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 stock of other companies. The Company seeks to discover, unlock and
grow value in privately-held or illiquid companies, including through the exercise of 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 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 operations and perform continual evaluations of 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.
Market, Credit and Liquidity Risk
At March 31, 2016 and December 31, 2015
the majority of Company’s investments are 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 fund its obligations as and when they become due. 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 fund
its obligations or to raise additional capital to do so.
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.
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
Investments of the Company trade in
thin markets and throughout the year, depending upon market conditions, may be considered inactive. 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
investments.
Basis of Presentation
The accompanying financial statements
have been prepared using the accrual basis of accounting in conformity with accounting principles generally accepted in the United
States of America (“GAAP”) for interim financial information and the accounting and financial reporting conventions
of the investment company industry 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, 2015, included in the Company’s Annual Report on Form 10-K filed
with the SEC on May 2, 2016. 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 March 31, 2016, the
results of the Company’s operations for the three months period ended March 31, 2016 and the Company’s cash flows for
the three months ended March 31, 2016. The results of operations for the three months period ended March 31, 2016 are
not necessarily indicative of the results to be expected for the full year or any future interim periods.
Use of Estimates
The preparation of financial statements
in conformity with GAAP requires the Company’s management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash Equivalents
The Company considers any investments
in short-term money market funds with original maturities of three months or less to be cash equivalents.
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (CONTINUED)
Investments
Investments primarily comprise strategic,
non-controlling equity ownership interests in privately held businesses or public companies with very illiquid trading markets.
These strategic investments are accounted for at fair value as determined by internal valuation guidelines and/or outside appraisals
as there are no readily ascertainable fair market value prices in accordance with the Financial Accounting Standards Board (“FASB”)
Accounting Standards Codification (“ASC”) 946-10 and FASB ASC 820-10. Because the Company follows the financial accounting
and reporting conventions of the investment company industry, it reports investments at estimated fair value.
FASB ASC 820-10-65-4 provides additional
guidance for estimating fair value in accordance with FASB ASC 820-10 when the volume and level of market activity for the
asset or liability have significantly decreased. FASB ASC 820-10-65-4 also includes guidance on identifying circumstances
that indicate a transaction is not orderly. It acknowledges that in these circumstances quoted prices may not be
determinative of fair value. FASB ASC 820-10-65-4 emphasizes that even if there has been a significant decrease in the volume
and level of market activity for the asset or liability and regardless of the valuation technique(s) used, the objective of a
fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer
a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at
the measurement date under current market conditions. Under FASB ASC 820-10-65-4, quoted prices for assets or liabilities in
inactive markets may require adjustment due to uncertainty as to whether the underlying transactions are orderly. There is
little information, if any, to evaluate if individual transactions are orderly in an inactive market. Accordingly, the
Company is required to evaluate the facts and circumstances to determine whether the transaction is orderly based on the
weight of the evidence. FASB ASC 820-10-65-4 does not designate a specific method for adjusting a transaction or quoted
price; however, it does provide guidance for determining how much weight to give a transaction or quoted price. Price quotes
derived from transactions that are not orderly are not considered to be determinative of fair value and should be given less
weight, if any, when estimating fair value. In the absence of observable market data at March 31, 2016 and December 31, 2015, the
Company's fair value measurements included assumptions about future cash flow and appropriately risk-adjusted discount rates
that it believes market participants would make in orderly market transactions.
Fair Value Measurements and Valuation
Methodologies
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:
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (CONTINUED)
•
|
|
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.
|
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.
The Company often invests in common stocks
that are thinly traded where the closing trading price is not considered to be a fair indication of the value for which the Company
can sell or buy the common stock. In such cases, as in the case of private-company limited liability company membership interests
held by the Company, the common stock must be analyzed to determine what exit price the Company would receive when liquidating
the position. These positions are classified as Level 3 securities.
The significant unobservable inputs used
in the fair value measurement of the Company’s Level 3 common stocks are growth rate, risk premium, revenue multiples
and EBITDA multiples. Increases or decreases in any of those inputs in isolation would result in a lower or higher fair
value measurement, respectively.
The Company has warrants and call options to
purchase common stock in illiquid public companies. Generally, there is no established market for these investments. The Company
values these warrants and call options by using a model that takes into consideration the exercise or call price of the warrant
or call option, the price of the underlying common stock and the expiration date of the warrant or call option.
