CAPSTONE COMPANIES, INC. This Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and other parts of this Report contain forward-looking statements, that involve risks and uncertainties. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Forward-looking statements can also be identified by words such as "future," "anticipates," "believes," "estimates," "expects," "intends," "plans," "predicts," "will," "would," "could," "can," "may," and similar terms. Forward-looking statements are not guarantees of future performance and Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in this Report under the heading "Risk Factors," which are incorporated herein by reference. The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included in this Report. All information presented herein is based on CAPC's fiscal year 2020 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.
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 people who 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 has 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. 39 -------------------------------------------------------------------------------- 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. The impact of COVID-19 has resulted in an unprecedented decline in our revenue and earnings for the year endedDecember 31, 2020 , including goodwill impairment charges in the period. Total net revenue for the year endedDecember 31, 2020 decreased 77.7% to approximately$2.8 million as compared to$12.4 million in the same period of last year. The net loss was approximately$2.4 million for the year 2020 compared to a net loss of$892 thousand in 2019. The Company had an estimated net tax benefit in 2020 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. 40 -------------------------------------------------------------------------------- Our expectation is that the new Connected Surfaces portfolio advancing in 2021 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$699.00 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
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. As the products we have shipped on our direct import business model typically requires 3 to 4 months lead time, our revenue in 2020 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 for the 3rd and 4th quarters 2021. Since early 2020, the Company has been building its infrastructure to transition into the online retail business which nationally has experienced substantial increases during the pandemic. The Company saw a change in consumer buying trend long before the pandemic impact and has been investing in developing a social media presence over the last year and is now ready to officially launch shipping product by its online Smart Mirror business inApril 2021 . We believe the COVID-19 virus will continue to impact retail markets through the first half of 2021 but as we focus our channel strategy toward e-commerce, disruption to our business in 2021 should be moderate. 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 or treat its impact. These future developments are highly uncertain and cannot be predicted with confidence. 41 -------------------------------------------------------------------------------- We continue to make investments to ensure that we provide quality, useful products. Additionally, the Company continues to enhance its customer service support. In 2020 and 2019, the Company substantially expanded its investment and commitment to social media marketing. With the growing importance of on-line commerce and social media to consumers, this marketing will play a vital role in expanding our lifestyle brands and will also serve to establish credibility with the Company's growing consumer base. The effort will focus on creating a more extensive and aggressive social media presence through use of third-party social media like Facebook, Twitter, YouTube and Instagram. Continued analytics will govern and refine our investments in these social media campaigns. The Company oversees and controls the manufacturing of its products, which are currently made inChina andThailand by OEM contract manufacturers, through three wholly owned operating subsidiaries:CAPI , CIHK and CLTL. To support the current e-commerce model that will drive our business in 2021, we will be putting inventories into warehouse facilities stateside for direct-to-consumer fulfillment. When introducing the Connected Surfaces program to Big Box retailers in the back half of 2021, the Company will resume its direct import model. At that time, the Company's products will be built to order for specific promotional periods and does not require replenishment domestically. 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. Capstone's business practices have allowed development of excellent relationships with its OEM contract manufacturers and has resulted in commercially favorable payment terms, which over the years has greatly contributed to the Company's growth.
To date all of the company's retail sales are made on an order-by-order basis, rather than through long-term sales contracts. As such, the nature of the company's business did not provide visibility of material forward-looking information from its customers and suppliers beyond a few months.
With the launch of the Connected Surfaces online business and to ensure adequate inventory supply for the new product category in order to support immediate e-commerce shipments, the Company will be forecasting its inventory needs as the volume of sales are established.
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.
42
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• Technological Innovation and Advancement. Innovation and advancements in
consumer electronic categories continue to create expanded channel
opportunities. The smart home category was approximately
and is expected to grow to
Household penetration of smart homes is expected to grow to 19.5% by 2022.
Smart phone users in
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 2020 represented 75% of revenues and we expect that region to continue to be the major source of revenue for the Company. We also derived 25% 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. 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.
