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EX-10.1 - EXHIBIT 10.1 - CAPSTONE FINANCIAL GROUP, INC.capp-20150630_10qex10z1.htm
EX-31.2 - EXHIBIT 31.2 - CAPSTONE FINANCIAL GROUP, INC.capp-20150630_10qex31z2.htm
EX-31.1 - EXHIBIT 31.1 - CAPSTONE FINANCIAL GROUP, INC.capp-20150630_10qex31z1.htm
EX-32.2 - EXHIBIT 32.2 - CAPSTONE FINANCIAL GROUP, INC.capp-20150630_10qex32z2.htm
EX-10.5 - EXHIBIT 10.5 - CAPSTONE FINANCIAL GROUP, INC.capp-20150630_10qex10z5.htm
EX-32.1 - EXHIBIT 32.1 - CAPSTONE FINANCIAL GROUP, INC.capp-20150630_10qex32z1.htm
 
 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2015

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 000-54905

CAPSTONE FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
     
Nevada   46-0684479
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
     
8600 Transit Road, East Amherst, NY   14051
(Address of principal executive offices)   (Zip Code)
     
(866) 798-4478
(Registrant's telephone number, including area code)

 

Copies of Communications to:

Stradling Yocca Carlson & Rauth, P.C.

4365 Executive Drive

Suite 1500

San Diego, CA 92121

(858) 926-3000

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No  

 

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

 

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer   Accelerated filer  

Non-accelerated filer

(Do not check if a smaller reporting company)

  Smaller reporting company  

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

The number of shares of Common Stock, $0.001 par value, outstanding as of August 3, 2015 was 94,364,648 shares.

 
 
 

CAPSTONE FINANCIAL GROUP, INC.

QUARTERLY REPORT FOR THE QUARTER ENDED

JUNE 30, 2015

 

Index to Report on Form 10-Q

 

     
PART I   Financial Information Page
       
Item 1.   Financial Statements (unaudited) 3
       
Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations 16
       
Item 3.   Quantitative and Qualitative Disclosures About Market Risk 24
       
Item 4.   Controls and Procedures 24
       
PART II   Other Information  
       
Item 1.   Legal Proceedings 26
     
Item1A.   Risk Factors 26
       
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds 26
       
Item 3.   Defaults Upon Senior Securities 26
       
Item 4.   Mine Safety Disclosures 26
       
Item 5.   Other Information 26
       
Item 6.   Exhibits 27
       
-2-
 

 

PART I     Financial Information

 

Item 1.     Financial Statements

 

CAPSTONE FINANCIAL GROUP, INC.

INDEX TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

    PAGES 
      
Unaudited Condensed Statements of Financial Condition as of June 30, 2015 and December 31, 2014   4 
      
Unaudited Condensed Statements of Operations for the three months and six months periods ended June 30, 2015 and 2014   5 
      
Unaudited Condensed Statements of Cash Flows for the six months ended June 30, 2015 and 2014   6 
      
Notes to Unaudited Condensed Financial Statements   7 

 

-3-
 

CAPSTONE FINANCIAL GROUP, INC.

UNAUDITED CONDENSED STATEMENTS OF FINANCIAL CONDITION

 

   June 30,
2015
  December 31,
2014
ASSETS          
Financial instruments owned, at fair value  $14,154,841   $28,838,301 
Cash   1,560,422    12,685 
Accounts receivable   120,000    —   
Note receivable   —      603,952 
Prepaid expense   20,927    86,209 
Furniture and equipment, net   7,539    6,500 
Deposits   85,000    65,000 
Total assets   15,948,729    29,612,647 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
LIABILITIES          
Accrued expenses  $57,820   $48,547 
Accrued interest payable - related party   12,954    4,431 
Short term advances payable - related party   85,131    94,306 
Note payable - related party   553,552    1,203,552 
Deferred revenue   16,660    116,662 
Put and call option liability   847,576    9,973,684 
Income taxes payable   201,607    —   
Deferred tax liability   5,098,070    6,742,723 
Total liabilities   6,873,370    18,183,905 
           
STOCKHOLDERS' EQUITY          
Common stock, $0.001 par value, 2,000,000,000 shares authorized;          
94,364,648 and 94,564,648 issued and outstanding as of          
June 30, 2015 and December 31, 2014, respectively   94,365    94,565 
Additional paid in capital   958,422    1,176,633 
 Retained earnings   8,022,572    10,157,544 
Total stockholders' equity   9,075,359    11,428,742 
Total liabilities and stockholders' equity  $15,948,729   $29,612,647 

 

See Accompanying Notes to Unaudited Condensed Financial Statements.

 

-4-
 

CAPSTONE FINANCIAL GROUP, INC.

UNAUDITED CONDENSED STATEMENTS OF OPERATIONS

 

    

For the three months ended

    

For the six months ended

 
    June 30,    June 30, 
    2015    2014    2015    2014 
Revenues                    
Services income  $50,001   $—     $100,002   $—   
Interest – related party   7,014    10,188    14,460    18,695 
    57,015    10,188    114,462    18,695 
Expenses                    
Payroll   48,158    45,821    91,545    122,155 
Professional fees   340,596    102,960    601,594    185,522 
General and administrative   151,617    186,876    308,325    365,936 
Interest expense – related party   3,468    7,008    8,524    11,831 
    543,839    342,665    1,009,988    685,444 
                     
Realized and Unrealized Gain (Loss) on Financial Instruments                    
Realized gain (loss) on financial instruments, net   (2,286,616)   13,584    (826,456)   13,584 
Unrealized (loss) on financial instruments, net   (395,876)   —      (1,856,036)   (2,919)
Gain (loss) on financial instruments, net   (2,682,492)   13,584    (2,682,492)   10,665 
                     
Net (loss) before income taxes  (3,169,316)  (318,893)  (3,578,018)  (656,084)
Income tax (benefit)   (1,443,046)   —      (1,443,046)   —   
Net (loss)  $(1,726,270)  $(318,893)  $(2,134,972)  $(656,084)
Net (loss) per share – basic and diluted  $(0.02)  $(0.00)  $(0.02)  $(0.01)
Weighted average shares outstanding – basic and diluted   94,553,659    93,758,721    94,559,123    93,499,507 
                     

 

See Accompanying Notes to Unaudited Condensed Financial Statements.

 

-5-
 

CAPSTONE FINANCIAL GROUP, INC.

UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS

 

    For the six months ended
    June 30,
  2015    2014
CASH FLOW FROM OPERATING ACTIVITIES          
Net loss  $(2,134,972)  $(656,084)
Adjustments to reconcile net (loss) to net cash used in operating activities:          
Sale (purchase) of financial instruments, net   2,754,860    (2,919)
Net change in unrealized gain on financial instruments   1,856,036    2,919 
Net change in realized gain on financial instruments   826,456    —   
Depreciation   1,000    —   
(Increase) decrease in assets:          
Note receivable   400,000    —   
Accrued interest receivable – related party   (14,459)   (18,695)
Prepaid expense   65,282    14,956 
Deposits   (20,000)   (75,800)
Increase (decrease) in liabilities:          
Accounts payable   —      (12,973)
Accrued expenses   9,273    (11,032)
Accrued interest payable – related party   8,523    11,831 
Deferred revenue   (100,002)   —   
Net repayments on notes payable – related party   (650,000)   (151,937)
Net repayments on short term advances – related party   (9,175)   —   
Income taxes payable   201,607    —   
Deferred tax liability   (1,644,653)   —   
Net cash provided by (used) in operating activities   1,549,776    (899,734)
           
CASH FLOWS FROM INVESTING ACTIVITIES          
Purchase of furniture and equipment   (2,039)   —   
Net cash used in investing activities   (2,039)   —   
           
CASH FLOWS FROM FINANCING ACTIVITIES          
Proceeds from sale of common stock, net of offering costs   —      909,200 
Net cash provided by financing activities   —      909,200 
Increase in cash   1,547,737    9,466 
Cash at beginning of period   12,685    —   
Cash at end of period  $1,560,422   $9,466 
           

 

Supplemental Disclosure of Cash Flow Information:

 

Noncash purchase of treasury stock  $218,411   $—   

 

 See Accompanying Notes to Unaudited Condensed Financial Statements.

 

-6-
 

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

 

NOTE 1 – ORGANIZATION AND DESCRIPTION OF BUSINESS

 

Organization

 

The business focus of Capstone Financial Group, Inc. (the "Company") is to invest in equity securities of other companies. The Company seeks to discover, unlock and grow value in privately-held or illiquid companies, including through the exercise of friendly influence at a company in support of operational improvements and strategic initiatives. In some cases, the Company might be one of the largest shareholders of the other company.

 

The Company seeks to work closely and constructively with the management and boards of the other companies. While the Company does not manage the day-to-day operations of these companies, the Company seeks to maintain a thorough understanding of how they operate and evaluate their performance and prospects on an ongoing basis.

 

The Company may also seek to actively trade in its strategic investment positions and/or enter into private securities transactions with regard to those positions, to capitalize on price fluctuations and realize profits or minimize losses.

 

The Company was incorporated on July 10, 2012 under the laws of the State of Nevada, as Creative App Solutions, Inc. On August 23, 2013, the Company amended its articles of incorporation and changed its name to Capstone Financial Group, Inc.

 

Through December 31, 2012, the Company had not commenced significant operations and, in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 915, the Company was considered a development stage company. During the year ended December 31, 2013, the Company exited the development stage. Effective in 2014, the Company transitioned its business plan to its current business focus.

 

At June 30, 2015 the Company’s investments are entirely focused in one entity, Twinlab Consolidated Holdings, Inc. (“Twinlab”). Management believes that it will be able to liquidate a sufficient portion of its investment and/or raise additional capital to avoid and/or satisfy its call obligations as and when they become due and/or are exercised. However, no assurance can be given that market conditions in the future will continue to allow the Company to sell its investments in sufficient quantities to enable full warrant exercises or to raise additional capital to do so (see Note 6).

 

-7-
 

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

 

NOTE 2 – BASIS OF PRESENTATION

 

The accompanying unaudited condensed financial statements of have been prepared in accordance with financial reporting conventions of the investment company industry and United States generally accepted accounting principles (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 8 of Securities and Exchange Commission (“SEC”) Regulation S-X.  Accordingly, they should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2014, included in the Company’s Annual Report on Form 10-K filed with the SEC on April 30, 2015. The unaudited condensed financial statements contain all normal recurring accruals and adjustments that in the opinion of management, are necessary to present fairly the financial position of the Company at June 30, 2015, the results of the Company’s operations for the three months and six months periods ended June 30, 2015 and the Company’s cash flows for the six months ended June 30, 2015. It should be understood that accounting measurements at interim dates inherently involve greater reliance on estimates than at year-end. The results of operations for the three months and six months periods ended June 30, 2015 are not necessarily indicative of the results to be expected for the full year or any future interim periods.

 

NOTE 3 – RECENT ACCOUNTING PRONOUNCEMENTS

 

The Company has evaluated the recent accounting pronouncements through the date of this filing, and management does not expect adoption of such pronouncements to have an impact on the Company’s financial statements.

 

NOTE 4 – FAIR VALUE MEASUREMENTS

 

GAAP defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. GAAP establishes a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels: 

  Level 1: Inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

 

  Level 2: Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets; inputs to the valuation methodology include quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs to the valuation methodology that are derived principally from or can be corroborated by observable market data by correlation or other means.

 

  Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Level 3 assets and liabilities include financial instruments whose value is determined using discounted cash flow methodologies, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

 

-8-
 

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

 

The Company’s financial instruments are valued by level within the fair value hierarchy. Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The valuation methodology for each investment type and discussion of key unobservable inputs is described below.

 

Common Stocks

 

Generally, when the Company invests in common stocks that are traded on the NASDAQ Markets or over-the-counter markets (such as the OTCBB, OTCQB or OTC Pink marketplaces), such common stocks are valued at the last traded price. If there is no trade on a measurement date, the Company will typically value the common stock at the closing bid price. However, in certain circumstances, the closing trading price is not considered to be a fair indication of the value for which the Company can sell the common stock. In such cases, the common stock must be analyzed to determine what exit price the Company would receive when liquidating the position. Investments in non-marketable common stocks at June 30, 2015 and December 31, 2014 were valued based on subsequent transactions with unrelated third parties. These positions are classified as Level 3 securities by the Company.

 

Derivative Financial Instruments

 

Derivative financial instruments include call and put options and warrants at June 30, 2015 and December 31, 2014. Derivatives are accounted for at fair value with changes in fair value reported in operations. The significant unobservable inputs used in the fair value measurement of the Company’s derivative financial instruments include the underlying common stock, duration, volatility and discount rate, which are used in the Black-Scholes and Monte Carlo valuation models. Changes to any of those inputs in isolation would result in fluctuations in the fair value measurement.

 

NOTE 5 – MARKET, CREDIT AND LIQUIDITY RISK

 

Market risk is the potential loss the Company may incur as a result of changes in the market or fair value of a particular financial instrument. Risks arise in options and warrant contracts from changes in the market or fair value of their underlying financial instruments.

 

Credit risk is the potential loss the Company may incur as a result of the failure of a counterparty or an issuer to make payments according to the terms of a contract. Credit risk can arise from investment activities in financially distressed issuers. To manage this risk, the Company may seek to diversify its investment portfolio with respect to specific credits, sectors and asset classes.

 

The Company is also subject to market concentration risk since a significant portion of its investment portfolio has similar characteristics, and is therefore affected similarly by changes in economic conditions.

 

Investments of the Company trade in relatively thin markets and throughout the year, depending upon market conditions, may be considered illiquid. As a result, the market values can be more volatile and difficult to determine relative to other securities. In addition, if the Company is required to liquidate all or a portion of its portfolio quickly, it may realize significantly less than the value at which it previously recorded its financial instruments.

 

-9-
 

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

 

NOTE 6 – INVESTMENTS, AT FAIR VALUE

 

Financial instruments, net are comprised of the following at June 30, 2015.

