TOMI Environmental Solutions, Inc. (“TOMI”, the “Company”���Company”, “we”, “our” and “us”) is a global provider of infection prevention and decontamination products and services, focused primarily on life sciences including healthcare, bio-safety, pharmaceutical, clean-room and research.

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, 2016 and notes thereto which are included in the Annual Report on Form 10-K previously filed with the SEC on March 29, 2017. The Company follows the same accounting policies in the preparation of interim reports. The results of operations for the interim periods covered by this Form 10-Q may not necessarily be indicative of results of operations for the full fiscal year or any other interim period.

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.

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.

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 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 accounts receivable, inventory, 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.

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:

Our financial instruments include cash and equivalents, accounts receivable, accounts payable, accrued expenses and convertible debt. 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. The recorded value of convertible debt approximates its fair value as the terms and rates approximate market rates (See also Note 6).

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 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,June 30, 2017 and December 31, 2016. 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.

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

Potentially dilutive securities as of March 31,June 30, 2017 consisted of 9,814,80511,111,100 shares of common stock from convertible debentures, 37,584,74538,091,411 shares of common stock issuable upon exercise of outstanding warrants, 200,000 shares of common stock issuable upon outstanding options and 510,000 shares of common stock issuable upon conversion of outstanding shares of Preferred A stock (“Convertible Series A Preferred Stock”). Diluted and basic weighted average shares are the same, as potentially dilutive shares are anti-dilutive.

After giving effect to the add back of interest expense on the convertible note and the amortization of the debt discount on the convertible notes totaling $14,270, netBasic loss per share is computed by dividing net loss attributable to common shareholders by the weighted average number of common shares assumed to be outstanding during the period of computation. Diluted loss per share is computed similarly to basic loss per share except that the denominator is increased to include the number of additional common shares that would be $0.01have been outstanding if the potential shares had been issued and if the additional common shares were dilutive. Options, warrants, preferred stock and shares associated with the conversion of debt to purchase approximately 49.9 million and 37.2 shares of common stock were outstanding at June 30, 2017 and 2016, respectively, but were excluded from the computation of diluted loss per share due to the anti-dilutive effect on net loss per share.

For revenue from services and product sales, we recognize 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:Revenue is recognized when: (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.

We account 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. During the year ended December 31, 2015, we had one active stock-based compensation plan, the TOMI Environmental Solutions, Inc. Stock Option and Restricted Stock Plan (the “2008 Plan”). The 2008 Plan allowed 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 awards to its employees, consultants and board members. Stock options are granted with an exercise price equal to the closing price of our 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 our outstanding equity securities are granted at an exercise price that is not less than 110% of the closing price of our common stock on the date of grant and have a term no greater than five years. On the date of a grant, we determine the fair value of the stock option award and recognize 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, we terminated the 2008 Plan.

On January 29, 2016, our board of directors adopted the 2016 Equity Compensation Plan (the “2016 Plan”), subject to approval by our shareholders. The 2016 Plan authorizes the grant of stock options, stock appreciation rights, restricted stock, restricted stock units and performance units/shares. Up to 5,000,000 shares of common stock are authorized for issuance under the 2016 Plan. Shares issued under the 2016 Plan may be either authorized but unissued shares, treasury shares, or any combination thereof. Provisions in the 2016 Plan permit the reuse or reissuance by the 2016 Plan of shares of common stock for numerous reasons, including, but not limited to, shares of common stock underlying canceled, expired, or forfeited awards of stock-based compensation and stock appreciation rights paid out in the form of cash. Stock-based compensation will typically be awarded in consideration for the future performance of services to us. All recipients of awards under the 2016 Plan are required to enter into award agreements with the Company at the time of the award; awards under the 2016 Plan are expressly conditioned upon such agreements. For the year ended December 31, 2016, the Company issued options to purchase 100,000 shares of common stock out of the 2016 Plan. As of March 31,On July 7, 2017, our shareholders approved the 2016 Plan had not been approved byat our shareholders.2017 Annual Meeting of Shareholders (See Note 13).

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (ASU 2014-09) “Revenue from Contracts with Customers (Topic 606).” 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 reflects the consideration to which the entity expects to be entitled 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 March 2016, the FASB issued Accounting Standards Update No. 2016-09 (ASU 2016-09) “Compensation – Stock Compensation (Topic 718).”  ASU 2016-09 provides improvements to employee share-based payment accounting.  ASU 2016-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period.

For the three and six months ended March 31,June 30, 2017, depreciation was $56,545 and $123,320, respectively. For the three and six months ended June 30, 2016, depreciation was $66,775$53,386 and $40,890,$94,276 respectively.