43
--------------------------------------------------------------------------------CONSOLIDATED RESULTS OF OPERATIONS AND OUTLOOK
Year Ended
December 31, 2020 December 31, 2019
Dollars % of Revenue Dollars % of Revenue
Revenue, Net $ 2,770 100.0 % $ 12,404 100.0 %
Cost of sales 2,266 81.8 % 9,972 80.4 %
Gross Profit 504 18.2 % 2,432 19.6 %
Operating Expenses:
Sales and marketing 300 10.8 % 379 3.1 %
Compensation 1,516 54.7 % 1,554 12.5 %
Professional fees 423 15.3 % 435 3.5 %
Product development 250 9.0 % 349 2.8 %
Other general and administrative 477 17.2 % 648 5.2 %
Goodwill impairment charge 624 22.5 % - - %
Total Operating Expenses 3,590 129.6 % 3,365 27.1 %
Operating Loss (3,086 ) (111.4 )% (933 ) (7.5 )%
Other Income (Expenses)
Miscellaneous Income (Expense), net 90 3.2 % 29 0.2 %
Interest expense - - % (3 ) - %
Total Other Income (Expense) 90 3.2 % 26 0.2 %
Loss Before Tax Benefit (2,996 ) (108.2 )% (907 ) (7.3 )%
Benefit for Income Tax (612 ) (22.1 )% (15 ) (.1 )%
Net Loss $ (2,384 ) (86.1 )% $ (892 ) (7.2 )%
Net Revenues
Our business operations and financial performance for the year ended December
31, 2020 was adversely impacted by the economic effects of the COVID-19 pandemic
to the U.S. and global economy. For the year ended December 31, 2020 , net
revenues were approximately $2.8 million , a decrease of approximately $9.6
million or 77.7% from $12.4 million in fiscal 2019. The decrease in 2020 net
revenue was driven by the uncertainty felt by retailers, as to the short and
long-term impact on the U.S. retail market of COVID-19 resulting from the
reduction of consumer foot traffic in brick and mortar stores. 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 fund 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 $341.2 thousand
and $1.18 million for the years ended December 31, 2020 and 2019, respectively.
For the years ended
44
--------------------------------------------------------------------------------The following table disaggregates net revenue by major source:
For the Year
Ended
December 31, For the Year Ended
2020 December 31, 2019
Capstone Brand % of Revenue Capstone Brand % of Revenue
Lighting Products- U.S. $ 2,066,519 75 % $ 11,218,714 90 %
Lighting Products-International 703,839 25 % 1,185,731 10 %
Total Revenue $ 2,770,358 100 % $ 12,404,445 100 %
Gross Profit and Cost of Sales
Gross profit for the year endedDecember 31, 2020 , was approximately$504 thousand , or 18.2 % of net revenues, as compared to$2.4 million or 19.6% of net revenues, for fiscal 2019. For the years endedDecember 31, 2020 and 2019, cost of sales were approximately$2.3 million and$10.0 million , respectively, a decrease of$7.7 million or 77% from the previous year. This reduction was the direct result of the reduced revenue in the year. Costs represented 81.8% and 80.4% of net revenues for 2020 and 2019, respectively. Overall product costs overseas remained stable during the year.
Operating Expenses
Sales and Marketing Expenses
In fiscal 2020 and 2019, sales and marketing expenses were approximately$300 thousand and$379 thousand respectively, a decrease of$79 thousand or 20.8%. As a percent to revenue 2020 expenses were 10.9% as compared to 3.1% in 2019. Social Media expense in 2020 was$30.3 thousand , an increase of$13.8 thousand or 83.6% from$16.5 thousand in 2019, as we further developed our Social Media marketing presence in preparation for the launch of the Smart Mirror program. Advertising and promotional expenses were$34.7 thousand in 2020 as compared to$85.6 thousand in 2019, a reduction of$50.9 thousand or 59.5% due to the reduced retail promotional activities during 2020.
Compensation Expenses
For the years endedDecember 31, 2020 and 2019 compensation expenses were approximately$1.5 million and$1.6 million , respectively, a reduction of$39 thousand or 2.5%. As a percent of net revenues 2020 expenses were 54.7% as compared to 12.5% in 2019. With the reduced revenue and the transition of production intoThailand , the Company eliminated 4 positions in theHong Kong office during 2020. Professional Fees For fiscal 2020, professional fees were approximately$423 thousand compared to$435 thousand in 2019, a decrease of$12.2 thousand or 2.8%. As a percent of net revenue 2020 expenses were 15.3% as compared to 3.5% in 2019. In 2020, consulting fees were approximately$165 thousand the same amount as incurred in 2019. Accounting, legal and other expenses were$257 thousand , a decrease of$12 thousand from$270 thousand in the prior year.