 

   Cost  Estimated
Fair Value
ASSETS          
Common Stock  $504,315   $10,649,197 
2014 Call Options   450    1,138,860 
Series B Warrants   —      2,366,784 
   $504,765   $14,154,841 
           
LIABILITIES          
Contingent Call Options  $—     $(225,599)
Third-Party Call Options   —      (621,977)
   $—     $(847,576)

 

The Company records the sales of securities on a trade date basis and at June 30, 2015 had a receivable of $120,000 related to two such sales, both of which were fully settled in July 2015.

 

Financial instruments, net are comprised of the following at December 31, 2014.

 

   Cost  Estimated
Fair Value
ASSETS          
Common Stocks  $6,212   $8,018,621 
2014 Call Options   2,492    6,644,680 
Series A Warrants   —      9,947,368 
Series B Warrants   —      4,227,632 
   $8,704   $28,838,301 
           
LIABILITIES          
Warrant Put Option  $—     $(9,973,684)

 

During the first quarter of 2014, the Company purchased shares in a company (other than Twinlab) traded on the OTC Markets for a total of $2,919. The Company currently categorizes these holdings as Level 3 assets. As of June 30, 2015, this investment is carried at $0 value under management’s valuation guidelines.

 

-10-
 

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

 

In August 2014, the Company purchased 10,987,500 split-adjusted shares of common stock of Twinlab in private transactions from 25 shareholders for total consideration of $3,296.

 

In August 2014, the Company purchased options to acquire 8,743,000 outstanding shares of Twinlab’s Common Stock (collectively, the “2014 Call Options”) in a private transaction from 14 stockholders, for total consideration of $2,623. The 2014 Call Options exercise price is $0.0001 per share and the 2014 Call Options expire in August 2015. Such options are immediately exercisable and in February 2015, the Company exercised 7,244,500 of those options.

 

In September 2014, Twinlab issued to the Company a Series A Warrant to purchase up to 52,631,579 shares of Twinlab’s Common Stock at an exercise price of $0.76 per share (the “Series A Warrant”) and a Series B Warrant to purchase up to 22,368,421 shares of Twinlab’s Common Stock at an exercise price of $0.76 per share (the “Series B Warrant”). Both the Series A Warrant and the Series B Warrant were exercisable from October 2014 through October 2017.

 

Twinlab and the Company also entered into a Common Stock Put Agreement, dated as of September 30, 2014, as amended on December 15, 2014 (the “Put Agreement”). Pursuant to the Put Agreement, if the Company did not exercise the Series A Warrant by February 16, 2015 and thereafter at a rate of no less than 1,461,988 shares of Common Stock (the “Minimum Amount”) per month (the “Minimum Rate”) over the term of the Series A Warrant, Twinlab had the right (subject to certain conditions) to require the Company to exercise the Series A Warrant at the Minimum Rate for the duration of the Series A Warrant.

 

During the six months ended June 30, 2015, the Company sold an aggregate of 3,976,647 units of Twinlab securities to various unrelated third party accredited investors. Each unit consisted of one share of (unrestricted) Twinlab common stock and a detachable call option to purchase from the Company, for $1.00 per share, one (restricted) share of Twinlab common stock. The term of each such call option was three years from the respective unit sale date.

 

-11-
 

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

 

Twinlab and the Company also entered into a Compromise Agreement and Release and an Amendment No. 1 to Series B Warrant, each dated as of May 28, 2015, pursuant to which, among other things: (a) the Company surrendered the entire remaining-unexercised portion of the Series A Warrant (51,973,684 warrants) and 4,368,421 of the warrants under the Series B Warrant; (b) the Put Agreement was terminated; (c) the remaining 18,000,000 warrants under the Series B Warrant were deemed divided into four tranches, each with an associated date beyond which it would no longer be exercisable: one tranche for 2,000,000 warrant shares (no longer exercisable after November 30, 2015), one for 4,000,000 warrant shares (no longer exercisable after March 31, 2016), one for 6,000,000 warrant shares (no longer exercisable after July 31, 2016) and another for 6,000,000 warrant shares (no longer exercisable after November 30, 2016); and (d) the Company granted Twinlab three contingent call options, at $0.01 per share, to acquire Twinlab shares from the Company to the extent that upon effective expiration of the second, third and fourth tranches the Company had not exercised the warrants within such tranches (the “Contingent Call Options”). The three Contingent Call Options would be for a number of Twinlab shares equal to 25% of such unexercised warrants (i.e., a maximum of 1,000,000 shares if the Company exercised no warrants from the second tranche, a maximum of 1,500,000 shares if the Company exercised no warrants from the third tranche and a maximum of 1,500,000 shares if the Company exercised no warrants from the fourth tranche). In addition, Twinlab cannot exercise a Contingent Call Option unless it has satisfied such option’s “Liquidity Condition,” namely that for each of the three or four months before the tranche’s effective expiration date Twinlab must have a financial position sufficient to show a 1.15x fixed charge coverage ratio for a certain trailing period, all as defined by Twinlab’s Credit and Security Agreement dated January 22, 2015. Twinlab also agreed in the Compromise Agreement and Release that, given that the Company has identified, and may in the future identify, to Twinlab on a confidential basis persons to whom the Company might sell the Company’s Twinlab shares, Twinlab shall not, without the Company’s prior written consent, privately place Twinlab equity securities to any persons theretofore or thereafter first introduced to Twinlab by the Company; provided that Twinlab may, without the Company’s consent, privately place Twinlab equity securities to such a person at any time after the earlier of (a) the date the entire Series B Warrant has expired and/or been exercised, or (b) the first anniversary of such particular introduction.

 

Fair Value of Financial Instruments

 

The Company's financial instruments recorded at fair value have been categorized based upon a fair value hierarchy. The following fair value hierarchy table presents information about the Company's financial instruments measured at fair value.

-12-
 

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

 

   Assets and Liabilities Measured at
   Fair Value on a Recurring Basis
   June 30, 2015
    Level 1    Level 2    Level 3    Total 
Assets                    
Financial instruments, at fair value:                    
Common Stocks  $—     $—     $10,649,197   $10,649,197 
2014 Call Options   —      —      1,138,860    1,138,860 
Series B Warrants   —      —      2,366,784    2,366,784 
Total financial instruments, at fair value   —      —      14,154,841    14,154,841 
Total assets held at fair value  $—     $—     $14,154,841   $14,154,841 
                     
Liabilities                    
Financial instruments, at fair value:                    
Third-Party Call Options  $—     $—     $621,977   $621,977 
Contingent  Call Options   —      —      225,599    225,599 
Total liabilities held at fair value  $—     $—     $847,576   $847,576 

 

   Assets and Liabilities Measured at
   Fair Value on a Recurring Basis
   December 31, 2014
    Level 1    Level 2    Level 3    Total 
Assets                    
Financial instruments, at fair value:                    
Common Stocks  $—     $—     $8,018,621   $8,018,621 
2014 Call Options   —      —      6,644,680    6,644,680 
Series A Warrants   —      —      9,947,368    9,947,368 
Series B Warrants   —      —      4,227,632    4,227,632 
Total financial instruments, at fair value   —      —      28,838,301    28,838,301 
Total assets held at fair value  $—     $—     $28,838,301   $28,838,301 
                     
Liabilities                    
 Financial instruments, at fair value:                    
Warrant Put Option   —      —      9,973,684    9,973,684 
Total liabilities held at fair value  $—     $—     $9,973,684   $9,973,684 

 

This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. For some products or in certain market conditions, observable inputs used in valuing certain financial assets and liabilities were unavailable. In situations where there is little, if any, market activity for an asset or liability at the measurement date, the fair value measurement objective remains to measure the financial asset at the price that would be received by the holder of the financial asset (or liability) in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date.

