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:          September 30, 2014

 

(   )

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  ☒   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  ☒   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 ☒
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  ☒

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 33,588,734 as of November 3, 2014.

 

 

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	25
Item 4.	Controls and Procedures	26
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	27
Item 1A.	Risk Factors	27
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	38
Item 3.	Defaults Upon Senior Securities	38
Item 4.	Mine Safety Disclosures	38
Item 5.	Other Information	38
Item 6.	Exhibits	39

 

 

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:

 

	●	Our future strategy, structure, and business prospects;
	●	The planned commercialization of our products;
	●	The size and growth of the potential markets for our products and technology;
	●	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 anticipated sales to customers in the United States;
	●	Our ability to obtain reimbursement for patient testing with the TearLab® System;
	●	Our efforts to assist our customers in obtaining their CLIA waiver certifications or providing them with support from certified professionals;
	●	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; and
	●	Use of cash, cash needs and ability to raise capital.

 

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)

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(expressed in U.S. dollars except par values and share amounts)

(in thousands)

 

		September 30, 2014				December 31, 2013
		(Unaudited)
ASSETS
Current assets
Cash		$	20,744			$	37,778
Accounts receivable, net			3,064				3,524
Inventory			3,541				885
Prepaid expenses and other current assets			779				699
Total current assets			28,128				42,886
Fixed assets, net			4,352				3,429
Patents and trademarks, net			87				108
Intangible assets, net			3,978				3,494
Other non-current assets			53				40
Total assets		$	36,598			$	49,957
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable		$	1,754			$	631
Accrued liabilities			3,800				3,844
Deferred rent			144				67
Obligations under warrants			399				4,047
Total current liabilities			6,097				8,589
Exchange right			250				—
Stockholders’ equity
Capital stock
Preferred Stock, $0.001 par value, authorized 10,000,000, none outstanding			—				—
Common stock, $0.001 par value, 65,000,000 authorized, 33,588,734 and 33,288,701 issued and outstanding at September 30, 2014 and December 31, 2013, respectively			34				33
Additional paid-in capital			482,836				477,172
Accumulated deficit			(452,619	)			(435,837	)
Total stockholders’ equity			30,251				41,368
Total liabilities and equity		$	36,598				49,957

 

See accompanying notes to interim condensed consolidated financial statements

 

 

TearLab Corporation

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

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

(Unaudited)

(in thousands except number of shares and (loss) per share)

 

		Three months ended
		September 30,
		2014				2013
Revenue		$	5,212			$	4,207
Cost of goods sold (excluding amortization of intangible assets)			2,726				2,277
Gross profit			2,486				1,930
Operating expenses
General and administrative			3,485				1,859
Clinical, regulatory and research & development			586				255
Sales and marketing			4,147				3,341
Amortization of intangible assets			382				304
Total operating expenses			8,600				5,759
Loss from operations			(6,114	)			(3,829	)
Other income (expense)
Interest income			6				11
Changes in fair value of warrant obligations			310				(382	)
Other, net			13				(40	)
Total other income (expense)			329				(411	)
Net loss and comprehensive loss		$	(5,785	)		$	(4,240	)
Weighted average shares outstanding - basic			33,588,734				31,913,521
Net loss per share – basic		$	(0.17	)		$	(0.13	)
Weighted average shares outstanding - diluted			33,711,814				31,913,521
Net loss per share – diluted		$	(0.18	)		$	(0.13	)

 

See accompanying notes to interim condensed consolidated financial statements

 

 

TearLab Corporation

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

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

(Unaudited)

(in thousands except number of shares and (loss) per share)

 

		Nine months ended
		September 30,
		2014				2013
Revenue		$	14,422			$	10,207
Cost of goods sold (excluding amortization of intangible assets)			7,391				5,822
Gross profit			7,031				4,385
Operating expenses
General and administrative			10,203				5,922
Clinical, regulatory and research & development			1,768				685
Sales and marketing			11,900				9,136
Amortization of intangible assets			1,080				911
Total operating expenses			24,951				16,654
Loss from operations			(17,920	)			(12,269	)
Other income (expense)
Interest income			22				21
Changes in fair value of warrant obligations			1,032				(12,520	)
Other, net			84				(69	)
Total other income (expense)			1,138				(12,568	)
Net loss and comprehensive loss		$	(16,782	)		$	(24,837	)
Weighted average shares outstanding - basic			33,574,846				29,960,835
Net loss per share – basic		$	(0.50	)		$	(0.83	)
Weighted average shares outstanding - diluted			33,725,555				29,960,835
Net loss per share – diluted		$	(0.53	)		$	(0.83	)

 

See accompanying notes to interim condensed consolidated financial statements

 

 

TearLab Corporation

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(expressed in U.S. dollars)

(Unaudited)

(in thousands)

 

		Nine months ended September 30,
		2014				2013
OPERATING ACTIVITIES
Net loss for the period		$	(16,782	)		$	(24,837	)
Adjustments to reconcile net loss to cash used in operating activities:
Stock-based compensation			2,943				2,505
Depreciation of fixed assets			1,063				373
Amortization of patents and trademarks			21				21
Amortization of intangible assets			1,080				911
Changes in fair value of warrant obligations			(1,032	)			12,520
Loss on disposal of fixed assets			1				-
Net change in working capital and non-current asset balances related to operations			(1,139	)			(459	)
Cash used in operating activities			(13,845	)			(8,966	)
INVESTING ACTIVITIES
Additions to fixed assets, net of proceeds			(2,145	)			(2,490	)
Cash paid for business acquisition			(1,400	)			-
Cash used in investing activities			(3,545	)			(2,490	)
FINANCING ACTIVITIES
Proceeds from issuance of shares in an underwritten public offering			-				40,365
Proceeds from warrants exercised			-				387
Proceeds from the exercise of options			175				296
Exchange right			250				-
Costs of issuance of shares			(69	)			(3,055	)
Cash provided by financing activities			356				37,993
Net increase (decrease) in cash and cash equivalents during the period			(17,034	)			26,537
Cash, beginning of period			37,778				15,437
Cash, end of period		$	20,744			$	41,974

 

See accompanying notes to interim condensed consolidated financial statements

 

 

TearLab Corporation

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(expressed in 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 and all of its wholly owned subsidiaries. Intercompany accounts and transactions have been eliminated on consolidation.