Product Development Expenses
For the years endedDecember 31, 2020 and 2019, product development expenses were approximately$250 and$349 thousand , respectively, a decrease of$98.9 thousand or 28.4%. In 2020, the Company invested$182 thousand in the Smart Mirror development compared to$207 thousand in 2019, a reduction of$25 thousand or 7.4%. With the reduced revenue, quality control expenses in 2020 were$44 thousand compared to$98 thousand in 2019, a reduction of$54 thousand or 55.1%. Other expenses such as prototype charges and courier charges were also reduced by$20 thousand from$44 thousand in 2019 to$24 thousand in 2020. As a percent of revenue, 2020 expenses were 9.0% as compared to 2.8% in 2019. We have continued to invest in new product design, software development, product prototyping and testing and related to the Smart Mirror project. 45 --------------------------------------------------------------------------------
Other General and Administrative Expenses
For fiscal 2020 and 2019, other general and administration expenses were approximately$477 thousand and$648 thousand , respectively, a decrease of$171 thousand or 26.3%. As a percent to revenue 2020 expenses were 17.2% as compared to 5.2% in 2019. In 2020 the Company's rent expense was$166 thousand compared to$99 thousand in 2019, an increase of$67 thousand or 67.6%. The Directors insurance also increased in 2020 from$57 thousand in 2019 up to$71 thousand a$14 thousand or 24.6% 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$171 thousand or 26.3% as compared to the same period in 2019. 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, 2020 , 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, 2020 and 2019 was approximately$624 thousand and$0 , respectively. This charge equated to 22.5% of net revenue in 2020.
Total Operating Expenses
For the years endedDecember 31, 2020 and 2019, total operating expenses were$3.6 million and$3.4 million , respectively. This represents a$223 thousand or 6.6% increase over fiscal 2019. The$624 thousand impairment charge was the main reason for the expense increase. If we eliminate the effect of the impairment charge, total operating expenses in fiscal year 2020 would have been$3.0 million , a reduction of approximately$400 thousand or 11.8% from 2019 expense level. Operating Loss
For the year ended
Other Income (Expense)
For fiscal 2020 other income was approximately$90 thousand compared to a$26 thousand in 2019. The other income resulted from the forgiveness of the$90 thousand loan received as part of theSmall Business Administration's Paycheck Protection Program. The Company through a combination of efficient cash flow management, favorable payment terms with our overseas suppliers and a strong cash position was able to eliminate the need for increased borrowing or purchase order funding which resulted in$0 interest expense in 2020 and$3.2 thousand expense in 2019. Benefit for Income Tax For the years endedDecember 31, 2020 and 2019 the net benefit for income tax was estimated at$612 thousand compared to$15 thousand in the same period 2019. The benefit is 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. For the year endedDecember 31, 2020 , the Company has recorded approximately$612 thousand of net benefit for income tax after deferred tax liabilities and has an income tax refundable of$861 thousand .
The effective tax rate for the years ended
46
--------------------------------------------------------------------------------Net Loss
For fiscal 2020 and 2019 net loss was approximately
RESULTS OF OPERATIONS AND BUSINESS OUTLOOK
In 2020, 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 2021 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 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.
By working diligently overseas with alternate manufacturers located outside
As the products we have shipped on our direct import business model typically requires 3 to 4 months lead time, our revenue in 2020 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 for the 3rd and 4th quarters 2021.
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 to
• to design, enhance and build the Smart Mirror product portfolio.
During 2020 we have been able to complete the above priorities and are now preparing for the launch of the Smart Mirror program in 2021.
47
--------------------------------------------------------------------------------Contractual Obligations
The following table represents contractual obligations as ofDecember 31, 2020 . Payments Due by Period Total 2021 2022 2023 After 2024 (In thousands) Purchase Obligations$ 825,690 $ 825,690 $ - $ - $ - Short-Term Debt - - - - - Long-Term Debt - - - - -
Operating and Short Term Leases 170,997 63,307 70,157 37,533
-
Total Contractual Obligations $ 996,687 $ 888,997 $ 70,157 $ 37,533 $ -
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 - None. Operating Leases - Operating lease obligations are related to facility leases for our operations in theU.S. and inHong Kong .