 

-13-
 

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

 

The following table presents a summary of changes in the fair value amounts of the financial instruments classified within Level 3 for the three and six months ended June 30, 2015.

 

  

Common Stock

 

2014 Call Options

 

Series A Warrants

 

Series B Warrants

 

Put Option Liability

 

Call Option Liability

 

Total

Fair value, net, January 1, 2015  $8,018,621   $6,644,680   $9,947,368   $4,227,632   $(9,973,684)  $—     $18,864,617 
Total gains (losses) included in earnings:                                   
Unrealized gains (losses)   4,045,660    (5,505,820)   —      —      —      —      (1,460,160)
Fair value, net, March 31, 2015   12,064,281    1,138,860    9,947,368    4,227,632    (9,973,684)   —      17,404,457 
Total gains (losses) included in earnings:                                   
Unrealized gains (losses)   (1,915,084)   —      —      2,366,784    —      (847,576)   (395,876)
Realized gains (losses)   —      —      (9,823,026)   (4,227,632)   9,849,013    —      (4,201,645)
Exercised   500,000   —      (124,342)   —      124,671    —      500,329 
Fair value, net,
June 30, 2015
  $10,649,197   $1,138,860   $—     $2,366,784   $ —     $(847,576)  $13,307,265 

 

NOTE 7 – INCOME TAXES

 

The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined on the basis of the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Income tax benefit for the six months ended June 30, 2015 was $1,443,046 at an effective tax rate of 40.33%, which was greater than the federal statutory rate due to the state income tax expense.

 

The impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more likely than not to be sustained upon audit by the relevant tax authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. The disclosures regarding the Company's unrecognized tax benefits at December 31, 2014 included in the Company's 2014 Annual Report on Form 10-K continue to be relevant for the periods ended June 30, 2015 as to the Company’s unrecognized tax benefits at June 30, 2015.

 

-14-
 

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

 

NOTE 8 – SUBSEQUENT EVENTS

 

The Company has evaluated subsequent events through the date the financial statements were available to be issued. Except as noted below, there are no events which require adjustments to, or disclosure in, the financial statements for the periods ended June 30, 2015.

 

In July 2015, the Company sold 168,420 Twinlab shares to unrelated third parties for $128,000. In August 2015 through the date the financial statements were available to be issued, the Company sold 198,000 Twinlab shares to an unrelated third party for $150,480.

 

In July 2015, the Company made two partial exercises of the Series B Warrant and received 657,895 Twinlab shares in exchange for an aggregate exercise price of $500,000.

 

In July 2015, in exchange for $277,500, the Company acquired a 20% interest in privately-held Western New York real estate companies LC Strategic Realty, LLC and LC Strategic Holdings, LLC, as well as in all other business conducted or to be conducted by the firms’ majority holders to the extent such other business has a primary focus on (a) real estate (subject to the exclusion of certain specified projects), (b) media/entertainment/show business, or (c) endorsements/advertisements/personal appearances/use of likeness/monetization of celebrity.

 

-15-
 

ITEM 2.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q contains forward-looking statements and involves risks and uncertainties that could materially affect expected results of operations, liquidity, cash flows, and business prospects. Forward-looking statements may appear throughout this report, including without limitation, the following sections: Part I Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Forward-looking statements generally can be identified by words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “predicts,” “projects,” “will be,” “will continue,” “will likely result,” and similar expressions. These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties, which could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on April 30, 2015, and in particular, the risks discussed under the caption “Risk Factors” in Part I Item 1A thereof, and those discussed in other documents we file with the SEC. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

 

Overview and Outlook

 

Our business focus is to use our own capital to acquire the outstanding equity securities of other companies. We do not produce goods or services ourselves. Rather, our primary purpose is to own and trade shares of other companies. We seek to discover, unlock and grow value in privately-held or illiquid companies, including through the exercise of friendly influence at a company in support of operational improvements and strategic initiatives. In some cases, we might be one of the largest shareholders of the other company.

 

We seek to work closely and constructively with the management and boards of the other companies. While we do not manage the day-to-day operations of these companies, we seek to maintain a thorough understanding of how they operate and evaluate their performance and prospects on an ongoing basis.

 

We may also seek to actively trade in our strategic investment positions and/or enter into private securities transactions with regard to those positions, to capitalize on price fluctuations and realize profits or minimize losses.

 

We were initially formed to design and sell mobile apps for smart phones and other mobile platforms such as tablets. We never launched an active business based on this focus.

 

During the third quarter of 2013, we refocused ourselves as a financial services company.

 

On January 15, 2014, in support of our financial services business focus, we effected a reverse triangular merger whereby Capstone Affluent Strategies, Inc. (“Affluent”), a California corporation, became our wholly owned subsidiary. Affluent, a financial services company, had been wholly owned by Darin Pastor.

 

In March 2014, we refocused ourselves again, to our current business model. We believe our current business model is likely to result in lower expenses levels than would have been associated with our financial services company business model.

 

-16-
 

On August 11, 2014, we effectively unwound the Affluent merger transaction, due to Affluent’s inability to produce audited financial statements as required and the change in our business focus. In October 2014, we acquired from Darin Pastor certain Affluent assets and assumed certain Affluent liabilities. (Affluent had been dissolved earlier in 2014.)

 

Currently our primary strategic investment position is in securities of Twinlab Consolidated Holdings, Inc. (“Twinlab”). In August 2014, we purchased 10,987,500 shares of common stock of Twinlab in private transactions from 25 shareholders, for nominal consideration. Additionally, in August 2014, we purchased options to acquire 8,743,000 currently-outstanding shares of Twinlab’s common stock (collectively, the “2014 Call Options”) from 14 shareholders in a private transaction, for nominal consideration. The 2014 Call Options exercise price is $0.0001 per share and the 2014 Call Options expiration date was August 2015. (In February 2015, we exercised the Call Options. Optionors honored the exercise as to 7,244,500 Twinlab shares. Other optionors have not yet honored the exercise, as to at least 1,498,500 Twinlab shares. We intend, if necessary, to file suit to enforce the exercises as to those shares.)

 

On September 30, 2014, Twinlab issued to us a Series A Warrant to purchase up to 52,631,579 shares of Twinlab common stock at an exercise price of $0.76 per share (the “Series A Warrant”), and a Series B Warrant to purchase up to 22,368,421 shares of Twinlab common stock at an exercise price of $0.76 per share (the “Series B Warrant”). By their original terms, the Series A Warrant and the Series B Warrant were both exercisable from October 2014 through October 2017.