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (CONTINUED)
The significant unobservable inputs used
in the fair value measurement of the Company’s warrants and call options includes the price of the underlying thinly
traded common stock (determined based upon growth rate, risk premium, revenue multiples and EBITDA multiples), duration
and discount rate and volatility. Increases or decreases in the premium-to-parity would result in a higher or lower
fair value measurement, respectively.
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 March 31, 2016 and December 31, 2015 were valued based, in part, on subsequent transactions with unrelated third parties and at
December 31, 2015 were valued by the Company with the assistance of an independent valuation consultant. These positions are classified
as Level 3 securities by the Company.
From time to time, the Company has investments
in private limited liability companies. Generally, there is no established market for these investments. The Company values these
interests by means of both quantitative and qualitative measures, generally including the financial stability of the company, the
economic rights of the interests and the economic prospects of the company.
The significant unobservable input used in
the fair value measurement of the Company’s limited liability company investments is the expected recovery of contributed
capital. Increases or decreases in the expected recovery would result in a higher or lower fair value measurement, respectively.
Derivative Financial Instruments
Derivative financial instruments include call
options and warrants at March 31, 2016 and December 31, 2015. 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 option
pricing model. Changes to any of those inputs in isolation would result in fluctuations in the fair value measurement.
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (CONTINUED)
Investment Transaction, Related
Income and Expenses
Purchases and sales of investments are
recorded on a trade-date basis. Realized gains and losses on investments are recognized on the first-in, first-out method. Dividend
income on investments owned is recognized on the ex-dividend date, net of applicable withholding taxes.
Treasury Stock Purchases
The Company is authorized to repurchase
shares of the Company’s common stock in private transactions from time to time.
Revenue Recognition
The Company recognizes revenue for services
when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement; (2) the related
service has been provided to the customer; (3) the amount of fees to be paid by the customer is fixed or determinable; and
(4) the collection of fees is probable.
Earnings per Share
The Company follows FASB ASC 260 for
earnings per share. Basic earnings per common share calculations are determined by dividing net income by the weighted average
number of shares of common stock outstanding during the year. Diluted earnings per common share calculations are determined by
dividing net income by the weighted average number of common shares and dilutive common share equivalents outstanding. During periods
when common stock equivalents, if any, are anti-dilutive they are not considered in the computation. As of March 31,
2016 and 2015, there were no dilutive common shares equivalents outstanding.
Concentration Risks
During the quarter ended March 31, 2016,
the Company had $12,000 of sublease income from two sublessees. During the quarter ended March 31, 2015, the Company had $50,001
in revenue generated from one customer for consulting services and had interest income from a related party of $7,446.
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (CONTINUED)
Income Taxes
The Company follows ASC Topic 740 for
recording the provision for income taxes. Deferred tax assets and liabilities are computed based upon the difference between the
financial statement and income tax basis of assets and liabilities using the enacted marginal tax rate applicable when the related
asset or liability is expected to be realized or settled. Deferred income tax expenses or benefits are based on the changes in
the asset or liability each period. If available evidence suggests that it is more likely than not that some portion or all of
the deferred tax assets will not be realized, a valuation allowance is required to reduce the deferred tax assets to the amount
that is more likely than not to be realized. Future changes in such valuation allowance are included in the provision for deferred
income taxes in the period of change.
Deferred income taxes may arise from
temporary differences resulting from income and expense items reported for financial accounting and tax purposes in different periods.
Deferred taxes are classified as current or non-current, depending on the classification of assets and liabilities to which they
relate. Deferred taxes arising from temporary differences that are not related to an asset or liability are classified as current
or non-current depending on the periods in which the temporary differences are expected to reverse.
The Company applies a more-likely-than-not
recognition threshold for all tax uncertainties. ASC Topic 740 allows the recognition of those tax benefits that have a greater
than 50% likelihood of being sustained upon examination by the taxing authorities. As of March 31, 2016 the Company reviewed its
tax positions and determined there were no outstanding or retroactive tax provisions with less than a 50% likelihood of being sustained
upon examination by the taxing authorities.
The Company is required to file Federal
and New York and California state income tax returns. The Company’s tax return status will remain open until a tax return
has been filed.
Advertising costs
Advertising costs are expensed as incurred.
For the quarters ended March 31, 2016 and 2015, advertising costs of $14,930 and $21,170, respectively, were included in general
and administrative
expenses.
