NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. DESCRIPTION OF BUSINESS

TOMI is a leading provider of infection prevention and decontamination products and services, focused primarily on life sciences including healthcare, bio-safety, pharmaceutical, clean-room and research. Our mission is to help our customers create a healthier world thru TOMI’s product line. TOMI’s motto is “innovating for a safer world” for healthcare and life.

As a global decontamination and infectious disease control company, TOMI provides environmental solutions for indoor and outdoor surface decontamination through the sale of equipment, services and licensing of our SteraMist TM Binary Ionization Technology® (“BIT TM ”) which is a hydrogen peroxide based mist and fog registered with the Environmental Protection Agency (“EPA”).

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The interim unaudited condensed consolidated financial statements included herein, presented in accordance with generally accepted accounting principles utilized in the United States of America (“GAAP”), and stated in U.S. dollars, have been prepared by the Company, without an audit, pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading.

These financial statements reflect all adjustments, consisting of normal recurring adjustments, which, in the opinion of management, are necessary for fair presentation of the information contained therein. These unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements of the Company for the year ended December 31, 2015 and notes thereto which are included in the Form 10-K previously filed with the SEC on March 30, 2016. The Company follows the same accounting policies in the preparation of interim reports.

Principles of Consolidation

The accompanying condensed consolidated financial statements include the accounts of TOMI, and its wholly-owned subsidiary, TOMI Environmental Solutions, Inc., a Nevada Corporation.  The Company’s 55% owned subsidiary, TOMI Environmental-China, has been dormant since its formation in April 2011. All significant intercompany accounts and transactions have been eliminated in consolidation.

Reclassification of Accounts

Certain reclassifications have been made to prior-year comparative financial statements to conform to the current year presentation. These reclassifications had no effect on previously reported results of operations or financial position.

Use of Estimates

The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the amounts reported and disclosed in the accompanying unaudited condensed consolidated financial statements and the accompanying notes. Actual results could differ materially from these estimates. On an ongoing basis, we evaluate our estimates, including those related to the accounts receivable, fair values of financial instruments, intangible assets, useful lives of intangible assets and property and equipment, fair values of stock-based awards, income taxes, and contingent liabilities, among others. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of our assets and liabilities.

 

 

Fair Value Measurements

The authoritative guidance for fair value measurements defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or the most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact, and (iv) willing to transact. The guidance describes a fair value hierarchy based on the levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value, which are the following:

Level 1:	Quoted prices in active markets for identical assets or liabilities.
Level 2:	Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or corroborated by observable market data or substantially the full term of the assets or liabilities.
Level 3:	Unobservable inputs that are supported by little or no market activity and that are significant to the value of the assets or liabilities.

 

The Company’s financial instruments include cash and equivalents, accounts receivable, and accounts payable and accrued expenses.  All these items were determined to be Level 1 fair value measurements.

The carrying amounts of cash and cash equivalents, accounts receivable, and accounts payable and accrued expenses approximated fair value because of the short maturity of these instruments.

Cash and Cash Equivalents

For purposes of the statement of cash flows, cash and cash equivalents includes cash on hand held at financial institutions and other liquid investments with original maturities of three months or less.

Accounts Receivable

 

Our accounts receivable are typically from credit worthy customers or, for certain international customers, are supported by pre-payments. For those customers to whom we extend credit, we perform periodic evaluations of them and maintain allowances for potential credit losses as deemed necessary.  We have a policy of reserving for doubtful accounts based on our best estimate of the amount of potential credit losses in existing accounts receivable. We periodically review our accounts receivable to determine whether an allowance is necessary based on an analysis of past due accounts and other factors that may indicate that the realization of an account may be in doubt. Account balances deemed to be uncollectible are charged to the allowance after all means of collection have been exhausted and the potential for recovery is considered remote.  Bad debt expense for the three months ended March 31, 2016 and 2015 was $30,000 and $482, respectively.

At March 31, 2016 and December 31, 2015, the allowance for doubtful accounts was $75,000 and $45,000, respectively.

 

As of March 31, 2016, one customer accounted for 13% of net accounts receivable.  Two customers accounted for 52% of net revenues for the three months ended March 31, 2016

As of December 31, 2015 three customers accounted for 42% of net accounts receivable. Three customers accounted for 70% of net revenues for the quarter ended March 31, 2015

Inventories

Inventories are valued at the lower of cost or market using the first-in, first-out (“FIFO”) method.  Inventories consist primarily of finished goods and raw materials.  At March 31, 2016 and December 31, 2015, we did not have a reserve for slow-moving or obsolete inventory.

 

 

Deposits on Merchandise

Deposits on merchandise primarily consist of amounts incurred or paid in advance of the receipt of inventory. (See note 11)

 

Property and Equipment

 

We account for property and equipment at cost less accumulated depreciation. We compute depreciation using the straight-line method over the estimated useful lives of the assets, generally three to five years. Depreciation for equipment, furniture and fixtures and vehicles commences once placed in service for its intended use.  Leasehold improvements are amortized using the straight-line method over the lives of the respective leases or service lives of the improvements, whichever is shorter.

