UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended: March 31, 2016

 

[  ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ___________ to ___________

 

Commission File Number: 000-51030

 

TearLab Corporation

(Exact name of registrant as specified in its charter)

 

Delaware		59 343 4771
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

 

9980 Huennekens Street., Suite 100, San Diego, CA 92121

(Address of principal executive offices)

 

(858) 455-6006

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [  ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [X] No [  ]

 

Indicate by check mark whether registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer [  ]		Accelerated filer [X]
Non-accelerated filer [  ] (Do not check if a smaller reporting company)		Smaller reporting company [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):

Yes [  ] No [X]

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 34,214,447 as of May 2, 2016.

 

 

 

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	27
Item 4.	Controls and Procedures	28
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	28
Item 1A.	Risk Factors	29
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	41
Item 3.	Defaults Upon Senior Securities	41
Item 4.	Mine Safety Disclosures	41
Item 5.	Other Information	41
Item 6.	Exhibits	43

 

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q contains forward-looking statements relating to future events and our future performance within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “pursue,” “potential” and similar expressions intended to identify forward-looking statements. These forward-looking statements include, without limitation, statements relating to future events, future results, and future economic conditions in general and statements about:

 

●	The adequacy of our funding and our forecast of the period of time through which our financial resources will be adequate to support our operations;
●	Our future strategy, structure, and business prospects;
●	Our ability to obtain additional financing for working capital on acceptable terms and in a timely manner;
●	The planned commercialization of our current product;
●	Our ability to meet the financial covenants under our credit facilities;
●	Our anticipated use of cash, cash needs and ability to raise capital;
●	The size and growth of the existing and potential markets for our product and technology;
●	The effect of our strategy to streamline our organization and lower our costs;
●	The adequacy of current, and the development of new distributor, reseller, and supplier relationships, and our efforts to expand relationships with distributors and resellers in additional countries;
●	Our anticipated expansion of United States and international sales and operations;
●	Our ability to obtain and protect our intellectual property and proprietary rights;
●	The results of our clinical trials;
●	Our plan to continue to develop and execute our conference and podium strategy to ensure visibility and evidence-based positioning of the TearLab® Osmolarity System among eye care professionals;
●	Our ability to attract and retain a sufficient number of scientists, clinicians, sales personnel and other key personnel with extensive experience in medical technology, who are in short supply;
●	Our beliefs about our employee relations; and
●	Our efforts to assist our customers in obtaining their CLIA waiver or providing them with support from certified professionals.

 

These statements involve known and unknown risks, uncertainties and other factors, including the risks described in Part II, Item 1A. of this Quarterly Report on Form 10-Q, which may cause our actual results, performance or achievements to be materially different from any future results, performances, time frames or achievements expressed or implied by the forward-looking statements. Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. Information regarding market and industry statistics contained in this Quarterly Report on Form 10-Q is included based on information available to us that we believe is accurate. It is generally based on academic and other publications that are not produced for purposes of securities offerings or economic analysis. We have not reviewed or included data from all sources and cannot assure you of the accuracy of the market and industry data we have included.

 

Unless the context indicates or requires otherwise, in this Quarterly Report on Form 10-Q, references to the “Company” shall mean TearLab Corporation or TearLab Corp. and its subsidiaries. References to “$” or “dollars” shall mean U.S. dollars unless otherwise indicated.

 

 

TearLab Corporation

 

PART I.	FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS (Unaudited)

 

 

TearLab Corporation

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(expressed in thousands of U.S. dollars except number of shares)

(Unaudited)

 

		March 31, 2016				December 31, 2015
		(Unaudited)
ASSETS
Current assets
Cash		$	7,200			$	13,838
Accounts receivable, net			3,026				3,021
Inventory			3,642				3,972
Prepaid expenses and other current assets			1,265				790
Total current assets			15,133				21,621
Fixed assets, net			5,220				5,352
Intangible assets, net			885				1,197
Other non-current assets			213				181
Total assets		$	21,451			$	28,351
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable		$	3,013			$	2,292
Accrued liabilities			3,578				5,047
Deferred Rent			111				114
Obligations under warrants			2				29
Total current liabilities			6,704				7,482
Long-term debt			25,195				24,859
Total liabilities			31,899				32,341
Exchange right			-				250
Commitments and contingencies (Note 10)
Stockholders’ deficit
Capital stock
Preferred Stock, $0.001 par value, authorized 10,000,000, none outstanding			—				—
Common stock, $0.001 par value, 65,000,000 authorized, 34,214,447 and 33,760,904 issued and outstanding at March 31, 2016 and December 31, 2015, respectively			34				34
Additional paid-in capital			489,561				488,514
Accumulated deficit			(500,043	)			(492,788	)
Total stockholders’ deficit			(10,448	)			(4,240	)
Total liabilities and stockholders’ deficit		$	21,451			$	28,351

 

See accompanying notes to interim condensed consolidated financial statements

 

 

TearLab Corporation

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(expressed in thousands of U.S. dollars except shares and per share amounts)

(Unaudited)

 

		March 31,
		2016				2015
Revenue
Product sales		$	5,502			$	4,092
Reader equipment rentals			1,265				1,316
Total revenue			6,767				5,408
Cost of goods sold
Cost of goods sold (excluding amortization of intangible assets)			2,540				2,387
Cost of goods sold - reader equipment depreciation			554				392
Gross profit			3,673				2,629
Operating expenses
Sales and marketing			4,636				5,278
Clinical, regulatory and research & development			1,138				1,404
General and administrative			3,931				3,637
Amortization of intangible assets			304				381
Total operating expenses			10,009				10,700
Loss from operations			(6,336	)			(8,071	)
Other income (expense)
Interest income (expense)			(883	)			(155	)
Changes in fair value of warrant obligations			27				113
Other, net			(62	)			(55	)
Total other income (expense)			(918	)			(97	)
Net loss and comprehensive loss		$	(7,254	)		$	(8,168	)
Weighted average shares outstanding - basic			33,825,669				33,647,720
Net loss per share – basic		$	(0.21	)		$	(0.24	)
Weighted average shares outstanding - diluted			33,825,669				33,692,507
Net loss per share – diluted		$	(0.21	)		$	(0.25	)

 

See accompanying notes to interim condensed consolidated financial statements

 

 

TearLab Corporation

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(expressed in thousands of U.S. dollars)

(Unaudited)

 

		Three months ended
		March 31,
		2016				2015
OPERATING ACTIVITIES
Net loss for the period		$	(7,254	)		$	(8,168	)
Adjustments to reconcile net loss to cash used in operating activities:
Stock-based compensation			714				1,061
Depreciation of fixed assets			620				414
Amortization of intangible assets			315				389
Changes in fair value of warrant obligations			(27	)			(113	)
Amortization of deferred financing charges			43				15
Interest accrued			-				51
Net change in working capital and non-current asset balances related to operations			(549	)			(683	)
Cash used in operating activities			(6,138	)			(7,034	)
INVESTING ACTIVITIES
Additions to fixed assets, net of proceeds			(500	)			(581	)
Cash used in investing activities			(500	)			(581	)
FINANCING ACTIVITIES
Proceeds from the issuance of term loan			-				14,554
Proceeds from the exercise of options			-				38
Cash provided by financing activities			-				14,592
Increase (decrease) in cash and cash equivalents during the period			(6,638	)			6,977
Cash, beginning of period			13,838				16,338
Cash, end of period		$	7,200			$	23,315

 

See accompanying notes to interim consolidated financial statements

 

 

TearLab Corporation

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(expressed in thousands of U.S. dollars except as otherwise stated)

(Unaudited)

 

1. BASIS OF PRESENTATION

 

Nature of Operations

 

TearLab Corporation (formerly OccuLogix, Inc.) (“TearLab” or the “Company”), a Delaware corporation, is an ophthalmic device company that is commercializing a proprietary in vitro diagnostic tear testing platform, the TearLab® test for dry eye disease, or DED, which enables eye care practitioners to test for highly sensitive and specific biomarkers using nanoliters of tear film at the point-of-care.

 

The accompanying condensed consolidated financial statements include the accounts of the Company, all of its wholly owned subsidiaries, and all of OcuHub, LLC, a majority owned subsidiary. Intercompany accounts and transactions have been eliminated on consolidation.

 

Liquidity and Going Concern

 

The accompanying condensed consolidated financial statements have been prepared on the going concern basis, which assumes that the Company will continue to operate as a going concern and which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. However, the Company has sustained substantial losses of $7,254 for the three months ended March 31, 2016 and $33,229 for the year ended December 31, 2015. The Company’s working capital surplus at March 31, 2016 is $8,429 which represents a $5,710 decrease from its working capital at December 31, 2015. As a result of the Company’s history of losses and financial condition, there is substantial doubt about the ability of the Company to continue as a going concern. On May 9, 2016, the Company issued 23,000,000 shares of stock at $0.75 per share to raise additional funds for general corporate purposes. The Company’s existing cash of $7,200 at March 31, 2016, combined with funds received from the equity raise and anticipated cash flows provided by the sales of its products may not be sufficient to cover its cash requirements through the next twelve months if management is unsuccessful in decreasing the cash consumed by operating activities. Based on the Company’s current rate of cash consumption management estimates cash will go below $5,000 within the next twelve months, violating a debt covenant, and the Company will need additional capital or a waiver to remain compliant. These matters, among others, raise substantial doubt about the Company’s ability to continue as a going concern.

 

A successful transition to attaining profitable operations is dependent upon obtaining sufficient financing to fund the Company’s planned expenses and achieving a level of revenues adequate to support the Company’s cost structure. If events or circumstances occur that impact the Company’s access to funding, it may be required to reduce operating expenses and reduce the planned levels of inventory and capital expenditures which could have an adverse impact on its ability to achieve its intended business objectives. The accompanying condensed consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

 

2. SIGNIFICANT ACCOUNTING POLICIES

 

The consolidated balance sheet at December 31, 2015 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States (“U.S. GAAP”) for complete financial statements. These unaudited interim condensed consolidated financial statements have been prepared using significant accounting policies that are consistent with the policies used in preparing the Company’s audited consolidated financial statements for the year ended December 31, 2015. The audited financial statements for the year ended December 31, 2015, filed with the SEC with our annual report on Form 10-K on March 9, 2016 include a summary of our significant accounting policies and should be read in conjunction with this Form 10-Q. Management believes that all adjustments necessary for the fair presentation of results, consisting of normally recurring items, have been included in the unaudited condensed consolidated financial statements for the interim periods presented.

 

 

TearLab Corporation

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make 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 the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. The principal areas of judgment relate to revenue and inventory reserves, allowance for doubtful accounts, impairment of long-lived and intangible assets, and the fair value of stock options and warrants.

 

Revenue recognition

 

Revenue is recognized when all four of the following criteria are met: (i) persuasive evidence that an arrangement exists; (ii) delivery of the products has occurred; (iii) the selling price is fixed or determinable; and (iv) collectibility is reasonably assured. The Company’s timing of revenue recognition is impacted by factors such as passage of title, payments and customer acceptance. Amounts received in excess of revenue recognizable are deferred.

 

The Company sells its proprietary TearLab® Osmolarity System and related test cards to external customers, who are primarily eye care professionals, for use in osmolarity testing procedures. Revenue is primarily derived from the sale of disposable test cards. Products are generally shipped from a distribution and warehousing facility located in San Diego, California. The Company’s sales are currently direct to customers in the United States and Canada and to distributors in South America, Europe, Asia and Australia.

