compared to 2016.


39

For the 9 months ended September 30, 2018, and 2017, Other Income (Expense) was $145.3 and 2016, other expense was approximately $113,400 and $213,900, respectively, for a reduction of $100,400 or 47.0% as compared to the same period in 2016.$(113.4) thousand respectively.

29



Despite havingDuring the second quarter of 2018 as consideration for relocating offices to a substantial revenue growth duringnew location, the 9-month period, we have been ableexisting landlord agreed to curtailpay the need for increased borrowing. With the increased cash flow resulting from operational profits in 2017, we have also been able to eliminate the need for purchase order funding, substantially reduce director loans and reduced the daily funding requirements from Sterling National Bank,Company $150,000 which has allowed us to substantially reduce the interest expense.is reported as other income net of expenses, of which all funds were received as of September 30, 2018.

Provision (Benefit) for Income Tax

For the 3 months ended September 30, 2017 and 2016,2018 the provision for income tax was approximately $ 390,000 and $24,400, respectively, an increase of $365,600 asestimated at $6.0 thousand compared to last year. Asa provision of $390.0 thousand in the Company has now offset its previous year's net operating losses, the Company must now provide for future income tax expense.same period 2017.

For the 9 months ended September 30, 2018 and 2017 and 2016, the provision(benefit) for income tax was approximately $920,000 and $37,000, respectively, an increase of $883,000estimated at $(71.0) thousand compared to last year.a provision of $920.0 thousand in the same period 2017. The (benefit) was a result of the net loss incurred during the period.

Net Income (Loss)

For the 3 months ended September 30, 2017,2018 the Company had a net income of approximately $990,500 aswas $172.1 thousand compared to a net income of $1,489,800$990.5 thousand in the same period last year, a reduction of $499,300.2017.

For the 9 months ended September 30, 2017,2018 the Company had a net income of approximately $2,142,600 as(loss) was $(370.2) thousand compared to a net income of $2,473,100$2.142 million in the same period last year, a reduction of $ 330,500.

During the 9 months ended September 30, 2017, the Company has achieved record net revenue, record gross profit and record net operating income. This record performance was achieved after the Company provided for approximately $1,287,000 of increased operating expense mainly resulting from higher revenues and further investment for future revenue growth.
 During the 9 months ended September 30, 2017, the Company also provided for increased tax provision of $920,000 which is $883,000 higher than in 2016 and is the main reason why net income for the 9 months ended September 30, 2017 was approximately $330,500 lower than in 2016.2017.

Off-Balance Sheet Arrangements

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

Contractual Obligations

There were no material changes to contractual obligations for the 9 months ended September 30, 2017.

30
2018.

LIQUIDITY AND CAPITAL RESOURCES

Our cash balances as of September 30, 2018 and December 31, 2017 was $3.6 million and $3.7 million, respectively. The Company also had available borrowing capacity under the Sterling National Bank financing agreement of approximately $2.029 million and $3.713 million, respectively, which is capped based on 85% of  outstanding accounts receivables.

The Sterling National Bank credit facility which was expanded on July 20, 2018, which allows the Company to borrow up to $10.0 million, of which $2.0 million has been allocated as a Capstone expansion credit line, available as needed to support the expansion of Capstone's new product development and is not subject to the bank's collateral conditions as required for the remaining $8.0 million trade receivable line. As of September 30, 2018, and December 31, 2017 the Sterling Bank loan balance for both periods was $0.

Historically, our Directors have been a significant source of financing and continue to support our operations as necessary. With the strong operational cash flows achieved during 2017, the Company was able to pay off all Director debt and accumulated interest. As of both September 30, 2018 and December 31, 2017, the Company had approximately $3,240,700notes payable to related parties of cash on hand compared to $1,646,100 on December 31, 2016 an increase of $1,594,600 or 96.9%. Working capital of approximately $5,177,700 as of September 30, 2017, increased 85.6% as compared to $2,790,100 at December 31, 2016.$0.


 For the Nine Months Ended 
(In thousands)September 30, 2017 September 30, 2016 
Net cash provided by (used in):    
Operating Activities $2,142  $(3,740)
Investing Activities $(48) $(16)
Financing Activities $(500) $3,751 
Total $1,594  $(5)
40


 For the Nine Months ended September 30, 
Summary of Cash Flows2018 2017 
(In thousands)    
Net cash provided by (used in):    
Operating Activities $56  $2,142 
Investing Activities  (131)  (48)
Financing Activities  -   (499)
Net increase (decrease) in cash and cash equivalents $(75) $1,595 

With the Company'sOur expanded borrowing capability atcapacity with Sterling National Bank, positive cashflow from operations, favorable payment terms with suppliers and as neededvendors, funding support from certain Company Directors and cash flow from operations provide the Company haswith the financial resources needed to run operations and reinvest in the growth of our business.