LIQUIDITY AND CAPITAL RESOURCES
The COVID-19 pandemic has significantly affectedU.S. consumer shopping patterns and caused the health of theU.S. economy to deteriorate. We cannot foresee when the COVID-19 pandemic will be effectively contained, nor can we predict the severity and duration of its impact on our business and our financial results. 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, 2020 , the Company used cash in operations of approximately$1.9 million and generated net operating losses of$2.4 million . As ofDecember 31, 2020 , the Company has working capital of approximately$1.4 million and an accumulated deficit of$4.5 million . The Company's cash balance dropped by approximately$1.9 million from$3.1 million as ofDecember 31, 2019 to$1.2 million as ofDecember 31, 2020 . With the reduced revenues in 2020 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. 48 -------------------------------------------------------------------------------- OnJuly 31, 2020 , the Company terminated its factoring agreement withSterling National Bank . The Company has had discussions with alternate funding sources that offer extensive programs that are more in line with the Company's future business model, particularly a facility that provides funding options that are suitable for the e-commerce business that the Company is transitioning into. The borrowing costs associated with such financing are dependent upon market conditions and our credit rating. We have not finalized any institutional funding as of the date of this Form 10-K report, and we cannot assure that we will be able to negotiate competitive rates, which could increase our cost of borrowing in the future. OnJanuary 4, 2021 , the Company entered a$750,000 working capital loan agreement with Directors,Stewart Wallach andJeffrey Postal . The term of the loan startedJanuary 4, 2021 and endsJune 30, 2021 ("Initial Period'). The Company may extend the Initial Period for an additional six consecutive months, endingDecember 31, 2021 , under the same terms and conditions of the Initial Period. The Company may borrow under the agreement up to$750,000 and prepay wholly or partially the unpaid principal amount at any time.
The Company has an income tax refundable as of
The Company for both years ending 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 under the$750,000 working capital line of credit, the operational funding 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.
However, additional capital or increased cash from operations will be required to fund increased revenue levels.
Summary of Cash Flows
Years ended December 31,
2020 2019
(In thousands)
Net cash provided by (used in):
Operating Activities $ (1,858 ) $ (586 )
Investing Activities (13 ) (34 )
Financing Activities (36 ) (71 )
Net (decrease) in cash and cash equivalents
As ofDecember 31, 2020 the Company's working capital was approximately$1.4 million of which$1.2 million was cash. Current liabilities were$889 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$56 thousand . 49
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Cash Flows provided by (used in) Operating Activities
Cash used in operating activities was approximately$1.86 million in 2020 compared with approximately$586 thousand in 2019. The cash used in operating activities in 2020 included the negative cash impact of the net loss, which was approximately$2.38 million , an income tax refundable increase of$641 thousand , which was partially offset by the goodwill impairment charge of approximately$624 thousand ,$260 thousand increase in deferred tax liabilities$174 thousand increase in accounts receivable and prepaid expenses and a$106 thousand from several other accounts.
Cash Flows used in Investing Activities
Cash used in investing activities in 2020 was approximately$13 thousand compared to$34 thousand in 2019. The Company continued to invest in new product molds and tooling. With the 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 used in financing activities for the years ended
As of
The Company has negotiated beneficial payment terms with our main overseas
manufacturers including the new supplier in
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 2020 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.
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--------------------------------------------------------------------------------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. 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.
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--------------------------------------------------------------------------------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, 2020 and 2019, the Company had processed approximately$341.2 thousand and$1.18 million , 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 receivable are recognized at the amount expected to be collected and are not subject to any interest or finance charges. The Company does not have any off-balance sheet credit exposure related to any of its customers. 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, 2020 and 2019, management determined that the accounts receivable is fully collectible. As such, management has not recorded an allowance for doubtful accounts.
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--------------------------------------------------------------------------------The following table summarizes the components of Accounts Receivable, net:
December
31,
2020 2019
Trade Accounts Receivables at period end $
197,166
(77,102 ) (263,092 )
Total Accounts Receivable, net $ 120,064 $ 13,459
Goodwill
On September 13, 2006 , the Company entered into a Stock Purchase Agreement with
Capstone Industries, Inc. , a Florida corporation ("Capstone"). Capstone was
incorporated in Florida on May 15, 1996 and is engaged primarily in the business
of wholesaling technology inspired consumer products to distributors and
retailers in the United States .
Under the Stock Purchase Agreement, the Company acquired 100% of the issued and
outstanding shares of Capstone's Common Stock, and recorded goodwill of
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, 2020 , 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, 2020 was approximately$623.5 thousand .
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,
2020 2019
Balance at the beginning of the period $ 1,936,020 $ 1,936,020
Impairment charges - net (623,538 ) -
Balance at December 31, 2020 $ 1,312,482 $ 1,936,020
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.
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--------------------------------------------------------------------------------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, 2020 , the Company had federal and state net operating loss carry forwards of approximately$1,044,000 and$3,500,000 , 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, 2020 and 2019 was$260,000 and$0 , 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
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, 2020 and 2019. 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 approximately$345,397 . 54
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The Company recognizes liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. While the Company believes that it has appropriate support for the positions taken on its tax returns, the Company regularly assesses the potential outcome of examinations by tax authorities in determining the adequacy of its provision for income taxes.
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