 

Purchase commitments for Use Agreements and Flex Agreements are expressed in the agreement for a specified period of time (generally one to three years). The purchase commitment for Masters Agreements is implied for large physician practices with an expectation of purchasing certain levels of test cards. The Company recovers the cost of providing the reader equipment in the amount charged for disposable test cards. These agreements are treated as operating leases as collectability of the minimum lease payments is not reasonably predictable at the outset of the arrangement. Accordingly, revenue is recognized over the defined contract term as disposable test cards are shipped. Revenue under such agreements is allocated between the lease of the reader equipment and the sale of the disposables based upon each component’s relative fair value. When reader equipment is placed with a customer at no separate cost, the Company retains title to the equipment and it remains capitalized on the Company’s Consolidated Balance Sheet as equipment classified within fixed assets, net. The equipment is depreciated on a straight-line basis once shipped to a customer location over its estimated useful life and depreciation expense is included in cost of goods sold within the Consolidated Statements of Operations and Comprehensive Loss.

 

Revenue recognition for Purchase Agreements with multiple deliverables is based on the individual units of accounting determined to exist in the contract. A delivered item is considered a separate unit of accounting when the delivered item has value to the customer on a stand-alone basis. Items are considered to have stand-alone value when they are sold separately by any vendor or when the customer could resell the item on a stand-alone basis. Considering that test cards are essential to the operation of a TearLab reader, there is no alternative vendor for the test cards and no indication that a secondary market for the TearLab readers is established, the deliverables under the contracts do not meet criteria for separation under the multiple-element arrangements guidance. Consideration is allocated at the inception of the contract to all deliverables based on their relative selling price, as determined by the selling price of similar individual items on a stand-alone basis. The Company recognizes revenue for each of the elements only when it determines that all applicable recognition criteria have been met.

 

 

TearLab Corporation

 

Although the Company typically has a no return policy for its products, the Company has established a reserve for product sales that contain an implicit right of return. The Company reserves for estimated returns or refunds by reducing revenues at the time of shipment based on historical experience. The reserve of $16 and $67 as of March 31, 2016 and December 31, 2015, respectively, has reduced revenue and is included in accounts receivable.

 

Warrant liabilities

 

The Company issued several rounds of warrants related to various debt and equity transactions which occurred in 2011. The Company determined that these warrants do not meet the criteria for classification as equity and, accordingly, classified the warrants as current liabilities. The warrant liabilities are subject to remeasurement at each balance sheet date, with any change in fair value recognized as a component of other income (expense), net in the Statements of Operations and Comprehensive Loss. Warrants are also remeasured at fair value immediately prior to being exercised, and the resulting fair value is reclassified into additional paid-in capital, net of any applicable exercise proceeds. The Company estimated the fair value of these warrants at the respective balance sheet dates using the Black-Scholes Merton option-pricing model, based on the estimated market value of the underlying common stock at the valuation measurement date, the remaining contractual term of the warrant, risk-free interest rates and expected dividends on and expected volatility of the price of the underlying common stock.

 

Recent accounting pronouncements

 

In March 2016, the Financial Accountings Standards Board (the “FASB”) issued Accounting Standards Update No. 2016-09, Improvement to Employee Share-Based Payment Accounting (“ASU 2016-09”), which involves several aspects of accounting for share-based payment transactions, including income tax consequences, classification of awards as liabilities or equity, and classifications on the statement of cash flows. ASU 2016-09 is effective for fiscal and interim periods beginning after December 15, 2016. The Company is currently evaluating the impact the adoption of the new standard will have on its financial statements.

 

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (“ASU 2016-02”). ASU 2016-02 establishes a right-of-use model that requires a lessee to record an asset and liability on the balance sheet for all leases with terms longer than twelve months. ASU 2016-02 is effective for fiscal years and interim periods beginning after December 15, 2018. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The Company is currently evaluating the impact of the new standard on its financial statements.

 

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. Early application is not permitted. On April 1, 2015, the FASB voted to propose a deferral of the effective date of the standard by one year which would result in the new standard being effective for the Company at the beginning of its first quarter of fiscal year 2018. The Company has not yet completed its assessment of the impact of the new standard, including possible transition alternatives, on the Company’s financial statements.

 

 

TearLab Corporation

 

3. BALANCE SHEET DETAILS

 

Accounts receivable

 

		March 31, 2016				December 31, 2015
Trade receivables		$	3,689			$	3,610
Allowance for doubtful accounts			(663	)			(589	)
		$	3,026			$	3,021

 

Inventory

 

Inventory is recorded at the lower of cost or market and consists of finished goods. Inventory is accounted for on a first-in, first-out basis.

 

		March 31, 2016				December 31, 2015
Finished goods		$	3,673			$	4,002
Inventory reserves			(31	)			(30	)
		$	3,642			$	3,972

 

The Company evaluates inventory for estimated excess quantities and obsolescence, based on expected future sales levels and projections of future demand, and establishes inventory reserves for obsolete and excess inventories. In addition, the Company assesses the impact of changing technology and market conditions. The Company has entered into a long term purchase commitment to buy the test cards from MiniFAB (Note 10). The purchase commitment contains required minimum annual purchases and a total purchase commitment under the manufacturing agreement. As part of its analysis of excess or obsolete inventories, the Company considers future annual minimum purchases, estimated future usage and the expiry dating of the cards to determine if any inventory reserve is needed.

 

Prepaid expenses and other current assets

 

		March 31, 2016				December 31, 2015
Prepaid trade shows		$	280			$	246
Prepaid insurance			347				87
Manufacturing deposits			337				154
Subscriptions			104				128
Other fees and services			174				146
Other current assets			23				29
		$	1,265			$	790

 

 

TearLab Corporation

 

Fixed assets

 

		March 31, 2016				December 31, 2015
Capitalized TearLab equipment		$	8,752			$	8,349
Leasehold improvements			61				61
Computer equipment and software			1,023				1,023
Furniture and office equipment			281				278
Medical equipment			500				431
		$	10,617			$	10,142
Less accumulated depreciation			(5,397	)			(4,790	)
		$	5,220			$	5,352

 

Depreciation expense was $619 and $414 during the three months ended March 31, 2016 and 2015, respectively.

 

Accrued liabilities

 

		March 31, 2016				December 31, 2015
Due to professionals		$	560			$	256
Due to employes and directors			1,770				2,130
Sales and use tax liabilities			186				231
Royalty liability			407				753
Warranty			126				94
Other			529				1,583
		$	3,578			$	5,047

 

4. INTANGIBLE ASSETS

 

The Company’s intangible assets consist primarily of the value of TearLab® Technology acquired in the acquisition of TearLab Research and the value of the OcuHub platform technology acquired in the acquisition of the OcuHub business unit from AOAExcel. The TearLab Technology consists of a disposable lab card and card reader, supported by an array of patents and patent applications that are either held or in-licensed by the Company. The TearLab Technology is being amortized using the straight-line method over an estimated useful life of 10 years. The OcuHub platform technology was fully-impaired as of December 31, 2015, with the impairment charge taken in December 2015. Amortization expense for the three months ended March 31, 2016 and 2015 was $315 and $389, respectively.

 

On April 8, 2016, OcuHub Holdings, Inc., a wholly-owned subsidiary of the Company, completed the sale of 10,167.5 units of OcuHub to an executive of OcuHub and an unrelated third party. After the sale, OcuHub Holdings, Inc. owns 10.5% of OcuHub on a fully-diluted basis. The sale of OcuHub does not represent a significant strategic shift for the Company.

 

 

TearLab Corporation

 

Intangible assets subject to amortization consist of the following:

		Remaining												Net Book
		Useful Life				Gross Value				Accumulated				Value at
		(Years)				at March 31, 2016				Amortization				March 31, 2016
TearLab® technology			1			$	12,172			$	(11,409	)		$	763
Patents and trademarks			2				271				(217	)			54
Prescriber list			2				90				(22	)			68
Total						$	12,533			$	(11,648	)		$	885

 

										Net Book
		Gross Value at				Accumulated				Value at
		December 31, 2015				Amortization				December 31, 2015
TearLab® technology		$	12,172			$	(11,106	)		$	1,066
Patents and trademarks			268				(216	)			52
Prescriber list			90				(11	)			79
Total		$	12,530			$	(11,333	)		$	1,197

 

The estimated amortization expense for the intangible assets for the remainder of 2016 and thereafter is as follows:

 

		Amortization
		of intangible
		assets
Remainder of 2016		$	826
2017			59
		$	885

 

5. TERM LOAN

 

On March 4, 2015, the Company executed a term loan agreement with CRG LP and certain of its affiliate funds (“CRG”) as lenders providing the Company with access of up to $35,000 under the arrangement. The Company received $15,000 in gross proceeds under the arrangement on March 4, 2015, and an additional $10,000 on October 6, 2015. A third tranche of $10,000 is available to the Company if the Company achieves at least $38,000 in trailing twelve-month revenue prior to June 30, 2016 and satisfies other borrowing conditions. The Term Loan Agreement matures on December 31, 2020 and bears interest at 13% per annum, with quarterly payments of interest only for the first four years. While interest on the loan is accrued at 13% per annum, the Company may elect to make interest-only payments at 8.5% per annum. The unpaid interest of 4.5% is added to the principal of the loan and is subject to additional accrued interest (“PIK interest”). The accrued interest can be deferred and paid together with the principal in the fifth and sixth years.

 

 

TearLab Corporation

 

As part of the amended Term Loan Agreement, and funding of the second tranche, CRG received 350,000 warrants dated as of October 6, 2015 to purchase common shares of the Company at a price of $5.00 per share (the “CRG Warrants”). The CRG Warrants have a five-year life. The CRG Warrants are classified as equity on the Consolidated Balance Sheet as of December 31, 2015 and March 31, 2016. The CRG Warrants were valued at their issuance date using the Black-Scholes Merton model. The related reduction of the long-term debt will be amortized over the life of the debt (Note 7).

 

The Company incurred financing and legal fees associated with the debt of $606, which were recorded as a direct discount to the debt and is being amortized using the effective interest method. The Company presents the debt issuance costs related to the recognized debt liability on the Consolidated Balance Sheet as a reduction of the liability.

 

The following is a summary of the Term Loan Agreement as of March 31, 2016 and related maturities of outstanding principle:

 

Prinicple balance outstanding		$	25,000
PIK interest			974
less discount on term loan:
deferred financing fees, net			(508	)
fair value of detachable warrants, net			(271	)
Total term loan		$	25,195

 

Principal due for each of the next 5 years and in the aggregate thereafter:

 

Remaining 2016		$	-
2017			-
2018			-
2019			12,987
2020			12,987
Total principal due			25,974
Less: discount on term loan			(779	)
Total term loan		$	25,195

 

The Term Loan Agreement provides for prepayment fees of 5% of the outstanding balance of the loan if the loan is repaid prior to March 31, 2016. The prepayment fee is reduced 1% per year for each subsequent year until maturity.

 

The loan is collateralized by all assets of the Company. Additionally, the terms of the Term Loan Agreement contain various affirmative and negative covenants agreed to by the Company. Among them, the Company must attain minimum certain annual revenue and minimum cash threshold levels. On April 7, 2016, the Company amended the Term Loan Agreement to change the required minimum revenue levels. The amended minimum revenue is $27,000 for 2016, $31,000 for 2017, $36,000 for 2018, $45,000 for 2019 and $55,000 for 2020. The amendment also reduced the exercise price of the CRG Warrants from $5.00 per share to $1.50 per share.