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 2 – SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (CONTINUED)
Recent Accounting Pronouncements
In May 2014, the FASB issued Accounting
Standards update 2014-09,
Revenue from Contracts with Customers
("ASU 2014-09"). ASU 2014-09 specifies a comprehensive
model to be used in accounting for revenue arising from contracts with customers, and supersedes most of the current revenue recognition
guidance, including industry specific guidance. It applies to all contracts with customers except those that are specifically within
the scope of other FASB topics, and certain of its provisions also apply to transfers of nonfinancial assets, including in-substance
nonfinancial assets that are not an output of an entity's ordinary activities. The core principal of the model is that revenue
is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the
transferring entity expects to be entitled in exchange. To apply the revenue model, an entity will: 1) identify the contract(s)
with a customer, 2) identify the performance obligations in the contract, 3) determine the transaction price, 4) allocate the transaction
price to the performance obligations in the contract, and 5) recognize revenue when (or as) the entity satisfies a performance
obligation. For public companies, ASU 2014-09 is effective for annual reporting periods (including interim reporting periods within
those periods) beginning after December 15, 2016. Early adoption is not permitted. Upon adoption, entities can choose to use either
a full retrospective or modified approach, as outlined in ASU 2014-09. As compared with current GAAP, ASU 2014-09 requires significantly
more disclosures about revenue recognition. The Company has not yet assessed the potential impact of ASU 2014-09 on the financial
statements.
In May 2015, the FASB issued amended
guidance on the disclosures for investments in certain equities that calculate net asset value per share (or its equivalent). The
amendments remove the requirement to categorize within the fair value hierarchy all investments for which fair value is measured
using the net asset value per share practical expedient. The amendments also remove the requirement to make certain disclosures
for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. Rather,
those disclosures are limited to investments for which the entity has elected to measure the fair value using that practical expedient.
The guidance is effective for fiscal years beginning after December 15, 2015 and for interim periods within those years.
In February 2016, the FASB issued Accounting
Standards update 2016-02,
Leases
("ASU 2016-02"). ASU 2016-02 requires a lessee to recognize a lease asset representing
its right to use the underlying asset for the lease term, and a lease liability for the payments to be made to lessor, on its balance
sheet for all operating leases greater than 12 months. ASU 2016-02 will be effective for fiscal years, and interim periods within
those fiscal years, beginning after December 15, 2018. The Company has not yet adopted ASU 2016-02 nor assessed its potential impact
on the financial statements.
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 3 – FAIR VALUE MEASUREMENTS
The Company's financial instruments
recorded at fair value have been categorized based upon a fair value hierarchy in accordance with accounting guidance. The following
fair value hierarchy tables set forth the Company’s recurring fair value measurements at March 31, 2016 and December 31,
2015.
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 3 – FAIR VALUE MEASUREMENTS
(CONTINUED)
|
|
Assets and Liabilities Measured at
|
|
|
Fair Value on a Recurring Basis
|
|
|
March 31, 2016
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial instruments, at fair value:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stocks
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
8,598,030
|
|
|
$
|
8,598,030
|
|
Real Estate Company Investments
|
|
|
—
|
|
|
|
—
|
|
|
|
277,500
|
|
|
|
277,500
|
|
2014 Call Options
|
|
|
—
|
|
|
|
—
|
|
|
|
1,135,863
|
|
|
|
1,135,863
|
|
Series B Warrants
|
|
|
—
|
|
|
|
—
|
|
|
|
1,268,937
|
|
|
|
1,268,937
|
|
Total Financial instruments, at fair value
|
|
|
—
|
|
|
|
—
|
|
|
|
11,280,330
|
|
|
|
11,280,330
|
|
Total assets held at fair value
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
11,280,330
|
|
|
$
|
11,280,330
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial instruments, at fair value:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Third Party Call Options
|
|
|
—
|
|
|
|
—
|
|
|
|
608,731
|
|
|
|
608,731
|
|
Total liabilities held at fair value
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
608,731
|
|
|
$
|
608,731
|
|
|
|
Assets and Liabilities Measured at
|
|
|
Fair Value on a Recurring Basis
|
|
|
December 31, 2015
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial instruments, at fair value:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stocks
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
9,896,605
|
|
|
$
|
9,896,605
|
|
Real Estate Company Investments
|
|
|
—
|
|
|
|
—
|
|
|
|
277,500
|
|
|
|
277,500
|
|
2014 Call Options
|
|
|
—
|
|
|
|
—
|
|
|
|
1,135,863
|
|
|
|
1,135,863
|
|
Series B Warrants
|
|
|
—
|
|
|
|
—
|
|
|
|
1,851,750
|
|
|
|
1,851,750
|
|
Total Financial instruments, at fair value
|
|
|
—
|
|
|
|
—
|
|
|
|
13,161,718
|
|
|
|
13,161,718
|
|
Total assets held at fair value
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
13,161,718
|
|
|
$
|
13,161,718
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial instruments, at fair value:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Third Party Call Options
|
|
|
—
|
|
|
|
—
|
|
|
|
619,122
|
|
|
|
619,122
|
|
Total liabilities held at fair value
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
619,122
|
|
|
$
|
619,122
|
|
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 3 – FAIR VALUE MEASUREMENTS
(CONTINUED)
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.
