This Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and other parts of this Report contain forward-looking statements,that involve risks and uncertainties. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Forward-looking statements can also be identified by words such as "future," "anticipates," "believes," "estimates," "expects," "intends," "plans," "predicts," "will," "would," "could," "can," "may," and similar terms. Forward-looking statements are not guarantees of future performance and Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in this Report under the heading "Risk Factors," which are incorporated herein by reference. The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included in this Report. All information presented herein is based on CAPC's fiscal year 2021 results. Unless otherwise stated, references to particular years or quarters refer to the CAPC's fiscal years ended in December and the associated quarters of those fiscal years. Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law. 34 Executive Summary InDecember 2019 , COVID-19 emerged and spread worldwide. TheWorld Health Organization declared COVID-19 a pandemic inMarch 2020 , resulting in federal, state and local governments and private entities mandating various restrictions, including the closure of non-essential businesses, travel restrictions, restrictions on public gatherings, stay-at-home orders and advisories and quarantining of peoplewho may have been exposed to the virus. After closely monitoring and taking into consideration the guidance from federal, state and local governments, inMarch 2020 , we temporarily closed our corporate offices in theU.S untilMay 2020 , when the Corporate office was reopened daily but with staff working on a rotating schedule. COVID-19 has caused substantial disruption to travel, business activities, and global supply chains, significant volatility in global financial markets, and resulted in a dramatic increase in unemployment, particularly in theU.S. The extent to which COVID-19 will continue to impact the company's results will depend primarily on future developments, including the severity and duration of the crisis, the speed and effectiveness of the national vaccine inoculation programs, potential mutations of COVID-19, and the impact of actions taken and that will be taken to contain COVID-19 or treat its impact. These future developments are highly uncertain and cannot be predicted with confidence. This pandemic has had and may continue to have a material impact on our business, results of operations, financial position and cash flow. In response to the COVID-19 pandemic, we took precautionary measures to maintain adequate liquidity by suspending share repurchases, temporarily deferring salaries of our executives by 50%, significantly scaling back on non-essential operating expenses, and downsizing ourHong Kong operation, as we transferred manufacturing toThailand . Our goal was to preserve cash but to continue to invest where needed to support the relaunch of the Connected Surfaces program. In order to further reduce overseas expenses, the Company decided to make dormant in 2022, the CIHK operation entirely but retaining two key employees as independent contractors. The impact of COVID-19 has resulted in an unprecedented decline in our revenue and earnings for the year endedDecember 31, 2021 , including goodwill impairment charges in 2020. Total net revenue for the year endedDecember 31, 2021 decreased 75.2% to approximately$686 thousand as compared to$2.8 million in the same period of last year. The net loss was approximately$2.0 million for the year 2021 compared to a net loss of$2.4 million in 2020. The Company had an estimated net tax provision in 2021 of$15.1 thousand and in 2020 a benefit of$612 thousand due to the tax benefit from the CARES Act which was enacted into law onMarch 27, 2020 . The CARES Act eliminated the taxable income limit for certain net operating losses ("NOLs") and allow businesses to carry back NOLs arising in 2018, 2019, and 2020 to the five prior tax years. The Company was able to carryback the NOL to 2017 tax years and generate an estimated refund of previously paid income taxes at an approximate 34% federal tax rate. The following discussion is designed to provide a better understanding of our audited consolidated financial statements and notes thereto, including a brief overview of our business and products, key factors that impacted our performance and a summary of operating results. Overview
Capstone Companies, Inc. ("Company" or "CAPC") is a public holding company organized under the laws of theState of Florida . The Company is a leading designer, manufacturer and marketer of consumer inspired products that simplify daily living through technology. Over the past decade, the Company's various product lines have been distributed globally including consumer markets inAustralia ,Japan ,Korea ,North America ,South America , and theUnited Kingdom . The primary operating subsidiary isCapstone Industries, Inc. ("CAPI"), aFlorida corporation located at the principal executive offices of the Company. To oversee and manage business activities in thePacific Rim , the Company establishedCapstone International Hong Kong, Ltd. , or "CIHK", allowing it to expand the Company's product development, engineering, and factory resource capabilities. The Company has a history of exploiting technologies in areas of induction charging, power failure control, security and home LED lighting products and most recently has entered the electronics market with its introduction of Capstone's Connected Surfaces. The Company's focus through 2017 has been in the integration of LEDs into most commonly used consumer lighting products in today's home. Over the last few years there has been significant LED price erosion, which has commoditized LED consumer products. The LED category has matured and is no longer the innovative "must have" consumer product as in previous years. Capstone's success has been in its ability to identify emerging product categories where Capstone's management experience can be fully leveraged. Over the past decade, the Company's consistent low-cost manufacturing and operations have provided an advantage in delivering quality products at very competitive prices.
In late 2017, as management recognized that the LED category was maturing, it sought a business opportunity that would transition the Company's revenue streams to an emerging category. While we currently continue to supply LED products on a limited basis, our strategic plan to develop and launch new innovative product lines, like Smart Mirrors, is believed to be essential for sustaining or growing revenues. 35 Our expectation is that the new Connected Surfaces portfolio advancing in 2022 appeals to a much larger audience than our traditional LED lighting product line. The new portfolio is designed to tap into consumer's ever-expanding connected lifestyles prevalent today. The products have both touch screen and voice interfacing, internet access and an operating system capable of running downloadable applications. The average selling prices will be comparable to that of tablets and smartphones, expected retails to start at$899.00 per unit, with the goal to deliver consumer value to mainstream America. Whereas, during the day your smartphone/tablet keeps you connected, whether it is work or personal, now when entering your home, Capstone's new Connected Surfaces products will enable users the same level of connectivity in a more relaxed manner that does not require being tethered to these devices. The Company's financial initiatives are driven by its entry to new distribution channels and calls for an increased emphasis on an e-commerce business model. As a result of the pandemic, retail foot traffic has been diminished substantially and e-commerce platforms have advanced with consumers across all product lines. The Connected Surfaces category should find its way to retail shelves after it has been established through its direct-to-consumer effort. The Company's marketing strategy will shift its historic reliance on Big Box while delivering more profitable business. The gross margins generated by the e-commerce model will be substantially greater than in the past and should provide strong cash flows. The Company will require additional funding to build its marketing effort, inventory levels and service levels once the initial marketing phase validates the Company's strategic initiatives. The future growth will be directly impacted by the level of exposure, messaging and distribution capabilities. For the short term, Corporate Insiders and Directors have pledged to continue supporting the Company's needs.