 

The consolidated balance sheet at December 31, 2013 has been derived from the audited 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 for complete financial statements.

 

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 $16.8 million for the nine months ended September 30, 2014 and $29.0 million for the year ended December 31, 2013. The Company's working capital surplus at September 30, 2014 is $22.0 million. Based on the Company’s annual operating plan approved by the Board of Directors, management believes the Company’s existing cash and cash equivalents of $20.7 million at September 30, 2014 combined with anticipated cash flows provided by sales of its products in 2014 will be sufficient to fund its cash requirements through at least September 30, 2015.

 

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. The Company may be required to seek additional debt or equity financing to support its operations until it becomes cash flow positive. There can be no assurances that there will be adequate financing available to the Company on acceptable terms or at all. If the Company is not able to achieve its planned revenue or incurs costs in excess of its forecasts and is unable to obtain additional financing, the Company would need to significantly curtail or reorient its operations, which could have a material adverse effect on the Company’s ability to achieve its business objectives.  The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts classified as liabilities that might be necessary should the Company be forced to take any such actions.

 

2.     SIGNIFICANT ACCOUNTING POLICIES

 

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, 2013. 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. 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 revenues and expenses during the reporting period. Actual results could differ from those estimates. The principal areas of judgment relate to revenue and inventory reserves, impairment of long-lived and intangible assets, and the fair value of stock options and warrants.

 

 

TearLab Corporation

 

 

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) collectability is reasonably assured. The Company’s timing of revenue recognition is impacted by factors such as passage of title and payments. Amounts received in excess of revenue recognizable are deferred.

 

The Company enters into contracts where revenue is derived from multiple deliverables containing a mix of products, which generally includes either the sale or the right to use a TearLab Osmolarity System and sales of a number of test cards. The Company has multiple revenue programs, in which it either sells readers and test cards as a combined unit with no future commitments on behalf of the customer, provides the use of readers to large practices with an expectation of purchasing certain levels of test cards or allows the customer to use the readers with a commitment to fulfill a minimum purchase obligation, typically over a three year period. Revenue recognition for contracts 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. When multiple elements have stand-alone value, consideration is allocated at the inception of the contract to all deliverables based on their relative selling price. The relative selling price for each deliverable is determined using vendor specific objective evidence (VSOE) of selling price or third-party evidence of selling price if VSOE does not exist. If neither VSOE nor third-party evidence exists, the Company uses its best estimate of the selling price for the deliverable. When no stand-alone value to the elements exists, as is currently the case for the TearLab reader when sold together with related disposables, arrangement consideration is recognized on the combined unit of accounting. The Company recognizes revenue for each of the elements only when it determines that all applicable recognition criteria have been met.

 

The TearLab® Osmolarity System for Dry Eye Disease (“DED”) consists of hardware and related disposable test cards. In 2013 and 2014, the Company’s revenues have been derived primarily from programs where customers are given the use of a TearLab Osmolarity System in exchange for various programs to purchase test cards. The Company’s sales are currently direct to customers in the United States, Canada and the United Kingdom and to distributors in Europe and Asia. The Company records revenue when all of its obligations are completed which is generally upon shipment of the Company’s products.

 

Although the Company typically has a no return policy for its products, the Company has established a return 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 $152,000 and $173,000 as of September 30, 2014 and December 31, 2013, respectively, has reduced revenue and is included as a reduction to accounts receivable.

 

Warrant liabilities

 

The Company issued several rounds of warrants related to various debt and equity transactions which occurred in 2011. The Company accounts for its warrants issued in accordance with the US GAAP accounting guidance under Accounting Standards Codification (ASC) 815 applicable to derivative instruments, which requires every derivative instrument within its scope to be recorded on the balance sheet as either an asset or liability measured at its fair value, with changes in fair value recognized in earnings.  Based on this guidance, the Company determined that the Company's warrants do not meet the criteria for classification as equity.  Accordingly, the Company classified the warrants as current liabilities. The warrants are subject to re-measurement 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. The Company estimated the fair value of these warrants at the respective balance sheet dates using the Black-Scholes option-pricing model, based on the 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. There is a degree of subjectivity involved when using option pricing models to estimate warrant liability and the assumptions used in the Black-Scholes option-pricing model are judgmental.

 

 

TearLab Corporation

 

 

Acquisition

 

On March 14, 2014, the Company acquired the net assets of the OcuHub business unit from AOAExcel, Inc., the for-profit subsidiary of the American Optometric Association ("AOA") in an all cash transaction for $1.4 million and a working capital deficit of $201,000. Of the net purchase price, $1,564,000 has been allocated to intangible assets, $38,000 to property, plant and equipment, $30,000 to prepaid expense and $230,000 to accrued liabilities. The acquisition was accounted for as a business combination in accordance with the authoritative guidance. The allocation of purchase price is based on our valuation of the fair value of tangible and intangible assets acquired and liabilities assumed as of the closing. The fair value assigned to intangible assets has been determined primarily by using a variation of the income approach known as the discounted cash flow method, which estimates the value based on the present value of the after-tax free cash flows attributable to owning the intangible asset.

 

Recent Accounting Pronouncements 

 

In May 2014, the Financial Accountings Standards Board issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers, or 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. The standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for us on January 1, 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor have we determined the effect of the standard on our ongoing financial reporting.

 

In August 2014, the Financial Accountings Standards Board issued guidance which requires management to assess an entity’s ability to continue as a going concern and to provide related disclosures in certain circumstances. Under the new guidance, disclosures are required when conditions give rise to substantial doubt about an entity’s ability to continue as a going concern within one year from the financial statement issuance date. The guidance is effective for annual periods ending after December 15, 2016, and all annual and interim periods thereafter. Early application is permitted. The adoption of this guidance will not have any impact on the Company’s financial position and results of operations and, as this time, the Company does not expect any impact on its disclosures.

 

3.     BALANCE SHEET DETAILS

 

Accounts receivable

 

(in thousands)		September 30, 2014				December 31, 2013
Trade receivables		$	3,520			$	3,939
Allowance for doubtful accounts			(456	)			(415	)
		$	3,064			$	3,524

 

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.