 

If the Company does not have annual revenue greater or equal to the annual revenue covenant in a calendar year, the Company will have the right to cure within 90 days of the end of the respective calendar year by raising subordinated debt or equity equal to twice the difference between the annual revenue and the revenue covenant, with the total proceeds from this financing to be used to reduce the principal of the Term Loan Agreement. In the event of a default, the Company may be required to repay any outstanding amounts earlier than anticipated, and the lenders may foreclose on their security interest in the Company’s assets.

 

 

TearLab Corporation

 

Borrowings under the term loan are subject to non-occurrence of a material adverse change in our business or operations (financial or otherwise), or a material impairment of the prospect of repayment of obligations.

 

At March 31, 2016, the Company was in compliance with all of the covenants.

 

6. FAIR VALUE MEASUREMENTS

 

The Company measures certain assets and liabilities in accordance with authoritative guidance which requires fair value measurements be classified and disclosed in one of the following three categories:

 

	●	Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities.
	●	Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.
	●	Level 3: Unobservable inputs are used when little or no market data is available.

 

Assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurements. The Company reviews the fair value hierarchy classification on a quarterly basis. Changes in the ability to observe valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy. The Company did not have any assets or liabilities in Level 1 and Level 2 and no transfers to or from Level 3 of the fair value measurement hierarchy during the three months ended March 31, 2016.

 

At March 31, 2016, the Company had a liability for warrants to purchase 219,604 shares of common stock at an exercise price of $1.86 per share valued at $2 (Note 7). The warrant liability is classified as a Level 3 fair value measurement.

 

The following table provides a reconciliation for the warrant liability measured at fair value using significant unobservable inputs (Level 3) for the three months ended March 31, 2016 (in thousands):

 

		Fair Value Measurements
		Using Significant
		Unobservable Inputs (Level 3)
Balance of warrant liability at January 1, 2016		$	29
Warrant exercises			-
Change in fair value of warrant liability included in other (income) / expense			(27	)
Balance of warrant liability at March 31, 2016		$	2

 

 

TearLab Corporation

 

7. STOCKHOLDERS’ EQUITY

 

(a) Authorized share capital

 

The total number of authorized shares of common stock of the Company is 65,000,000. Each share of common stock has a par value of $0.001 per share. The total number of authorized shares of preferred stock of the Company is 10,000,000. Each share of preferred stock has a par value of $0.001 per share.

 

(b) Stock Incentive Plan

 

The Company has a stock incentive plan, the 2002 Stock Incentive Plan (the “Stock Incentive Plan”), under which up to 6,200,000 options are available for grant to employees, directors and consultants. Options granted under the Stock Incentive Plan may be either incentive stock options or non-statutory stock options. Under the terms of the Stock Incentive Plan, the exercise price per share for an incentive stock option shall not be less than the fair market value of a share of stock on the effective date of grant and the exercise price per share for non-statutory stock options shall not be less than 85% of the fair market value of a share of stock on the date of grant. No option granted to a holder of more than 10% of the Company’s common stock shall have an exercise price per share less than 110% of the fair market value of a share of stock on the effective date of grant.

 

Options granted are typically service-based options. Generally, options expire 10 years after the date of grant. No incentive stock options granted to a 10% owner optionee shall be exercisable after the expiration of five years after the effective date of grant of such option, no option has been granted to a prospective employee, prospective consultant or prospective director prior to the date on which such person commences service, and with the exception of an option granted to an officer, director or consultant, no incentive option shall become exercisable at a rate less than 20% per annum over a period of five years from the effective date of grant of such option unless otherwise approved by the Board.

 

The Company accounts for stock-based compensation under the authoritative guidance which requires that share-based payment transactions with employees be recognized in the financial statements based on their fair value and recognized as compensation expense over the vesting period. The amount of expense recognized during the period is affected by subjective assumptions, including: estimates of the Company’s future volatility, the expected term for its stock options, option exercise behavior, the number of options expected to ultimately vest, and the timing of vesting for the Company’s share-based awards.

 

The following table sets forth the total stock-based compensation expense resulting from stock options and the employee stock purchase plan included in the Company’s condensed consolidated statements of operations and comprehensive loss (in thousands):

 

		Three months ended
		March 31,
		2016				2015
Sales and marketing		$	136			$	504
Clinical, regulatory and research and development			83				99
General and administrative			495				458
Stock-based compensation expense before income taxes		$	714			$	1,061

 

 

TearLab Corporation

 

(c) Employee Stock Purchase Plan

 

In July 2014, the Company’s Board of Directors adopted the 2014 Employee Stock Purchase Plan (the “ESPP”) which was approved by the Company’s stockholders in June 2014 at the Company’s Annual Meeting of Stockholders. A total of 671,500 shares of the Company’s common stock are reserved for issuance under the plan, which permits eligible employees to purchase common stock at a discount through payroll deductions.

 

The price at which stock is purchased under the ESPP is equal to 90% of the fair market value of the common stock on the first or the last day of the offering period, whichever is lower. Generally, each offering under the ESPP will be for a period of six months as determined by the Company’s Board of Directors. Employees may invest up to 20% of their gross compensation through payroll deductions. In no event may an employee invest more than $25 worth of stock in the plan during each calendar year or more than 5,000 shares per offering period. During the three months ended March 31, 2016 and 2015, the Company recorded $3 and $19 of expense, respectively, under the ESPP. During the three months ended March 31, 2016, the Company issued 67,743 shares of common stock under the ESPP.

 

(d) Warrants

 

On June 13, 2011, the Company issued 1,629,539 shares of its common stock as well as warrants (‘‘Financing Warrants’’) to purchase 109,375 shares of its common stock in consideration of conversion and retirement of the Company’s outstanding July and August 2009 debt obligations. The exercise price of the Financing Warrants is $1.60 per common share representing the price per share equal to the closing bid price per share of the Company’s common stock on the NASDAQ stock market on July 15, 2009. No Financing Warrants were exercised during the three months ended March 31, 2016 or 2015.

 

On June 30, 2011, the Company closed a private placement financing in which 3,846,154 shares of common stock and warrants (‘‘2011 Warrants’’) to purchase 3,846,154 shares of common stock for gross proceeds of approximately $7,000. The exercise price of the warrants is $1.86 per share. The warrants are exercisable until June 30, 2016. The Company estimated the fair value of the warrants at the date of issuance using the Black-Scholes Merton option pricing model with a 101% volatility, 5.0 years expected life and a risk-free interest rate of 1.76%. The 2011 Warrants are recorded as a liability on the Company’s balance sheet and remeasured each period using the Black-Scholes Merton option-pricing model. There were no exercises of 2011 Warrants during the three months ended March 31, 2016 or 2015. There were 219,604 of the 2011 Warrants outstanding as of March 31, 2016 and December 31, 2015 with a value of $2 and $29, respectively. Changes in the fair value of the 2011 Warrants outstanding were presented as Changes in fair value of warrant obligations in the Consolidated Statements of Operations and Comprehensive Loss.

 

The estimated fair value of the 2011 Warrants at March 31, 2016 was determined using the Black-Scholes option-pricing model with the following assumptions:

 

Volatility			122	%
Expected life of Warrants			0.25				years
Risk-free interest rate			0.21	%
Dividend yield			0	%

 

In October 2015, as part of the second amendment to the Term Loan Agreement and funding of the $10,000 tranche, CRG received warrants to purchase 350,000 common shares in the Company at a price of $5.00 per share (the “CRG Warrants”). The CRG Warrants are exercisable any time prior to October 6, 2020. The CRG Warrants are classified as equity on the Consolidated Balance Sheets as of December 31, 2015 and March 31, 2016. The CRG Warrants were valued at issuance using the Black-Scholes Merton model assuming volatility of 73%, an expected life of 5.0 years, a risk-free interest rate of 1.71%, and 0% dividend yield. No CRG Warrants were exercised during the three months ended March 31, 2016. On April 8, 2016, the Company amended its Term Loan Agreement. As part of the amendment, the term of the CRG Warrants were changed to allow the holder to purchase 350,000 common shares in the Company at a price of $1.50 per share.

 

 

TearLab Corporation

 

(e) Exchange Right

 

In August 2014, the Company sold membership units in OcuHub LLC, a Delaware limited liability company and a wholly owned subsidiary of TearLab Corporation in exchange for 2% ownership of OcuHub LLC. In connection with the sale of the membership units, the new members received an exchange right allowing the units to be exchanged upon written notice and during a specified exchange window for shares in the Company’s common stock. On March 31, 2016, the members exchanged the ownership interest in OcuHub LLC for 385,800 shares of the Company’s common stock.

 

8. NET INCOME (LOSS) PER SHARE

 

Basic income (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares and vested restricted stock units outstanding. Diluted income (loss) per share is computed by dividing net income (loss), less any dilutive amounts recorded during the period for the change in fair value of warrant liabilities, by the weighted average number of common shares and vested restricted stock units outstanding and the weighted average number of dilutive common stock equivalents, from stock options, warrants, and non-vested restricted stock units. Common stock equivalents are only included in the diluted earnings per share calculation when their effect is dilutive. Diluted loss per share for the three months ended March 31, 2015 includes the dilutive impact of the gain recorded from the Company’s June 30, 2011 warrants.

 

The following securities were not included in the calculation of diluted earnings per share because their effects were anti-dilutive:

 

		Three Months Ended
(in thousands of shares)		March 31,
		2016				2015
Stock options			6,376				6,400
Warrants			644				74
ESPP shares			76				-
Total			7,096				6,474

 

 

TearLab Corporation

 

9. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

The net change in working capital and non-current asset balances related to operations consists of the following:

 

		Three months ended
		March 31,
		2016				2015
Accounts receivable, net		$	(5	)		$	160
Inventory			338				(189	)
Prepaid expenses and other assets			(475	)			(96	)
Other non-current assets			(32	)			(40	)
Accounts payable			721				272
Accrued liabilities			(1,385	)			(769	)
Deferred interest			292				-
Deferred rent/revenue			(3	)			(21	)
		$	(549	)		$	(683	)

 

10. COMMITMENTS AND CONTINGENCIES

 

On March 7, 2016, the Company, through its subsidiary, TearLab Research, Inc., entered into a supply and development agreement (“Supply Agreement”) with MiniFAB (Aust) Pty Ltd (“MiniFAB”). The agreement is an exclusive supply agreement through June 2021, which will provide 16% savings on the purchase and delivery of individual osmolarity test cards following a transition period to account for ending inventory at December 31, 2015 and other elements of the prior agreement. The savings consist of lower prices for the purchase of the test cards and for freight costs to ship the cards to the Company’s distribution facility. The lower purchase price will remain in place until the earlier of, the Company reaches an annual volume of 4.5 million test cards or March 31, 2018. The savings from freight costs will remain in place throughout the agreement. The Supply Agreement requires, in any given 6 calendar months, the Company must place aggregate purchase orders equal to at least 50% of the orders forecasted for that 6 month period at its onset. The Supply Agreement can be extended by either party for a term of five years with the option for the Company to buyout the exclusive supply provision during any extended term. This Supply Agreement replaces the July 2011 agreement between MiniFAB and the Company.

 

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes, included in Item 1 of this Report. Unless otherwise specified, all dollar amounts are U.S. dollars.