By working diligently overseas with alternate manufacturers located outside
The Company began its foray into the electronic industry in 2019 with its Connected Surfaces initiative. We entered the market as we identified the smart home category to be emerging with strong long term growth potential .This strategy would require the company to adopt a different business model short term as a way of building awareness and revenues .The business model is consumer direct through e-commerce marketing including a company webstore as well as Amazon, Wayfair and other recognized ecommerce platforms. This is a costly business as it requires the buildup of inventory domestically to support the demand. The ecommerce platform will not only build product awareness ,but it will also allow the company to exploit the brick-and-mortar environment as retailers recognize the categories business potential. The company's original assumptions about the category and what it could mean for the company have been validated over the past 2 years. The Company is assessing various organic and digital paid advertising campaigns to define its long term marketing strategy. OnMarch 10, 2020 , theWorld Health Organization declared the outbreak of the COVID-19 coronavirus to be a pandemic. COVID-19 caused substantial disruption to travel, business activities, and global supply chains, significant volatility in global financial markets, and resulted in a dramatic increase in unemployment, particularly in theU.S. While the Company announced the plan to launch its ecommerce initiative inMarch 2021 , that effort was continually delayed because of COVID-19 forced closures overseas and inventories planned for Q3, 2021 sales were only shipped in December 2021,which will facilitateJanuary 2022 sales planning. It is unclear as of the date of the filing of this Form 10-K report if our Q1 2022 e-commerce activity will compensate for loss of Smart Mirror revenues planned for Q 3
and 4, 2021.
During the year, the Company also experienced limitations in employee resources resulting from travel restrictions and "stay at home" orders. Despite these restrictions, the Company continues to manage the overseas supply chain requirements of our customers.
During recent months as consumer confidence has increased and the public has become more accustomed and feel safer about visiting stores, in store foot traffic has increased, particularly in theWarehouse Clubs that we sell in. The promotional activities both domestically and internationally in the Club channel have gradually increased as compared to previous quarters. We believe retail buying confidence will continue to improve and expect that promotional opportunities will begin to normalize for the 3rd and 4th Qs, 2022. We believe the COVID-19 virus will continue to impact retail markets through the first half of 2022 but as we focus our channel strategy toward e-commerce. Disruption to our business in 2021 was significant. Consumer confidence will rise commensurately with increased job opportunities and income recovery. The extent to which COVID-19 will continue to impact the company's results will depend primarily on future developments, including the severity and duration of the crisis, the speed and effectiveness of the national vaccine inoculation program, potential mutations of COVID-19, and the impact of future actions that will be taken to contain COVID-19 pandemic or treat its impact. These future developments are highly uncertain and cannot be predicted with confidence.
36
Principal Factors Affecting Our Financial Performance
There are a number of industry factors that affect our financial performance which include, among others:
? Overall Demand for Products and Applications. Our potential for growth depends
on the successful introduction and consumer acceptance of the Connected
Surfaces portfolio. The Company's products are characterized as non-essential
and economic conditions, especially consumer uncertainty or worries over
economic conditions and growth, affect consumer demand. Uncertainty over global
economic conditions that may affect the
consumer purchases of our category of consumer products. These uncertainties
make demand difficult to forecast for us and our customers.
? Strong and Constantly Evolving Competitive Environment. While we have
demonstrated our abilities to compete successfully in the retail channels since
our inception, competition in the marketplace we serve is strong. Many
companies have made significant investments in product development, production
equipment and product marketing. Product pricing pressures exist as market
participants often initiate pricing strategies to gain or protect market share.
To remain competitive, market participants must continuously increase product
performance or functionality, reduce costs and develop improved ways to support
their customers. To address these competitive measures, we invest in research
and development activities to support new product development, sustain low
product costs and deliver higher levels of performance and product
functionality to differentiate our products in the market.
? Profit Margins. The Company's product planning strategies are driven by the
need to deliver sustainable profit margins. This, in conjunction with close
management of related marketing costs, are required to sustain or grow the
Company's market presence.
? Technological Innovation and Advancement. Innovation and advancements in
consumer electronic categories continue to create expanded channel
opportunities. The smart home category is expected to grow to
2023, a CAGR of 18.2% since 2018. Household penetration of smart homes is
expected to grow to 19.5% by 2022. Smart phone users in
exceeds 269 million and is projected to be 290 million by 2024. Through the
Company's continual research and development activities, differentiation of its
smart home products and their related value to the consumer, a consistent
market share expansion is anticipated.