Approximate amortization over the next five years is as follows:

Our board of directors may, without further action by our shareholders, 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.

Our authorized Convertible Series A Preferred Stock, $0.01 par value, consists of 1,000,000 shares. At March 31,June 30, 2017 and December 31, 2016, 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.

Our authorized Convertible Series B Preferred Stock, $1,000 stated value, 7.5% Cumulative dividend, consists of 4,000 shares. At March 31,June 30, 2017 and December 31, 2016, there were no shares issued and outstanding, respectively.

During the threesix months ended March 31, 2017, we did not issue any shares of common stock. DuringJune 30, 2016, the three months ended March 31, 2016, weCompany issued 275,416425,416 shares of common stock valued at approximately $145,000$221,694 for professional services rendered.

In February 2016, we issued options to purchase 100,000 shares of common stock to four directors, valued at $54,980 in total. The options have an exercise price of $0.55 per share. The optionsshare and 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.

For the threesix months ended March 31,June 30, 2016, we recognized total equity based compensation of approximately $58,000$65,000 on warrants issued to the Chief Financial Officer (“CFO”)CFO in connection with his current and previous employment agreements. For the threesix months ended March 31,June 30, 2016, we recognized $7,000$14,000 in stock compensation expense for the accrued but unvestednot vested portion of the warrants issued to the CFO under his previous agreement with the Company. In addition, on January 26, 2016, we issued warrantsa warrant to purchase up to 100,000 shares of common stock at an exercise price of $0.55 per share to the CFO with a term of five years, thatwhich vested upon issuance and have an exercise price of $0.55 per share.issuance. We utilized the Black-Scholes method to fair value the warrants to purchase up to 100,000 shares of common stock received by the CFO totalingwarrant at 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 share underlying the warrant was $0.51.

For the threesix months ended March 31,June 30, 2016, we recognized equity compensation expense of approximately $57,000$69,000 related to warrants issued in April 2016the vested and accrual of an unvested warrant contracted to an employee pursuant to his employment agreement with the Company. We accrued for the estimated fair value of the warrants as of March 31,that were issued in April 2016. We utilized the Black-Scholes method to fair value the warrantswarrant to purchase 300,000 shares of common stock 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 share underlying the warrant was $0.46.

For the three and six months ended March 31,June 30, 2017, we recognized approximately $12,000 and $24,000 in equity compensation expense for the accrued but unvested portion of the warrants issued to an employee pursuant to his agreement with the Company.

In March and May of 2017, in connection with the issuance of the Notes, we issued three-year warrants to purchase up to an aggregate of 883,332999,998 shares of common stock at an exercise price of $0.69 per share (see Note 6).

For each of the three and six months ended March 31,June 30, 2017 and 2016, we incurred fees for legal services rendered by Harold Paul in the amount of $15,000 and $30,000, respectively. Mr. Paul is also a director of the Company.

In September 2014, we entered into a lease agreement for office and warehouse space in Frederick, Maryland. As part of the lease agreement, we received a rent holiday in the first 5 months of the lease. The lease also provides for an escalation clause pursuant to which 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 and $22,854 in rent expense for the three and six months ended March 31,June 30, 2017 and 2016, respectively. Approximate minimum annual rents under the lease are as follows:

In March 2017, we increased the annual board fee to directors to $30,000, to be paid on a quarterly basis, with the exception of the audit committee chairperson, whose annual fee we increased to $35,000, also to be paid on a quarterly basis. In addition, we issued to each of our four board members 50,000 shares of common stock.stock in April 2017. The 200,000 shares of common stock were valued at $32,000 and accrued for in the threesix months ended March 31,June 30, 2017.

Our first quartersales results for the six months ended June 30, 2016 included revenue from our exclusive distributor of approximately $650,000 based on the contractual minimum purchase requirements. During the first quartersix months of 2017, our exclusive distributor failed to place an order for their annual minimum purchase commitment which contributed to the decline in revenue for 2017 compared to 2016. As a result of the distributor’s failure to meet their contractual minimum purchase requirement, the distributor lost its exclusivity.

Our discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The estimation process requires assumptions to be made about future events and conditions, and as such, is inherently subjective and uncertain. Actual results could differ materially from our estimates.

The SEC defines critical accounting policies as those that are, in management’s view, most important to the portrayal of our financial condition and results of operations and most demanding of our judgment. We consider the following policies to be critical to an understanding of our condensed consolidated financial statements and the uncertainties associated with the complex judgments made by us that could impact our results of operations, financial position and cash flows.

 For revenue from services and product sales, we recognize 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:Revenue is recognized when: (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) is 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.