 

Overview

 

We are an in-vitro diagnostic company based in San Diego, California. We have commercialized a proprietary tear testing platform, the TearLab® Osmolarity System that enables eye care practitioners to test for highly sensitive and specific biomarkers using nanoliters of tear film at the point-of-care. Our first product measures tear film osmolarity for the diagnosis of Dry Eye Disease (“DED”). Our results are included in our financial statements, which are included under Item 8 to this Annual Report on Form 10-K.

 

TearLab Research, Inc.

 

TearLab Research, Inc. (“TearLab Research”), our wholly-owned subsidiary, develops technologies to enable eye care practitioners to test a wide range of biomarkers (chemistries, metabolites, genes and proteins) at the point-of-care. Commercializing that tear testing platform is now the focus of our business.

 

Our product, the TearLab® Osmolarity System, enables the rapid measurement of tear osmolarity in the doctor’s office. Osmolarity is a quantitative and highly specific biomarker that has been shown to assist in the diagnosis and disease management of DED. Based on the Beaver Dam Offspring Study (2005-2008), prevalence of DED was 14.5% across an adult population aged 21-84, impacting 17.9% of women and 10.5% of men in the study.The innovation of the TearLab® Osmolarity System is its ability to precisely and rapidly measure osmolarity in nanoliter volumes of tear samples, using a highly efficient and novel tear collection system at the point of care. Historically, eye care researchers have relied on expensive instruments to perform tear biomarker analysis. In addition to their cost, these conventional systems are slow, highly variable in their measurement readings, and not categorized as waived by the United States Food and Drug Administration (the “FDA”), under regulations promulgated under the Clinical Laboratory Improvement Amendments, (“CLIA”).

 

The TearLab® Osmolarity System consists of the following three components: (1) the TearLab disposable, which is a single-use microfluidic microchip; (2) the TearLab Pen, which is a hand-held device that interfaces with the TearLab disposable; and (3) the TearLab Reader, which is a small desktop unit that allows for the docking of the TearLab Pen and provides a quantitative reading for the operator.

 

In October 2008, the TearLab® Osmolarity System received CE mark approval, clearing the way for sales in the European Union and all countries recognizing the CE mark. While our current focus is on developing our business in the United States, we do have agreements with numerous distributors for distribution of the TearLab® Osmolarity System in South America, Europe, Asia and Australia.

 

 

RESULTS OF OPERATIONS

 

Revenue, Cost of Sales and Gross Margin

 

(in thousands)		Three Months Ended March 31,
		2016				2015				Change
TearLab revenue		$	6,767			$	5,408			$	1,359
TearLab – cost of sales			3,094				2,779				315
TearLab gross profit			3,673				2,629				1,044
Gross profit percentage			54	%			49	%

 

Revenue

 

TearLab revenue consists of sales of the TearLab® Osmolarity System, which is a hand-held tear film test for the measurement of tear osmolarity, a quantitative and highly specific biomarker that has shown to correlate with dry eye disease (“DED”).

 

The TearLab Osmolarity System consists of the following three components: (1) the TearLab disposable, which is a single-use microfluidic lab test card; (2) the TearLab pen, which is a hand-held device that interfaces with the TearLab disposable; and (3) the TearLab reader, which is a small desktop unit that allows for the docking of the TearLab disposable and the TearLab pen and provides a quantitative reading for the operator.

 

TearLab revenue increased by $1.4 million or 25% for the three months ended March 31, 2016 compared to the three months ended March 31, 2015. The increase is attributable to an increase in test card sales of $1.1 million and an increase of $257,000 in reader sales, when compared to the three months ended March 31, 2015.

 

Cost of Sales

 

TearLab cost of sales includes costs of goods sold, warranty, and royalty costs. Our cost of goods sold consists primarily of costs for the manufacture of the TearLab Osmolarity System, including the costs we incur for the purchase of component parts from our suppliers, applicable freight and shipping costs, fees related to warehousing and logistics inventory management.

 

TearLab costs of sales for the three months ended March 31, 2016 increased $315,000, or 11%, compared to the three months ended March 31, 2015. The increased costs associated with higher sales volumes were offset, in part, by cost savings on our gross margin.

 

Gross Profit

 

TearLab gross profit for the three months ended March 31, 2016 increased by $1.0 million or 40% compared to the three months ended March 31, 2015. The increase is due to a combination of higher sales volume and improved gross margin. The gross margin percentage of revenue for the three months ended March 31, 2016 was 54% as compared to 49% for the three months ended March 31, 2015. Gross margin improvement for the three months ended March 31, 2016 was due primarily to the conversion and addition of our more productive Flex accounts. Also, beginning January 1, 2016, gross margin benefited from a two year moratorium on the 2.3% medical device excise tax on sales in the United States.

 

 

Operating Expenses

 

		Three Months Ended
(in thousands)		March 31,
		2016				2015				Change
Sales and marketing		$	4,636			$	5,278			$	(642	)
Clinical, regulatory and research and development			1,138				1,404				(266	)
General and administrative			3,931				3,637				294
Amortization of intangible assets			304				381				(77	)
Operating expenses		$	10,009			$	10,700			$	(691	)

 

Sales and Marketing Expense

 

Sales and marketing expenses decreased by $642,000 or 12% in the three months ended March 31, 2016, as compared with the comparable period in fiscal 2015. The reduction in sales and marketing expenses is attributable to cost savings from our February 2016 organizational restructuring and reduced marketing spend in the three months ended March 31, 2016, offset in part by $175,000 of restructuring related expenses.

 

The cornerstone of our sales and marketing strategy to date has been to increase awareness of our products among eye care professionals and, in particular, the key opinion leaders in the eye care professions. We assist key opinion leaders in performing clinical trials to generate increased data to provide an increased understanding in the use of the TearLab Osmolarity System for diagnostic, treatment and monitoring of patients. Presently we are primarily focused on increasing sales in North America and we continue to develop and execute our conference and podium strategy to ensure visibility and evidence-based positioning of the TearLab® Osmolarity System among eye care professionals.

 

Clinical, Regulatory and Research and Development Expenses

 

Total clinical, regulatory and research and development expenses decreased $266,000 or 19% in the three months ended March 31, 2016 as compared with the three months ended March 31, 2015. The expense decrease in comparing the three months ended March 31, 2016 with the corresponding period in the prior year was almost entirely due to a decrease in external product development costs of $242,000 related to the timing of the next generation of diagnostic products.

 

General and Administrative Expenses

 

Total general and administrative expenses increased $294,000 or 8% in the three months ended March 31, 2016 as compared with the three months ended March 31, 2015. The increase when compared to the prior fiscal period was driven by higher legal and other professional services costs associated with our shelf offering withdrawn from the market in February of 2016.

 

 

Amortization of Intangible Assets

 

Amortization expense of intangible assets for the three months ended March 31, 2016 was $304,000, as compared to the $381,000 in the prior year fiscal period, with the decrease of $77,000 resulted from the amortization of certain OcuHub related intangibles in the prior year fiscal period. The OcuHub intangibles were fully impaired in the fourth quarter of 2015, so no corresponding amortization expense was incurred in 2016.

 

Other Income (Expense)

 

(in thousands)		Three Months Ended March 31,
		2016				2015				Change
Interest income (expense)		$	(883	)		$	(155	)		$	(728	)
Changes in fair value of warrant obligations			27				113				(86	)
Other (net )			(62	)			(55	)			(7	)
Other income		$	(918	)		$	(97	)		$	(821	)

 

Interest Income (Expense)

 

Interest expense for the three months ended March 31, 2016 and 2015 was from the interest for the CRG term loan. For the three months ended March 31, 2016, we paid $552,000 of interest and deferred $292,000 into the balance of long-term debt. For the three months ended March 31, 2015, we paid $95,000 and deferred $51,000. Interest expense increased for the three months ended March 31, 2016 on larger average balances of long-term debt outstanding during the period.

 

Changes in Fair Value of Warrants Obligations

 

The Company records outstanding warrants considered liabilities at fair value at the end of each reporting period, resulting in an adjustment to the warrant obligations, with any gain or loss recorded in earnings for the applicable period. The Company recorded income related to a decrease in the fair value of warrant obligations of $27,000 and $113,000 for the three months ended March 31, 2016 and 2015, respectively.

 

Other (net)

 

Other income (loss) for the three months ended March 31, 2016 and 2015 consists primarily of foreign exchange transaction gains and losses, based on fluctuations of the Company’s foreign denominated currencies.

 

Liquidity and Capital Resources

 

(in thousands)		March 31, 2016				December 31, 2015				Change
Cash and cash equivalents		$	7,200			$	13,838			$	(6,638	)
Percentage of total assets			33.6	%			48.8	%
Working capital		$	8,429			$	14,139			$	(5,710	)

 

 

Financial Condition

 

On May 9, 2016, the Company issued 23,000,000 shares of stock at $0.75 per share to raise additional funds for general corporate purposes. The Company may be able to raise either additional debt financing or additional equity financing. The CRG Term Loan Agreement provides for an increase in the term loan of up to $10.0 million, provided we achieve trailing twelve-month revenue of at least $38.0 million prior to June 30, 2016. The Company can make no assurances that it will be able to raise the required additional capital, either through debt or equity financing, on acceptable terms or at all. Unless we succeed in decreasing the cash consumed by operating activities, we anticipate that we will be below our required minimum cash balance under our debt agreement within the next twelve months. As a result of the Company’s historical losses and financial condition, there is substantial doubt about the Company’s ability to continue as a going concern.

 

Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement and involves risks and uncertainties. Actual results could vary as a result of a number of factors. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect. Our future funding requirements will depend on many factors, including but not limited to:

 

	●	whether government and third-party payers agree to reimburse the TearLab® Osmolarity System;
	●	whether eye care professionals engage in the process of obtaining their CLIA waiver certification;
	●	the costs and timing of building the infrastructure to market and sell the TearLab® Osmolarity System;
	●	the cost and results of continuing development of the TearLab® Osmolarity System;
	●	the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights;
	●	the effect of competing technological and market developments; and
	●	Our purchases of test cards are in Australian dollars and fluctuations in the exchange rate between the U.S. dollar and Australian dollar may be material. For example, in 2015 we purchased Australian dollars to pay to our Australian supplier and the exchange rate between the U.S. and Australian dollar fluctuated from $0.82 USD to $0.69 USD per $1.00 AUD.

 

At the present time, our only product is the TearLab Osmolarity System, and although we have received 510(k) approval from the FDA and a CLIA waiver approval from the FDA, at this time we do not know when we can expect to begin to generate significant revenues from the TearLab Osmolarity System in the United States.

 

Further, a successful transition to attaining profitable operations is dependent upon obtaining sufficient financing to fund the Company’s planned expenses and achieving a level of revenue adequate to support the Company’s cost structure. If events or circumstances occur such that we do not meet our plans to fund the business, we may be required to reduce operating expenses and reduce the planned levels of inventory and fixed assets in 2016 which could have an adverse impact on our ability to achieve our intended business objectives.

 

 

Indebtedness

 

On March 4, 2015, we executed the Term Loan Agreement with CRG as lenders providing us with access of up to $35.0 million under the Term Loan Agreement. We entered into a second amendment to the Term Loan Agreement with CRG on August 6, 2015. We received $15.0 million in gross proceeds under the Term Loan Agreement on March 4, 2015, and an additional $10.0 million on October 6, 2015. A third tranche of $10.0 million is available to us if we achieve at least $38.0 million in trailing twelve-month revenue prior to June 30, 2016, and satisfy other borrowing conditions. As part of the second amendment to the Term Loan Agreement and funding of the $10.0 million tranche, CRG received warrants to purchase 350,000 common shares in the Company at a price of $5.00 per share. The warrants have a life of five years. The Term Loan Agreement has a term of six years and bears interest at 13% per annum, with quarterly payments of interest only for the first four years. At our option, during the first four years a portion of the interest payments may be deferred and paid together with the principal in the fifth and sixth years.