 

Deferred Financing Costs

The Company follows authoritative guidance for accounting for financing costs as it relates to convertible debt issuance cost.  These costs are deferred and amortized over the term of the debt period or until redemption of the convertible debentures.  Amortization of deferred financing costs amounted to approximately $0 and $84,000 for the three months ended March 31, 2016 and 2015, respectively.

Accounts Payable

 

As of March 31, 2016 and December 31, 2015, one vendor accounted for approximately 83% and 72% of total accounts payable, respectively.

For the three months ended March 31, 2016 and 2015, one vendor accounted for 77% and 87% of cost of goods sold, respectively.

Accrued Warranties

 

Accrued warranties represent the estimated costs, if any, that will be incurred during the warranty period of our products. We make an estimate of expected costs that will be incurred by us during the warranty period and charge that expense to the consolidated statement of operations at the date of sale. Our manufacturer assumes warranty against product defects for one year which we extend to our customers.  We assume responsibility for product reliability and results. As of March 31, 2016 and 2015, the Company did not establish a reserve.

 

Income taxes

Deferred income tax assets and liabilities are determined based on differences between the financial statement reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws in effect when the differences are expected to reverse. The measurement of deferred income tax assets is reduced, if necessary, by a valuation allowance for any tax benefits, which are, on a more likely than not basis, not expected to be realized; in accordance with ASC guidance for income taxes. Net deferred tax benefits have been fully reserved at March 31, 2016 and December 31, 2015. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in the period that such tax rate changes are enacted.

Loss Per Share

Basic loss per share is computed by dividing the Company’s net loss by the weighted average number of common shares outstanding during the period presented.  Diluted loss per share is based on the treasury stock method and includes the effect from potential issuance of common stock such as shares issuable pursuant to the exercise of warrants and conversions of debentures.

Potentially dilutive securities as of March 31, 2016, consisted of 36,026,413 shares of common stock from outstanding warrants, 200,000 shares of common stock from options and 510,000 shares of common stock from convertible Series A preferred stock.  Diluted and basic weighted average shares are the same, as potentially dilutive shares are anti-dilutive.

 

 

Potentially dilutive securities as of March 31, 2015, consisted of 17,496,552 shares of common stock from convertible debentures, 32,451,413 shares of common stock from outstanding warrants (including warrants to purchase up to 7,611,000 shares of common stock issued in conjunction with convertible notes), 100,000 shares of common stock from options and 510,000 shares of common stock from convertible Series A preferred stock.  Diluted and basic weighted average shares are the same, as potentially dilutive shares are anti-dilutive.

Revenue Recognition

For revenue from services and product sales, the Company recognized revenue in accordance with Staff Accounting Bulletin No. 104, “Revenue Recognition” (SAB No. 104), which superseded Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (SAB No. 101). SAB No. 104 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) service has been rendered or delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgment regarding the fixed nature of the selling prices of the services rendered or products delivered and the collectability of those amounts. Provisions for discounts to customers, and allowance, and other adjustments will be provided for in the same period the related sales are recorded.

 

Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with Financial Accounting Standards Board (“FASB”), ASC 718, Compensation- “Stock Compensation.” Under the provisions of FASB ASC 718, stock-based compensation cost is estimated at the grant date based on the award’s fair value and is recognized as expense over the requisite service period. The Company had one active stock-based compensation plan, the TOMI Environmental Solutions, Inc. Stock Option and Restricted Stock Plan (the “2008 Plan”). The 2008 Plan calls for the Company, through a committee of its board of directors, to issue up to 2,500,000 shares of restricted common stock or stock options. The Company generally issues grants to its employees, consultants, and board members. Stock options are granted with an exercise price equal to the closing price of its common stock on the date of the grant with a term no greater than 10 years. Generally, stock options vest over two to four years. Incentive stock options granted to shareholders who own 10% or more of the Company’s outstanding equity securities are granted at an exercise price that may not be less than 110% of the closing price of the Company’s common stock on the date of grant and have a term no greater than five years. On the date of a grant, the Company determines the fair value of the stock option award and recognizes compensation expense over the requisite service period, which is generally the vesting period of the award. The fair value of the stock option award is calculated using the Black-Scholes option-pricing model. On August 25, 2015, the 2008 Plan was terminated.

 

Concentrations of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents.  The Company maintains cash balances at financial institutions which exceed the current Federal Deposit Insurance Corporation (“FDIC”) limit of $250,000 at times during the year.