Cash Flows provided by Operating Activities

Cash flow provided by operating activities was approximately $2,141,800 in the 9nine months ended September 30, 20172018 was approximately $55.8 thousand compared with approximately $3,740,200 used in$2.142 million provided by operating activities in 2016.the same period 2017.  In the 9period, approximately $1.8 million of cash was generated by the collection of accounts receivables and a further $132 thousand by a reduction of on hand inventories.  This cash was used in underwriting the $370 thousand year-to-date loss, a $932 thousand reduction of accounts payable and accrued liabilities and $613 thousand decrease in income tax payable.

Cash Flows used in Investing Activities

During the nine months ended September 30, 2017,2018, the net income of approximately $2,142,600 combined with a $224,300 decreaseCompany has invested $130.7 thousand in inventoryproperty and a $731,500 decrease in accounts receivable helped to offset cash usage resulting from a $263,900 decrease in accounts payable, a $135,337 decrease in notes payable interest and an $831,700 decrease in accrued sales allowances. During 2016, the net income of $2,473,100 was offset by a large increase of $6,755,200 in accounts receivable.

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

Investing Activities

Cash used for investing activities for the 9 months ended September 30, 2017 was approximately $47,600 compared to $15,500 in 2016.  The Company continues to invest inequipment including new product molds and tooling.  With the product expansion into new LED home lighting categories, the Company's future capital requirements will increase.  Our Hong Kong management team has the task of negotiating favorable payment terms with factories which will reduce the amounts of upfront cash required to have available when initiating a new project.  Management believes that our cash flow from operations and additional borrowing will provide for these necessary capital expenditures.

Financing Activities

Cash used in financing activities forupdated Corporate computer systems. During the nine months ended September 30, 2017, was approximately $499,600 compared to $3,750,500 provided by financing activitiesthe Company had cash outflows of $47.6 thousand for the purchase of new product tooling in 2016. the period.

Cash Flows used in Financing Activities

During the periodnine months ended September 30, 2018 and 2017 cash used in financing activities was $0 and $(499.6) thousand, respectively. The cash outflow in 2017 resulted from the Company repurchased and retired $250,000repurchasing $250 thousand of the Company common stockshares from Involve LLC and paidthe Company paying off $257,100$257 thousand of director'sDirectors loans outstanding sincefrom 2010 and 2013 including all accrued interest. The Company was also able to maintain the Sterling Bank loan at $0 balance. The Company sold some outstanding warrants totaling $7,500.2013.

31
Our ability to maintain sufficient liquidity is highly dependent upon achieving expected operating results. Failure to achieve expected operating results could have a material adverse effect on our liquidity, our ability to obtain financing, and our operations in the future.

At September 30, 2017,2018, the Company was in compliance with all agreementsof the terms pursuant to existing credit facilities.  Management believes that our cash flow from operations, continued support from Sterling National Bank and support of certain of our Directors as needed will provide sufficient financial resources for the Company during 2017.in 2018.

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



41

Impact of Inflation: The Company's major expense has been the cost of selling and marketing product lines to customers in North America.  That effort involves mostly sales staff traveling to make direct marketing and sales pitches to customers and potential customers, trade shows around North America and visiting China to maintain and seek to expand distribution and manufacturing relationships and channels. With the current reduced price of world oil, althoughAlthough labor costs are continuingstarting to increase, the Company expects purchasing costs to remain stable with the Chinese manufacturers. The Company generally has been able to reduce cost increases by negotiating volume purchases or re-engineering products. With our Hong Kong office firmly established,However the Company expectstariff trade dispute between the U.S. and China and with the implementation of higher import tariffs into the U.S., it is expected that consumer retail prices will remain steady through 2017.increase to offset the higher import duties which could adversely impact the demand for Company products.

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

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

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

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

Interest Rate Risk: The Company does not have significant interest rate risk during the period ended September 30, 2017.2018.

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

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Not applicable.


32



Item 4.  Controls and Procedures

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

Our management, includingwith the participation of our principalchief executive officer and principalchief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2016September 30, 2018. As of the date of this Report, Stewart Wallach is our Chief Executive Officer and concluded thatJames Gerald McClinton is our Chief Financial Officer and Chief Operating Officer.

The management of the disclosure controlsCompany is responsible for establishing and procedures were effective under Rules 13a-15(e) and 15d-15(e)maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Exchange Act as a process designed by, or under the supervision of, the Company's principal executive and principal financial officers and effected by the Company's Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:


42


·Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company.

·Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

·Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.

·Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Company's management assessed the effectiveness of the Company's internal control over financial reporting as of JuneSeptember 30, 2017, to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in Commission regulations and forms and (ii) accumulated and communicated to2018. In making this assessment, the Company's management including its principal executive officer and principalused the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) 2013 Internal Control-Integrated Framework. Based on their assessment, management concluded that, as of September 30, 2018, the Company's internal control over financial officer,reporting is effective based on those criteria. Based on that evaluation, our management concluded that our internal control over financial reporting, as appropriate, to allow timely decisions regarding required disclosures.of September 30, 2018, was effective at the reasonable assurance level.

Because the Company is a smaller reporting company, this annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our independent registered public accounting firm.

Changes in internal controls:  There were no changes in our internal controls over financial reporting.

There are no changes to our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the three months covered by this quarterly report on Form 10-Q or "Report"ended September 30, 2018 that havehas materially affected or are reasonablyreasonable likely to materially affect, our internal controlscontrol over financial reporting.

The Chairman of our Audit Committee has reviewed the internal control reports in detail and has spoken to the external auditors in depth about the audit, the internal controls and the auditors' findings. The Chairman has had detailed discussions with the auditors about these matters, prior to, during, and on completion of the audit.

The certifications of our Chief Executive Officer and Chief Financial Officer attached as Exhibits 31 and 32 and to this Report include information concerning our disclosure controls and procedures and internal control over financial reporting. Such certifications should be read in conjunction with the information contained in Item 4, including the information incorporated by reference to our annual report on Form 10-K for the fiscal year ended December 31, 2016,2017, for a more complete understanding of the matters covered by such certifications.



43

PART II — OTHER INFORMATION
Item 1.  Legal Proceedings.

Cyberquest, Inc.  Capstone received a letter in July 2017 from a purported holder of 70,000 shares of a series of preferred stock issued by CBQ, Inc., a predecessor of the Company, in the 1998 acquisition of Cyberquest, Inc., a company that ceased operations by 2002.  The letter was a request to inspect Capstone corporate records.   Capstone investigated these claims and, due to perceived deficiencies in the stock certificate, our inability to substantiate the purported ownership of said preferred stock to date and absence of validation that shares of the series of preferred stock are still outstanding, Capstone refused the purported holder's request to inspect corporate records per a September 1, 2017 letter to the purported holder.  Capstone did not receive any responsive communications from the purported holder after September 1, 2017, until the purported holder filed a declaratory judgement action in Dallas County, Texas state court on March 21, 2018 seeking validation of purported holder's ownership of the preferred stock and to compel inspection of Capstone corporate records.  Capstone received notice of the state declaratory action on April 3, 2018.  The Company retained local Dallas, Texas legal counsel, answered the suit, filed a counter claim to recover attorney's fees, and removed litigation from the State Court to the U.S. District Court in Texas.  The Company contested this declaratory judgment action for the reasons stated above for denial of the July 2017 request to inspect corporate records.

As previously reported in filings with the Commission by Capstone, the purported holder of the preferred stock made the same letter request in 2006 and, after receiving a denial of the request, the purported holder of the preferred stock made no further communications or demands to Capstone in the matter.

The Company and the claimant in the declaratory action pursued court-sponsored mediation which was held on September 12, 2018 in Dallas, Texas and resulted in a settlement agreement dated September 19, 2018. Under this agreement all parties acknowledged and agreed that this matter was amicably resolved without any admission of liability.

On September 27, 2018 both parties to this action filed a Joint Stipulation and Order for Dismissal with Prejudice with the U.S. district Court in Dallas, Texas, thereby closing this dispute.

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

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

Item 1A.  Risk Factors.

As a "smaller reporting company," we are not required to provideThere have been no material changes in reported risk factors from the information required byreported in our Annual Report on Form 10-K for the year ended December 31, 2017, except as described in this Item 1A.quarterly report on Form 10-Q.


33



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

There were no unregistered issuances of Company securities in the fiscal quarter ending September 30, 2017.2018.

Item 3.  Defaults Upon Senior Securities

None.



44

Item 4.  Mine Safety Disclosures

Not Applicable.

Item 5.  Other Information

None.The Company has no information to disclose that was required to be in a report on Form 8-K during the period covered by this report but was not reported. There have been no material changes to the procedures by which security holders may recommend nominees to our board of directors.

Item 6.  Exhibits

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

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



3445



SIGNATURES

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



Capstone Companies, Inc.


Dated:    November 14, 20172018


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



3546