Note 3 Summary of Significant Accounting Policies

Basis of Presentation and Preparation

The consolidated financial statements include the accounts of Capstone and its consolidated subsidiaries (collectively, the “Company”). Intercompany accounts and transactions have been eliminated. The preparation of these financial statements and accompanying notes is in accordance with accounting principles generally accepted in the United States of America. (U.S. GAAP). In the opinion of management, the financial statements include all adjustments necessary and were of a normal recurring nature for the fair presentation of the Company’s financial position, results of operations, and cash flows.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the SEC's Form 10-Q instructions and Article 10 of Regulation S-X (the interim reporting rule). Accordingly, they do not include all of the information and notes required by GAAP for annual consolidated financial statements.

The consolidated balance sheet on  December 31, 2025 has been derived from the audited consolidated financial statements at that date but does not include all the information and notes required by GAAP for complete financial statements. These financial statements have been prepared on a basis that is consistent with the accounting principles applied in our Annual Report on Form 10-K for the fiscal year ended on  December 31, 2025 (“2025 Form 10-K”). This report should be read in conjunction with our 2025 Form 10-K filed with the SEC on April 16, 2026, as amended on April 17, 2026.

In our opinion, the accompanying unaudited interim consolidated financial statements include all normal and recurring adjustments (which consist primarily of accruals, estimates, and assumptions that impact the financial statements) considered necessary to present fairly the Company’s financial position as of  June 30, 2026 and its results of operations, cash flows, and changes in stockholders’ Equity (deficit) for the three and six months ended June 30, 2026 and 2025. The results for the three and six months ended June 30, 2026, are not necessarily indicative of the results expected for any future period or the full year.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make some estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period and accompanying notes. Management bases its estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Although these estimates are based on management’s assumptions regarding current events and actions that may impact on the Company in the future, actual results may differ from these estimates and assumptions.

Business Combinations

The Company accounts for business acquisitions using the acquisition method of accounting, in accordance with which assets acquired, and liabilities assumed are recorded at their respective fair values at the acquisition date. The fair value of the consideration paid, including contingent consideration, is assigned to the assets acquired and liabilities assumed based on their respective fair values. Goodwill represents the excess of the purchase price over the estimated fair values of the assets acquired and liabilities assumed at acquisition date.

The Company’s management exercises significant judgments in determining the fair value of assets acquired and liabilities assumed, as well as intangibles and their estimated useful lives. Fair value and useful life determinations are based on, among other factors, estimates of future expected cash flows and appropriate discount rates used in computing present values. These judgments may materially impact the estimates used in allocating acquisition date fair values to assets acquired and liabilities assumed, as well as the Company’s current and future operating results. Actual results may vary from these estimates which may result in adjustments to goodwill and acquisition date fair values of assets and liabilities during a measurement period or upon a final determination of asset and liability fair values, whichever occurs first. Adjustments to provisional amounts identified after the end of the measurement period are recognized in the Company's consolidated statements of operations.

Fair Value Measurements

The Company measures certain assets and liabilities at fair value in accordance with ASC 820, Fair Value Measurement. ASC 820 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. ASC 820 establishes a three-level hierarchy that prioritizes the inputs used in measuring fair value at the date of acquisition:

Level 1 — Quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

Level 2 — Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and inputs that are derived principally from or corroborated by observable market data.

Level 3 — Unobservable inputs for the asset or liability that are supported by little or no market activity and that are significant to the fair value measurement. Level 3 inputs reflect the Company's own assumptions about the assumptions market participants would use in pricing an asset or liability, developed based on the best information available in the circumstances.

The categorization of an asset or liability within the hierarchy is based on the lowest level of input that is significant to the fair value measurement. Transfers between levels are recognized at the end of the reporting period in which the transfer occurs.