Long-Lived Assets Including Acquired Intangible Assets

The Company assesses long-lived assets for potential impairments at the end of each year, or during the year if an event or other circumstance indicates that we may not be able to recover the carrying amount of the asset. In evaluating long-lived assets for impairment, the Company measures recoverability of these assets by comparing the carrying amounts to the future undiscounted cash flows the assets are expected to generate.  If the Company’s long-lived assets are considered to be impaired, the impairment to be recognized equals the amount by which the carrying value of the asset exceeds its fair market value. The Company bases its calculations of the estimated fair value of its long-lived assets on the income approach. For the income approach, the Company uses an internally developed discounted cash flow model that include, among others, the following assumptions: projections of revenues and expenses and related cash flows based on assumed long-term growth rates and demand trends; expected future investments to grow new units; and estimated discount rates. We base these assumptions on our historical data and experience, industry projections, micro and macro general economic condition projections, and our expectations. We have had no long-lived asset impairment charges for the three months ended March 31, 2016 and 2015

 

 

Advertising and Promotional Expenses

The Company expenses advertising costs in the period in which they are incurred. For the three months ended March 31, 2016 and 2015, advertising and promotional expenses were approximately $41,000 and $3,000, respectively.

Research and Development Expenses

The Company expenses research and development expenses in the period in which they are incurred. For the three months ended March 31, 2016 and 2015, research and development expenses were approximately $9,000 and $22,000, respectively.

Shipping and Handling Costs

The Company includes shipping and handling costs relating to the delivery of products directly from vendors to the Company in cost of sales. Shipping and handling costs, which include third-party delivery costs relating to the delivery of products from the Company to customers, are classified as a general and administrative expense. Shipping and handling costs included in general and administrative expense were $29,000 and $7,000 for the three months ended March, 31, 2016 and 2015, respectively.

 

Recent Accounting Pronouncements

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (ASU 2014-09) “Revenue from Contracts with Customers.”  ASU 2014-09 supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605)”, and requires entities to recognize revenue when it transfers promised goods or services to customers in an amount that reflect the consideration to which the entity expects to be entitled to in exchange for those goods or services.  ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period.  Early adoption is not permitted.  We are currently in the process of evaluating the impact of the adoption of ASU 2014-09 on our consolidated financial statements.

In November 2015, the FASB issued Accounting Standards Update No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes (ASU 2015-17), which simplifies the presentation of deferred income taxes by requiring that deferred tax assets and liabilities be classified as non-current. We retrospectively adopted this standard as of December 31, 2015.  As a result, there was no impact to the Company’s results of operations.

In February 2016, the FASB issued Accounting Standards Update No. 2016-02 (ASU 2016-02) “Leases.”  ASU 2016-02 provides new lease accounting guidance.  ASU 2016-02 is effective for annual reporting periods beginning after   December 15, 2018 , including interim periods within that reporting period.  Early adoption is permitted.  We are currently in the process of evaluating the impact of the adoption of ASU 2016-02 on our consolidated financial statements.

 

 

For the three months ended March 31, 2016 and 2015, depreciation was $40,890 and $32,876, respectively.

NOTE 5. INTANGIBLE ASSETS

 

Intangible assets consist of patents and trademarks related to our Binary Ionization Technology.  All of these assets were pledged as collateral for the convertible notes as described below in Note 6.  The patents are being amortized over the estimated remaining lives of the related patents.  The trademarks have an indefinite life Amortization expense was $92,377 and $92,377 for the three months ended March 31, 2016 and 2015.

           Definite life intangible assets consist of the following:

Indefinite life intangible assets consist of the following:

 

Trademarks

$

440,000

$

440,000

Total Intangible Assets, net

$

2,195,171

$

2,287,548

 

Approximate amortization over the next five years is as follows:

 

 

NOTE 6. CONVERTIBLE DEBT

 

In November 2012, the Company initiated a private placement offering a maximum of 240 Units (as defined below) of the Company’s securities at a price of $25,000 per Unit or $6,000,000. The initial closing of the offering occurred in April 2013 as the bulk of the net proceeds of the offering were to be allocated for the asset purchase from L-3 Applied Technologies, Inc., which was finalized April 2013.   Each Unit consisted of $25,000 par amount of a 10% Senior Secured Callable Convertible Promissory Note due and payable on July 31, 2015 (the “Notes”) and 37,500 warrants each of which allows the investor to purchase one share of common stock and expires on July 31, 2018.  Interest was payable on the Notes at a rate of 10% per annum, and payable on July 31 st and January 31 st .   The Notes were secured by the Company’s intellectual property such as the patents, royalties, receivables of the Company and all equipment except for the new equipment acquired with the proceeds from any future financing that is initially secured by this new equipment.  The Notes called for the establishment of a sinking fund.  Within 45 days of each calendar quarter 15% of the Company’s reported revenue was required to be deposited into the Company’s escrowed sinking fund account.