 

On April 7, 2016, we further amended the Term Loan Agreement (the “Fourth Amendment”). The Fourth Amendment changes the required minimum revenue levels under the Term Loan Agreement to $27.0 million, $31.0 million, $36.0 million, $45.0 million and $55.0 million for the calendar years 2016, 2017, 2018, 2019 and 2020, respectively. In addition, the Fourth Amendment releases the guaranty and other obligations given by OcuHub LLC under the Term Loan Agreement. The Fourth Amendment also reduced the exercise price of the warrants to purchase 350,000 common shares in the Company issued to CRG from $5.00 per share to $1.50 per share.

 

The Term Loan Agreement is collateralized by all our assets. Additionally, the terms of the Term Loan Agreement contain various affirmative and negative covenants. Among them, we must attain minimum certain annual revenue and minimum cash threshold levels. The minimum cash balance required is $5.0 million, subject to certain conditions.

 

If we do not have annual revenue greater or equal to the annual revenue covenant in a calendar year, we will have the right to cure by raising subordinated debt or equity equal to twice the difference between the annual revenue and the revenue covenant, with the total proceeds from this financing to be used to reduce the principal of the Term Loan Agreement. In the event we do not achieve the minimum revenue threshold and cannot cure as described above, we may be in default of the Term Loan Agreement. In the event of a default, we may be required to repay any outstanding amounts earlier than anticipated, and the lenders may foreclose on their security interest in our assets.

 

Ongoing Sources and Uses of Cash

 

We anticipate that our cash and cash equivalents and cash generated from increased revenues and the senior term loan agreement will be sufficient to sustain our operations into the second quarter of 2016. We continually evaluate various financing possibilities but we typically expect our primary sources of cash will be related to the collection of accounts receivable and, to a lesser degree, interest income on our cash balances. Our accounts receivable collections will be impacted by our ability to grow our point-of-care revenue.

 

We expect our primary uses of cash will be to fund our operating expenses and pursuing and maintaining our patents and trademarks. In addition, dependent on available funds, we expect to expend cash to improve production capability of the TearLab test, to further improve the performance of the TearLab test, and to pursue additional applications for the lab-on-a-chip technology.

 

Changes in Cash Flows

 

Cash Used in Operating Activities

 

Net cash used to fund our operating activities during the three months ended March 31, 2016 was $6.1 million. Net cash used in operating activities during the three month period was less than our net loss of $7.3 million primarily due to the amortization of intangible assets, depreciation of fixed assets, stock-based compensation and changes in the fair value of warrant obligations. In aggregate, these non-cash items totaled $1.7 million.

 

 

The net change in working capital and non-current asset balances related to operations for the three months ended March 31, 2016 and 2015 consists of the following:

 

		Three months ended
		March 31,
		2016				2015
Accounts receivable, net		$	(5	)		$	160
Inventory			338				(189	)
Prepaid expenses and other assets			(475	)			(96	)
Other non-current assets			(32	)			(40	)
Accounts payable			721				272
Accrued liabilities			(1,385	)			(769	)
Deferred interest			292				-
Deferred rent/revenue			(3	)			(21	)
		$	(549	)		$	(683	)

 

Explanations of the more significant net changes in working capital and non-current asset balances are as follows:

 

	●	Inventory decreased in the three months ended March 31, 2016 because of a combination of reduced levels of test card inventory on hand and more favorable pricing for the inventory on hand.
	●	Prepaid expenses increased in the three months ended March 31, 2016 due to the timing of some of our second quarter conferences and the annual renewal cycle of our insurance policies.
	●	Accounts payable and accrued liabilities had a net decrease during the three months ended March 31, 2016 because of the timing of invoices received late in the period for professional services rendered. The change included invoices that were unbilled at December 31, 2015 for development associated with the next generation diagnostic products and invoiced during the first quarter of 2016 which resulted in an accounts payable increase and a corresponding decrease in accrued liabilities during the three months ended March 31, 2016.
	●	Deferred interest in the three months ended March 31, 2016 relates to the Company electing the option to defer 4.5 percent of the interest on the Term loan Agreement and pay together with the principal in the fifth and sixth year of the Term Loan Agreement.

 

Cash Used in Investing Activities

 

Net cash used in investing activities for the three months ended March 31, 2016 and 2015 was $500,000 and $581,000, respectively, to acquire fixed assets, primarily TearLab Osmolarity systems.

 

Cash Provided by Financing Activities

 

There was no net cash provided by or used in financing activities during the three months ended March 31, 2016. For the three months ended March 31, 2015, net cash provided by financing activities consisted primarily of proceeds from the term loan.

 

 

Off-Balance-Sheet Arrangements

 

As of March 31, 2016, we did not have any material off-balance-sheet arrangements as defined in Item 303(1)(4)(ii) of SEC Regulation S-K.

 

Critical Accounting Policies and Estimates

 

Management’s discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements which are prepared in accordance with accounting principles that are 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 and liabilities, related disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. We continually evaluate our estimates and judgments, the most critical of which are those related to revenue recognition and inventory valuation. We base our estimates and judgments on historical experience and other factors that we believe to be reasonable under the circumstances. Materially different results can occur as circumstances change and additional information becomes known.

 

There were no significant changes during the three months ended March 31, 2016 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. For further clarification with regards to the Company’s specific policies for revenue recognition, see Note 2 of the Notes to the Unaudited Condensed Consolidated Financial Statements for the three months ended March 31, 2016 included in Item 1.

 

Recent Accounting Pronouncements

 

For information on the recent accounting pronouncements impacting our business, see Note 2 of the Notes to the unaudited Condensed Consolidated Financial Statements for the three months ended March 31, 2016 included in Item 1.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Currency Fluctuations and Exchange Risk

 

Our sales are denominated primarily in U.S. dollars with minimal sales in euros and pound sterling. Most of our expenses are denominated in U.S. dollars, however, purchases of test cards are in Australian dollars and a minor portion of our other expenses are in Canadian dollars, Australian dollars and pounds sterling. We cannot predict any future trends in the exchange rate of the Canadian dollar, Australian dollar, euro or pound sterling against the U.S. dollar. Any strengthening of the Canadian dollar, Australian dollar, euro or pound sterling in relation to the U.S. dollar would increase the U.S. dollar cost of our operations, and affect our U.S. dollar measured results of operations. We maintain bank accounts in Canadian dollars, Australian dollars, euros and pounds sterling to meet short term operating requirements. We do not engage in any hedging or other transactions intended to manage these risks. In the future, we may undertake hedging or other similar transactions or invest in market risk sensitive instruments if we determine that is advisable to offset these risks.

 

 

Interest Rate Risk

 

Our interest payments to CRG are based on a fixed contractual interest rate of 13%. A decrease in market interest rates would increase the fair value of our long-term debt.

 

ITEM 4. CONTROLS AND PROCEDURES.

 

(a) Disclosure Controls and Procedures.

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefit of controls must be considered relative to their costs. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based on that evaluation, our chief executive officer and chief financial officer concluded that, as at March 31, 2015 our disclosure controls and procedures were effective at the reasonable assurance level.

 

(b) Changes in Internal Control over Financial Reporting.

 

During the first quarter of 2016, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS.

 

We are not aware of any material litigation involving us that is outstanding, threatened or pending.

 

 

ITEM 1A. RISK FACTORS.

 

Risks Relating to Our Financial Condition

 

We have limited working capital and a history of losses that raise substantial doubts as to whether we will be able to continue as a going concern.

 

We have prepared our consolidated financial statements on the basis that we would continue as a going concern. However, we have incurred losses in each year since our inception. Our net working capital balance at March 31, 2016 was $8.4 million which represents a $5.7 million decrease in the balance from our working capital of $14.1 million at December 31, 2015. We do not currently have any available borrowing under our term loan or credit facility.

 

Although current levels of cash flows are negative, management believes the Company’s existing cash as of March 31, 2016 will be sufficient to cover its operating and other cash demands through the second quarter of 2016.

 

Our consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary if we were not able to continue as a going concern. If we are unable to generate positive cash flows from operations, we would need to undertake a review of potential business alternatives, which may include, but are not limited to, a merger or sale of the company or ceasing operations and winding down the business.

 

We have incurred losses since inception and anticipate that we will incur continued losses for the foreseeable future.

 

We have incurred losses in each year since our inception. As of March 31, 2016, we had an accumulated deficit of $500.0 million. Our losses have resulted primarily from expenses incurred in research and development of our product candidates from the former retina and glaucoma business divisions. We do not know when or if we will successfully commercialize the TearLab® Osmolarity System in the United States or in international markets. As a result, and because of the numerous risks and uncertainties facing us, it is difficult to provide the extent of any future losses or the time required to achieve profitability, if at all. Any failure to become and remain profitable would require us to undertake a review of the potential business alternatives discussed above.

 

We will need to raise additional capital in the near future. Such capital may not be available to us on reasonable terms, if at all, when or as we require additional funding. If we issue additional shares of our common stock or other securities that may be convertible into, or exercisable or exchangeable for, our common stock, our existing stockholders, would experience further dilution.

 

We expect that we will seek to raise additional capital from time to time in the future. Such financings may involve the issuance of debt, equity and/or securities convertible into or exercisable or exchangeable for our equity securities. These financings may not be available to us on reasonable terms or at all when and as we require funding. Any failure to obtain additional working capital when required would have a material adverse effect on our business and financial condition, our ability to continue as a going concern and would be expected to result in a decline in our stock price. If we consummate such financings, the terms of such financings may adversely affect the interests of our existing stockholders. Any issuances of our common stock, preferred stock, or securities such as warrants or notes that are convertible into, exercisable or exchangeable for, our capital stock, would have a dilutive effect on the voting and economic interest of our existing stockholders.

 

 

We may not be able to generate sufficient cash to service our indebtedness, which currently consists of our credit facility with CRG. We may not be able to satisfy our minimum revenue and cash covenants, as required by the CRG term loan. If our annual sales revenue levels do not meet or exceed the levels required by the CRG covenants, we will be required to raise additional equity or subordinated debt, with the proceeds paid to reduce the outstanding principal of the CRG term loan. This financing could dilute existing shareholders and impact the value of their investment.

 

On March 4, 2015, we executed a term loan agreement with CRG as lenders (the “Term Loan Agreement”) providing us with access of up to $35.0 million under the Term Loan Agreement. We entered into an amendment of the Term Loan Agreement with CRG on August 6, 2015. We received $25.0 million in gross proceeds during 2015. A third tranche of $10.0 million is available to us only if we achieve at least $38.0 million in twelve-month sales revenue prior to June 30, 2016, and satisfy other borrowing conditions, and we may not be able to achieve these conditions. We can make no assurance that we will be able to raise either additional debt financing or additional equity capital. There can be no assurances that there will be adequate financing available to us on acceptable terms or at all.

 

Our ability to make scheduled payments or to refinance our debt obligations depends on numerous factors, including the amount of our cash reserves and our actual and projected financial and operating performance. These amounts and our performance are subject to certain financial and business factors, as well as prevailing economic and competitive conditions, some of which may be beyond our control. We cannot assure you that we will maintain a level of cash reserves or cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our existing or future indebtedness. If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our indebtedness. We cannot assure you that we would be able to take any of these actions, or that these actions would permit us to meet our scheduled debt service obligations. In addition, in the event of our breach of the Term Loan Agreement with CRG, we may not be allowed to draw additional amounts under the agreement, we may be required to repay any outstanding amounts earlier than anticipated, and the lenders may foreclose on their security interest in our assets.

