CAPP Capstone Financial Group Inc (GM)

NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 1 – ORGANIZATION AND DESCRIPTION OF BUSINESS

Organization

Capstone Financial Group, Inc. (the "Company") is a diversified company whose primary business focuses going forward include (a) investing in stock of other companies, (b) identification and pursuit of and capitalization on opportunities in the minerals and agricultural commodities industries and (c) commercial lending in foreign countries.

In the third quarter of 2016 the Company entered into mirroring agreements for the purchase and for the resale of quantities of livestock over time, thereby creating a “middleman” arbitrageur position as to this livestock. These agreements are characterized as best efforts supply and sale agreements and will be accounted for as livestock is purchased and sold as it appears there is no practical market mechanism to facilitate settlement of these transactions. At September 30, 2016, there was a $175,000 prepaid balance related to a purchase order for livestock (see Note 7).

In addition, in the third quarter of 2016 the Company entered into an agreement to sell quantities of gold over time, with the intention of arranging a mirroring supply of gold in order to thereby create a “middleman” position as to this gold. There were no gold transactions during the third quarter of 2016.

Until the second quarter of 2016, the Company considered its primary business focus to be investing its own capital to acquire the outstanding equity securities of other companies and to unlock and grow value in these privately-held or illiquid companies.

The Company sought, and 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 sought, and 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.

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 1 – ORGANIZATION AND DESCRIPTION OF BUSINESS (CONTINUED)

Market, Credit and Liquidity Risk

At September 30, 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.

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 September 30, 2016, the results of the Company’s operations for the three month and nine month periods ended September 30, 2016 and the Company’s cash flows for the nine months ended September 30, 2016. The results of operations for the three months and nine month periods ended September 30, 2016 are not necessarily indicative of the results to be expected for the full year or any future interim periods.

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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.

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 September 30, 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.

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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: 

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.

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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.

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 September 30, 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 September 30, 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 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. The Company records treasury stock purchases at cost. Any treasury stock removed from treasury is valued at cost using the specific identification method.

Revenue Recognition

The Company recognizes revenue for sales of physical commodities or other goods when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement; (2) the physical commodities or other goods have been delivered to the customer; (3) the purchase price to be paid by the customer is fixed or determinable; and (4) the collection of the purchase price is reasonably assured.

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 reasonably assured.

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 September 30, 2016 and 2015, there were no dilutive common shares equivalents outstanding.

Concentration Risks

During the three and nine months ended September 30, 2016, the Company had $21,624 and $37,224, respectively, of sublease income from two sublessees. During the three and nine months ended September 30, 2015, the Company had $16,660 and $116,662, respectively, in revenue generated from one customer for consulting services and had interest income from a related party of $0 and $14,460, respectively.

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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 September 30, 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 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 three and nine month periods ended September 30, 2016, advertising costs of $1,068 and $16,283, respectively, were included in general and administrative expenses. For the three and nine month periods ended September 30, 2015, advertising costs of $2,502 and $38,792, respectively, were included in general and administrative expenses.

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED 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 (updated with ASU 2015-14) is effective for annual reporting periods (including interim reporting periods within those periods) beginning after December 15, 2017. 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 its 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. As of September 30, 2016, the Company does not own any investments in equities that calculate net asset value per share (or its equivalent).

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 its financial statements.

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED 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:

For the quarter ended September 30, 2016, the Company recorded a net change in unrealized gain on financial instruments of $(501,614) and a net realized gain on financial instruments of $114,954. For the quarter ended September 30, 2015, the Company recorded a net change in unrealized gain on financial instruments of $(2,213,158) and a net realized gain on financial instruments of $364,368.

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 3 – FAIR VALUE MEASUREMENTS (CONTINUED)

For the nine month period ended September 30, 2016, the Company recorded a change in net unrealized gain on financial instruments of $(3,191,438) and a net realized gain on financial instruments of $1,866,263. For the nine month period ended September 30, 2015, the Company recorded a change in net unrealized gain on financial instruments of $(4,069,194) and a net realized loss on financial instruments of $(480,088).

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 September 30, 2016, this investment is carried at $0.

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 September 30, 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 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. In the second quarter of 2016, the Company sold an aggregate of 592,106 shares of Twinlab common stock (without any associated detachable call options) to various unrelated third party accredited investors, for $0.76 per share. In the third quarter of 2016, the Company sold an aggregate of 151,316 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 September 30, 2016, the Company owned 10,599,626 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 (expired on 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 September 30, 2016, the Company held 6,000,000 warrants under the Series B Warrant.

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.

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 3 – FAIR VALUE MEASUREMENTS (CONTINUED)

As of September 30, 2016, the Company’s position in Twinlab securities was as follows, and the Company had no contingent liabilities to Twinlab:

As of September 30, 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 FINANCIAL STATEMENTS

NOTE 3 – FAIR VALUE MEASUREMENTS (CONTINUED)

The following table includes a roll forward of the amounts for the quarter ended September 30, 2016 for financial instruments classified within Level 3.

In the nine months ended September 30, 2016, the Company sold an aggregate of 2,456,581 shares of Twinlab common stock to various unrelated third party accredited investors, in private transactions, for $0.76 per share. In the three months ended September 30, 2016, the Company sold an aggregate of 151,316 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, and 6,000,000 of the Company’s warrants to purchase Twinlab common stock (for $0.76 per share) expired on July 31, 2016 in accordance with their terms.

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 4 – STOCKHOLDERS’ EQUITY

During the third quarter of 2016, the Company issued 1,946,179 shares to accredited investors for $1,664,250, of which $600,000 had been subscribed in the second quarter of 2016. In addition, accredited investors paid the Company $10,000 in the third quarter of 2016 in respect of subscriptions for 11,766 shares, which shares were not issued until the fourth quarter of 2016.

NOTE 5 – 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 $100,000 at September 30, 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 September 30, 2016 and December 31, 2015, the unrepaid balance of such advances and direct-payments was $168,199 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.

NOTE 6 – 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 September 30, 2016 was $528,313. Income tax benefit for the nine months ended September 30, 2016 was $1,754,073, which reflected an effective tax rate of 39.73%, 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 Company believes that, as of September 30, 2016, it does not have any uncertain tax positions.

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 September 30, 2016 as to the Company’s unrecognized tax benefits at September 30, 2016.

CAPSTONE FINANCIAL GROUP, INC.

NOTES TO UNAUDITED FINANCIAL STATEMENTS