The Company sold 202.96 Units for gross proceeds of $5,074,000 and issued warrants to purchase up to 7,611,000 shares of common stock in connection with the Units.  Net proceeds amounted to $4,462,693 after expenses of offering totaling $611,307.  In addition, the placement agent received warrants to purchase up to 1,014,800 shares of common stock valued at $165,180.

The Notes were convertible, at the option of the note holder, into shares of our common stock at an initial conversion price of $.29 (which conversion price is subject to adjustment upon the occurrence of events specified in the Notes, including stock dividends, stock splits, certain fundamental corporate transactions, and certain issuances of common stock by the Company).

The warrants are exercisable into shares of common stock (the “Warrant Shares”) at an initial exercise price of $0.30 (which may be subject to certain adjustments as set forth in the warrants). 

The Company evaluated the warrants under ASC 815-40-15 due to the exercise price being adjustable upon certain events occurring.  The Company determined that the warrants are considered indexed to the Company’s own common stock and thus meet the scope exception under FASB ASC 815-10-15-74 and are therefore not considered a derivative.  The estimated fair value of the warrants, which contain reset provisions, were calculated using the Monte Carlo valuation model.   The Company recorded the warrants’ relative fair value of $956,712 as an increase to additional paid in capital and a discount against the related debt.

The Notes contained a provision whereby the conversion price is adjustable upon the occurrence of certain events, including the issuance of common stock or common stock equivalents at a price which is lower than the current conversion price. Under FASB ASC 815-40-15-5, the embedded conversion feature was not considered indexed to the Company’s own common stock and, therefore, did not meet the scope exception in FASB ASC 815-10-15 and thus needed to be accounted for as a derivative liability.  The initial fair value of the embedded conversion feature was estimated at $7,316,092 and recorded as a derivative liability, resulting in an additional discount of $4,117,288 to the Notes and a finance charge of $3,198,804 included in the statement of operations for the year ended December 31, 2013.  The fair value of the embedded conversion feature was estimated at the end of each quarterly reporting period using the Monte Carlo model.

Inherent in the Monte Carlo Valuation model are assumptions related to expected volatility, remaining life, risk-free rate and expected dividend yield.  For the Notes using a Monte Carlo model, we estimate the probability and timing of potential future financing and fundamental transactions as applicable.  The Company applied various assumptions into the Monte Carlo Valuation models to determine the change in the fair value of the derivative liability as of the retirement dates of the Notes.

The debt discount was amortized over the life of the convertible note using the effective interest method and was fully amortized upon the retirement of the convertible notes during the quarter ended June 30, 2015.

 

In June 2015, the Company offered the noteholders options to convert to cash or at a reduced conversion price on the Notes from $.29 per share provided the conversion feature was exercised prior to June 30, 2015.  If the noteholder agreed to lock up the converted shares for six (6) months or an uplist to a market on the NYSE or NASDAQ Stock Market, LLC, whichever is shorter, the conversion price was reduced to $.26 per share. Absent the lock up, the noteholder could convert at $.275 per share. All noteholders except two converted at $.26.  Pursuant to the terms of the conversion offer, an aggregate of $3,774,000 of the Notes and $124,000 of accrued interest were converted into 14,913,968 shares of the Company’s common stock.  The Company recognized an induced conversion cost of $930,383 related to all conversions and retirements.

In addition, during the quarter ended June 30, 2015, an aggregate of $1,300,000 of the Notes and $87,500 in accrued interest were repaid in the form of cash.

 

 

NOTE 7. FAIR VALUE

           Level 3 financial instruments consist of certain embedded conversion features. The fair value of these embedded conversion features that have exercise reset features are estimated using a Monte Carlo valuation model. The Company adopted the disclosure requirements of ASU 2011-04, “Fair Value Measurements.” (See note 6) The unobservable input used by the Company was the estimation of the likelihood of a reset occurring on the embedded conversion feature of the Convertible Notes.  These estimates of the likelihood of completing an equity raise that would meet the criteria to trigger the reset provisions are based on numerous factors, including the remaining term of the financial instruments and the Company’s overall financial condition.

 

 

The following table summarizes the changes in fair value of the Company’s Level 3 financial instruments for the period ended March 31, 2016 and December 31, 2015.  Upon the retirement of the Notes in June 2015, the fair value of the derivative liability was $0.

 

Changes in the unobservable input values would likely cause material changes in the fair value of the Company’s Level 3 financial instruments. The significant unobservable input used in the fair value measurement is the estimation of the likelihood of the occurrence of a change to the conversion price based on the contractual terms of the financial instruments. A significant increase (decrease) in this likelihood would result in a higher (lower) fair value measurement.  As of March 31, 2016 and December 31, 2015, the balance of derivative liability was $0 as the Notes were retired during the second quarter of 2015.