The Company's recurring fair value measurements as of June 30, 2026 consist of (i) the embedded conversion features bifurcated from the Senior Secured Convertible Notes, classified as derivative liabilities and measured at fair value using significant unobservable inputs (Level 3); and (ii) the contingent earn-out consideration related to the Carolina Stone (Carolina Stone Distributors, LLC) and Canadian Stone Industries (Fraser Canyon Holdings Inc.) acquisitions, measured at fair value (as stated in FASB ASC 805-30-35-1 Subsequent measurement) using a probability-weighted expected payout, discounted at a rate that reflects the risk of the underlying performance metric cash flow model with significant unobservable inputs (Level 3). The Company also performs nonrecurring fair value measurements in connection with business combinations (Note 4) and goodwill impairment testing (Note 7), which involve Level 3 inputs including projected cash flows, discount rates, and market multiples. The Company has no recurring Level 1 or Level 2 fair value measurements as of June 30, 2026 or December 31, 2025.

Cash

Cash consists of balances held in a commercial bank account.

Accounts Receivable

Accounts receivables are recorded and carried at the original invoiced amount less any estimates for allowance for doubtful debts that are potentially uncollectible amounts. The Company estimates the allowance for expected credit losses (“ECL”) based upon its assessment of various factors, including historical experience, the age of the accounts receivable balances aging, credit quality of its customers, current economic conditions, and other factors that may affect the Company’s ability to collect from customers. Additionally, the company has elected to assume that current conditions as of the balance sheet date remain unchanged for the remaining life of accounts recievables as it relates to the development of reasonable and supportable forecasts. As of June 30, 2026 and December 31, 2025, the allowance for doubtful accounts totaled approximately $139.0 and $127.0 thousand, respectively.

Certain of the Company’s contracts with customers include retainage provisions. Retainage represents amounts withheld from billings by customers until installation work has been inspected to ensure that performance obligations have been satisfied under the contract. (According to ASC 606). Company invoices are retained and included in contract receivables when obligations have been satisfied and the right to collect is subject only to the passage of time. As of June 30, 2026 and December 31, 2025, retainage receivables were $14.0 and $15.0 thousand, respectively.

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to concentration of credit risk consist principally of cash and trade accounts receivable. The Company places cash with high credit quality institutions. During the normal course of business, balances in these accounts may exceed the maximum amount insured by the Federal Deposit Insurance Corporation (“FDIC”). Concentrations of credit risk with respect to accounts receivable are limited due to the large number of customers comprising the Company’s diverse customer base and generally short payment terms. Management believes there is no business vulnerability regarding concentrations of accounts receivable and sales due to the strong relationships and financial strength of our customers.

Inventories

Inventories consisting of finished goods are stated at the lower cost or net realizable value. Cost is determined using the average cost method. Inventories also include deposits placed on inventory purchases for shipments not yet received. Significant prepaid inventory may be located overseas. The total prepaid inventory balance as of June 30, 2026 and December 31, 2025, is $251.0 thousand and $61.0 thousand, respectively. The reserve for obsolete inventory at June 30, 2026 and December 31, 2025, totaled $790.0 and $793.0 thousand, respectively.

Other Current Assets

In February 2026, the U.S. Supreme Court ruled that tariffs imposed under the International Emergency Economic Powers Act ("IEEPA"), including the reciprocal tariffs, were imposed without statutory authority. Following the ruling, U.S. Customs and Border Protection ("CBP") established an administrative process through which importers of record may claim refunds of IEEPA and reciprocal duties previously paid.

During the period from March 2025 through February 2026, the Company's subsidiary TotalStone, as importer of record, paid $438.0 thousand of IEEPA and reciprocal duties on imported merchandise. TotalStone filed 109 refund claims with CBP through its customs broker using CBP’s CAPE refund declaration system, all of which showed a status of CAPE Accepted on June 12, 2026. Based on the Supreme Court's ruling, CBP's acceptance of the claims prior to the balance sheet date, and the operation of CBP's refund process, management concluded that recovery of these duties is probable and recognized the refund as a recovery of previously recognized costs.

Accordingly, as of June 30, 2026, the Company recorded a tariff refund receivable of $438.0 thousand, included within other current assets in the accompanying unaudited condensed consolidated balance sheet. Because the merchandise to which the refunded duties relate was sold on or before June 30, 2026, the duties had been previously recognized in cost of goods sold; the refund was therefore recorded as a reduction of cost of goods sold in the accompanying unaudited condensed consolidated statements of operations for the six months ended June 30, 2026. No refunds had been received as of June 30, 2026. Subsequent to June 30, 2026, and through August 12, 2026, the Company received $99.0 thousand of tariff refunds. CBP has indicated that accepted refunds will be paid within approximately 60 to 90 days of acceptance, together with statutory interest, which the Company will recognize in other income when received.