? Affordable Funding. The Company needs to secure affordable funding resources to
support ongoing product development and new market penetration. Intellectual Property Issues. Market participants rely on patented and non-patented proprietary information relating to product development and other core competencies of their business. Protection of intellectual property is important. Therefore, steps such as patent applications, confidentiality and non-disclosure agreements, as well as other security measures are generally taken. The Company has not created a litigation reserve for intellectual property rights litigation. As a business judgment, the Company does not patent or copyright or trademark all intellectual property due to a combination of factors, including, in part, the cost of registration and maintenance of registration, odds and cost of successful defense of the registration and commercial value of the intellectual property rights. To enforce or protect intellectual property rights, litigation or threatened litigation is common. The Company has not sued any third parties over intellectual property rights. Results of operations. Net Revenues Revenue is derived from sales of our residential lighting products. 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. Most of our sales are to the U.S. market which in 2021 represented 50% of revenues and we expect in the future that region to continue to be the major source of revenue for the Company. We also derived 50% of our revenue from overseas sales. Net revenue also includes the cost of instant rebate coupons, and product support allowances provided to retailers to promote certain products. All of our revenue is denominated inU.S. dollars. 37 Cost of Goods Sold Our cost of goods sold consists primarily of purchased products from contract manufacturers and when applicable associated duties and inbound freight. In addition, our cost of goods sold also include reserves for potential warranty claims and freight allowances. We source our manufactured products based on
customer orders. Gross Profit Our gross profit has and will continue to be affected by a variety of factors, including average sales price for our products, product mix, promotional allowances, our ability to reduce product cost fluctuations in the cost of our purchased components. See "Risk Factors" above in Item 1A. Operating Expenses Operating expenses include sales and marketing expenses, consisting of social media advertising, sales representatives' commissions, advertising, show expense and costs related to employee's compensation. In addition, operating expense includes charges relating to product development, office and warehousing, accounting, legal, insurance and stock-based compensation
CONSOLIDATED RESULTS OF OPERATIONS AND OUTLOOK
Year EndedDecember 31, 2021 Compared to the Year EndedDecember 31, 2020 (In Thousands) December 31, 2021 December 31, 2020 Dollars % of Revenue Dollars % of Revenue Revenue, Net$ 686 100.0 %$ 2,770 100.0 % Cost of sales 639 93.1 % 2266 81.8 % Gross Profit 47 6.9 % 504 18.2 % Operating Expenses: Sales and marketing 29 4.2 % 300 10.8 % Compensation 1,276 186.0 % 1,516 54.7 % Professional fees 368 53.6 % 423 15.3 % Product development 309 45.0 % 250 9.0 %
Other general and administrative 421 61.4 %
477 17.2 % Goodwill impairment charge - - % 624 22.5 % Total Operating Expenses 2403 350.3 % 3,590 129.6 % Operating Loss (2,356 ) (343.4 )% (3,086 ) (111.4 )% Other Income (Expenses) Miscellaneous Income (Expense), net 456 66.4 % 90 3.2 % Interest expense, net (49 ) (7.1 )% - - % Total Other Income (Expense) 407 59.3 % 90 3.2 % Loss Before Tax Benefit (1,949 ) (284.1 )% (2,996 ) (108.2 )% Income Tax Expense (Benefit) 15 2.2 % (612 ) (22.1 )% Net Loss$ (1,964 ) (286.3 )%$ (2,384 ) (86.1 )% Net Revenues Our business operations and financial performance for the year endedDecember 31, 2021 was adversely impacted by the economic effects of the COVID-19 pandemic to theU.S. and global economy. For the year endedDecember 31, 2021 , net revenues were approximately$686 thousand , a decrease of approximately$2.0 million or 75.2% from$2.8 million in fiscal 2020. The decrease in 2021 net revenue was driven by the uncertainty felt by retailers, as to the short and long-term impact on theU.S. retail market of COVID-19 resulting from the reduction of consumer foot traffic in brick and mortar stores. Overseas, the impact of COVID19 created substantial logistic delays from components, product testing and certification, manufacturing and ocean freight. This uncertainty resulted in the postponement of many promotional opportunities during the year. The Company selectively supports retailer's initiatives to maximize sales of the Company's products on the retail floor or to assist in developing consumer product awareness, by providing marketing und allowances to the customer. Sales reductions for anticipated discounts, allowances and other deductions are recognized during the period the related revenue is recorded. The reduction of accrued allowances is included in net revenues and amounted to$8.0 thousand and$341.2 thousand for the years endedDecember 31, 2021 and 2020 respectively.
For the years ended
38
The following table disaggregates net revenue by major source:
For the Year Ended For the Year EndedDecember 31, 2021 December 31, 2020 Capstone Brand % of
Revenue Capstone Brand % of Revenue
Lighting Products-
$ 340,896 49 % $ 2,066,519 75 % Smart Mirror Products- U.S. 3,795 1 % - - Lighting Products-International 341,163
50 % 703,839 25 % Total Revenue $ 685,854 100 % $ 2770,358 100 %
Gross Profit and Cost of Sales
Gross profit for the year endedDecember 31, 2021 , was approximately$47 thousand , or 6.9% of net revenues, as compared to$504 thousand or 18.2% of net revenues, for fiscal 2020. For the years endedDecember 31, 2021 and 2020, cost of sales were approximately$639 thousand and$2.3 million , respectively, a decrease of$1.6 million or 71.8% from the previous year. This reduction was the direct result of the reduced revenue in the year. Costs represented 93.1% and 81.8% of net revenues for 2021 and 2020, respectively. This increased cost was partially due to the higher ocean freight-logistics costs associated with the shortage of containers and vessels arriving from overseas. Operating Expenses Sales and Marketing Expenses In fiscal 2021 and 2020, sales and marketing expenses were approximately$29 thousand and$300 thousand respectively, a decrease of$271 thousand or 90.3%. As a percent to revenue 2021 expenses were 4.2% as compared to 10.9% in 2020. Social Media expense in 2021 was$20.5 thousand , a decrease of$9.8 thousand or 32.3% from$30.3 thousand in 2020.With the resulting delays of the Connected Surfaces program we continued our Social Media marketing presence in preparation for the launch of the Smart Mirror program, but as inventory was not available the advertising program was not as intense as originally planned. Advertising and promotional expenses were$2.2 thousand in 2021 as compared to$34.7 thousand in 2020, a reduction of$32.4 thousand or 93.4% due to the reduced retail promotional activities during 2021. Trade Show expense was$0.5 thousand in 2021 as compared to$149 thousand in 2020 , a reduction of$148.5 thousand or 99.7% due to cancellation of CES trade show resulted from the COVID19 pandemic.$8.0 thousand and$341.2 thousand for the years endedDecember 31 ,
2021 and 2020 respectively. Compensation Expenses For the years endedDecember 31, 2021 and 2020 compensation expenses were approximately$1.3 million and$1.5 million , respectively, a reduction of$240 thousand or 15.8%. As a percent of net revenues 2021 expenses were 186.0% as compared to 54.7% in 2020. With the reduced revenue and the transition of production intoThailand , the Company eliminated 2 positions during 2021 and 4 positions in theHong Kong office during 2020. Professional Fees For fiscal 2021, professional fees were approximately$368 thousand compared to$423 thousand in 2020, a decrease of$55 thousand or 13.0 %. As a percent of net revenue 2021 expenses were 53.6% as compared to 15.3% in 2020. In 2021, consulting fees were approximately$165 thousand the same amount as incurred in 2020. Accounting, legal and other expenses were$203 thousand , a decrease of$55 thousand from$258 thousand in the prior year.