 

The CRG loan is collateralized by all our assets. Additionally, the terms of the Term Loan Agreement contain various affirmative and negative covenants agreed to by the Company. Among them, we must attain minimum annual revenue and minimum cash threshold levels. The minimum annual revenue threshold levels required by the Term Loan are $27.0 million, $31.0 million, $36.0 million, $45.0 million and $55.0 million for calendar years 2016, 2017, 2018, 2019 and 2020, respectively. The minimum cash balance required is $5.0 million, subject to certain conditions.

 

If we do not have annual revenue greater or equal to the annual revenue covenant in a calendar year, we will have the right to cure by raising subordinated debt or equity equal to twice the difference between the annual revenue and the revenue covenant, with the total proceeds from this financing to be used to reduce the principal of the Term Loan Agreement. We cannot assure you that we will be able to achieve the annual revenue thresholds and the daily cash threshold. We cannot assure you that we would be able to raise the financing described above, if required. In addition, in the event of our breach of the Term Loan Agreement with CRG, we may not be allowed to draw additional amounts under the Term Loan Agreement, we may be required to repay any outstanding amounts earlier than anticipated, and the lenders may foreclose on their security interest in our assets.

 

Borrowings under the Term Loan Agreement are subject to certain conditions, including the non-occurrence of a material adverse change in our business or operations (financial or otherwise), or a material impairment of the prospect of repayment of obligations.

 

 

Our existing Term Loan Agreement contains restrictive and financial covenants that may limit our operating flexibility.

 

Our existing Term Loan Agreement with CRG contains certain restrictive covenants that limit our ability to incur additional indebtedness and liens, merge with other companies or consummate certain changes of control, acquire other companies, engage in new lines of business, make certain investments, pay dividends, transfer or dispose of assets, amend certain material agreements or enter into various specified transactions. We therefore may not be able to engage in any of the foregoing transactions unless we obtain the consent of the lender or terminate the Term Loan Agreement. There is no guarantee that we will be able to generate sufficient cash flow or sales to meet the financial covenants or pay the principal and interest under the agreement. Furthermore, there is no guarantee that future working capital, borrowings or equity financing will be available to repay or refinance the amounts outstanding under the Term Loan Agreement.

 

Our financial results may vary significantly from year-to-year [and quarter-to-quarter] due to a number of factors, which may lead to volatility in the trading price of our common stock.

 

Our annual and quarterly revenue and results of operations have varied in the past and may continue to vary significantly from year-to-year and quarter-to-quarter. The variability in our annual and quarterly results of operations may lead to volatility in our stock price as research analysts and investors respond to these annual fluctuations. These fluctuations are due to numerous factors that are difficult to forecast, including:

 

	●	fluctuations in demand for our products;
	●	changes in customer budget cycles and capital spending;
	●	seasonal variations in customer operations that could occur during holiday or summer vacation periods;
	●	tendencies among some customers to defer purchase decisions until the end of the quarter;
	●	the large unit value of our systems;
	●	changes in our pricing and sales policies or the pricing and sales policies of our competitors;
	●	our ability to design, manufacture and deliver products to our customers in a timely and cost effective manner;
	●	quality control or yield problems in our manufacturing operations;
	●	our ability to timely obtain adequate quantities of the components used in our products;
	●	new product introductions or enhancements by us and our competitors;
	●	unanticipated increases in costs or expenses;
	●	our complex, variable and, at times, lengthy sales cycle;
	●	global economic conditions; and
	●	fluctuations in foreign currency exchange rates.

 

In addition, we may experience seasonal variations in our customer operations such as could occur during holiday vacation periods. For example, one of our principal target markets consists of private ophthalmic and optometric practices, and our operating results in the quarter ending September 30 of each fiscal year could be adversely affected by summer vacation periods. The foregoing factors, as well as other factors, could materially and adversely affect our quarterly and annual results of operations. In addition, a significant amount of our operating expenses are relatively fixed due to our manufacturing, research and development, and sales and general administrative efforts. Any failure to adjust spending quickly enough to compensate for a revenue shortfall could magnify the adverse impact of such revenue shortfall on our results of operations. We expect that our sales will continue to fluctuate on a quarterly basis and our financial results for some periods may differ from those projected by securities analysts, which could significantly decrease the price of our common stock.

 

 

Risks Related to Our Business

 

Our near-term success is highly dependent on the success of the TearLab® Osmolarity System, and we cannot be certain that it will be successfully commercialized in the United States.

 

The TearLab® Osmolarity System is currently our only product. Our product is currently sold outside of the United States pursuant to CE mark approval; in Canada pursuant to a Health Canada Medical Device License; and in the United States as a result of having received 510(k) approval from the FDA to market the TearLab® Osmolarity System to those reference and physician operated laboratories with CLIA waiver certifications. Even though the TearLab® Osmolarity System has received all regulatory approvals in the United States, it may never be successfully commercialized. If the TearLab® Osmolarity System is not as successfully commercialized as expected, we may not be able to generate revenue, become profitable or continue our operations. Any failure of the TearLab® Osmolarity System to be successfully commercialized in the United States would have a material adverse effect on our business, operating results, financial condition and cash flows and could result in a substantial decline in the price of our common stock.

 

Our near-term success is highly dependent on increasing sales of the TearLab® Osmolarity System outside the United States, and we cannot be certain that we will successfully increase such sales.

 

Our product is currently sold outside of the United States pursuant to CE mark approval and Health Canada Approval in Canada. Our near-term success is highly dependent on increasing our international sales. We may also be required to register our product with health departments in our foreign market countries. A failure to successfully register in such markets would negatively affect our sales in any such markets. In addition, import taxes are levied on our product in certain foreign markets. Other countries may adopt taxation codes on imported products. Increases in such taxes or other restrictions on our product could negatively affect our ability to import, distribute and price our product.

 

We have outstanding liabilities, which could adversely affect our ability to adjust our business to respond to competitive pressures and to obtain sufficient funds to satisfy our future research and development needs, and to defend our intellectual property.

 

As of March 31, 2016, our total liabilities were $31.9 million including $25.2 million of long-term obligations under our Term Loan Agreement. Our significant liability service requirements could adversely affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities. For example, our liabilities present the following risks:

 

	●	our liabilities increase our vulnerability to economic downturns and adverse competitive and industry conditions and could place us at a competitive disadvantage compared to those of our competitors that are less leveraged;
	●	our liabilities could limit our flexibility in planning for, or reacting to, changes in our business and our industry and could limit our ability to pursue other business opportunities, borrow money for operations or capital in the future and implement our business strategies; and
	●	our liabilities may restrict us from raising additional funds on satisfactory terms to fund working capital, capital expenditures, product development efforts, strategic acquisitions, investments and alliances, and other general corporate requirements.

 

If we are at any time unable to generate sufficient cash flow to service our liabilities when payment is due, we may be required to attempt to renegotiate the terms of the instruments relating to the liabilities, seek to refinance all or a portion of the liabilities or obtain financing. There can be no assurance that we will be able to successfully renegotiate such terms, that any such refinancing would be possible or that any additional financing could be obtained on terms that are favorable or acceptable to us.

 

 

We may not be able to raise the capital necessary to fund our operations.

 

Since inception, we have funded our operations through debt and equity financings, including the exercise of warrants and options in 2013, the underwritten public offering in July 2013, as well as the Term Loan Agreement in March 2015. However, our prospects for obtaining additional financing are uncertain. Additional capital may not be available on terms favorable to us, or at all. If financing is available, it may not be sufficient for us to continue as a going concern and it may be on terms that adversely affect the interest of our existing stockholders. In addition, future financings could result in significant dilution of existing stockholders and adversely affect the economic interests of existing stockholders.

 

We will face challenges in bringing the TearLab® Osmolarity System to market in the United States and may not succeed in executing our business plan.

 

There are numerous risks and uncertainties inherent in the development of new medical technologies. In addition to our requirement for additional capital, our ability to bring the TearLab® Osmolarity System to market in the United States and to execute our business plan successfully is subject to the following risks, among others:

 

	●	Our clinical trials may not succeed. Clinical testing is expensive and can take longer than originally anticipated. The outcomes of clinical trials are uncertain, and failure can occur at any stage of the testing. We could encounter unexpected problems, which could result in a delay in efforts to complete clinical trials supporting our commercialization efforts.
	●	The TearLab® Osmolarity System is rated under a CLIA waiver certification which requires our customers to be certified under the CLIA waiver requirements to be reimbursed under Medicare, including certain parallel state requirements. If our customers are unwilling or unable to comply with such requirements, it could have an adverse effect on their acceptance of and on our ability to market the TearLab® Osmolarity System in the United States.
	●	Our suppliers and we will be subject to numerous FDA requirements covering the design, testing, manufacturing, quality control, labeling, advertising, promotion and export of the TearLab® Osmolarity System and other matters. If our suppliers or we fail to comply with these regulatory requirements, the TearLab® Osmolarity System could be subject to restrictions or withdrawals from the market and we could become subject to penalties.
	●	Even though we successfully obtained the sought-after FDA approvals, we may be unable to commercialize the TearLab® Osmolarity System successfully in the United States. Successful commercialization will depend on a number of factors, including, among other things, achieving widespread acceptance of the TearLab® Osmolarity System among physicians, establishing adequate sales and marketing capabilities, addressing competition effectively, the ability to obtain and enforce patents to protect proprietary rights from use by would-be competitors, key personnel retention and ensuring sufficient manufacturing capacity and inventory to support commercialization plans.

 

 

Our business is subject to health care industry cost-containment measures that could result in reduced sales of our TearLab® Osmolarity System.

 

Most of our customers rely on third-party payers, including government programs and private health insurance plans, to reimburse some or all of the cost of the procedures which use our TearLab® Osmolarity System. The continuing efforts of governmental authorities, insurance companies, and other health care payers to contain or reduce these costs could lead to patients being unable to obtain approval for payment from these third-party payers. If patients cannot obtain third-party payer payment approval, the use of our TearLab® Osmolarity System may decline significantly and our customers may reduce or eliminate the use of our system. The cost-containment measures that health care providers are instituting, both in the U.S. and internationally, could harm our ability to operate profitably. For example, managed care organizations have successfully negotiated volume discounts for pharmaceuticals. While this type of discount pricing does not currently exist for the medical systems we supply, if managed care or other organizations were able to affect discount pricing for such systems, it could result in lower prices to our customers from their customers and, in turn, reduce the amounts we can charge our customers for our products.

 

If we are subject to regulatory enforcement action as a result of our failure to comply with regulatory requirements, our commercial operations would be harmed.

 

While we received the 510(k) clearance and CLIA waiver that we were seeking, we will be subject to significant ongoing regulatory requirements, and if we fail to comply with these requirements, we could be subject to enforcement action by the FDA or state agencies, including:

 

	●	adverse publicity, warning letters, fines, injunctions, consent decrees and civil penalties;
	●	repair, replacement, refunds, recall or seizure of our product;
		`
	●	operating restrictions or partial suspension or total shutdown of production
	●	delay or refusal of our requests for 510(k) clearance or premarket approval of new products or of new intended uses or modifications to our existing product;
	●	refusal to grant export approval for our products;
	●	withdrawing 510(k) clearances or premarket approvals that have already been granted; and
	●	criminal prosecution.

