TOMI Environmental Solutions, Inc. — Q3 2013 Form 10-Q
Business context and period. The unaudited report covers the three and nine months ended September 30, 2013. TOMI sells and provides services using environmental decontamination technologies, including SteraMist Binary Ionization Technology (BIT). In April 2013, it acquired BIT-related technology, patents, equipment and inventory from L-3 Applied Technologies for $3.5 million. Results are not necessarily indicative of full-year performance.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $294,627 | $261,266 | $506,656 | $544,968 |
| Gross profit / margin | $109,529 / 37.2% | $68,255 / 26.1% | $226,253 / 44.7% | $193,251 / 35.5% |
| Operating loss | $(701,817) | $(51,034) | $(1,284,387) | $(135,550) |
| Net loss | $(2,946,146) | $(220,380) | $(11,124,772) | $(361,106) |
| Loss per share, basic and diluted | $(0.04) | $(0.00) | $(0.15) | $(0.01) |
- Cash flow: For the first nine months, operating cash use was $795,718, investing cash use was $3,450,990 (primarily the acquisition), and financing provided $5,294,805. Cash increased to $1,121,520 from $73,424 at year-end 2012.
- Liquidity and obligations: Current assets were $1,764,975 and current liabilities $14,223,240, implying a working-capital deficit of about $12.46 million. The balance sheet included a $13,549,466 current derivative liability. Convertible notes had $5,074,000 principal outstanding, but were reported at a net carrying amount of $30,071 after discounts and amortization. Total liabilities were $14,253,311; stockholders’ equity was a deficit of $8,578,975.
- Other metrics: Total assets were $5,674,336. Intangible assets, net, were $3,108,999. The company reported no material legal proceedings, no defaults on senior securities, and no off-balance-sheet arrangements.
Material changes and notable items
- Q3 revenue rose 13% year over year, while nine-month revenue declined 7%. Management attributed the nine-month decline partly to L-3’s shutdown of the product division during negotiations and TOMI’s focus on product development and manufacturing transition. Q3 cost of sales fell 4%; nine-month cost of sales fell 20%, which management attributed to economies of scale and product mix.
- Operating costs increased substantially, including consulting fees of $495,993 for the nine months, depreciation and amortization of $220,332, and other general and administrative costs of $533,204. Management cited staffing, lab rent, consulting, trade shows and insurance; some consulting costs were noncash or related to Rolyn Companies.
- Net loss included a $6,233,374 noncash fair-value increase in the embedded conversion derivative and $3,198,804 in financing costs, largely noncash charges recorded with the convertible-note financing. The derivative is measured using Level 3 inputs and a Monte Carlo model; management disclosed that changes in unobservable assumptions could materially change its value.
- The company sold $5.074 million of 10% senior secured convertible notes, due July 31, 2015, and issued 7,611,000 associated warrants. Notes are secured by intellectual property and other assets and require 15% of reported revenue to be deposited into a sinking fund. The conversion feature is adjustable and accounted for as a derivative liability.
- Common shares outstanding were 79,225,132 at September 30; 79,933,883 were reported outstanding November 1. Potential dilution included 17,496,552 shares from convertible debentures and 19,325,800 shares from warrants, in addition to options and preferred shares.
- A Panama Social Security Program contract began with a $419,790 initial biomass-reduction project and a three-year maintenance arrangement. TOMI reported billing $125,937 and recognizing $41,979 by September 30, with $83,958 deferred; the remaining initial work was completed in October. Management also reported a Saudi customer order of approximately $356,000. These opportunities had not established future revenue levels in the filing.
Outlook, risks and contingencies
Management said available funds and anticipated SteraMist sales were expected to cover cash requirements for the following 12 months, but cautioned that unexpected issues could require additional capital through securities, debt or strategic partnerships; availability and terms were not assured. The company had incurred recurring operating losses and negative operating cash flow. The filing provides no quantified revenue or earnings guidance. Key uncertainties include converting contracts and orders into collected revenue, maintaining liquidity, raising capital, potential equity dilution, and the valuation and contractual effects of the convertible notes and derivative liability. The acquisition purchase-price allocation was preliminary pending a final valuation report.
Management stated that disclosure and internal controls were effective for the quarter and that no control changes were made. The filing also notes the inherent limits of control systems and refers investors to the company’s 2012 Form 10-K for risk factors.
Important facts for investors to verify
- Reconcile the cash-flow discussion: the cash-flow statement reports operating cash use of $795,718, while MD&A cites approximately $826,000.
- Review the convertible-note terms, sinking-fund requirements, collateral, conversion-price adjustments and derivative valuation assumptions; the reported derivative liability is large and Level 3.
- Assess cash runway against the working-capital deficit, recurring operating cash use and management’s stated possibility of needing more capital.
- Confirm collection, delivery, recognition and renewal prospects for the Panama contract and the reported Saudi order; distinguish contract value from revenue earned.
- Check the final allocation and useful lives of acquired assets, and the potential dilution from outstanding notes, warrants and subsequent share issuances.