Product Development Expenses
For the years endedDecember 31, 2021 and 2020, product development expenses were approximately$309 and$250 thousand , respectively, an increase of$59 thousand or 23.6%. In 2021, the Company invested$237 thousand in the Smart Mirror development compared to$182 thousand in 2020, a increase of$55 thousand or 30.2%. In 2021, Smart Mirror FCC & ETL and other certification fees of approximately$98K were incurred as compared to$0 in prior year. With the reduced revenue, quality control expenses in 2021 were$1 thousand compared to$44 thousand in 2020, a reduction of$43 thousand or 97.7%. Other expenses such as prototype, sample and courier charges were increased by approximately$51 thousand from$7 thousand in 2020 to$58 thousand in 2021. As a percent of revenue, 2021 expenses were 45.0% as compared to 9.0% in 2020. We have continued to invest in new product design, software development, product prototyping and testing and related to the Smart Mirror project. 39
Other General and Administrative Expenses
For fiscal 2021 and 2020, other general and administration expenses were approximately$421 thousand and$477 thousand , respectively, a decrease of$56 thousand or 11.7%. As a percent to revenue 2021 expenses were 61.4% as compared to 17.2% in 2020. In 2021 the Company's rent expense was$148 thousand compared to$166 thousand in 2020, a decrease of$18 thousand or 10.6%. The Directors insurance also increased in 2021 from$71 thousand in 2020 up to$100 thousand a$29 thousand or 40.8% increase. Despite these increases, as part of an expense mitigation plan in response to the impact of COVID19, the Company reduced discretionary expenses which included auto, office and computer supplies, courier services, travel and hotel expenses, telephone and bank charges, which resulted in a net expense reduction of$70 thousand or 14.7% as compared to the same period in 2020. These discretionary expenses are included in the other general and administrative expenses. Goodwill Impairment Charge As a result of the economic uncertainties caused by the COVID-19 pandemic during the year endedDecember 31, 2021 , management determined sufficient indicators existed to trigger the performance of interim goodwill impairment analyses for each reporting quarter. The total impairment charge for the years endedDecember 31, 2021 and 2020 was approximately$0 and$624 thousand , respectively. The interim analysis concluded that the Company's fair value of its single reporting unit exceeded the carrying value and a goodwill impairment charge for the year endingDecember 31, 2021 , was not required. Total Operating Expenses For the years endedDecember 31, 2021 and 2020, total operating expenses were$2.4 million and$3.6 million , respectively. This represents a$1.2 million or 33.1% decrease over fiscal year 2020. A decrease in total operating expenses of$1.2 million for the year endingDecember 31, 2021 , represents reduction of selling and marking expense of approximately$272 thousand , compensation expense of$240 thousand and goodwill impairment charge of$624 thousand over expense level from fiscal year 2020. Operating Loss For the year endedDecember 31, 2021 the operating loss was approximately$2.4 million as compared to$3.1 million in 2020, a loss decrease of$730 thousand over 2020. Other Income (Expense)
For fiscal 2021 other income was approximately$456 thousand compared to a$90 thousand in 2020, an increase of$366 thousand over 2020. The other income for the year endedDecember 31, 2021 resulted mainly from reversal of approximately$340 thousand accrued marketing and promotional allowances against previous sales that is no longer required as ofDecember 31, 2021 . Marketing allowances include the cost of underwriting an in store instant rebate coupon or a targeted markdown allowance on specific products. The Company accrues and retains these allowances for a period of 3 to 5 years in the event the customer chargeback a promotional allowance against future open invoices or submits to us an invoice. These allowances are also evaluated when our relationship with a customer is terminated, or we cease selling a specific product to a customer. We evaluated certain allowances and were satisfied that these allowances were no longer required based on the age of the allowance and sale of the products for which these allowances relate being significantly reduced. These allowances were charged to other income during the year endedDecember 31, 2021 . For the years endedDecember 31, 2021 the net expense for income tax was estimated at$15 thousand compared to a net benefit of$612 thousand in the same period 2020. The benefit in 2020 was a result of the CARES Act which eliminated the taxable income limit for certain net operating losses ("NOLs") and allow businesses to carry back NOLs arising in 2018, 2019, and 2020 to the five prior tax years. The Company was able to carryback the 2018 and the 2019 NOLs to 2017 tax year and generate an estimated refund of previously paid income taxes at an approximate 34% federal tax rate.