 

On September 30, 2014, Twinlab and we also entered into the Put Agreement. Pursuant to the Put Agreement, if we did not exercise the Series A Warrant by February 16, 2015 and thereafter at a rate of no less than 1,461,988 shares of Twinlab common stock (the “Minimum Amount”) per month (the “Minimum Rate”) over the term of the Series A Warrant, Twinlab had the right (subject to certain conditions) to require us to exercise the Series A Warrant at the Minimum Rate for the duration of the Series A Warrant. In the event Twinlab exercised its right to require us to exercise the Series A Warrant, the purchase price per share of Twinlab common stock thereunder would have been $0.775.

 

We did not exercise the “Minimum Amount” of shares per the Put Agreement. In April 2015 we exercised the Series A Warrant as to 657,895 Twinlab shares.

 

In November 2014, we sold 436,681 of our Twinlab shares for approximately $1,000,000.

 

During the six months ended June 30, 2015, we sold an aggregate of 3,976,647 units of Twinlab securities to various unrelated third party accredited investors. Each unit consisted of one share of (unrestricted) Twinlab common stock and a detachable call option (“Third-Party Call Options”) to purchase from us, for $1.00 per share, one (restricted) share of Twinlab common stock. The term of each such call option was three years from the respective unit sale date. In each case, the sale price per unit was $0.76. In the first quarter of 2015 we sold 1,921,497 Twinlab shares and Third-Party Call Options for $1,460,340. In the second quarter of 2015 we sold 2,055,150 Twinlab shares and Third-Party Call Options for $1,561,920.

 

In addition, in the second quarter of 2015 we sold 464,466 Twinlab shares (without any associated Third-Party Call Options) for $353,000.

 

In total, during the six months ended June 30, 2015 we sold Twinlab securities for $3,375,260.

 

-17-
 

On May 28, 2015, we entered into a Compromise Agreement and Release and an Amendment No. 1 to Series B Warrant, each between Twinlab and us. Pursuant to these two agreements:

 

  - The Put Agreement was terminated.
  - We surrendered the entire remaining-unexercised portion of the Series A Warrant (51,973,684 warrants).
  - We surrendered 4,368,421 of the warrants under the Series B Warrant.
  - The remaining 18,000,000 warrants under the Series B Warrant were deemed divided into four tranches, each with an associated date beyond which it would no longer be exercisable: one tranche for 2,000,000 warrant shares (no longer exercisable after November 30, 2015); one for 4,000,000 warrant shares (no longer exercisable after March 31, 2016); one for 6,000,000 warrant shares (no longer exercisable after July 31, 2016); and another for 6,000,000 warrant shares (no longer exercisable after November 30, 2016);
  - We granted Twinlab three contingent call options, at $0.01 per share, to acquire Twinlab shares from us to the extent that upon effective expiration of the second, third and fourth tranches we had not exercised the warrants within such tranches (the “Contingent Call Options”). The three Contingent Call Options would be for a number of Twinlab shares equal to 25% of such unexercised warrants (i.e., a maximum of 1,000,000 shares if we exercised no warrants from the second tranche, a maximum of 1,500,000 shares if we exercised no warrants from the third tranche and a maximum of 1,500,000 shares if we exercised no warrants from the fourth tranche). In addition, Twinlab cannot exercise a Contingent Call Option unless it has satisfied such option’s “Liquidity Condition,” namely that for each of the three or four months before the tranche’s effective expiration date Twinlab must have a financial position sufficient to show a 1.15x fixed charge coverage ratio for a certain trailing period, all as defined by Twinlab’s Credit and Security Agreement dated January 22, 2015.
  - Given that we have identified, and may in the future identify, to Twinlab on a confidential basis persons to whom we might sell our Twinlab shares, Twinlab agreed that it shall not, without our prior written consent, privately place Twinlab equity securities to any persons theretofore or thereafter first introduced to Twinlab by us; provided that Twinlab may, without our consent, privately place Twinlab equity securities to such a person at any time after the earlier of (a) the date the entire Series B Warrant has expired and/or been exercised, or (b) the first anniversary of such particular introduction.

 

As a result of these two agreements, our investment position in Twinlab as of immediately after the two agreements was as follows:

 

  - We have no further potential cash obligation to Twinlab under the Put Agreement; an imminent cash obligation to Twinlab of approximately $40.8 million was thereby avoided.
  -

We retained all of our 14,476,567 outstanding Twinlab shares (13,818,672 unrestricted, free-trading Twinlab shares and 657,895 restricted Twinlab shares).

-          Later in the second quarter of 2015 we sold an additional 464,466 unrestricted, free-trading Twinlab shares to accredited investors.

-          Our obligations to our accredited-investor counterparties under the 3,976,647 Third-Party Call options continued unchanged.

-          We obtained an additional 526,316 restricted Twinlab shares upon a partial exercise of the Series B Warrant on July 7, 2015.

-          We obtained an additional 131,579 restricted Twinlab shares upon a partial exercise of the Series B Warrant on July 23, 2015.

 

-18-
 
  -

We retained 18,000,000 warrants under the Series B Warrant, at an unchanged $0.76 per share exercise price, with effective expiration dates ranging from November 30, 2015 to November 30, 2016 (and with at least 14 months of remaining term for 12,000,000 of the warrants).

-          We exercised 526,316 of such warrants on July 7, 2015.

-          We exercised 131,579 of such warrants on July 23, 2015.

  - The Registration Rights Agreement remains in full force and effect to enable the Securities Act registration of all Twinlab shares issued upon exercise of the Series B Warrant.
  - Under the Contingent Call Options, we undertook a contingent obligation to deliver to Twinlab (at $0.01 per share) up to 4,000,000 Twinlab shares, but the obligation would be reduced or entirely eliminated to the extent we exercise the last three deemed tranches of the Series B Warrant and/or to the extent that Twinlab fails to meet a required fixed charge coverage ratio for certain months. The redelivered Twinlab shares would not have to be free-trading Twinlab shares.

 

At June 30, 2015, the fair value of the liability under the 3,976,647 Third-Party Call Options was recorded on our balance sheet at $621,977.

 

At June 30, 2015, the fair value of the liability under the Contingent Call Options was recorded on our balance sheet at $225,599.

 

On October 28, 2014, we entered into a transaction in which we acquired from Darin Pastor certain assets which had been assets of Affluent and assumed certain liabilities which had been liabilities of Affluent, including liabilities under notes in favor of Darin Pastor. At June 30, 2015, the outstanding principal amount of and accrued interest on such assumed notes was $566,506.

 

In July 2015, in exchange for $277,500, we acquired a 20% interest in privately-held Western New York real estate companies LC Strategic Realty, LLC and LC Strategic Holdings, LLC, as well as in all other business conducted by the firms’ majority holders to the extent such other business has a primary focus on (a) real estate (subject to the exclusion of certain specified projects), (b) media/entertainment/show business, or (c) endorsements/advertisements/personal appearances/use of likeness/ monetization of celebrity.