Details of the Company’s recurring
fair value measurements are as follow:
March 31, 2016
|
|
Cost
|
|
Estimated
Fair Value
|
|
Unrealized
Gain (Loss)
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stocks
|
|
$
|
1,004,478
|
|
|
$
|
8,598,030
|
|
|
$
|
7,593,552
|
|
Real Estate Company Investments
|
|
|
277,500
|
|
|
|
277,500
|
|
|
|
—
|
|
2014 Call Options
|
|
|
450
|
|
|
|
1,135,863
|
|
|
|
1,135,413
|
|
Series B Warrants
|
|
|
—
|
|
|
|
1,268,937
|
|
|
|
1,268,937
|
|
|
|
$
|
1,282,428
|
|
|
$
|
11,280,330
|
|
|
$
|
9,997,902
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
Third-Party Call Options
|
|
$
|
—
|
|
|
$
|
(608,731
|
)
|
|
$
|
(608,731
|
)
|
December 31, 2015
|
|
Cost
|
|
Estimated
Fair Value
|
|
Unrealized
Gain (Loss)
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
Common Stocks
|
|
$
|
1,004,992
|
|
|
$
|
9,896,605
|
|
|
$
|
8,891,613
|
|
Real Estate Company Investments
|
|
|
277,500
|
|
|
|
277,500
|
|
|
|
—
|
|
2014 Call Options
|
|
|
450
|
|
|
|
1,135,863
|
|
|
|
1,135,413
|
|
Series B Warrants
|
|
|
—
|
|
|
|
1,851,750
|
|
|
|
1,851,750
|
|
|
|
$
|
1,282,942
|
|
|
$
|
13,161,718
|
|
|
$
|
11,878,776
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
|
|
|
|
|
|
|
|
|
|
|
|
|
Third Party Call Options
|
|
$
|
—
|
|
|
$
|
(619,122
|
)
|
|
$
|
(619,122
|
)
|
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 3 – FAIR VALUE MEASUREMENTS
(CONTINUED)
For the quarter ended March 31, 2016, the Company
recorded a net unrealized loss on financial instruments of $1,870,997 and a net realized gain on financial instruments of $1,302,000.
For the quarter ended March 31, 2015, the Company recorded a net unrealized loss on financial instruments of $1,460,160 and a net
realized gain on financial instruments of $1,460,160.
During the first quarter of 2014, the
Company purchased shares in a company traded on the OTC Markets for a total of $2,919. The Company currently categorizes these
holdings as Level 3 assets. As of March 31, 2016, this investment is carried at $0 value under management’s valuation guidelines.
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 November 2014, the Company sold 436,681 of these shares.
In August 2014, the
Company purchased options to acquire 8,743,000 outstanding shares of Twinlab’s Common Stock (collectively, the
“Call Options”) in a private transaction from 14 stockholders, for total consideration of $2,623. The Call
Options exercise price is $0.0001 per share and the Call Options expired in August 2015. Such options were immediately
exercisable and in February 2015, the Company exercised 7,244,500 of those options. As of March 31, 2016, the Company
owns 1,498,500 of these options to acquire shares of Twinlab’s Common Stock.
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.
In 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 and the call
option was valued at $0.156 per call option.
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 3 – FAIR VALUE MEASUREMENTS
(CONTINUED)
In addition, in 2015, the Company sold
an aggregate of 2,078,255 shares of Twinlab common stock (without any associated detachable call options) to various unrelated
third party accredited investors, for $0.76 per share.