 

(in thousands)		September 30, 2014				December 31, 2013
Finished goods		$	3,561			$	899
Inventory reserves			(20	)			(14	)
		$	3,541			$	885

 

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 11). 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. The usage of the minimum purchase commitments is predicated upon increases in revenues from TearLab products as compared to 2013 and prior years.

 

 

TearLab Corporation

 

 

Prepaid Expenses and Other Current Assets

 

(in thousands)		September 30, 2014				December 31, 2013
Prepaid trade shows		$	187			$	162
Prepaid insurance			131				227
Manufacturing deposits			275				104
Subscriptions			44				86
Other fees and services			142				120
		$	779			$	699

 

Fixed Assets

 

(in thousands)		September 30, 2014				December 31, 2013
Furniture and office equipment		$	267			$	221
Leasehold improvements			50				47
Computer equipment and software			631				386
Capitalized TearLab equipment			5,330				3,640
Medical equipment			403				401
			6,681				4,695
Less accumulated depreciation			(2,329	)			(1,266	)
		$	4,352			$	3,429

 

Depreciation expense was $1,063,000 and $373,000 during the nine months ended September 30, 2014 and 2013, respectively, and $394,000 and $190,000 during the three months ended September 30, 2014 and 2013, respectively.

 

Patents and trademarks

 

(in thousands)		September 30, 2014				December 31, 2013
Patents		$	236			$	236
Trademarks			32				32
			268				268
Accumulated amortization			(181	)			(160	)
		$	87			$	108

 

Amortization expense of patents and trademarks was $21,000 and $21,000 during the nine months ended September 30, 2014 and 2013, respectively, and $7,000 and $7,000 during the three months ended September 30, 2014 and 2013, respectively.

 

Accrued liabilities

 

(in thousands)		September 30,				December 31,
		2014				2013
Due to professionals		$	487			$	616
Due to employees and directors			1,830				1,503
State sales and use tax liabilities			279				527
Royalty liability			317				281
Readers and test cards in transit			463				368
Other			424				549
		$	3,800			$	3,844

 

 

TearLab Corporation

 

 

4.     INTANGIBLE ASSETS

 

The Company's intangible assets consist 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 consists of the right to access and commercialize the OcuHub cloud-based technology platform which facilitates an effective and efficient shared care model providing secure connectivity between doctors, patients, institutions and payers. The OcuHub platform technology is being amortized using the straight-line method over an estimated useful life of 5 years. Amortization expense for the three months and nine months ended September 30, 2014 and 2013 was $382,000, $304,000, $1,080,000 and $911,000, respectively.

 

Intangible assets subject to amortization consist of the following:

 

		September 30, 2014								December 31, 2013
		Cost				Accumulated Amortization				Cost				Accumulated Amortization
TearLab® technology		$	12,172			$	9,588			$	12,172			$	8,678
OcuHub platform technology			1,564				170				-				-
		$	13,736			$	9,758			$	12,172			$	8,678

 

The estimated amortization expense for the intangible assets for the remainder of 2014 and each of the remaining five years is as follows:

 

		Amortization of intangible assets ($ 000’s)
Remainder of 2014		$	382
2015			1,527
2016			1,379
2017			313
2018			313
2019			64
		$	3,978

 

5.     RELATED PARTY TRANSACTIONS

 

On August 20, 2009, the Company entered into a distribution agreement with Science with Vision Inc., pursuant to which Science with Vision obtained exclusive Canadian distribution rights with respect to the Company’s products.  The Company began selling products through the Canadian distributor in 2010. On September 3, 2013, the Company and Science with Vision Inc. agreed to terminate the distribution agreement including exclusive distribution rights of TearLab products in Canada. In consideration of the termination agreement, the Company agreed to a one-time payment to Science with Vision Inc. of $200,000 Canadian dollars and a royalty on all sales in Canada of products for which Science with Vision Inc. had exclusive distribution rights. The one-time payment resulted in a charge of $190,000 USD during the quarter ended September 30, 2013 and is recorded within sales and marketing expense. Royalties are recorded as cost of goods sold in the income statement in the period in which revenue is recognized for the associated products sold. The Company’s chairman of the board of directors and chief executive officer has a material financial interest in Science with Vision. Sales to this distributor for the nine months ended September 30 2014 was $0, and the outstanding accounts receivable balances due at September 30, 2014 and December 31, 2013 was $0. Royalty expense related to the termination agreement with this distributor for the three and nine months ended September 30, 2014 was $3,000 and $8,000, respectively, and the outstanding accrued liability balances at September 30, 2014 and December 31, 2013 was $3,000.

 

 

TearLab Corporation

 

 

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 nine months ended September 30, 2014.

 

At September 30, 2014, the Company has a liability for warrants to purchase 219,604 shares of common stock at an exercise price of $1.86 per share valued at $399,000 (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 nine months ended September 30, 2014 (in thousands):

 

		Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Balance of warrant liability at January 1, 2014		$	4,047
Warrant exercises			(2,616	)
Change in fair value of warrant liability included in other (income) / expense			(1,032	)
Balance of warrant liability at September 30, 2014		$	399

 

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.

 

 

TearLab Corporation

 

 

(b)  Common stock

 

The Company has funded operations over the years through the issuance of equity in public and private offerings including on July 30, 2013, the Company closed an underwritten public offering of 2.99 million shares of its common stock at a price to the public of $13.50 per share. The Company received gross proceeds of $40,365,000, with associated costs of $3,055,000.

 

(c)  Stock Option Plan

 

The Company has a stock incentive plan, the 2002 Stock Incentive Plan (the "Stock Incentive Plan"). Under the Stock Incentive Plan, 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 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 requisite service 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 September 30,								Nine months ended September 30,
		2014				2013				2014				2013
General and administrative		$	568			$	189			$	1,914			$	1,239
Clinical, regulatory and research and development			41				37				119				66
Sales and marketing			434				521				910				1,200
Stock-based compensation expense before income taxes		$	1,043			$	747			$	2,943			$	2,505

 

(d)  Employee Stock Purchase Plan

 

In July 2014, the Company’s Board of Directors adopted the 2014 Employee Stock Purchase Plan, or 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 $25,000 worth of stock in the plan during each calendar year or more than 5,000 shares per offering period. The initial offering period commenced in July 2014. For the three and nine months ended September 30,2014, the expense related to the Employee Stock Purchase Plan was $18,000 and $18,000, respectively.