 

NOTE 8. STOCKHOLDERS’ EQUITY

The Company’s board of directors may, without further action by the Company’s stockholders, from time to time, direct the issuance of any authorized but unissued or unreserved shares of preferred stock in series and at the time of issuance, determine the rights, preferences and limitations of each series. The holders of such preferred stock may be entitled to receive a preference payment in the event of any liquidation, dissolution or winding-up of the Company before any payment is made to the holders of our common stock. Furthermore, the board of directors could issue preferred stock with voting and other rights that could adversely affect the voting power of the holders of our common stock.

Convertible Series A Preferred Stock

The Company has authorized 1,000,000 shares of Convertible Series A Preferred Stock, $0.01 par value. At March 31, 2016 and December 31, 2015, there were 510,000 shares issued and outstanding, respectively. The Convertible Series A Preferred Stock is convertible at the rate of one share of common stock for one share of Convertible Series A Preferred Stock.

Convertible Series B Preferred Stock

The Company has authorized 4,000 shares of Convertible Series B Preferred Stock, $1,000 stated value, 7.5% Cumulative dividend. At March 31, 2016 and December 31, 2015, there were no shares issued and outstanding, respectively.

Common Stock

During the three months ended March 31, 2015, the Company issued 100,000 shares of common stock valued at approximately $25,000 for professional services rendered.

During the three months ended March 31, 2015, the Company issued 20,245 shares of common stock valued at $6,000 to Nick Jennings, CFO, as part of his annual compensation from the Company.

During the three months ended March 31, 2015, the Company sold, through its confidential private offering, 1,500,002 equity units.  Each unit consisted of 1 share of common stock and 2.5 warrants.  The warrants have an exercise price of $.29 per share and a term of seven years. Gross proceeds to the Company amounted to $434,826.  In connection with the sale, the Company incurred a [cash finder’s fee in the amount of $43,500 in addition to a finder’s fee to be paid in common stock of 45,000 shares valued at $13,050

 

 

During the three months ended March 31, 2015, the Company directly sold, 260,000 equity units.  Each unit consisted of 1 share of common stock and 2.5 warrants.  The warrants have an exercise price of $.29 per share and a term of seven years. Gross proceeds to the Company amounted to $75,387.  In connection with the sale, the Company incurred a cash finder’s fee in the amount of $7,500 in addition to a finder’s fee to be paid in common stock of 7,800 shares valued at $2,262

During the three months ended March 31, 2016, the Company issued 275,416 shares of common stock valued at approximately $145,000 for professional services rendered.

Stock Options

The Company issued 40,000 options valued at $10,798 to two directors in January 2015. The options have an exercise price of $0.27 per share. The options expire in January 2025. The options were valued using the Black-Scholes model using the following assumptions: volatility: 237%; dividend yield: 0%; zero coupon rate: 1.61%; and a life of 10 years.

The Company issued 100,000 options valued at $54,980 to four directors in February 2016. The options have an exercise price of $0.55 per share. The options expire in February 2026. The options were valued using the Black-Scholes model using the following assumptions: volatility: 224%; dividend yield: 0%; zero coupon rate: 1.47%; and a life of 10 years.

 

The following table summarizes stock options outstanding as of March 31, 2016 and December 31, 2015:

Options outstanding and exercisable by price range as of March 31, 2016 were as follows:

 

 

Stock Warrants

For the three months ended March 31, 2015, the Company recognized equity based compensation of approximately $79,000 on the warrants issued to the CEO in connection with the employment agreement.  In addition, the Company recognized approximately $28,000 to a consultant (Note 11), and $7,400 on the vesting of warrants issued to the CFO on October 1, 2014 (Note 9).

 

 

During the quarter ended March 31, 2015, the Company issued warrants to purchase up to 4,400,005 shares of common stock in connection with equity units sold to investors.  See note 8 (common stock) for additional details.

For the three months ended March 31, 2016, the Company recognized total equity based compensation of approximately $168,000 on warrants issued to the CEO in connection with his current and previous employment agreements (Note 9).  For the three months ended March 31, 2016, the Company recognized $39,000 in stock compensation expense for the warrants issued to the CEO in February 2014 that vested in February 2016.  In addition, on March 31, 2016, the Company issued warrants to purchase up to 250,000 shares of common stock to the CEO with a term of five years that vest upon issuance and have an exercise price of $.50 per share.  The Company utilized the Black-Scholes method to fair value the warrants to purchase up to 250,000 shares of common stock received by the CEO totaling approximately $129,000 with the following assumptions: volatility, 162%; expected dividend yield, 0%; risk free interest rate, 1.47%; and a life of 5 years. The grant date fair value of each warrant was $0.51.  (See note 9 for additional details)