In addition, the Company estimates that it paid $136.0 thousand of IEEPA and reciprocal duties through purchases of merchandise from suppliers that acted as importer of record on the related shipments. The Company expects that it paid additional duties of this type but is unable to confirm the amounts at this time. Any recovery of these amounts depends on the suppliers' receipt of refunds from CBP and the Company's arrangements with those suppliers. Because the Company was not the importer of record on those shipments, it could not file CAPE refund claims for those duties and does not hold the direct legal right to the refunds. Accordingly, no amounts have been recognized in the accompanying consolidated financial statements, and the Company will recognize any such recovery when realized.

On June 2, 2026, the U.S. Department of Justice filed a notice of appeal with the U.S. Court of Appeals for the Federal Circuit contesting CBP's obligation to refund certain entries that were liquidated and outside the applicable protest window, a category limited to importers pursuing refunds through litigation. The Company's claims were accepted through CBP's administrative refund process and are not within the scope of the appeal; accordingly, management does not expect the appeal to affect the recognized receivable.

Property and Equipment

Property and equipment are stated at cost and is depreciated over the estimated useful lives ranging from three to forty years according to asset category. Depreciation is computed by using the straight-line method. Property and equipment is comprised of building, machinery & equipment, computer equipment, leasehold improvements, software, office equipment, vehicles, and furniture & fixtures. Minor maintenance and repairs are charged to expenses as incurred.

Goodwill and Other Intangible Assets

Goodwill represents costs in excess of fair values assigned to the underlying net assets of acquired businesses. Goodwill and indefinite lived intangible assets are not amortized but rather are tested for impairment annually as of the 1st day of the fourth quarter of each year or more frequently if events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. Such triggering events or changes in circumstances include, but are not limited to: a significant adverse change in the business climate or legal factors; an adverse action or assessment by a regulator; unanticipated competition; a loss of key personnel; a more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of; or a sustained decline in the Company's stock price or overall market capitalization according to ASC 350.

The Company’s goodwill is allocated to the Company’s reporting units for impairment assessment purposes. As of June 30, 2026, the Company has three reporting units: TotalStone (TotalStone, LLC), Canadian Stone Industries (Fraser Canyon Holdings Inc.), and Carolina Stone (Carolina Stone Distributors, LLC). The Company aggregates TotalStone and Canadian Stone Industries into a single reportable segment for ASC 280 segment-reporting purposes (see Note 18).

During the year ended December 31, 2025, the Company performed a quantitative goodwill impairment test for the Instone reporting unit as of October 1, 2025, and recorded a goodwill impairment charge of $6.2 million. See Note 7 for additional information regarding the Company's goodwill impairment testing. As of June 30, 2026, the Company concluded no quantitative goodwill impairment test was required.

In evaluating potential goodwill impairment, the Company first assesses qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If, based on a review of qualitative factors, it is more likely than not that the fair value of a reporting unit is less than its carrying value, the Company performs a quantitative analysis. If the quantitative analysis indicates the carrying value of a reporting unit exceeds its fair value, the Company measures any goodwill impairment loss as the amount by which the carrying amount of a reporting unit exceeds its fair value, not to exceed the total amount of goodwill allocated to that reporting unit.

Based on this qualitative assessment, the Company concluded that no significant events or changes in circumstances have occurred that would more likely than not reduce the fair value of any reporting unit less than its carrying amount.  Accordingly, an interim quantitative goodwill impairment test was not required, and no goodwill impairment charge was recorded for the three and six months ended June 30, 2026. The Company will perform its annual goodwill impairment test as of October 1, 2026, or earlier if events or circumstances indicate that an interim test is required.

As of June 30, 2026, the Company performed a qualitative interim assessment under ASC 350-20-35-3C to determine whether events or changes in circumstances had occurred that would more likely than not reduce the fair value of any reporting unit below its carrying amount. In performing this assessment, the Company considered, among other factors macroeconomic conditions, industry and market factors, entity specific events, or overall financial performance trends, like share-price movements (including the Company’s status with respect to the Nasdaq minimum bid price requirement for which the Company was granted an additional 180-day compliance period), and reporting-unit-changes.