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:

Our financial instruments include cash and equivalents, accounts receivable, accounts payable, accrued expenses and convertible debt. All these items were determined to be Level 1 fair value measurements.

The carrying amounts of cash and equivalents, accounts receivable, accounts payable and accrued expenses approximated fair value because of the short maturity of these instruments. The recorded value of convertible debt approximates its fair value as the terms and rates approximate market rates

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 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. 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.

 

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

Potentially dilutive securities as of March 31,June 30, 2017 consisted of 9,814,80511,111,100 shares of common stock from convertible debentures, 37,584,74538,091,411 shares of common stock issuable upon exercise of outstanding warrants, 200,000 shares of common stock issuable upon outstanding options and 510,000 shares of common stock issuable upon conversion of outstanding shares of Preferred A stock (“Convertible Series A Preferred Stock”). Diluted and basic weighted average shares are the same, as potentially dilutive shares are anti-dilutive.

We account 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. During the year ended December 31, 2015, we had one active stock-based compensation plan, the TOMI Environmental Solutions, Inc. Stock Option and Restricted Stock Plan (the “2008 Plan”). The 2008 Plan allowed 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 awards to its employees, consultants and board members. Stock options are granted with an exercise price equal to the closing price of our 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 our outstanding equity securities are granted at an exercise price that is not less than 110% of the closing price of our common stock on the date of grant and have a term no greater than five years. On the date of a grant, we determine the fair value of the stock option award and recognize 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, we terminated the 2008 Plan.

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09 (ASU 2014-09) “Revenue from Contracts with Customers (Topic 606).” 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 reflects the consideration to which the entity expects to be entitled 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 March 2016, the FASB issued Accounting Standards Update No. 2016-09 (ASU 2016-09) “Compensation – Stock Compensation (Topic 718).”  ASU 2016-09 provides improvements to employee share-based payment accounting.  ASU 2016-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period.

During the three months ended March 31,June 30, 2017 and 2016, our cost of sales was approximately $416,000$512,000 and $748,000,$707,000, respectively, representing a decrease of $332,000195,000 or 44%27%. The primary reason for the decrease in cost of sales is lower sales during the three months ended March 31,June 30, 2017 as compared to the prior year. Our gross profit margins as a percentage of sales for the three months ended March 31,June 30, 2017 increased as compared to the prior period as a result of the customerproduct mix in sales, as there was an order placed by a distributor in the first quarter of 2016 that lowered our gross profit.sales.

Professional fees for the three months ended March 31,June 30, 2017 were approximately $272,000,$395,000, as compared to $178,000$96,000 during the prior year, representing an increase of approximately $94,000,$299,000, or 53%311%. The increase is attributable to increased efforts to protect and strengthen our intellectual property and general corporate matters.the lawsuit with Astro Pak which we settled in July 2017. Professional fees are mainly comprised of legal, accounting and financial consulting fees.

Depreciation and amortization was approximately $159,000$149,000 and $133,000$146,000 for the three months ended March 31,June 30, 2017 and 2016, respectively, representing an increase of $26,000,$3,000, or 19%2%. The increase in depreciation expense for the three months ended March 31,June 30, 2017 is attributable to additional fixed assets acquired in the prior year.

Selling expenses for the three months ended March 31,June 30, 2017 were approximately $179,000,$371,000, as compared to $352,000$517,000 in the same period in 2016, representing a decrease of $173,000$146,000 or 49%28%. The decrease in selling expenses is attributable to lower sales volume in the three months ended March 31,June 30, 2017 and a reduced number of employees as compared to the prior year. These expenses represent selling salaries and wages, trade show fees, commissions and marketing expenses.

Research and development expenses for the three months ended March 31,June 30, 2017 were approximately $31,000,$18,000, as compared to $9,000$19,000 in the three months ended March 31, 2016, representing an increase of $22,000, or 244%. The primary reason for the increase is increased testing costs related to our international product registrations.June 30, 2016. Research and development expenses mainly include costs incurred in generating and supporting research on improving, extending and applying our patents in the field of mechanical cleaning and decontamination.

Consulting fees for the three months ended March 31,June 30, 2017 were approximately $31,000,$86,000, as compared to $130,000$101,000 during the quarter ended March 31,June 30, 2016, representing a decrease of approximately $99,000,$15,000, or 76%15%.

Consulting fees for the six months ended June 30, 2017 were approximately $117,000, as compared to $231,000 during the six months ended June 30, 2016, representing a decrease of approximately $114,000, or 49%. The decrease in consulting fees is primarily due to significant charge incurred in the first quarter of 2016 with no such charge in the current year.