For the three months ended March 31, 2016, the Company recognized total equity based compensation of approximately $58,000 on warrants issued to the CFO in connection with his current and previous employment agreements (Note 9).  For the three months ended March 31, 2016, the Company recognized $7,000 in stock compensation expense for the accrued but not vested portion of the warrants issued to the CFO under his previous agreement with the Company.  In addition, on January 26, 2016, the Company issued warrants to purchase up to 100,000 shares of common stock to the CFO with a term of five years that vest upon issuance and have an exercise price of $.55 per share.  The Company utilized the Black-Scholes method to fair value the warrants to purchase up to 100,000 shares of common stock received by the CFO totaling approximately $51,000 with the following assumptions: volatility, 164%; expected dividend yield, 0%; risk free interest rate, 1.47%; and a life of 5 years. The grant date fair value of each warrant was $0.51.  (See note 9 for additional details)

For the three months ended March 31, 2016, the Company recognized equity compensation expense of approximately $57,000 related to warrants contracted to an employee pursuant to his employment agreement with the Company that were issued in April of 2016.  The Company has accrued for the estimated fair value of the warrants as of March 31, 2016.  The Company utilized the Black-Scholes method to fair value the warrants received by the employee with the following assumptions: volatility, 159%; expected dividend yield, 0%; risk free interest rate, 1.47%; and a life of 5 years. The grant date fair value of each warrant was $0.46. (See note 12)

The following table summarizes the outstanding common stock warrants as of March 31, 2016 and December 31, 2015:

 

 

Warrants outstanding and exercisable by price range as of March 31, 2016 were as follows:  

 

Unvested warrants outstanding as of March 31, 2016 were as follows:

Unvested Warrants
Weighted Average Exercise Price				Number				Average Weighted Remaining Contractual Life in Years
$	0.30				100,000				5.00

 

NOTE 9.  RELATED PARTY TRANSACTIONS

 

 

NOTE 10. COMMITMENTS AND CONTINGENCIES

 

Lease Commitments

In September of 2014 the Company entered into a lease agreement for office and warehouse space in Fredrick Maryland. As part of the lease agreement, the Company received a rent holiday in the first 5 months of the lease.  The lease also provides for an escalation clause where the Company will be subject to an annual rent increase of 3%, year over year.  The lease expires on January 31, 2018.  The Company accounts for the lease using the straight line method and recorded $11,427 in rent expense for the three months ended March 31, 2016 and 2015.  Approximate minimum annual rents under the lease are as follows:

 

 

Legal Contingencies 

We may become a party to litigation in the normal course of business.  In the opinion of management, there are no legal matters involving us that would have a material adverse effect upon our financial condition, results of operations or cash flows.

Product Liability

 

As of March 31, 2016 and December 31, 2015, there were no claims against the Company for product liability.

NOTE 11. CONTRACTS AND AGREEMENTS

Employment Agreements

On February 11, 2014, the Company entered into an employment agreement with Halden S. Shane, our Chief Executive Officer (“CEO”).  The term of the employment agreement extended through December 31, 2016 with automatic renewal for successive one-year periods unless otherwise terminated by either party thereunder.  Dr. Shane’s annual base salary was $36,000, which shall increase to $120,000 upon the Company exceeding gross revenues of $5,000,000 on a calendar year basis and to $175,000 upon the Company exceeding gross revenues of $10,000,000 on a calendar year basis.  Dr. Shane also received a grant of 3,000,000 warrants to purchase shares of the Company’s common stock at a price of $0.30 per share which have a term of five years and vest upon the following schedule: 1,000,000 vested upon issuance, 1,000,000 vested on February 11, 2015, and 1,000,000 vested February 11, 2016.  Dr. Shane’s employment agreement includes restrictive covenants of non-solicitation and confidentiality of proprietary information.  Under the employment agreement, Dr. Shane assigned any and all of his rights to Company proprietary information to the Company and agreed that all property created by him during and in connection with his employment constitutes “works for hire” as defined in the United States Copyright Act.

On February 8, 2016, the Company entered into an employment agreement with Robert Wotczak in connection with his role as the Company’s President.  Mr. Wotczak’s annual salary is $240,000 per annum paid bi-weekly.  Additionally, in accordance with the terms of the agreement, the Company agreed to issue him 150,000 shares of common stock, which was issued in April 2016.  Mr. Wotczak will also be entitled to (i) annual grants of stock options to purchase up to 250,000 shares of common stock each year under the 2016 Plan, (ii) additional shares of common stock granted on an annual basis based on achievement of performance objectives, (iii) an annual raise and/or bonus for meeting or achieving certain performance objectives, (iv) a vehicle expense up to $750 per month and (v) health insurance contributions equal to 80% toward the cost of an individual plan. Mr. Wotczak’s agreement includes restrictive covenants of non-solicitation and confidentiality of proprietary information.  In the event of a change in control of the Company, which results in his termination, Mr. Wotczak will be entitled to a lump sum payment of one year’s salary and all equity awards will be accelerated and fully vested.   The Company may terminate Mr. Wotczak’s employment at any time; provided, however, that the Company must provide fourteen days’ notice if any of the following events occur: (a) the sale of substantially all of the Company’s assets, (b) sale, exchange, or other disposition in one transaction of the majority of the Company’s outstanding capital stock, (c) the Company’s decision to terminate its business and liquidate its assets, (d) the merger or consolidation of the Company with another company, or (e) bankruptcy or chapter 11 reorganization.