Goodwill balances as of June 30, 2026 and December 31, 2025 are $18,475.0 thousand and $18,460.0 thousand, respectively.

Intangible assets with finite lives, consist of a distribution agreement, customer relationships and non-compete agreements that are amortized over the terms of the agreements or expected useful lives.

Long-lived Asset Impairments

Long-lived assets and finite lived identifiable intangibles are reviewed for impairment whenever events of changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of the assets is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount of which the carrying amount of the assets exceeds the fair value of the assets. The Company determined that no impairment was required for the financial period presented.

Convertible Debt

The Company accounts for convertible debt in accordance with ASC 470-20, Debt with Conversion and Other Options, and ASC 815, Derivatives and Hedging. At issuance, the Company evaluates whether embedded conversion features require bifurcation as derivative liabilities under ASC 815-15. If bifurcation is required, the embedded feature is recorded at fair value as of the issuance date, with the initial fair value recognized as a derivative liability and a corresponding debt discount on the host instrument. The derivative liability is remeasured at fair value as of each subsequent balance sheet date, with changes in fair value recognized in earnings as other income or expense. The Company reassesses the classification of its derivative instruments at each balance sheet date. Upon modification of convertible debt, the Company evaluates the transaction under ASC 470-50, Debt Modifications and Extinguishments, and remeasures the bifurcated derivative immediately before and after the modification, with the change in fair value recognized in earnings. Upon conversion, the Company derecognizes the pro-rata carrying amount of the host debt (including unamortized OID, debt issuance costs, and derivative discount) and the corresponding portion of the derivative liability at its then-current fair value.

Revenue Recognition

Our sales primarily consist of distributing manufactured and natural stone cladding products, natural stone landscape products, and related goods for residential and commercial construction through a dealer network in 38 states and two Canadian provinces. For distribution sales, the Company recognizes revenue when control over the products has been transferred to the customer, typically upon shipment, and the Company has a present right to payment. For installation and project-based work, the Company recognizes revenue over time as performance obligations are satisfied. For production and custom residential jobs, revenue is generally recognized upon completion, as substantially all projects are short-term in nature. A small portion of commercial projects are recognized based on progress toward percentage of completion, typically through monthly billings. For the three and six months ended June 30, 2026 and 2025, there were no significant estimates of variable consideration represented in revenue. Net revenue recognized at a point in time primarily relates to TotalStone (see Note 18), which totaled approximately $18.3 million and $12.9 million for the three months ended June 30, 2026 and 2025, respectively. Net revenue recognized at a point in time totaled approximately $28.6 million and $20.8 million for the six months ended June 30, 2026 and 2025, respectively. Net revenue recognized over time primarily related to Carolina Stone (see Note 18), which totaled approximately $3.2 million and $0.0 million for the three months ended June 30, 2026 and 2025, respectively. Net revenue recognized over time totaled approximately $5.5 million and $0.0 million for the six months ended June 30, 2026 and 2025, respectively.

Shipping and Handling

The Company includes amounts billed to customers related to shipping and handling expenses in cost of goods sold.

Advertising Costs

Advertising and promotional expenses are expensed in the period incurred unless there are material costs that benefit future periods. The consolidated financial statements currently do not reflect any prepaid advertising expenses. For the three and six months ended June 30, 2026 and 2025, advertising expenses were $22.0 and $9.0 thousand and $50.0 and $24.0 thousand, respectively.

Research and Development

Research and development costs are expensed as incurred and were not significant in the periods presented.

Mandatorily Redeemable Preferred Stock

The Company classifies preferred stock that embodies an unconditional obligation to redeem the instrument by transferring assets at a specified or determinable date as a liability in accordance with ASC 480, Distinguishing Liabilities from Equity. Such instruments are initially measured at fair value and subsequently measured at the present value of the amount to be paid at settlement, with interest expense accrued using the rate implicit at inception. Periodic dividend obligations on mandatorily redeemable preferred stock classified as a liability are presented as interest expense in the consolidated statements of operations. The Company's Series Z 8% Non-Convertible Preferred Stock, issued September 30, 2025, has been assessed as mandatorily redeemable and is presented as a liability in the accompanying consolidated balance sheets. See Note 5 for additional information.