In addition, in the first quarter
of 2016, the Company sold an aggregate of 1,713,159 shares of Twinlab common stock (without any associated detachable call
options) to various unrelated third party accredited investors, for $0.76 per share. As of March 31, 2016, the Company owns
11,343,048 shares of Twinlab’s Common Stock.
Twinlab and the Company 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; such tranche of warrants expired mostly unexercised), one for
4,000,000 warrant shares (expired on 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 could not
exercise a Contingent Call Option unless it had 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. As of immediately after the close of business
on March 31, 2016, the Company held 12,000,000 warrants under the Series B Warrant.
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 3 – FAIR VALUE MEASUREMENTS
(CONTINUED)
On October 1, 2015, Twinlab and the Company
entered into Amendment No. 1 to Agreement for Limited Waiver of Non-Circumvention Provision and to Compromise Agreement and Release,
pursuant to which a prior agreement calling for contingent payments of cash and equity to the Company was amended to remove the
Company’s right to any such contingent payments of cash and equity compensation, and in return the three Contingent Call
Options were immediately cancelled.
As of March 31, 2016, the Company owned
less than 10% of Twinlab’s outstanding common stock.
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.
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 3 – FAIR VALUE MEASUREMENTS
(CONTINUED)
The following table includes a roll
forward of the amounts for the quarter ended March 31, 2016 for financial instruments
classified within Level 3.
Level 3 Recurring Fair Value Measurements
For the Three Months Ended March 31, 2016
|
|
Common Stock
|
|
Real Estate Company Investments
|
|
2014 Call Options
|
|
Series B Warrants
|
|
Third-Party Call Options Liability
|
|
Total
|
Fair value, net, January 1, 2016
|
|
$
|
9,896,605
|
|
|
$
|
277,500
|
|
|
$
|
1,135,863
|
|
|
$
|
1,851,750
|
|
|
$
|
(619,122
|
)
|
|
$
|
12,542,596
|
|
Unrealized gains (losses) included in earnings
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(582,813
|
)
|
|
|
10,391
|
|
|
|
(572,422
|
)
|
Purchases
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Sales
|
|
|
(1,298,575
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
(1,298,575
|
)
|
Settlements/exercises
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Transfers in and/or out of Level 3
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Fair value, net, March 31, 2016
|
|
$
|
8,598,030
|
|
|
$
|
277,500
|
|
|
$
|
1,135,863
|
|
|
$
|
1,268,937
|
|
|
$
|
(608,731
|
)
|
|
$
|
10,671,599
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized gains (losses) still held
|
|
$
|
7,593,552
|
|
|
$
|
—
|
|
|
$
|
1,135,413
|
|
|
$
|
1,268,937
|
|
|
$
|
(608,731
|
)
|
|
$
|
9,389,171
|
|
Quantitative information about the valuation
techniques and unobservable inputs is required to be disclosed for certain recurring and nonrecurring fair value measurements.
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 3 – FAIR VALUE MEASUREMENTS
(CONTINUED)
The following tables present quantitative information
about the valuation techniques and unobservable inputs applied to Level 3 fair value measurements for financial instruments measured
at fair value on a recurring and nonrecurring basis at March 31, 2016 and December 31, 2015.