 

On June 17 and 18, 2015, we filed a Form 4 and an amended Schedule 13D statement to report a June 10, 2015 sale by us of 13,157,895 shares of Twinlab common stock to a third party. The third party did not timely honor its payment obligation under the sale contract and still had not honored it as of the filing date of this Quarterly Report on Form 10-Q, and accordingly we will not reflect this “sale” in our financial statements until the quarter (if ever) when the purchase price is actually paid, and until then we will treat the transaction as a non-event for financial reporting purposes.

 

We currently are considering electing to become a Business Development Company and/or filing (or causing an affiliated company to file) an application with the United States Small Business Administration to become a Small Business Investment Company. We can give no assurance that such an application will be filed or that, if filed, it will be granted.

 

-19-
 

Results of Operations for the Quarterly Periods Ended June 30, 2015 and 2014

 

Revenues.  Total revenues (excluding gain and loss on investment securities) for the quarters ended June 30, 2015 and 2014 were $57,015 and $10,188. The 2015 period included services income of $50,001. Due to our current business focus, we do not expect to regularly generate material amounts of services income.

 

Realized and Unrealized Gain (Loss) on Financial Instruments. We recorded a $2,286,616 realized loss on financial instruments for the quarter ended June 30, 2015 as a result of the May 28, 2015 transaction with Twinlab in which we surrendered the entire remaining-unexercised portion of the Series A Warrants (51,973,684 warrants) and amended the Series B Warrant terms and amount (combined realized loss of $14,050,658) and the Put Agreement was terminated (realized gain of $9,849,013), together with our combined sales of 2,519,616 Twinlab shares to third parties during the quarter (realized gain of $1,915,084). We also recorded a $395,876 unrealized loss on financial instruments for the quarter ended June 30, 2015 as a result of such sales of 2,519,616 Twinlab shares to third parties during the quarter (resulting in a transfer of $1,915,084 of gain from the category of unrealized gain to the category of realized gain) and unrealized loss of $621,977 for the establishment of the Third-Party Call Options and $225,599 for the establishment of the Contingent Call Options, partially offset by $2,366,784 of unrealized gain recorded for the Series B Warrant as amended on May 28, 2015. The overall net loss on financial instruments for the quarter was $2,682,492.

 

If our assessments/estimates of the fair value of our holdings of Twinlab securities were to change from quarter to quarter, there could be significant changes in our unrealized gain on such holdings, which in turn would result in significant gain or loss on our statement of operations for the quarter in question. However, at both March 31, 2015 and June 30, 2015, our determination was that the fair value of Twinlab common stock was $0.76 per Twinlab share. Accordingly, there was no such gain or loss on our statement of operations for the quarter ended June 30, 2015 due to any such change in valuation. Although our sales of Twinlab stock in the second quarter of 2015 generated $1,914,920 (of which $120,000 was not actually received in cash until the third quarter), we did not record an overall net gain on financial instruments on such sales, because the sales prices ($0.76 per share) were the same as the fair value we had determined for our Twinlab stock and at which we were carrying the Twinlab stock on our books. The sales merely resulted in a transfer of unrealized gain to realized gain.

 

We did not own any Twinlab securities in the second quarter of 2014.

 

Payroll.  Payroll for the quarters ended June 30, 2015 and 2014 was $48,158 and $45,821, respectively. We are holding the salaries of our most senior officers at very low levels.

 

Professional Fees.  Professional fees for the quarters ended June 30, 2015 and 2014 were $340,596 and $102,960, respectively. The increase was primarily due to legal fees for preparing documents for production as required by legal process, and accounting and legal fees related to required restatements of financial statements and amendments of previous SEC periodic reports.

 

General and Administrative.  General and administrative expenses (excluding payroll expense and professional fees) for the quarters ended June 30, 2015 and 2014 were $151,617 and $186,876, respectively; the decrease in 2015 was primarily due to the absence of rent expense in April 2015, before the start of our 126-month lease for our East Amherst, New York headquarters building.

 

-20-
 

Results of Operations for the Six Months Periods Ended June 30, 2015 and 2014

 

Revenues.  Total revenues (excluding gain and loss on investment securities) for the six months periods ended June 30, 2015 and 2014 were $114,462 and $18,695. The 2015 period included services income of $100,002. Due to our current business focus, we do not expect to regularly generate material amounts of services income.

 

Realized and Unrealized Gain (Loss) on Financial Instruments. We recorded a $826,456 realized loss on financial instruments for the six months period ended June 30, 2015 as a result of the May 28, 2015 transaction with Twinlab in which we surrendered the entire remaining-unexercised portion of the Series A Warrants (51,973,684 warrants) and amended the Series B Warrant terms and amount (combined realized loss of $14,050,658) and the Put Agreement was terminated (realized gain of $9,849,013), together with our combined sales of 4,441,113 Twinlab shares to third parties during the six months period (realized gain of $3,375,260). We also recorded a $1,856,036 unrealized loss on financial instruments for the six months period ended June 30, 2015 as a result of such sales of 4,441,113 Twinlab shares to third parties during the six months period (resulting in a transfer of $3,375,260 of gain from the category of unrealized gain to the category of realized gain) and unrealized loss of $621,977 for the establishment of the Third-Party Call Options and $225,599 for the establishment of the Contingent Call Options, partially offset by $2,366,784 of unrealized gain recorded for the Series B Warrant as amended on May 28, 2015. The overall net loss on financial instruments for the six months period ended June 30, 2015 was $2,682,492.

 

If our assessments/estimates of the fair value of our holdings of Twinlab securities were to change from quarter to quarter, there could be significant changes in our unrealized gain on such holdings, which in turn would result in significant gain or loss on our statement of operations for the quarter in question. However, at both December 31, 2014 and June 30, 2015, our determination was that the fair value of Twinlab common stock was $0.76 per Twinlab share. Accordingly, there was no such gain or loss on our statement of operations for the six months period ended June 30, 2015 due to any such change in valuation. Although our sales of Twinlab stock in the first six months of 2015 generated $3,375,260 (of which $120,000 was not actually received in cash until the third quarter), we did not record an overall net gain on financial instruments on such sales, because the sales prices ($0.76 per share) were the same as the fair value we had determined for our Twinlab stock and at which we were carrying the Twinlab stock on our books. The sales merely resulted in a transfer of unrealized gain to realized gain.

 

We did not own any Twinlab securities in the first six months of 2014.

 

Payroll.  Payroll for the six months periods ended June 30, 2015 and 2014 was $91,545 and $122,155, respectively; the decrease in 2015 was primarily due to our change in business focus in March 2014. For most of the first quarter of 2014 our business focus was that of a financial services company. We are holding the salaries of our most senior officers at very low levels.

 

Professional Fees.  Professional fees for the six months periods ended June 30, 2015 and 2014 were $601,594 and $185,522, respectively. The increase was primarily due to legal fees for preparing documents for production as required by legal process, and accounting and legal fees related to required restatements of financial statements and amendments of previous SEC periodic reports.