 

 

On September 30, 2014, the Company entered into an employment agreement with Nick Jennings, our Chief Financial Officer (“CFO”) to provide part-time services.  The term of the employment agreement was through December 31, 2014 with a review of employment in January 2015.  Mr. Jennings’ salary was $5,000 per month in cash and $2,000 in common stock per month, paid quarterly.  Mr. Jennings also received a 5 year warrant to purchase up to 300,000 shares of common stock at a price per share equal to $0.30 and vests upon the following schedule: 100,000 vested upon issuance, 100,000 vested on October 1, 2015, and 100,000 will vest as of October 1, 2016.  In connection with the employment agreement, Mr. Jennings entered into agreements that included restrictive covenants of non-solicitation and confidentiality of proprietary information.

On October 16, 2014, we entered into an employment agreement with Norris Gearhart pursuant to which he agreed to serve as the Company’s Chief Operating Officer (“COO”).  Mr. Gearhart’s salary was $126,000 per annum paid bi-monthly.  Additionally, Mr. Gearhart received 100,000 shares of Common Stock upon signing his agreement, a monthly transportation expense up to $500 towards a vehicle and the ability to receive an additional cash or equity bonus upon the achievement of pre-agreed performance objectives.

On September 2, 2015, we entered into a new employment agreement with Mr. Gearhart, which superseded his prior agreement, pursuant to which he will continue to serve as our COO.  Mr. Gearhart’s’ annual salary is $145,000 which is reviewed each at the end of the second anniversary.  Mr. Gearhart will receive annual grants of stock options to purchase up to 250,000 shares of Common Stock at an exercise price equal to the volume weighted average price of the five-day period prior to the close of the year.  Mr. Gearhart is also entitled to additional equity compensation based upon superior performance of his responsibilities, as determined by the board of directors, in its sole discretion.  In the event of a change in control of the Company, which results in his termination, Mr. Gearhart will be entitled to a lump sum payment of one year’s salary and all equity awards will be accelerated and fully vested.  In the event his employment is termination other than for cause, Mr. Gearhart will receive an amount equal to his annual salary as of such terminate date after the second employment anniversary.

Sales and Distribution Agreement

In September 2014, the Company entered into a Sales and Distribution Agreement, superseding previous agreements, with TOMI Panama S.A. (“TOMI Panama”) covering Panama.  TOMI Panama is the exclusive distributor of the Company’s products and services within the country of Panama.  For the three months ended March 31, 2016 and 2015, the Company made sales and provided services to TOMI Panama for approximately $18,000 and $37,000, respectively.

Distribution and Licensing Agreement

On March 21, 2014, the Company entered into a distribution and licensing agreement with Plascencia Universal, S. de R.L. de C.V. (“Plascencia Universal”), a Mexican company that will act as the exclusive distributor of TOMI’s products and services in Mexico. The principal of Plascencia Universal is also the broker for the Company’s insurance policies and was appointed a director of the Company.  In April of 2015, the Company modified its agreement with Plascencia Universal with respect to the license fee included in the original agreement.  In December of 2015, the principal of Plascencia Universal resigned from the board of directors.  For the quarter ended March 31, 2016, sales to Plascencia Universal were approximately $655,000.

Manufacturing Agreement

On October 15, 2014, the Company entered into a manufacturing and development agreement with RG Group, Inc.  The agreement does not provide for any minimum purchase commitments and is for a term of 2 years with provisions to extend. For the three months ended March 31, 2016 and the year ended December 31, 2015, RG Group, Inc. manufactured substantially all of the Company’s equipment.  At March 31, 2016 and December 31, 2015, the Company maintained required deposits with RG Group, Inc. in the amounts of $237,345 and $442,358, respectively.

 

Consulting Agreement

 

In January 2015, the Company entered into a consulting agreement which has since been terminated that provided for a fee based on revenue received from existing and prospective clients assigned and revenue from sales related to customers the consultant finds for the Company.  The agreement also provided for the issuance of 100,000 shares of the Company’s common stock that were issued in February 2015 and valued at $25,000.  In addition, the agreement provides for the issuance of 75,000 common stock warrants on a quarterly basis that vest upon issuance with a strike price equal to the volume weighted average price for the 5 day period prior to the close of the quarter with a term of 3 years.  The exercise price for the warrants issued was $0.50, $0.62 and $0.33. During the year ended December 31, 2015,   the Company utilized the Black-Scholes method to fair value the warrants to purchase up to 225,000 shares of common stock with the following range of assumptions: volatility, 157%-174%; expected dividend yield, 0%; risk free interest rate, 1.01%-1.42%; and a life of 3 years. The grant date fair value of the warrants issued was $0.37, $0.54 and $0.30. For the quarter ended March 31, 2015, the Company recognized approximately $28,000 in equity based compensation on the issuance of the warrants.  This consulting agreement was terminated October 1, 2015 when the consultant accepted a full time employment position with the Company.