The effective tax rate for the years ended
40 Net Loss
For fiscal 2021 and 2020 net loss was approximately
RESULTS OF OPERATIONS AND BUSINESS OUTLOOK
In 2021, the impact of COVID-19 resulted in an unprecedented decline in our
revenue and earnings for the year ended
Our expectation is that the new portfolio advancing in 2022 appeals to a much larger audience than our traditional LED lighting product line. Management believes that the execution of the Company's strategy and development of the Connected Surfaces category will provide attractive opportunities for profitable growth over the long-term The Company's financial initiatives are driven by its entry to new distribution channels and calls for an increased emphasis on an e-commerce business model. Online platforms have advanced with consumers across all product lines. The Connected Surfaces category should find its way to retail shelves after it has been established through its direct-to-consumer effort. The Company's marketing strategy will shift its historic reliance on Big Box while delivering more profitable business. The gross margins generated by the e-commerce model is anticipated to be greater than in the past and should provide strong cash flows. The Company will require additional funding to build its marketing effort, inventory levels and service levels once the initial marketing phase validates the Company's strategic initiatives. The future growth will be directly impacted by the level of exposure, messaging and distribution capabilities. By working diligently overseas with alternate manufacturers located outsideChina , particularly inThailand , we anticipate minimal impact to our selling prices and related margins of profit that could otherwise be impacted by an ongoing trade dispute betweenthe United States andChina . Other factors, like inflation and its impact on consumer confidence and willingness to purchase discretionary purchases like our Smart Mirrors, may impact selling prices and related margins of profit. As the products we have shipped on our direct import business model typically requires 3 to 4 months lead time, our revenue in 2021 was significantly impacted by the uncertainty of reduced consumer foot traffic in the stores during the pandemic. This uncertainty caused retail buyers to delay or postpone promotional events. During recent months as consumer confidence has increased and the public has become more accustomed and feel safer about visiting stores, in store foot traffic has increased, particularly in theWarehouse Clubs that we sell in. The promotional activities both domestically and internationally in the Club channel have gradually increased as compared to previous quarters. We believe retail buying confidence will continue to improve and expect that promotional opportunities will begin to normalize in 2022.
With the impact of COVID-19 Management was even more focused on the following priorities:
? to protect the safety and wellbeing of the Capstone team.
? to expedite the transition of the Company's marketing presence from brick and
mortar retail to online retail.
? to expand the Company's social media platforms and online visibility.
? to revamp the Company's website to support online business.
? to build the logistics and fulfilment structure to support online orders.
? to transfer Smart Mirror production capability toThailand fromChina .
? to design, enhance and build the Smart Mirror product portfolio.
During 2021 we were able to complete the above priorities and are now preparing for the launch of the Smart Mirror program in 2022. Logistical problems affecting Asian-U.S. commerce and shipment of products to theU.S. may adversely impact our ability to establish the Smart Mirror product line as a viable revenue source in 2022. Contractual Obligations The following table represents contractual obligations as ofDecember 31, 2021 . Payments Due by Period Total 2022 2023 2024 After 2025
Purchase Obligations$ 538,551 $ 538,551 $ - $ - $ - Short-Term Debt - - - - - Long-Term Debt - related parties 1,030,340 - 1,030,340 - -
Operating and Short Term Leases 107,690 70,157 37,533
- -
Total Contractual Obligations
41
Notes to Contractual Obligations Table
Purchase Obligations - Purchase obligations are comprised of the Company's liability for goods and services in the normal course of business.
Short Term Debt - None.
Long Term Debt - Note payable related parties.
Operating Leases - Operating lease obligations are related to facility leases
for our operations in the
LIQUIDITY AND CAPITAL RESOURCES
The COVID-19 pandemic significantly affectedU.S. consumer shopping patterns and caused the health of theU.S. economy to deteriorate. If the variants of COVID-19 are not effectively and timely controlled, our business operations, financial condition, and liquidity may be materially and adversely affected because of prolonged disruptions in consumer spending. Operational cashflow is significantly influenced by the timing and launch of new products as well as favorable payment terms negotiated with overseas suppliers. With ourHong Kong andThailand operational presence, we have built an operational structure that, through relationships with factory-suppliers both inThailand andChina combined with our expertise, that under normal operating circumstances, can develop and release quality, innovative products to the marketplace substantially quicker than in previous years.
Our ability to generate cash from operations has been one of our fundamental strengths and has provided us with flexibility in meeting our operating, financing and investing needs in the past.
During the year endedDecember 31, 2021 , the Company used cash in operations of approximately$2.4 million and generated net operating losses of$1.96 million . As ofDecember 31, 2021 , the Company had working capital of approximately$1.9 million and an accumulated deficit of$6.4 million . The Company's cash balance increased by approximately$54 thousand from$1.223 million as ofDecember 31, 2020 to$1.277 million as ofDecember 31, 2021 . With the reduced revenues in 2021 and to conserve cash, the Company initiated an expense mitigation plan that reduced discretionary spending including travel, lodging and trade show expenses, deferred executive management compensation, and significantly reduced the cost of theHong Kong operation. The Company has a recent history of losses and negative cash from operations. The uncertainty and the continuing negative impact that this COVID-19 disruption could negatively impact the demand for our products or delay future planned promotional opportunities. However, with a successful launch of the Smart Mirror portfolio using the online retail platform, the Company will also require an inventory credit facility to support increasedU.S. domestic inventory to facilitate revenue growth in the online business. OnJanuary 4, 2021 , the Company entered a$750,000 working capital loan agreement with Directors,Stewart Wallach andJeffrey Postal . The short-term facility endedJune 30, 2021 ("Initial Period'). The Company had the option to extend the Initial Period for an additional six consecutive months, endingDecember 31, 2021 , but decided not to renew. OnApril 5, 2021 , the Company entered into five separate securities purchase agreements ("SPAs") whereby the Company privately placed an aggregate of 2,496,667 shares of Common Stock for an aggregate purchase price$1,498,000 (transactions being referred to as the "Private Placement"). The five investors in the Private Placement consisted of four private equity funds and one individual - all being "accredited investors" (under Rule 501(a) of Regulation D under the Securities Act of 1933, as amended, ("Securities Act"). The$1,498,000 in proceeds from the Private Placement was used mostly to purchase start up inventory for the Company's new Smart Mirror product line, for a major online e-commerce fulfilment company, and the remainder for advertising and working capital.