 

General and Administrative.  General and administrative expenses (excluding payroll expense and professional fees) for the six months periods ended June 30, 2015 and 2014 were $308,325 and $365,936, respectively; the decrease in 2015 was primarily due to our change in business focus in March 2014 and the absence of rent expense in April 2015. For most of the first quarter of 2014 our business focus was that of a financial services company.

 

-21-
 

Liquidity and Capital Resources

 

As of June 30, 2015, we had $1,560,422 in cash and cash equivalents, Twinlab securities owned which we recorded at a $14,154,841 fair value, and credit for $85,000 of deposits given.  There is no active liquid public market for our Twinlab securities. In addition, we had accounts receivable of $120,000 with respect to sales of 157,895 of our Twinlab shares in June 2015; the fair value of those 157,895 shares is not included in the $14,154,841 fair value figure. We collected all of these accounts receivable in July 2015.

 

In late June 2015, we accepted $400,000 cash and the surrender of 200,000 shares of our outstanding common stock in exchange for the full satisfaction of the $600,000 principal amount of and $18,411 of accrued interest on an unsecured promissory note which we had issued to an accredited investor on November 14, 2014. The scheduled maturity date of the promissory note had been December 29, 2015.

 

We anticipate obtaining additional financing to fund operations through common stock offerings, sales of Twinlab stock and sales of future-acquired strategic investment securities, to the extent available. There can be no assurance we will be successful in raising the necessary funds to execute our business plan. The realization of cash proceeds, if any, on sales of our securities positions would likely be “bunchy,” unpredictable and irregular. We can make no assurances and therefore we may incur operating losses and/or negative cash flows in one or more future periods.  

 

Our current intention is to use meaningful amounts of any free cash flow we generate to make further partial exercises of the Series B Warrant, in order both to help Twinlab maintain and grow its business (thereby benefiting the value of our remaining Twinlab securities), to avoid triggering the exercisability of the Contingent Call Options (or to limit the number of Twinlab shares for which Twinlab could exercise the Contingent Call Options), and to avoid or reduce the risk of in effect having a “short” position in Twinlab stock (as described in the following paragraph).

 

The $9,973,684 warrant put option item on our December 31, 2014 balance sheet arose from the contingent possibility that a Put Agreement obligation might arise in the future. There was no such item on our June 30, 2015 balance sheet, because of our May 28, 2015 compromise agreement with Twinlab which terminated the Put Agreement. However, the June 30, 2015 balance sheet included a $225,599 liability item arising from the contingent possibility that the Contingent Call Options might become exercisable in the future and a $621,977 liability item arising from the Third-Party Call Options we granted to certain accredited investors in connection with our 2015 sales of Twinlab common stock to such investors. Our actual risk under the two types of options would be magnified if, due to sales of Twinlab common stock and/or expiration of unexercised Series B Warrants, we do not have as many Twinlab shares and/or available Series B Warrants as the number of shares we could be obliged to deliver under the options (i.e., to the extent we in effect are “short” Twinlab shares). The expiration date of the Third-Party Call Options is a substantial number of months after the expiration of the Series B Warrants. If we wish to avoid being “short” Twinlab shares in the manner just described, it may be necessary for us to purchase and hold Twinlab shares through the expiration date of the Third-Party Call Options, which would tie up a large amount of otherwise available cash. If insufficient cash is available for this purpose, it may be necessary for us to run the risk of having what in effect is a short position.

 

The $5,098,070 deferred tax liability item on our June 30, 2015 balance sheet represents the income taxes we would owe if we sold, during tax years in which our taxable income levels were large enough to support such current income taxes, all the Twinlab securities which we held as of June 30, 2015, at a price resulting in realization of all of the unrealized gain we recorded for such assets on our balance sheet (based on our fair value assessment as of June 30, 2015. No such taxes would be actually payable unless and until after we sell the Twinlab securities, and the amount of actual taxes payable would depend on the actual sales prices.

 

-22-
 

From time to time after October 28, 2014 our controlling stockholder Darin Pastor has made advances and direct-payments to assist us in covering expenses; he is not obligated to make any such advances and direct-payments and there can be no assurance that any such advances and direct-payments will continue. In addition, the amounts of these advances and direct-payments are reimbursable to him upon his demand at any time. At June 30, 2015, $85,131 of such advances and direct-payments had not yet been reimbursed.

 

At June 30, 2015, the remaining balance on the notes payable to Darin Pastor, which we assumed as part of our October 2014 transaction involving assets and liabilities of the former Capstone Affluent Strategies, Inc., was $553,552, plus $12,954 of accrued but unpaid interest.

 

We remind readers that our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by emerging companies. Also, our limited operating history makes predictions of future operating results and cash needs difficult to ascertain.

 

The following table provides detailed information about our net cash flow for the respective first six months of our 2015 and 2014 fiscal years.  

 

   For the six month periods ended June 30,
   2015  2014
Net cash provided by (used in) operating activities  $1,549,776   $(899,734)
Net cash provided by (used in) investing activities   (2,039)   —   
Net cash provided by (used in) financing activities   —      909,200 
Net increase (decrease) in cash   1,547,737    9,466 
Cash, beginning   12,685    —   
Cash, ending  $1,560,422   $9,466 

 

Operating activities

 

Net cash provided by operating activities was $1,549,776 for the first six months of 2015, despite our $2,134,972 after-tax net loss for that six months period. Although our sales of Twinlab securities in the first six months of 2015 generated $3,255,260 in cash proceeds (plus an additional $120,000 of accounts receivable, which were then collected in the third quarter), we did not record an overall net gain on financial instruments on such sales, because the sales prices ($0.76 per share) were the same as the fair value we had determined for our Twinlab stock and at which we were carrying the Twinlab stock on our books. In addition, the $1,856,036 net change in unrealized gain on (i.e., additional net loss on) financial instruments and the $826,456 net change in realized gain on (i.e., additional net loss on) financial instruments were noncash items.

 

Net cash used for operating activities was $899,734 for the first six months period of 2014 (primarily due to our $656,084 net loss for that six months period).

 

Financing activities

 

Net cash provided by financing activities in the first six months of 2014 was attributable to capital raised through the issuance of our common stock.

 

Off-Balance Sheet Arrangements

 

We did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

 

-23-
 

Critical Accounting Policies and Estimates

 

The preparation of our financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and judgments that affect our reported assets, liabilities, revenues, and expenses, and the disclosure of contingent assets and liabilities.  We base our estimates and judgments on historical experience and on various other assumptions, we believe to be reasonable under the circumstances.  Future events, however, may differ markedly from our current expectations and assumptions.  See Note 2 – Summary of Significant Accounting Policies in our Notes to Financial Statements.

 

Item 3.     Quantitative and Qualitative Disclosures about Market Risk

 

This item is not applicable, as we are classified as a smaller reporting company.