 

 

TearLab Corporation

 

 

(e)  Warrants

 

On June 13, 2011, the Company issued 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. There were 74,063 of these warrants outstanding at September 30, 2014 and December 31, 2013.

 

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 $7,000,000 were issued. The investors purchased the shares and warrants for $1.82 per unit (each unit consisting of one share and one warrant to purchase shares of common stock). The exercise price of the warrants is $1.86 per share. The warrants are exercisable at any time from the date of issuance until June 30, 2016. The Company’s estimated the fair value of the warrants at the date of issuance using the Black Scholes option model with a 101% volatility, 5.0 years expected life and a risk-free interest rate of 1.76%. The fair value of $5,518,000 was classified as a current liability as the Company determined that these warrants do not meet the criteria for classification as equity.

 

The Company accounts for the 2011 Warrants in accordance with applicable guidance to derivatives. The Company determined that the 2011 Warrants do not meet the criteria for classification as equity. Accordingly, the Company classified the 2011 Warrants as current liabilities at September 30, 2014.

 

The Company initially allocated the total proceeds received, pursuant to the Securities Purchase Agreement, to the shares of common stock and warrants issued based on their relative fair values. This resulted in an allocation of $3,012,000 of proceeds to warrant liability. The Company remeasures the fair value of the warrants at the end of each reporting period, resulting in an adjustment to the warrant obligations, with any gain or loss recorded in earnings of the applicable reporting period.

 

The estimated fair value of the 2011 Warrants at September 30, 2014 was determined using the Black-Scholes option-pricing model with the following assumptions:

 

Volatility			62	%
Expected life of Warrants (in years)			1.75
Risk-free interest rate			0.47	%
Dividend yield			0	%

 

The fair value of the 2011 warrants is highly sensitive to the changes in the Company’s stock price and stock price volatility.

 

During the three and nine months ended September 30, 2014 certain holders of 2011 Warrants exercised 0 and 304,945 warrants, respectively. The Company received $0 in proceeds from the cashless exercises during the nine month period ended September 30, 2014. The Company is required to record the outstanding warrants at fair value at the time of exercise, before moving the fair value into additional paid-in capital, resulting in an adjustment to the warrant obligations, with any gain or loss recorded in earnings of the applicable reporting period. The Company, therefore, estimated the fair value of the exercised 2011 Warrants in the first quarter of 2014 at their respective exercise dates to be $2,616,000, an increase in value of $263,000 from the previous value at December 31, 2013. This increase was recorded as an expense in other income (expense) in the condensed consolidated statement of operations and comprehensive loss for the three and nine months ended September 30, 2014.

 

 

TearLab Corporation

 

 

The Company recorded the outstanding warrants 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 of the applicable reporting period. The Company estimated the fair value of the remaining warrants as of September 30, 2014 to be $399,000, a decrease of $310,000, $725,000 and $1,295,000 from the previous values at June 30, 2014, March 31, 2014 and December 31, 2013, respectively. These amounts were recorded as income to other income (expense) in the condensed consolidated statement of operations and comprehensive loss for the three and nine months ended September 30, 2014.

 

The following table provides activity for the Warrants outstanding through September 30, 2014 (in thousands, except weighted average exercise prices):

 

		Number of warrants outstanding				Weighted average exercise price
Outstanding, December 31, 2013			599			$	1.83
Exercised			(305	)			1.86
Expired			—				—
Outstanding, September 30, 2014			294			$	1.79

 

(f)  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. The membership units sold generated cash proceeds of $250,000 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 our common stock. The first available exchange window follows the one year anniversary date of the purchase of membership units. The variable number of shares of common stock provided upon exchange is equal to the initial capital contribution amount received for the membership units sold divided by the closing sales price of TearLab Corporation common stock during the respective exchange window. Due to the exchange right option available to the membership unit holders, the entire loss from continuing operations related to OcuHub LLC of $683,000 and $1,438,000 for the three and nine months ended September 30, 2014 has been attributed to TearLab Corporation within the consolidated financial statements.

 

8.     COMPREHENSIVE LOSS

 

For the three and nine months ended September 30, 2014 and 2013, comprehensive loss was equal to net loss for each period.

 

9.     NET LOSS PER SHARE

 

The Company computes basic net income (loss) per share using the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per share assumes the conversion, exercise or issuance of all potential common stock equivalents, unless the effect of inclusion would be anti-dilutive. For purposes of this calculation, common stock equivalents include the Company's stock options, employee stock purchase plan ("ESPP") and warrants. Diluted loss per share for the three and nine months ended September 30, 2014 includes the dilutive impact of the gain recorded from the Company's June 30, 2011 warrants.

 

The following outstanding common stock equivalents were not included in the calculation of net loss per share because their effects were anti-dilutive (in thousands):

 

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2014				2013				2014				2013
Stock options			6,228				5,018				6,228				5,018
Warrants			74				964				74				964
ESPP shares			20				-				20				-
Exchange rights			74				-				74				-
Total			6,396				5,982				6,396				5,982

 

 

TearLab Corporation

 

 

10.    CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

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

 

		Nine months ended September 30,
		2014				2013
Accounts receivable, net		$	460			$	(2,512	)
Inventory			(2,656	)			903
Prepaid expenses and other assets			(51	)			1
Other non-current assets			(13	)			(13	)
Accounts payable			893				(162	)
Accrued liabilities			151				1,289
Deferred rent/revenue			77				35
		$	(1,139	)		$	(459	)

 

The following table lists those items that have been excluded from the condensed consolidated statements of cash flows as they relate to non-cash transactions and additional cash flow information (in thousands):

 

		Nine months ended September 30,
		2014				2013
Reclass of warrant liabilities to Stockholders Equity upon cashless exercise of warrants			2,616				10,404
Additions to fixed assets included in accounts payable and accrued liabilities			195				-