OnJuly 2, 2021 , the Board of Directors ("Board") resolved that the Company required a purchase order funding facility to procure additional inventory to support the online Smart Mirror business. The Board resolved that certain Directors could negotiate the terms of a Purchase Order Funding Agreement for up to$1,020,000 with DirectorsS. Wallach andJ. Postal andE. Fleisig , a natural person. This agreement has finalized, and the Company received the$1,020,000 funding under this agreement onOctober 18, 2021 . As ofDecember 31, 2021 , the Company had an outstanding balance on the Purchase Order Funding Agreement of$1,030,340 which includes accrued interest of$10,340 .
The Company has an income tax refundable as of
42 The Company's ability to maintain sufficient working capital is highly dependent upon achieving expected operating results. Failure to achieve expected operating results could have a material adverse effect on the Company's working capital, ability to obtain financing, and its operations in the future.
The Company as of
In addition, we may seek alternative sources of liquidity, including but not limited to accessing the capital markets, or the Company may be able to raise the required additional capital through debt and or equity financing. However, instability in, or tightening of the capital markets, could adversely affect our ability to access the capital markets on terms acceptable to us. The Company can make no assurances that it will be able to raise the required capital, on acceptable terms or at all. Management believes that with the cash on hand, and our availability will be adequate to meet the Company's cash needs for daily operations for the short-term period, however the Company does not have sufficient cash on hand to finance its plan of operations for the next 12 months from the filing of this report and will need to seek additional capital through debt and/or equity financing. These factors raise substantial doubt about the Company's ability to continue as a going concern. Summary of Cash Flows Years ended December 31, 2021 2020 (In thousands) Net cash provided by (used in): Operating Activities$ (2,371 ) $ (1,858 ) Investing Activities (32 ) (13 ) Financing Activities 2,457 (36 )
Net increase (decrease) in cash and cash equivalents $ 54 $
(1,907 ) As ofDecember 31, 2021 the Company's working capital was approximately$2.0 million of which$1.2 million was cash. Current liabilities were$609 thousand and include:
? Accounts payable of approximately
service providers.
? Accrued expenses of approximately
wages, and customer deposits.
? Warranty provision for estimated defective returns in the amount of
approximately
? Operating lease- current portion of approximately
Cash Flows provided by (used in) Operating Activities
Cash used in operating activities was approximately$2.4 million in 2021 compared with approximately$1.86 million in 2020. The cash used in operating activities in 2021 included the negative cash impact of the net loss, which was approximately$1.96 million , an increase in inventories of approximately$500 thousand , an increase of prepaid expenses of$425 thousand and decrease in accounts payable of$287 thousand . This was partially offset by an income tax refund of$576 thousand and$119 thousand decrease in accounts receivables.
Cash Flows used in Investing Activities
Cash used in investing activities in 2021 was approximately$32 thousand compared to$13 thousand in 2020. The Company continued to invest in new product molds and tooling. With further product expansion into Smart Home lighting and Smart Mirror categories, the Company's future capital requirements will increase to fund future mold and tooling as the Company expands the Connected Surfaces portfolio.
Cash Flows used in Financing Activities
Cash received and used in financing activities for the years endedDecember 31, 2021 and 2020, was approximately$2.457 million and$36 thousand , respectively. The Company received approximately$1.4 million from sales of common stock and approximately$1.0 million purchase order funding received from related party note payable during the year 2021. The Company repurchased 283,383 of common shares during the year 2020 at a cost of$36 thousand .
The Company has negotiated beneficial payment terms with our main overseas
manufacturers including the new supplier in
43 Exchange Rates We sell all of our products inU.S. dollars and pay for all of our manufacturing costs inU.S. dollars. Our factories are located in mainlandChina andThailand . During 2021 the average exchange rate between theU.S. Dollar and Chinese Yuan have been relatively stable approximatelyRMB 6.90 toU.S. $1.00 .
The average exchange rate between the
Operating expenses of theHong Kong office are paid in eitherHong Kong dollars orU.S. dollars. The exchange rate of theHong Kong dollar to theU.S. dollar has been very stable at approximately HK$7.80 toU.S. $1.00 since 1983 and, accordingly, has not represented a currency exchange risk to theU.S. dollar. While exchange rates have been stable for several years, we cannot assure you that the exchange rate betweenthe United States ,Hong Kong , Chinese andThailand currencies will continue to be stable and exchange rate fluctuations may have a material effect on our business, financial condition or results
of operations.
Off Balance Sheet Arrangements
We do not have material off-balance sheet arrangements that have or are reasonably likely to have a material future effect on our results of operations or financial condition.
DIVIDENDS We have not declared or paid any cash or other dividends on shares of our Common Stock in the last seven years and we presently have no intention of paying any cash dividends on shares of our Common Stock. RELATED-PARTY TRANSACTIONS
See Note 4 of the Consolidated Financial Statements at Item 15 of this Report.
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 1 of the Consolidated Financial Statements at Item 15 of this Report.