Earnings Per Share

Basic earnings (loss) per share is computed by dividing the net income (loss) applicable to the common stockholders of Capstone Holding Corp. by the weighted average number of shares of common stock outstanding during the year. Diluted earnings (loss) per share is computed by dividing the net income (loss) applicable to common stockholders by the weighted average number of common shares outstanding plus the number of additional common shares that would have been outstanding if all dilutive potential common shares had been issued, using the treasury stock method and the if-converted method for convertible notes. Potential common shares that have anti-dilutive effect are excluded from computation. 3i February warrants issued with a nominal exercise price of $0.01 per share are considered common stock equivalents and are included in the weighted-average number of common shares outstanding used to compute basic earnings (loss) per share.

For the six months ended June 30, 2026 and 2025, both the calculations for basic and diluted loss per share are the same as potential dilutive securities would have had an anti-dilutive effect. For the six months ended June 30, 2026 and 2025, the number of incremental common shares from potentially dilutive securities consisted of the following:

The table above reflects the conversion prices in effect at June 30, 2026. On August 10, 2026 the conversion price of both Senior Secured Convertible Notes was reduced to $0.2949 per share. Had that price been in effect at June 30, 2026, the incremental shares attributable to the convertible notes would have been approximately 6,445,438 rather than 2,115,154, and total potentially dilutive securities would have been approximately 8,509,260 rather than 4,178,976. See Note 19.

Restatement

On August 7, 2026, the Company identified an error in the computation of basic and diluted loss per share for the three months ended March 31, 2025, the three and six months ended June 30, 2025, and the three and nine months ended September 30, 2025. The amounts previously reported for the periods ended June 30, 2025 were the number of shares outstanding at the end of the period rather than averages weighted for the portion of the period each share was outstanding, and the amounts previously reported for the periods ended September 30, 2025 did not reflect the day weighted average of shares outstanding during those periods, in each case as required by ASC 260, Earnings Per Share. The error affected only the weighted average share amounts and the related per share amounts; it did not affect net loss, total assets, total liabilities, stockholders' equity, or cash flows for any period. The Company assessed the error as material and has restated the affected periods in accordance with ASC 250, Accounting Changes and Error Corrections. The Company is filing amendments on Form 10-Q/A for the quarterly periods ended June 30, 2025 and September 30, 2025. The restated weighted average share and per share amounts for the three months ended March 31, 2025 are presented as comparative amounts in Amendment No. 1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2026.

The effect of the restatement on the amounts previously reported for the three and six months ended June 30, 2025 is as follows:

Reclassifications

Certain reclassifications to prior period information have been made to conform with current period presentation.

Recent Accounting Pronouncements

In November 2024, the FASB issued ASU 2024-03, Income Statement — Reporting Comprehensive Income — Expense Disaggregation Disclosures (Subtopic 220-40), which requires public business entities to disclose disaggregated information about specified categories of expenses. The standard is effective for annual periods beginning after December 15, 2026 and interim periods within annual periods beginning after December 15, 2027, with early adoption permitted. The Company is evaluating the impact of the standard on its consolidated financial statement disclosures.

In November 2024, the FASB issued ASU 2024-04, Debt — Debt with Conversion and Other Options (Subtopic 470-20): Induced Conversions of Convertible Debt Instruments, which clarifies the assessment of whether modifications of convertible debt instruments should be accounted for as induced conversions. The Company adopted this guidance effective January 1, 2026 on a prospective basis. Adoption did not have a material effect on the Company’s consolidated financial statements.

On July 30, 2025 the FASB issued ASU 2025-05, Financial Instruments — Credit Losses (Topic 326): Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses for Accounts Receivable and Contract Assets, which provides a practical expedient permitting entities to assume current conditions as of the balance sheet date do not change for the remaining life of the asset when estimating expected credit losses for current accounts receivable and current contract assets arising from transactions accounted for under Topic 606. The amendments are effective for annual reporting periods beginning after December 15, 2025, and interim reporting periods within those annual reporting periods, with early adoption permitted. The Company adopted the standard effective January 1, 2026, electing the practical expedient, and the adoption did not have a material impact on its consolidated financial statements.