Agreements with Directors

The Company appointed Mr. Walter C. Johnsen as a director on January 29, 2016.  The term of his agreement as director commenced on February 1, 2016 for 1 year and until a successor is elected, or resignation or removal.  The agreement between the Company and Mr. Johnsen provides for an annual fee in the amount of $25,000 paid on a quarterly basis and an annual grant of options to purchase up to 25,000 shares of the Company’s common stock.  The Company issued the options to Mr. Johnsen in February 2016. (See note 8 - Stock Options)

The Company appointed Ms. Kelly J. Anderson as a director on January 29, 2016.  Ms. Anderson will serve as the chair of the Company’s audit committee.  The term of her agreement as director commenced on February 1, 2016 for 1 year and until a successor is elected, or resignation or removal.  The agreement between the Company and Ms. Anderson provides for an annual fee in the amount of $26,000 paid on a quarterly basis and an annual grant of options to purchase up to 25,000 shares of the Company’s common stock.  The Company issued the options to Ms. Anderson in February 2016.  (See note 8 - Stock Options)

The Company appointed Mr. Edward J. Fred as a Director on January 29, 2016.  The term of his agreement as director commenced on February 1, 2016 for 1 year and until a successor is elected, or resignation or removal.  The agreement between the Company and Mr. Fred provides for an annual fee in the amount of $25,000 paid on a quarterly basis and an annual grant of options to purchase up to 25,000 shares of the Company’s common stock.  The Company issued the options to Mr. Fred in February of 2016.  (See note 8 - Stock Options)

The Company issued 25,000 options to Harold Paul in February 2016.  Mr. Paul is a director of the Company. (See note 8 - Stock Options)

Other Agreements

In May 2015, the Company was awarded a grant by the United States Agency for International Development (“USAID”) in the amount of $559,000 for the development of SteraMist TM Mobile Decontamination Chambers to fight the Ebola epidemic.  The grant is based on milestones set forth on the agreement between the Company and USAID.  As of March 31, 2016, the Company has met the first five milestones and received gross proceeds from the grant in the amount of $537,272.  The Company has incurred costs in connection with the grant through March 31, 2016 in the amount of $350,552.  The proceeds received as part of the grant in excess of the costs incurred has been presented on the Company’s balance sheet as a liability in the amount of $186,720 as of March 31, 2016.  In May 2016, the Company completed the USAID Grant (See Note 14).

In June 2015, the Company launched the TOMI Service Network (“TSN”).  The TSN is a national service network composed of existing full service restoration industry specialists that have entered into licensing agreements with the Company to become Primary Service Providers (“PSP’s”).   The licensing agreements grant protected territories to PSP’s to perform services using the Company’s SteraMist TM platform of products and contain fixed price minimum equipment and solution orders based on the population of the territories granted pursuant to the licensing agreements.  The licensing agreements also provide for potential job referrals to PSP’s where the Company is entitled to referral fees.  Additionally, the agreement provides for commissions due to PSP’s for equipment and solution sales they facilitate to other service providers in their respective territories.  As part of these agreements, the Company is obligated to provide to the PSP’s various training, ongoing support and facilitate a referral network call center.  As of March 31, 2016, the Company had entered into 41 licensing agreements in connection with the launch of the TSN.

NOTE 12. COMMON STOCK AND WARRANTS TO BE ISSUED

               As of December 31, 2015, the Company was obligated to issue 202,000 shares of common stock valued at approximately $53,000 primarily to certain vendors and consultants.

               As of March 31, 2016, the Company was obligated to issue 338,174 shares of common stock valued at approximately $122,000 primarily to certain vendors, consultants and the President of the Company.  In addition, the Company was obligated to issue 300,000 stock warrants to an employee with 100,000 warrants to vest upon issuance, 100,000 to vest April 20, 2017 and 100,000 to vest April 20, 2018.  The estimated fair value of the warrants for the quarter ended March 31, 2016 was $57,000. (See Note 8 – Stock Warrants)

 

NOTE 13. CUSTOMER CONCENTRATION

The Company had certain customers whose revenue individually represented 10% of more of the Company’s total revenue, or whose accounts receivable balances individually represented 10% of more of the Company’s accounts receivable.

For the three months ended March 31, 2016, two customers accounted for 52% of revenue.  Three customers accounted for 70% of net revenues for the quarter ended March 31, 2015.  

At March 31, 2016, one customer accounted for 13% of accounts receivable.  As of December 31, 2015, three customers accounted for 42% of net accounts receivable