CRITICAL ACCOUNTING POLICIES The preparation of consolidated financial statements in conformity with accounting principles generally accepted inthe United States of America ("U.S. GAAP") requires management to make certain estimates and assumptions regarding matters that are inherently uncertain and that ultimately affect the reported amounts of assets, liabilities, revenues and expense, and the disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition; inventory valuation; depreciation; amortization and the recovery of long-lived assets; including goodwill and intangible assets; shared base-based payment expense; product warranty; and other reserves and assumptions based on management's experience and understanding of current facts and circumstances, historical experience and other relevant factors. These estimates may differ from actual results. Certain of our accounting policies are considered critical as they are both important to reflect our financial position and results of operations and require significant or complex judgement on the part of management. The following is a summary of certain accounting policies considered critical by management. Revenue Recognition The Company generates revenue from developing, marketing and selling consumer 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 specific overseas markets. These products may be offered either under the Capstone brand or a private brand.
A sales contract occurs when the customer-retailer submits a purchase order to buy a specific product, a specific quantity, at an agreed-fixed price, within a ship window, from a specific location and on agreed payment terms. The selling price in all of our customers' orders has been previously negotiated and agreed to including any applicable discount prior to receiving the customer's purchase order. The stated unit price in the customer's order has already been determined and is fixed at the time of invoicing. 44 The Company recognizes product revenue when the Company's performance obligations as per the terms in the customers purchase order have been fully satisfied, specifically, when the specified product and quantity ordered has been manufactured and shipped pursuant to the customers requested ship window, when the sales price as detailed in the purchase order is fixed, when the product title and risk of loss for that order has passed to the customer, and collection of the invoice is reasonably assured. This means that the product ordered and to be shipped has gone through quality assurance inspection, customs and commercial documentation preparation, the goods delivered, title transferred to the customer and confirmed by a signed cargo receipt or bill of lading. Only at the time of shipment when all performance obligations have been satisfied will the judgement be made to invoice the customer and complete the sales contract. The Company may enter into a licensing agreement with globally recognized companies, that allows the Company to market products under a licensed brand to retailers for a designated period of time, and whereby the Company will pay a royalty fee, typically a percentage of licensed product revenue to the licensor in order to market the licensed product.
The Company may also enter into a private label agreement, whereby the Company produces and ships product to a customer that has been packaged and will be marketed under the customers own private label.
The Company expenses license royalty fees and sales commissions when incurred and these expenses are recognized during the period the related sale is recorded. These costs are recorded within sales and marketing expenses.
We provide our customers with limited rights of return for non-conforming product warranty claims. As a policy, the Company does not accept product returns from retail customers, however occasionally as part of a customers in store test for new product, we may receive back residual inventory.
Customer orders received are not long-term orders and are typically shipped within six months of the order receipt, but certainly within a one-year period.
Our payment terms may vary by the type of customer, the customer's credit standing, the location where the product will be picked up from and for international customers, which country their corporate office is located. The term between invoicing date and when payment is due may vary between 30 days and 90 days depending on the customer type. In order to ensure there are no payment issues, overseas customers or new customers may be required to provide a deposit or full payment before the order is delivered to the customer. The Company selectively supports retailer's initiatives to maximize sales of the Company's products on the retail floor or to assist in developing consumer awareness of new products launches, by providing marketing fund allowances to the customer. The Company recognizes these incentives at the time they are offered to the customers and records a credit to their account with an offsetting charge as either a reduction to revenue, increase to cost of sales, or marketing expenses depending on the type of sales incentives. Sales reductions for anticipated discounts, promotional and marketing allowances, defective warranty claims, and other deductions are recognized during the period the related revenue is recorded. The Company may be subject to chargebacks from customers for negotiated promotional allowances, that are deducted from open invoices and reduce collectability of open invoices. For the years endedDecember 31, 2021 and 2020, the Company had processed approximately$8.0 thousand and$341.2 thousand , respectively for such allowances. Accounts Receivable For product revenue, the Company invoices its customers at the time of shipment for the sales value of the product shipped. Accounts receivables are recognized at the amount expected to be collected and are not subject to any interest or finance charges. The Company does not have any off-balance sheet credit exposure related to any of its customers. Previously in the factoring agreement withSterling National Bank , accounts receivable served as collateral when the Company borrowed against the credit facility. As ofDecember 31, 2020 , with the termination of the factoring agreement, the accounts receivables are fully unencumbered.
Allowance for Doubtful Accounts
The Company evaluates the collectability of accounts receivable based on a combination of factors. In cases where the Company becomes aware of circumstances that may impair a specific customer's ability to meet its financial obligations subsequent to the original sale, the Company will recognize an allowance against amounts due, and thereby reduce the net recognized receivable to the amount the Company reasonably believes will be collected. For all other customers, the Company recognizes an allowance for doubtful accounts based on the length of time the receivables are past due and consideration of other factors such as industry conditions, the current business environment and the Company's historical payment experience. An allowance for doubtful accounts is established as losses are estimated to have occurred through a provision for bad debts charged to earnings. This evaluation is inherently subjective and requires estimates that are susceptible to significant revisions as more information becomes available.
As of both Decembers 31, 2021 and 2020, management determined that the accounts receivable is fully collectible. As such, management has not recorded an allowance for doubtful accounts.
45
The following table summarizes the components of Accounts Receivable, net:
December 31, December 31, 2021 2020 Trade Accounts Receivables at period end$ 1,481 $ 197,166 Reserve for estimated marketing allowances, cash discounts and other incentives - (77,102 ) Total Accounts Receivable, net$ 1,481 $ 120,064 Goodwill
OnSeptember 13, 2006 , the Company entered into a Stock Purchase Agreement withCapstone Industries, Inc. , aFlorida corporation ("Capstone"). Capstone was incorporated inFlorida onMay 15, 1996 and is engaged primarily in the business of wholesaling technology inspired consumer products to distributors and retailers inthe United States .