 

Item 4.     Controls and Procedures

 

Disclosure Controls and Procedures

 

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

As required by Rule 13a-15 under the Securities Exchange Act, as of June 30, 2015 we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures.  This evaluation was carried out under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, who concluded that our disclosure controls and procedures are effective. The errors which required the restatement of financial statements and the amendments of periodic reports, as reported and summarized in our Current Report on Form 8-K filed on November 13, 2014 (as amended on November 24, 2014) and in such amendments and as further stated in the following paragraph of this item, were, in their judgment, not due to ineffectiveness of our disclosure controls and procedures.

 

Our Board of Directors concluded in November 2014 that the previously issued audited consolidated financial statements and other financial information contained in our initially-filed Annual Report on Form 10-K for the fiscal year ended December 31, 2013 failed to properly account for certain financial information.  Consequently, the Board concluded that for comparative purposes the previously issued unaudited financial statements and certain other financial information contained in the initially-filed Quarterly Reports on Form 10-Q for the fiscal periods ended June 30, 2013, September 30, 2013, March 31, 2014, and June 30, 2014, and our earnings releases and other financial communications after the filing of our initially-filed Annual Report on Form 10-K for the fiscal year ended December 31, 2013, should no longer be relied upon.

 

We thereafter filed corrective amendments of these periodic reports.

 

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Internal Control Over Financial Reporting

 

Our management is responsible for preparing our annual consolidated financial statements and for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, a company’s principal executive and principal financial officers and effected by a company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

 

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

 

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

 

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

 

All internal control systems, no matter how well designed, have inherent limitations and can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

 

Our management assessed the effectiveness of our internal control over financial reporting as of June 30, 2015. In making our assessment, we used the framework and criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework in 2014. Based on that assessment, our management has identified certain material weaknesses in our internal control over financial reporting.

 

Our management concluded that as of June 30, 2015 our internal control over financial reporting was not effective, and that material weaknesses existed in the following areas as of June 30, 2015:

 

(1)   we do not employ full time in-house personnel with the technical knowledge to identify and address some of the reporting issues surrounding certain complex or non-routine transactions. With respect to material, complex and non-routine transactions, management has and will continue to seek guidance from third-party experts and/or consultants to gain a thorough understanding of these transactions;

 

(2)   we have inadequate segregation of duties consistent with the control objectives including but not limited to the disbursement process, transaction or account changes, and the performance of account reconciliations and approval;

 

(3)   we have ineffective controls over the period end financial disclosure and reporting process caused by reliance on third-party experts and/or consultants and insufficient accounting staff; and

 

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(4)   we do not have a functioning audit committee of the Board of Directors and our Board of Directors, in its performance of the functions generally associated with audit committees, lacks a majority of (indeed, lacks any) independent members and lacks a majority of (indeed, lacks any) outside directors, resulting in ineffective oversight in the establishment and monitoring of required internal controls, approvals and procedures.

 

Changes in Internal Control Over Financial Reporting

 

No substantial changes in our internal control over financial reporting occurred during the second quarter of 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II

 

Item 1.     Legal Proceedings

 

We are not a party to any material legal proceedings.

 

Item 1A.     Risk Factors

 

This item is not applicable, as we are classified as a smaller reporting company. To better inform the readers of this Quarterly Report on Form 10-Q, however, we refer to the Risk Factors set forth in Part I, Item 1A of our Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 30, 2015, and to certain other risks identified within this Quarterly Report on Form 10-Q.

 

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

 

We made no unregistered sales of securities of our securities during the quarter ended June 30, 2015.

 

On June 26, 2015, we entered into a Prepayment and Repurchase Agreement with Thomas A. Tolworthy and accepted $400,000 cash and the surrender of 200,000 outstanding shares of our common stock in exchange for the full satisfaction of the unsecured promissory note (with a $600,000 principal amount and $18,411 of accrued interest) which he had issued to us on November 14, 2014.

 

Item 3.     Defaults Upon Senior Securities

 

None.

 

Item 4.     Mine Safety Disclosures

 

Not applicable.

 

Item 5.     Other Information

 

See Part II, Item 2 above. Also, see the description of the Third-Party Call Options in Part I, Item 2 above (Management’s Discussion and Analysis of Financial Condition and Results of Operations - Overview and Outlook).

 

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Item 6.     Exhibits

 

 (a) The following exhibits are included as part of this report:

 

            Incorporated by reference
Exhibit       Filed              Filing
Number   Exhibit Description   herewith   Form     Exhibit   date
2.1   Stock Purchase Agreement dated September 6, 2013 between Ryan Faught and Darin Pastor        10-K      2.1   2/18/2015
2.2   Stock Purchase Agreement dated September 6, 2013 between Ryan Faught and George L. Schneider        10-K      2.2   2/18/2015
2.3   Agreement and Plan of Merger among the Company, Capstone Sub Co. and Capstone Affluent Strategies, Inc., dated December 13, 2013       8-K     2.1   12/13/2013
2.3.1   Articles of Merger filed January 15, 2014, between Capstone Sub Co. and Capstone Affluent Strategies, Inc.       8-K     3(i)(d)   1/16/2014
2.3.2   Rescission of Agreement and Plan of Merger among the Company, Capstone Sub Co. and Capstone Affluent Strategies, Inc.       8-K     10.1   5/1/2014
3.1   Articles of Incorporation of Creative App Solutions Inc. dated July 10, 2012        S-1     3(i)(a)   10/17/2012
3.1.1   Certificate of Amendment to Articles of Incorporation filed August 26, 2013       8-K     3(i)(a)   8/29/2013
3.1.2   Certificate of Change filed September 6, 2013       8-K     3(i)(c)   9/12/2013
3.2   Bylaws        S-1     3(ii)   10/17/2012
3.2.1   Amended Bylaws, adopted August 26, 2013        10-K      3.2.1   2/18/2015
10.1   Form of Third-Party Investment Units Purchase Agreement (used from March 25, 2015 through May 28, 2015)   X              
10.2   Lease Agreement, dated as of April 29, 2015, between Iskalo 8600 Transit LLC and the Company       10-K     10.15   4/30/2015
10.3   Compromise Agreement and Release, dated May 28, 2015, between Twinlab Consolidated Holdings, Inc. and the Company       8-K     10.1   5/29/2015
10.4   Amendment No. 1 to Series B Warrant, dated May 28, 2015, between Twinlab Consolidated Holdings, Inc. and the Company       8-K     10.2   5/29/2015
10.5   Prepayment and Repurchase Agreement, dated as of June 26, 2015, between Thomas A. Tolworthy and the Company   X              
31.1   Certification pursuant to Securities Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 – CEO   X              
31.2   Certification pursuant to Securities Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 – CFO   X              
32.1   Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – CEO   X              
32.2   Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – CFO   X              

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

CAPSTONE FINANCIAL GROUP, INC.

 

By: /s/ Darin R. Pastor

Darin R. Pastor, Chief Executive Officer

Date: August 13, 2015

 

 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Signature Title Date

 

/s/ Darin R. Pastor

 

Chairman of the Board of Directors,

 

August 13, 2015

Darin R. Pastor Chief Executive Officer (Principal Executive Officer)  

 

/s/ Halford W. Johnson

 

Chief Financial Officer

 

August 13, 2015

Halford W. Johnson (Principal Financial Officer and Principal Accounting Officer)  

 

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