 

If the government initiated any of these enforcement actions, our business could be harmed.

 

We are required to demonstrate and maintain compliance with the FDA’s Quality System Regulation, or the QSR. The QSR is a complex regulatory scheme that covers the methods and documentation of the design, testing, control, manufacturing, labeling, quality assurance, packaging, storage and shipping of our products. The FDA must determine that the facilities which manufacture and assemble our products that are intended for sale in the United States, as well as the manufacturing controls and specifications for these products, are compliant with applicable regulatory requirements, including the QSR. The FDA enforces the QSR through periodic unannounced inspections. The FDA has not yet inspected our facilities, and we cannot assure you that we will pass any future FDA inspection. Our failure, or the failure of our suppliers, to take satisfactory corrective action in response to an adverse QSR inspection could result in enforcement actions, including a public warning letter, a shutdown of our manufacturing operations, a recall of our product, civil or criminal penalties or other sanctions, which would significantly harm our available inventory and sales and cause our business to suffer.

 

If we are unable to fully comply with federal and state “fraud and abuse laws,” we could face substantial penalties, which may adversely affect our business, financial condition and results of operations.

 

We are subject to various laws pertaining to health care fraud and abuse, including the U.S. Anti- Kickback Statute, physician self-referral laws (the “Stark Law”), the U.S. False Claims Act, the U.S. False Statements Statute, the Physician Payment Sunshine Act, and state law equivalents to these U.S. federal laws, which may not be limited to government-reimbursed items and may not contain identical exceptions. Violations of these laws are punishable by criminal and civil sanctions, including, in some instances, civil and criminal penalties, damages, fines, exclusion from participation in U.S. federal and state health care programs, including Medicare and Medicaid, and the curtailment or restructuring of operations. Any action against us for violation of these laws could have a significant impact on our business. In addition, we are subject to the U.S. Foreign Corrupt Practices Act. Any action against us for violation by us or our agents or distributors of this act could have a significant impact on our business.

 

 

If we fail to comply with contractual obligations and applicable laws and regulations governing the handling of patient identifiable medical information, we could suffer material losses or be adversely affected by exposure to material penalties and liabilities.

 

Many, if not all of our customers, are covered entities under the Health Insurance Portability and Accountability Act of August 1996 or HIPAA. As part of the operation of our business, we provide reimbursement assistance to certain of our customers and as a result we act in the capacity of a business associate with respect to any patient-identifiable medical information, or PHI, we receive in connection with these services. We and our customers must comply with a variety of requirements related to the handling of patient information, including laws and regulations protecting the privacy, confidentiality and security of PHI. The provisions of HIPAA require our customers to have business associate agreements with us under which we are required to appropriately safeguard the PHI we create or receive on their behalf. Further, we and our customers are required to comply with HIPAA security regulations that require us and them to implement certain administrative, physical and technical safeguards to ensure the confidentiality, integrity and availability of electronic PHI, or EPHI. We are required by regulation and contract to protect the security of EPHI that we create, receive, maintain or transmit for our customers consistent with these regulations. To comply with our regulatory and contractual obligations, we may have to reorganize processes and invest in new technologies. We also are required to train personnel regarding HIPAA requirements. If we, or any of our employees or consultants, are unable to maintain the privacy, confidentiality and security of the PHI that is entrusted to us, we and/or our customers could be subject to civil and criminal fines and sanctions and we could be found to have breached our contracts with our customers. Under the Health Information Technology for Economic and Clinical Health Act, or HITECH Act, and recent omnibus revisions to the HIPAA regulations, we are directly subject to HIPAA’s criminal and civil penalties for breaches of our privacy and security obligations and are required to comply with security breach notification requirements. The direct applicability of the HIPAA privacy and security provisions and compliance with the notification requirements requires us to incur additional costs and may restrict our business operations.

 

Our patents may not be valid, and we may not obtain and enforce patents to protect our proprietary rights from use by would-be competitors. Companies with other patents could require us to stop using or pay to use required technology.

 

Our owned and licensed patents may not be valid, and we may not obtain and enforce patents to maintain trade secret protection for our technology. The extent to which we are unable to do so could materially harm our business.

 

We have applied for, and intend to continue to apply for, patents relating to the TearLab® Osmolarity System and related technology and processes. Such applications may not result in the issuance of any patents, and any patents now held or that may be issued may not provide adequate protection from competition. Furthermore, it is possible that patents issued or licensed to us may be challenged successfully. In that event, if we have a preferred competitive position because of any such patents, any preferred position would be lost. If we are unable to secure or to continue to maintain a preferred position, the TearLab® Osmolarity System could become subject to competition from the sale of generic products.

 

 

Patents issued or licensed to us may be infringed by the products or processes of others. The cost of enforcing patent rights against infringers, if such enforcement is required, could be significant and the time demands could interfere with our normal operations. There has been substantial litigation and other proceedings regarding patent and other intellectual property rights in the pharmaceutical, biotechnology and medical technology industries. We could become a party to patent litigation and other proceedings. The cost to us of any patent litigation, even if resolved in our favor, could be substantial. Some of our would-be competitors may sustain the costs of such litigation more effectively than we can because of their greater financial resources. Litigation also may absorb significant management time.

 

Unpatented trade secrets, improvements, confidential know-how and continuing technological innovation are important to our future scientific and commercial success. Although we attempt, and will continue to attempt, to protect our proprietary information through reliance on trade secret laws and the use of confidentiality agreements with corporate partners, collaborators, employees and consultants and other appropriate means, these measures may not effectively prevent disclosure of our proprietary information, and, in any event, others may develop independently, or obtain access to, the same or similar information.

 

Certain of our patent rights are licensed to us by third parties. If we fail to comply with the terms of these license agreements, our rights to those patents may be terminated, and we will be unable to conduct our business.

 

It is possible that a court may find us to be infringing upon validly issued patents of third parties. In that event, in addition to the cost of defending the underlying suit for infringement, we may have to pay license fees and/or damages and may be enjoined from conducting certain activities. Obtaining licenses under third-party patents can be costly, and such licenses may not be available at all.

 

We may face future product liability claims.

 

The testing, manufacturing, marketing and sale of therapeutic and diagnostic products entail significant inherent risks of allegations of product liability. Our past use of the RHEO System and the components of the SOLX Glaucoma System in clinical trials and the commercial sale of those products may have exposed us to potential liability claims. Our use of the TearLab® Osmolarity System and its commercial sale could also expose us to liability claims. All of such claims might be made directly by patients, health care providers or others selling the products. We carry clinical trials and product liability insurance to cover certain claims that could arise, or that could have arisen, during our clinical trials or during the commercial use of our products. We currently maintain clinical trials and product liability insurance with aggregate annual coverage limits of $2.0 million. Such coverage, and any coverage obtained in the future, may be inadequate to protect us in the event of successful product liability claims, and we may not increase the amount of such insurance coverage or even renew it. A successful product liability claim could materially harm our business. In addition, substantial, complex or extended litigation could result in the incurrence of large expenditures and the diversion of significant resources.

 

If we do not introduce new commercially successful products in a timely manner, our products may become obsolete over time, customers may not buy our products and our revenue and profitability may decline.

 

Demand for our products may change in ways we may not anticipate because of:

 

	●	evolving customer needs;
	●	the introduction of new products and technologies; and
	●	evolving industry standards.

 

 

Without the timely introduction of new commercially successful products and enhancements, our products may become obsolete over time, in which case our sales and operating results would suffer. The success of our new product offerings will depend on several factors, including our ability to:

 

	●	properly identify and anticipate customer needs;
	●	commercialize new products in a cost-effective and timely manner;
	●	manufacture and deliver products in sufficient volumes on time;
	●	obtain and maintain regulatory approval for such new products;
	●	differentiate our offerings from competitors’ offerings;
	●	achieve positive clinical outcomes; and
	●	provide adequate medical and/or consumer education relating to new products.

 

Moreover, innovations generally will require a substantial investment in research and development before we can determine the commercial viability of these innovations and we may not have the financial resources necessary to fund these innovations. In addition, even if we successfully develop enhancements or new generations of our products, these enhancements or new generations of products may not produce revenue in excess of the costs of development and they may be quickly rendered obsolete by changing customer preferences or the introduction by our competitors of products embodying new technologies or features.

 

We rely on a limited number of suppliers of each of the key components of the TearLab® Osmolarity System and are vulnerable to fluctuations in the availability and price of our suppliers ‘ products and services.

 

We purchase each of the key components of the TearLab® Osmolarity System from a limited number of third-party suppliers. Our suppliers may not provide the components or other products needed by us in the quantities requested, in a timely manner or at a price we are willing to pay. In the event we were unable to renew our agreements with our suppliers or they were to become unable or unwilling to continue to provide important components in the required volumes and quality levels or in a timely manner, or if regulations affecting the components were to change, we would be required to identify and obtain acceptable replacement supply sources. We may not be able to obtain alternative suppliers or vendors on a timely basis, or at all, which could disrupt or delay, or halt altogether, our ability to manufacture or deliver the TearLab® Osmolarity System. If any of these events should occur, our business, financial condition, cash flows and results of operations could be materially adversely affected.

 

We face intense competition, and our failure to compete effectively could have a material adverse effect on our results of operations.

 

We face intense competition in the markets for ophthalmic products and these markets are subject to rapid and significant technological change. Although we have no direct competitors, we have numerous potential competitors in the United States and abroad. We face potential competition from industry participants marketing conventional technologies for the measurement of osmolarity and other in-lab testing technologies, and commercially available methods, such as the Schirmer Test and ocular surface staining. Many of our potential competitors have substantially more resources and a greater marketing scale than we do. If we are unable to develop and produce or market our products to effectively compete against our competitors, our operating results will materially suffer.

 

 

If we lose key personnel, or we do not attract and retain highly qualified personnel on a cost-effective basis, it would be more difficult for us to manage our existing business operations and to identify and pursue new growth opportunities.

 

Our success depends, in large part, upon our ability to attract and retain highly qualified scientific, clinical, manufacturing and management personnel. In addition, any difficulties in retaining key personnel or managing this growth could disrupt our operations. Future growth will require us to continue to implement and improve our managerial, operational and financial systems, and to continue to recruit, train and retain, additional qualified personnel, which may impose a strain on our administrative and operational infrastructure. The competition for qualified personnel in the medical technology field is intense. We are highly dependent on our continued ability to attract, motivate and retain highly qualified management, clinical and scientific personnel.

 

Due to our limited resources, we may not effectively recruit, train and retain additional qualified personnel. If we do not retain key personnel or manage our growth effectively, we may not implement our business plan effectively.

 

Furthermore, we have not entered into non-competition agreements with our key employees. In addition, we do not maintain “key person” life insurance on any of our officers, employees or consultants. The loss of the services of existing personnel, the failure to recruit additional key scientific, technical and managerial personnel in a timely manner, and the loss of our employees to our competitors would harm our research and development programs and our business.

 

If we fail to establish and maintain proper and effective internal controls, our ability to produce accurate financial statements on a timely basis could be impaired, which would adversely affect our consolidated operating results, our ability to operate our business and our stock price.

 

Ensuring that we have adequate internal financial and accounting controls and procedures in place to produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. Failure on our part to maintain effective internal financial and accounting controls would cause our financial reporting to be unreliable, could have a material adverse effect on our business, operating results, financial condition and cash flows, and could cause the trading price of our common stock to fall dramatically.