Under the Stock Purchase Agreement, the Company acquired 100% of the issued and
outstanding shares of Capstone's Common Stock, and recorded goodwill of
InJanuary 2017 , the FASB issued ASU 2017-04, Simplifying the Test forGoodwill Impairment, which requires an entity to perform a one-step quantitative impairment test, whereby a goodwill impairment loss will be measured as the excess of a reporting unit's carrying amount over its fair value (not to exceed the total goodwill allocated to that reporting unit). ASU 2017-04 was effective for the Company's fiscal year endedDecember 31, 2019 . The adoption of ASU 2017-04 did not have a material effect on the Company's consolidated financial statements.Goodwill is tested for impairment onDecember 31 of each year or more frequently if events or changes in circumstances indicate that the asset might be impaired. If the carrying amount exceeds its fair value, an impairment loss is recognized.Goodwill is not amortized. The Company estimates the fair value of its single reporting unit relative to the Company's market capitalization. As a result of the economic uncertainties caused by the COVID-19 pandemic during the year endedDecember 31, 2021 management determined sufficient indicators existed to trigger the performance of interim goodwill impairment analyses for each reporting quarter. The total impairment charge for the year endedDecember 31, 2021 and 2020 was$0 and$623.5 thousand , respectively.
The following table summarizes the changes in the Company's goodwill asset which is included in the total assets in the accompanying consolidated balance sheets:
December 31, December 31, 2021 2020 Balance at the beginning of the period$ 1,312,482 $ 1,936,020 Impairment charges - net - (623,538 ) Balance at December 31, 2021$ 1,312,482 $ 1,312,482
With the continuing economic uncertainties caused by the COVID-19 pandemic, the capital markets may have a downturn and adversely affect the Company's stock price which will require the Company to test its goodwill for impairment in future reporting periods. The Company's stock is deemed a "penny stock" under Commission rules. Accrued Liabilities Accrued liabilities contained in the accompanying consolidated balance sheets include accruals for estimated amounts of credits to be issued in future years based on potential product warranties, compensation, benefits, marketing allowances and other liabilities. 46 Income Taxes The Company is subject to income taxes in theU.S. federal jurisdiction, various state jurisdictions and certain other jurisdictions. The Company accounts for income taxes under the provisions ofFinancial Accounting Standards Board ("FASB") Accounting Standard Codification ("ASC") 740 Income Taxes. ASC 740 requires recognition of deferred income tax assets and liabilities for the expected future income tax consequences, based on enacted tax laws, of temporary differences between the financial reporting and tax bases of assets and liabilities. The Company and itsU.S. subsidiaries file consolidated income
tax returns.
Tax regulations within each jurisdiction are subject to the interpretation of the relaxed tax laws and regulations and require significant judgement to apply. The Company is not subject toU.S. federal, state and local tax examinations by tax authorities generally for a period of 3 years from the later of each return due date or date filed.
If the Company were to subsequently record an unrecognized tax benefit, associated penalties and tax related interest expense would be recorded as a component of income tax expense.
As ofDecember 31, 2021 , the Company had federal and state net operating loss carry forwards of approximately$2,687,000 and$5,073,000 , respectively. The federal net operating loss is available to the Company indefinitely and available to offset up to 80% of future taxable income each year. The net deferred tax liability as ofDecember 31, 2021 and 2020 was$274,000 and$260,000 , respectively, and is reflected in long-term liabilities in the accompanying consolidated balance sheets. OnMarch 27, 2020 , the CARES Act was enacted into law. The CARES Act is a tax and spending package intended to provide economic relief to address the impact of the COVID-19 pandemic. The CARES Act includes several significant income and other business tax provisions that, among other things, would eliminate the taxable income limit for certain net operating losses ("NOLs") and allow businesses to carry back NOLs arising in 2018, 2019, and 2020 to the five prior tax years. The Company was able to carryback the 2018 and the 2019 NOLs to 2017 tax year and generate an estimated refund of previously paid income taxes at an approximate 34% federal tax rate. This resulted in a net benefit of$575,645 which was recorded in the first quarter 2020. The Company expects to carryback a portion of its 2020 NOL, for which it recorded a further net benefit of$286,433 . In the third quarter 2020, the Company recorded a$21,222 net tax benefit for deferred tax liability adjustment related to goodwill impairment. For the year endedDecember 31, 2021 and 2020, the Company has recorded a net tax benefits$284,873 and$861,318 , respectively.
The Company received approximately
The effective tax rate for the years ended
The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. Deferred tax assets are to be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred assets will not be realized. The Company has evaluated the positive and negative evidence bearing upon its ability to realize the deferred tax assets. Management has considered the Company's history of cumulative net losses incurred and has concluded that it is more likely than not that the Company will not realize the benefits of the deferred tax assets. Accordingly, a full valuation allowance has been established against the deferred tax assets as ofDecember 31, 2021 and 2020. Since indefinite-lived assets cannot be used as a source of taxable income to support the realization of deferred tax asset, a valuation allowance was recorded against the deferred tax assets, and a net deferred tax liability or naked credit of approximately$260,000 is presented on the company's balance sheet. The Company's valuation allowance increased by$345,397 . The Company recognizes liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. While the Company believes that it has appropriate support for the positions taken on its tax returns, the Company regularly assesses the potential outcome of examinations by tax authorities in determining the adequacy of its provision for income taxes. As ofDecember 31, 2020 , the Company had an income tax refundable of approximately$861 thousand of which approximately$576 thousand income tax and$10.4 thousand of interest was refunded onFebruary 3, 2021 . As ofDecember 31, 2021 , the Company has a remaining tax refund of$285 thousand . 47
© Edgar Online, source