 

11.    COMMITMENTS AND CONTINGENCIES

 

On August 1, 2011, the Company, through its subsidiary, TearLab Research, Inc., entered into a manufacturing and development agreement, or the Manufacturing Agreement, with MiniFAB (Aust) Pty Ltd, or MiniFAB. Pursuant to the terms of the Manufacturing Agreement, MiniFAB will manufacture and supply test cards for the Company. The Manufacturing Agreement specifies minimum order quantities that will require the Company to purchase approximately $17.2 million (AUD $19.7 million) in test cards from MiniFAB for the years from 2014 through the end of 2015 of which $7.4 million (AUD $8.5 million) has been on order as of September 30,2014. The Company is also subject to annual minimum order commitments under the Manufacturing Agreement which is equal to $8.1 million (AUD $9.3 million) for 2014. The Manufacturing Agreement has a ten year initial term and may be terminated by either party if the other party is in breach or becomes insolvent. If terminated for any reason other than default by MiniFAB, the Company will be obligated to pay a termination fee based on the cost of products manufactured by MiniFAB, but not yet invoiced, repayment of capital invested by MiniFAB, less depreciation calculated in accordance with Australian accounting standards, and the expected profit to MiniFAB had the remaining minimum order quantities been purchased by the Company.

 

The Company has evaluated its 2014 outstanding purchase commitment with MiniFab to determine the potential amount of liability the Company may be obligated to pay if it doesn’t meet its annual order commitment. Having reviewed the submitted orders for test cards to MiniFAB for the nine months ended September 30, 2014, if the Company does not: 1) order the sufficient additional test cards to meet the 2014 minimum order commitment under the agreement or 2) seek to modify the existing minimum order quantity with MiniFab, the Company will be subject to liquidated damages estimated at $0.7 million (AUD $0.8 million).

 

 

TearLab Corporation

 

 

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 that has developed a proprietary tear testing platform, the TearLab® Osmolarity System. The TearLab test measures tear film osmolarity for diagnosis of Dry Eye Disease, or DED. Tear osmolarity is a quantitative and highly specific biomarker that has been shown to correlate with DED. The TearLab test enables the rapid measurement of tear osmolarity in a doctor's office. Commercializing our Point-of-Care tear testing platform is now the focus of our business.

 

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. In connection with the CE mark clearance, we have entered into multi-year agreements with numerous distributors for distribution of the TearLab Osmolarity System. Currently, we have signed distribution agreements in each of the following countries: Spain, Portugal, Germany, France, Turkey, Ukraine, Bulgaria, Belgium, Netherlands, Switzerland, Finland, Sweden, Denmark, Norway, South Korea, Australia, Russia, Hungary, Greece, Slovakia, Argentina, the Czech Republic, a sales representation agreement in Japan and are selling directly to the customer in Canada and the United Kingdom.

 

On May 19, 2009, we announced that we received 510(k) clearance from the U.S. Food and Drug Administration, or FDA. The 510(k) clearance allows us to market the TearLab Osmolarity System to those reference and physician operated laboratories with CLIA certifications allowing them to perform moderate and high complexity tests. Our efforts were then focused on obtaining a CLIA waiver from the FDA for the TearLab Osmolarity System as a CLIA waiver greatly reduces the regulatory compliance for our customers.

 

On October 19, 2010 we announced that a unique new Current Procedural Terminology, or CPT, code that will apply to the TearLab Osmolarity test had been published by the American Medical Association, or AMA. The new code became effective January 1, 2011. The new CPT code for the TearLab Osmolarity test is: 83861; Microfluidic analysis utilizing an integrated collection and analysis device, tear osmolarity (For microfluidic tear osmolarity of both eyes, report 83861 twice). This code falls under the Chemistry sub-section of the Pathology and Laboratory section of the CPT Codebook and was listed under the 2010 Clinical Laboratory Fee Schedule by the Centers for Medicare and Medicaid Services, or CMS. The payment code of 83861 that currently applies to the TearLab Osmolarity Test will be cross-walked or paired with code 84081. At current 2014 reimbursement rates, payment code 83861 would be reimbursed in every state by CMS at $22.54 per eye. This decision by CMS provides level reimbursement for and equal access to the TearLab Osmolarity Test across all of the United States.

 

On January 23, 2012, we announced that after reviewing and accepting labeling submitted to it by the Company, the FDA had granted the waiver categorization under CLIA for the TearLab Osmolarity System.

 

On March 14, 2014, we announced the closing of the acquisition of the assets of the OcuHub business unit from AOAExcel, Inc., the for-profit subsidiary of the American Optometric Association ("AOA") in an all cash transaction for $1.4 million. OcuHub, powered by AT&T and Covisint, facilitates an effective and efficient shared care model with a single sign-on portal, which simplifies secure connectivity between doctors, patients, institutions and payers. It is a subscription-based service that is HIPAA compliant and eliminates the need for a complex and expensive IT structure. The OcuHub platform will be a competitive advantage for EHR incentive payments, access to insured patients, participation in ACOs and other new payment systems and represents another important step toward TearLab creating an unprecedented partnership within the eye care community.

 

 

TearLab Corporation

 

 

Our success is highly dependent on our ability to increase sales of our testing platform in the United States as well as Europe and other countries recognizing the CE mark and in Canada where we have a Medical Device License. Meeting these objectives requires that we have sufficient capital to fund our operations. While our cash of $20.7 million as of September 30, 2014 may be insufficient to fund our long-term planned operations and our ability to generate increased revenues is uncertain, management believes that we have sufficient cash to fund our operations at current levels for at least the next 12 months. In spite of having adequate funding at this time we continue to evaluate various financing possibilities. If our revenues do not increase sufficiently to meet operational needs, we would be required to raise additional capital to fund our operations.