 

Maintaining proper and effective internal controls will require substantial management time and attention and may result in our incurring substantial incremental expenses, including with respect to increasing the breadth and depth of our finance organization to ensure that we have personnel with the appropriate qualifications and training in certain key accounting roles and adherence to certain control disciplines within the accounting and reporting function. Any failure in internal controls or any errors or delays in our financial reporting would have a material adverse effect on our business and results of operations and could have a substantial adverse impact on the trading price of our common stock.

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. GAAP. Our management does not expect that our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Our management has identified control deficiencies in the past and may identify additional deficiencies in the future.

 

We cannot be certain that the actions we are taking to improve our internal controls over financial reporting will be sufficient or that any changes in processes and procedures can be completed in a timely manner. In future periods, if the process required by Section 404 of the Sarbanes-Oxley Act of 2002 reveals material weaknesses or significant deficiencies, the correction of any such material weaknesses or significant deficiencies could require additional remedial measures which could be costly and time-consuming. In addition, we may be unable to produce accurate financial statements on a timely basis. Any of the foregoing could cause investors to lose confidence in the reliability of our consolidated financial statements, which could cause the market price of our common stock to decline and make it more difficult for us to finance our operations and growth.

 

 

Risks Related to Our Common Stock

 

The trading price of our common stock may be volatile.

 

The market prices for, and the trading volumes of, securities of medical device companies, such as ours, have been historically volatile. The market has experienced, from time to time, significant price and volume fluctuations unrelated to the operating performance of particular companies. The market price of our common shares may fluctuate significantly due to a variety of factors, including:

 

	●	the results of pre-clinical testing and clinical trials by us, our collaborators and/or our competitors;
	●	technological innovations or new diagnostic products;
	●	governmental regulations;
	●	developments in patent or other proprietary rights;
	●	litigation;
	●	public concern regarding the safety of products developed by us or others;
	●	comments by securities analysts;
	●	the issuance of additional shares to obtain financing or for acquisitions;
	●	general market conditions in our industry or in the economy as a whole; and
	●	political instability, natural disasters, war and/or events of terrorism.

 

In addition, the stock market in general has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of individual companies. Broad market and industry factors may seriously affect the market price of our stock, regardless of actual operating performance. In the past, securities class action litigation often follows periods of volatility in the overall market and market price of a particular company’s securities. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.

 

Because we do not expect to pay dividends on our common stock, stockholders will benefit from an investment in our common stock only if it appreciates in value.

 

We have never paid cash dividends on our common stock and have no present intention to pay any dividends in the future. We are not profitable and may not earn sufficient revenue to meet all operating cash needs. As a result, we intend to use all available cash and liquid assets in the development of our business. Any future determination about the payment of dividends will be made at the discretion of our board of directors and will depend upon our earnings, if any, our capital requirements, our operating and financial conditions and on such other factors as our board of directors may deem relevant. As a result, the success of an investment in our common stock will depend upon any future appreciation in its value. There is no guarantee that our common stock will appreciate in value or even maintain the price at which stockholders have purchased their shares.

 

 

Warrant holders will not be entitled to any of the rights of common stockholders, but will be subject to all changes made with respect thereto.

 

If you hold warrants, you will not be entitled to any rights with respect to our common stock (including, without limitation, voting rights and rights to receive any dividends or other distributions on our common stock), but you will be subject to all changes affecting our common stock. You will have rights with respect to our common stock only if you receive our common stock upon exercise of the warrants and only as of the date when you become a record owner of the shares of our common stock upon such exercise. For example, if a proposed amendment to our charter or bylaws requires stockholder approval and the record date for determining the stockholders of record entitled to vote on the amendment occurs prior to the date that you are deemed to be the owner of the shares of our common stock due upon exercise of your warrants, you will not be entitled to vote on the amendment; although, you will nevertheless be subject to any changes in the powers, preferences or special rights of our common stock.

 

We can issue shares of preferred stock that may adversely affect the rights of holders of our common stock.

 

Our certificate of incorporation authorizes us to issue up to 10.0 million shares of preferred stock with designations, rights, and preferences determined from time to time by our board of directors. Accordingly, our board of directors is empowered, without stockholder approval, to issue preferred stock with dividend, liquidation, conversion, voting or other rights superior to those of holders of our common stock. For example, an issuance of shares of preferred stock could:

 

	●	adversely affect the voting power of the holders of our common stock;
	●	make it more difficult for a third party to gain control of us;
	●	discourage bids for our common stock at a premium;
	●	limit or eliminate any payments that the holders of our common stock could expect to receive upon our liquidation; or
	●	otherwise adversely affect the market price or our common stock.

 

Our common stock may be delisted from The NASDAQ Capital Market if we cannot maintain compliance with NASDAQ’s continued listing requirements.

 

In order to maintain our listing on NASDAQ, we are required to maintain a stockholders’ equity and minimum bid price requirement. In particular, we are required to (i) maintain a minimum bid price of $1.00, and we have traded below that threshold since February 2, 2016, and (ii) maintain a minimum stockholders’ equity of $2.5 million or meet alternative market capitalization or income from continuing operations tests. On March 16, 2016, we received notices from NASDAQ stating (i) that we were not in compliance with Nasdaq Listing Rule 5550(a)(2) (the “Minimum Bid Price Rule”) because our common stock failed to maintain a minimum closing bid price of $1.00 for 30 consecutive business days; and (ii) that we were not in compliance with Nasdaq Listing Rule 5550(b)(1) (the “Stockholders’ Equity Rule”) because the Company did not have a minimum stockholders’ equity, as of December 31, 2015, of $2.5 million and the Company also did not meet the alternative market capitalization and income from continuing operations tests. The Notices have no immediate effect on the NASDAQ listing or trading of the Company’s common stock.

 

We have a compliance period for the Minimum Bid Price Rule of 180 calendar days, or until September 12, 2016, in which to regain compliance, pursuant to NASDAQ Marketplace Rule 5810(c)(3)(A). If, at any time before that date the bid price of our common stock closes at $1.00 per share or more for a minimum of 10 consecutive business days, NASDAQ will notify us that we have achieved compliance with the Rule. We submitted a plan for compliance with the Stockholders’ Equity Rule on May 2, 2016. If the plan is acceptable, NASDAQ will grant us an extension until August 31, 2016 to evidence compliance. If NASDAQ does not accept our plan, we will have the opportunity to appeal that decision to a NASDAQ Hearings Panel.

 

 

If we do not regain compliance with the Minimum Bid Price Rule and the Stockholders’ Equity Rule, then NASDAQ will notify us that our common stock will be delisted from the Nasdaq Capital Market, unless we request a hearing before a Nasdaq Hearings Panel. If we fail to regain compliance with the applicable requirements, our stock may be delisted. Delisting from The NASDAQ Capital Market could make trading our common stock more difficult for investors, potentially leading to declines in our share price and liquidity. Without a NASDAQ Capital Market listing, stockholders may have a difficult time getting a quote for the sale or purchase of our stock, the sale or purchase of our stock would likely be made more difficult and the trading volume and liquidity of our stock could decline. Delisting from The NASDAQ Capital Market could also result in negative publicity and could also make it more difficult for us to raise additional capital. The absence of such a listing may adversely affect the acceptance of our common stock as currency or the value accorded by other parties. Further, if we are delisted, we would also incur additional costs under state blue sky laws in connection with any sales of our securities. These requirements could severely limit the market liquidity of our common stock and the ability of our stockholders to sell our common stock in the secondary market. If our common stock is delisted by NASDAQ, our common stock may be eligible to trade on an over-the-counter quotation system, such as the OTCQB market, where an investor may find it more difficult to sell our stock or obtain accurate quotations as to the market value of our common stock. We cannot assure you that our common stock, if delisted from The NASDAQ Capital Market, will be listed on another national securities exchange or quoted on an over-the counter quotation system.

 

If we are delisted from The NASDAQ Capital Market, your ability to sell your shares of our common stock would also be limited by the penny stock restrictions, which could further limit the marketability of your shares.

 

If our common stock is delisted, it would come within the definition of “penny stock” as defined in the Securities Exchange Act of 1934, or the Exchange Act, and would be covered by Rule 15g-9 of the Exchange Act. That Rule imposes additional sales practice requirements on broker-dealers who sell securities to persons other than established customers and accredited investors. For transactions covered by Rule 15g-9, the broker-dealer must make a special suitability determination for the purchaser and receive the purchaser’s written agreement to the transaction prior to the sale. Consequently, Rule 15g-9, if it were to become applicable, would affect the ability or willingness of broker-dealers to sell our securities, and accordingly would affect the ability of stockholders to sell their securities in the public market. These additional procedures could also limit our ability to raise additional capital in the future.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

Not applicable.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION.

 

None.

 

 

ITEM 6. EXHIBITS (WSGR to update – need to include new MiniFAB agreement and CRG Amendment No. 4)

 

Exhibit Number		Exhibit Description		Incorporated by Reference
4.1		Form of warrant issued to certain affiliated funds of CRG LP (formerly known as Capital Royalty) pursuant to the terms of the Term Loan Agreement, dated as of March 4, 2015, as amended by the Omnibus Amendment Agreement, dated as of April 2, 2015, Amendment 2, dated August 6, 2015, Amendment 3, dated December 31, 2015, and Amendment 4, dated April 7, 2016, by and among TearLab Corporation, certain of its subsidiaries from time to time party thereto as guarantors and CRG LP (formerly known as Capital Royalty) and certain of its affiliate funds, as lenders, dated as of April 7, 2016.
10.1#		Manufacturing, Supply and Development Agreement between MiniFAB (Aust) Pty Ltd and TearLab Research, Inc., dated March 7, 2016.
10.2		Amendment to Term Loan Agreement, dated as of March 4, 2015, as amended by the Omnibus Amendment Agreement, dated as of April 2, 2015, Amendment 2, dated August 6, 2015, and Amendment 3, dated December 31, 2015, by and among the Registrant, certain of its subsidiaries from time to time party thereto as guarantors and CRG LP (formerly known as Capital Royalty) and certain of its affiliate funds, as lenders, dated as of April 7, 2016.
31.1		CEO’s Certification required by Rule 13A-14(a) of the Securities Exchange Act of 1934.
31.2		CFO’s Certification required by Rule 13A-14(a) of the Securities Exchange Act of 1934.
32.1+		CEO’s Certification of periodic financial reports pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, U.S.C. Section 1350.
32.2+		CFO’s Certification of periodic financial reports pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, U.S.C. Section 1350.
101.INS*		XBRL Instance
101.SCH*		XBRL Taxonomy Schema
101.CAL*		XBRL Taxonomy Extension Calculation
101.DEF*		XBRL Taxonomy Extension Definition
101.LAB*		XBRL Taxonomy Extension Labels
101.PRE*		XBRL Taxonomy Extension Presentation

  

# Portions of this exhibit have been omitted pursuant to a request for confidential treatment and the non-public information has been filed separately with the Securities and Exchange Commission.

 

*XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section.

 

+In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release No. 33-8238 and 34-47986, Final Rule: Management’s Reports on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, the certifications furnished pursuant to this item will not be deemed “filed” for purposes of Section 18 of the Exchange Act (15 U.S.C. 78r), or otherwise subject to the liability of that section. Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference.

 

 

SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

		TearLab Corp.
		(Registrant)
Date:	May 9, 2016	/s/ Joseph Jensen
		Joseph Jensen
		Chief Executive Officer