|
|
|
Quantitative Information about Level 3
|
|
|
|
|
|
Fair Value Measurements at March 31, 2016
|
|
|
|
Fair
|
|
Valuation
|
|
Unobservable
|
|
Range
|
|
|
|
Value
|
|
Technique
|
|
Inputs
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
$
|
8,598,030
|
|
Discounted cash flow
Guideline company transactions method
Guideline publicly-traded company method
|
|
Growth rate
Risk premium factors
Revenue multiple
EBITDA multiple
|
|
13.00%-15.20%
(2.50%)-7.00%
1.10-2.10
9.30-13.80
|
2014 Call Options
|
|
|
1,135,863
|
|
Discounted cash flow
Guideline company transactions method
Guideline publicly-traded company method
|
|
Growth rate
Risk premium factors
Revenue multiple
EBITDA multiple
|
|
13.00%-15.20%
(2.50%)-7.00%
1.10-2.10
9.30-13.80
|
Series B Warrants
|
|
|
1,268,937
|
|
Option pricing model
|
|
Duration
Risk-free interest rate
Volatility
|
|
0.33-0.67 years
0.52%-0.62%
50%
|
Investment in Real Estate Companies
|
|
|
277,500
|
|
Recent transaction
|
|
|
|
Total assets held at fair value
|
|
$
|
11,280,330
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
Call option liability
|
|
$
|
608,731
|
|
Option pricing model
|
|
Duration
Risk-free interest rate
Volatility
|
|
2.0-2.2 years
0.73%-0.75%
50%
|
|
|
|
|
|
|
|
|
|
|
Total liabilities held at fair value
|
|
$
|
608,731
|
|
|
|
|
|
|
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 3 – FAIR VALUE MEASUREMENTS
(CONTINUED)
|
|
|
Quantitative Information about Level 3
|
|
|
|
|
|
Fair Value Measurements at December 31, 2015
|
|
|
|
Fair
|
|
Valuation
|
|
Unobservable
|
|
Range
|
|
|
|
Value
|
|
Technique
|
|
Inputs
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
Common Stock
|
|
$
|
9,896,605
|
|
Discounted cash flow
Guideline company transactions method
Guideline publicly-traded company method
|
|
Growth rate
Risk premium factors
Revenue multiple
EBITDA multiple
|
|
13.00%-15.20%
(2.50%)-7.00%
1.10-2.10
9.30-13.80
|
2014 Call Options
|
|
|
1,135,863
|
|
Discounted cash flow
Guideline company transactions method
Guideline publicly-traded company method
|
|
Growth rate
Risk premium factors
Revenue multiple
EBITDA multiple
|
|
13.00%-15.20%
(2.50%)-7.00%
1.10-2.10
9.30-13.80
|
Series B Warrants
|
|
|
1,851,750
|
|
Option pricing model
|
|
Duration
Risk-free interest rate
Volatility
|
|
0.25-0.92 years
0.16%-0.62%
50%
|
Investment in Real
Estate Companies
|
|
|
277,500
|
|
Recent transaction
|
|
|
|
|
Total assets held at fair value
|
|
$
|
13,161,718
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
Call option liability
|
|
$
|
619,122
|
|
Option pricing model
|
|
Duration
Risk-free interest rate
Volatility
|
|
2.23-2.40 years
1.12%-1.16%
50%
|
|
|
|
|
|
|
|
|
|
|
Total liabilities held at fair value
|
|
$
|
619,122
|
|
|
|
|
|
|
In the first quarter of 2016, the
Company sold an aggregate of 1,713,159 shares of Twinlab common stock to various unrelated third party accredited investors,
in private transactions, for $0.76 per share. In addition, 4,000,000 of the Company’s warrants to purchase Twinlab common
stock (for $0.76 per share) expired on March 31, 2016 in accordance with their terms.
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 4 – RELATED PARTY TRANSACTIONS
Salary Advance to Related Party
In the first quarter of 2016 the Company
paid salary amounts to two of its officers covering the second, third, and fourth quarters of 2016. As a result, the Company recorded
a salary advance - related party of $300,000 at March 31, 2016 in connection with such payments.
Short-Term Advances from
Related Party
After October 28, 2014 the
Company’s controlling stockholder Darin Pastor made advances and direct-payments to assist the Company in covering
expenses. In addition, the amounts of these advances and direct-payments are reimbursable to him upon his demand at any time.
At March 31, 2016 and December 31, 2015, the unrepaid balance of such advances and direct-payments was $29,700 and $49,600,
respectively.
Notes Payable to Related Party
On October 28, 2014, the Company entered
into a transaction in which the Company 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 demand notes in favor of
Darin Pastor. The Company repaid these notes in their entirety on March 11, 2016. On December 31, 2015, the outstanding
principal obligation on such assumed notes was $68,416. The interest rate on the demand notes was
2% per annum.
CAPSTONE FINANCIAL GROUP, INC.
NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS
NOTE 5 – 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 three months ended March 31, 2016 was $500,348, which reflected an effective tax rate of 39.43%,
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, 2015 included in the Company's 2015 Annual Report
on Form 10-K continue to be relevant for the period ended March 31, 2016 as to the Company’s unrecognized tax benefits at
March 31, 2016.
NOTE 6 –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 March 31, 2016.
In April 2016,
the Company sold 394,737 Twinlab shares to unrelated third parties for $300,000.