 

Recent Developments 

 

RESULTS OF OPERATIONS

 

Revenue, Cost of Sales and Gross Margin

 

		Three Months Ended September 30, (in thousands)												Nine Months Ended September 30, (in thousands)
		2014				2013				Change				2014				2013				Change
Revenue		$	5,212			$	4,207			$	1,005			$	14,422			$	10,207			$	4,215
Cost of sales			2,726				2,277				449				7,391				5,822				1,569
Gross margin		$	2,486			$	1,930			$	556			$	7,031			$	4,385			$	2,646
Gross margin percentage			48	%			46	%			2	%			49	%			43	%			6	%

 

Revenues

 

TearLab 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 $1,005,000 or 24% for the three months ended September 30, 2014 as compared to the prior year quarter. The increase is primarily driven from test card sales volume representing $909,000 of the total increase from the prior year quarter and increase in reader revenue of $96,000. Test card volume increase is consistent with the increase of new customers signed onto the Company’s annual test card commitment programs and its high volume large multi-doctor practice programs for domestic customers.

 

TearLab revenue increased by $4,215,000 or 41% for the nine months ended September 30, 2014 as compared to the prior year period. The increase is primarily driven from test card sales volume representing $4,177,000 of the total increase from the prior year period and an increase in reader revenue of $38,000. Test card volume increase is consistent with the increase of new customers signed onto the Company’s annual test card commitment programs and its high volume large multi-doctor practice programs for domestic customers.

 

 

TearLab Corporation

 

 

TearLab Cost of Sales

 

TearLab cost of sales includes costs of goods sold, depreciation, warranty, and royalty costs. Our cost of goods sold consists primarily of costs for the manufacture of the TearLab test, 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 cost of sales for the three months ended September 30, 2014 increased by $449,000 or 20% compared to the prior year fiscal period due to increased volumes of TearLab test cards in the overall sales product mix, as the Company focuses its sales activities to its domestic customers on its annual test card commitment programs and its high volume large multi-doctor practice programs.

 

For the nine months ended September 30, 2014, TearLab cost of sales increased by $1,569,000 or 27% over the prior year fiscal period due to increased volumes of TearLab test cards in the overall sales product mix, as the Company focuses its sales activities to its domestic customers on its annual test card commitment programs and its high volume large multi-doctor practice programs

 

TearLab Gross Margin

 

TearLab gross margin for the three months ended September 30, 2014 increased by $556,000 or 29% compared to the prior year fiscal period. The increase is mainly due to higher sales volume. The gross margin percentage of revenue for the quarter ending September 30, 2014 was 48% as compared to 46% for the prior year fiscal period which is primarily due to lower cost associated with test cards sold during the period including the impact of the weakening Australian dollar at the time of purchasing test card inventory.

 

TearLab gross margin for the nine months ended September 30, 2014 increased by $2,646,000 or 60% compared to the prior year fiscal period. The increase is mainly due to higher sales volume. The gross margin percentage of revenue for the nine month period ending September 30, 2014 was 49% as compared to 43% for the prior year fiscal period which is primarily due to lower cost associated with test cards sold during the period including the impact of the weakening Australian dollar at the time of purchasing test card inventory.

 

Operating Expenses

 

		Three months ended September 30 (in thousands)												Nine months ended September 30 (in thousands)
		2014				2013				Change				2014				2013				Change
Amortization of intangible assets		$	382			$	304			$	78			$	1,080			$	911			$	169
General and administrative			3,485				1,859				1,626				10,203				5,922				4,281
Clinical, regulatory and research and development			586				255				331				1,768				685				1,083
Sales and marketing			4,147				3,341				806				11,900				9,136				2,764
Operating expenses		$	8,600			$	5,759			$	2,841			$	24,951			$	16,654			$	8,297

 

General and Administrative Expenses

 

General and administrative expenses increased by $1,626,000 or 87% during the three months ended September 30, 2014, as compared with the comparable period in fiscal 2013 primarily due to an increase of $975,000 in employee costs driven by a 40% increase in headcount to support the growth of the business and cost of new OcuHub employees, an increase of $379,000 in stock-based compensation expense primarily related to options granted to new employees along with an increase of $250,000 in administrative expenses, travel and public company costs.

 

 

TearLab Corporation

 

 

General and administrative expenses increased by $4,281,000 or 72% during the nine months ended September 30, 2014, as compared with the comparable period in fiscal 2013 primarily due to an increase of $2,314,000 increase in employee costs driven by a 44% increase in headcount including the addition of a Chief Operating Officer to support the growth of the business and cost of new OcuHub employees, an increase of $675,000 in stock-based compensation expense due to an increase in stock options vesting during the period, $662,000 in administrative expenses and an increase of $336,000 in professional fees including increasing audit and tax compliance costs due to overall growth of business activities.

 

We are continuing to focus our efforts on controlling costs by reviewing and improving upon our existing business processes and cost structure.

 

Clinical, Regulatory and Research and Development Expenses

 

Total clinical, regulatory and research and development expenses increased by $331,000 or 130% during the three months ended September 30, 2014, as compared with the corresponding prior year period. The increase was primarily due to a $299,000 increase in research and development expenses related to next generation diagnostic products.

 

Total clinical, regulatory and research and development expenses increased by $1,083,000 or 158% during the nine months ended September 30, 2014, as compared with the corresponding prior year period. The increase was mainly due to a $937,000 increase in research and development expenses related to next generation diagnostic products, $72,000 increase in professional fees and a $59,000 increase in stock-based compensation expense due to an increase in stock options vesting during the period.

 

Sales and Marketing Expense

 

Sales and marketing expenses increased by $806,000 or 24% during the three months ended September 30, 2014, as compared with the comparable period in fiscal 2013 primarily due to a $514,000 increase related to employee costs driven by a 44% increase in headcount, $262,000 increase in travel costs primarily associated with the continued focus on commercialization of the TearLab product in the United States and $385,000 increase in marketing and advertising costs offset by $229,000 decrease in administrative expenses and an $87,000 decrease in stock-based compensation expense driven by a declining re-valuation of consultant stock options as a result of a decline in TearLab stock price.

 

Sales and marketing expenses increased by $2,764,000 or 30% during the nine months ended September 30, 2014, as compared with the comparable period in fiscal 2013 primarily due to a $2,330,000 increase related to employee costs driven by a 46% increase in headcount, $635,000 increase in travel costs associated with the continued focus on commercialization of the TearLab product in the United States and $268,000 increase in marketing and advertising costs offset by $210,000 decrease in administrative expenses and an $289,000 decrease in stock-based compensation expense driven by a declining re-valuation of consultant stock options as a result of a decline in TearLab stock price.

 

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.

 

Amortization of Intangible Assets

 

Amortization expense of intangible assets for the three and nine months ended September 30, 2014, as compared to the prior year fiscal periods increased $78,000 and $169,000 and is directly related to the intangible assets acquired in the OcuHub business unit purchase from AOA Excel, Inc.

 

 

TearLab Corporation

 

 

Other Income (Expense)

 

		Three Months Ended September 30, (in thousands)												Nine Months Ended September 30, (in thousands)
		2014				2013				Change				2014				2013				Change
Interest income		$	6			$	11			$	(5	)		$	22			$	21			$	1
Changes in fair value of warrant obligations			310				(382	)			692				1,032				(12,520	)			13,552
Other			13				(40	)			53				84				(69	)			153
		$	329			$	(411	)		$	740			$	1,138			$	(12,568	)		$	13,706

 

Interest Income

 

Interest income for the three months ended September 30, 2014 decreased slightly by $5,000, and interest income for the nine months ended September 30, 2014 increased slightly by $1,000 as compared to the prior year fiscal periods primarily due to a larger cash balance earning interest during each period. Interest income consists of interest earned as a result of the Company’s cash position at the end of each corresponding fiscal period.

 

Changes in Fair Value of Warrants Obligations

 

The Company recorded income related to a decrease in the fair value of warrant obligations of $310,000 and $1,032,000 for the three and nine month periods ended September 30, 2014, respectively.

 

At the beginning of the nine month period ended September 30, 2014, the Company had a total of 524,549 warrants subject to fair value re-measurement each quarter. During the first quarter of 2014 certain holders of warrants exercised 304,945 warrants. The Company is required to record the outstanding warrants at fair value at the time of exercise, resulting in an adjustment to the warrant obligations, with any gain or loss recorded in earnings of the applicable reporting period. The Company, therefore, estimated the fair value of the exercised warrants during the first quarter 2014 to be $2,616,000, an increase of $263,000 from the previous value at December 31, 2013. This increase was recorded as a charge to other income (expense) in the condensed consolidated statement of operations for the three months ended March 31, 2014. There were no warrant exercises during the second or third quarters of 2014.

 

In addition, the Company is also required to record the outstanding warrants 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 of the applicable reporting period. The Company, therefore, estimated the fair value of the remaining warrants as of September 30, 2014 to be $399,000, a decrease of $1,295,000 from the previous value at December 31, 2013; reflecting a decrease of $570,000 for the three months ended March 31, 2014, a decrease of $415,000 for the three months ended June 30, 2014 and a decrease of $310,000 for the three months ended September 30, 2014. These amounts were recorded as a charge to other income (expense) in the condensed consolidated statement of operations for the three and nine months ended September 30, 2014, the primary driver of this change being a change in Black-Scholes valuation inputs for our decreased stock price.

 

Other

 

Other expense for the three and nine months ended September 30, 2014 and 2013 consists primarily of foreign exchange gains and losses, based on fluctuations of the Company’s foreign denominated currencies.

 

Liquidity and Capital Resources

(in thousands)

		September 30,				December 31,
		2014				2013				Change
Cash and cash equivalents		$	20,744			$	37,778			$	(17,034	)
Percentage of total assets			57	%			76	%
Working capital		$	22,031			$	34,297			$	(12,266	)

 

 

TearLab Corporation

 

 

Financial Condition

 

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 US dollar and Australian dollar may be material. In the 12 months ended September 30, 2014, the exchange rate incurred to purchase Australian dollars to pay our Australian supplier fluctuated from $0.87 USD to $0.96 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.

 

We believe that we have sufficient funding to meet operational needs for at least the next 12 months but if we are not able to achieve a cash positive operating position in the future we may need to raise additional funds, and our prospects for obtaining that capital are uncertain. Additional capital may not be available on terms favorable to us, or at all. In addition, future financings could result in significant dilution of existing stockholders.

 

Ongoing Sources and Uses of Cash

 

We anticipate that our cash and cash equivalents and cash generated from increased revenues, will be sufficient to sustain our operations for at least the next 12 months.   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.

 

 

TearLab Corporation

 

 

Changes in Cash Flows

 

		Nine months ended September 30, (in thousands)
		2014				2013				Change
Cash used in operating activities		$	(13,845	)		$	(8,966	)		$	(4,879	)
Cash used in investing activities			(3,545	)			(2,490	)			(1,055	)
Cash provided by financing activities			356				37,993				(37,637	)
Net increase in cash and cash equivalents during the period		$	(17,034	)		$	26,537			$	(43,571	)

 

Cash Used in Operating Activities

 

Net cash used to fund our operating activities during the nine months ended September 30, 2014 was $13,845,000.  Net loss during the nine month period was $16,782,000. The non-cash items which comprise a portion of the net loss during that period consist primarily of the amortization of intangible assets, patents and trademarks, depreciation of fixed assets, stock-based compensation and changes in the fair value of warrant obligations in the aggregate total of $4,076,000.

 

The net change in working capital and non-current asset balances related to operations for the nine months ended September 30, 2014 and 2013 consists of the following:

 

		Nine months ended September 30, (in thousands)
		2014				2013
Accounts receivable, net		$	460			$	(2,512	)
Inventory			(2,656	)			903
Prepaid expenses and other assets			(51	)			1
Other non-current assets			(13	)			(13	)
Accounts payable			893				(162	)
Accrued liabilities			151				1,289
Deferred rent/revenue			77				35
		$	(1,139	)		$	(459	)

 

Cash Used in Investing Activities

 

Net cash used in investing activities for the nine months ended September 30, 2014 and 2013 was $3,545,000 and $2,490,000, respectively, to acquire fixed assets, primarily related to the Company’s annual test card commitment programs or its high volume large multi doctor practice programs as well as $1,400,000 of cash used to acquire the net assets of the OcuHub business unit from AOAExcel, Inc.

 

Cash Provided by Financing Activities

 

During the nine months ended September 30, 2014, the Company issued 53,097 shares of common stock as a result of the exercise of options for gross proceeds of $175,000.

 

During the nine months ended September 30, 2013, the Company issued 1,043,270 shares of common stock as a result of the exercise of 1,219,086 warrants for gross proceeds of $387,000. In addition, 138,026 shares of common stock were issued as a result of the exercise of options for gross proceeds of $296,000. During the nine months ended September 30, 2013, the Company issued common stock in an underwritten public offering generating net proceeds of $37,310,000.

 

In August 2014, the Company sold membership units in OcuHub LLC, a Delaware limited liability company and a wholly owned subsidiary of TearLab Corporation. The membership units sold generated gross proceeds of $250,000 in exchange for 2% ownership of OcuHub LLC.

 

 

TearLab Corporation

 

 

Critical Accounting Policies and Estimates

 

Management’s discussion and analysis of our financial condition and results of operations are based upon our 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 nine months ended September 30, 2014 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, 2013. 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 nine months ended September 30, 2014 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 Consolidated Financial Statements for the nine months ended September 30, 2014 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 pounds sterling, while a minor portion of our expenses are in Canadian dollars, Australian dollars and Pounds sterling. Our purchases of test cards are in Australian dollars. 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 Pound sterling to meet short term operating requirements. Based on the balances in the Canadian dollar, Australian dollar, Euro and Pound sterling denominated bank accounts at September 30, 2014, hypothetical increases of $0.01 in the value of the Canadian dollar, the Australian dollar, the Euro and the Pound sterling in relation to the U.S. dollar would impact our results of our operations by less than $10,000. 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

 

The primary objective of our investment activity is to preserve principal while maximizing interest income we receive from our cash resources, without increasing risk. We believe this will minimize our market risk. We do not use interest rate derivative transactions to manage our interest rate risk. We reduce our exposure to interest rate risk by investing in savings or money market accounts. Declines in interest rates over an extended period of time will reduce our interest income while an increase over an extended period of time will increase our interest income. A reduction of interest rate by 100 basis points over the 12 months ended September 30, 2014 would reduce interest income by $22,000.

 

 

TearLab Corporation

 

 

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 September 30, 2014 our disclosure controls and procedures were effective at the reasonable assurance level.

 

(b)	Changes in Internal Control over Financial Reporting.

 

During the third quarter of 2014, 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.

 

 

TearLab Corporation

 

 

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 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 U.S. Food and Drug Administration, or the FDA, to market the TearLab Osmolarity System to those reference and physician operated laboratories with Clinical Laboratory Improvement Act, or 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.  These foreign markets include Turkey, Spain, Italy and France.  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.

 

Our commitment to purchase minimum levels of product from our suppliers may result in the purchase of excess quantities of product if we are not able to successfully commercialize the TearLab Osmolarity System.

 

On August 1, 2011, we entered into a manufacturing and development agreement, or the Manufacturing Agreement, with MiniFAB (Aust.) Pty Ltd, or MiniFAB.  Pursuant to the terms of the Manufacturing Agreement, MiniFAB will manufacture and supply test cards for us.  The Manufacturing Agreement specifies minimum order quantities that will require us to purchase approximately USD $17.2 million (AUD$19.7 million) in test cards from MiniFAB for the years 2014 and 2015.  Each year, we must purchase the covered test cards exclusively from MiniFAB until the minimum order quantity for such year has been met.  The Manufacturing Agreement has a ten-year initial term and may be terminated by either party if the other party is in breach or becomes insolvent.  If terminated for any reason other than a default by MiniFAB, we will be obligated to pay a termination fee based on the cost of products manufactured by MiniFAB, but not yet invoiced, repayment of capital invested by MiniFAB, less depreciation calculated in accordance with Australian accounting standards, and the expected profit to MiniFAB had the remaining minimum order quantities been purchased by us.

 

 

TearLab Corporation

 

 

The usage of test cards purchased under the minimum purchase commitment with MiniFAB is predicated upon significant increases in revenue from the TearLab products as compared to the year ended December 31, 2013 and prior periods. If we are not able to commercialize the TearLab® Osmolarity System sufficiently to sell the minimum order quantities required by the MiniFab Agreement, we will be required to purchase test cards that we may be unable to use and that may become obsolete, which would have a potentially adverse effect on our financial position, results of operations and cash flows.

 

Our limited working capital and history of losses have resulted in doubts as to whether we will be able to continue as a going concern.

 

In the years ended December 31, 2013 and the nine months ended September 30, 2014, 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 September 30, 2014 was $22.0 million, which represents a $12.3 million decrease in the balance from our working capital of $34.3 million at December 31, 2013.  

 

Although current levels of cash flows are negative, management believes the Company’s existing cash will be sufficient to cover its operating and other cash demands for at least the next 12 months.

 

 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.

 

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 September 30, 2014, we had an accumulated deficit of $452.6 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. 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 of our product to become and remain profitable would adversely affect the price of our common stock and our ability to raise capital and continue operations.

 

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 September 30, 2014, our total liabilities were approximately $6.1 million.   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 high level of liability presents 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;

 

 

TearLab Corporation

 

 

●

our liability obligations 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 level of 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 in 2012 by warrant holders, the April 2012 public offering financing, the July 2012 registered direct financing, the exercise of warrants and options in 2013 as well as the underwritten public offering in July 2013.  As of the date of filing of this quarterly Form 10-Q, we estimate that our cash and cash equivalents will be sufficient to meet our operating activities and other demands for at least the next 12 months. 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.

 

 

TearLab Corporation

 

 

●

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.

 

 

TearLab Corporation

 

 

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 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.

 

 

TearLab Corporation

 

 

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 and 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 $2,000,000.  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.

 

 

TearLab Corporation

 

 

We have entered into related party transactions with suppliers, creditors, stockholders, officers and other parties, each of which may have interests which conflict with those of our public stockholders.

 

We have entered into related party transactions with our suppliers, creditors, stockholders, officers and other parties, each of which may have interests which conflict with those of our public stockholders.

 

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.

 

 

TearLab Corporation

 

 

We rely on a single supplier 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 single third-party suppliers.  Our supplier 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 supplier 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.

 

 

TearLab Corporation

 

 

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 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.

 

We may need to raise additional capital in the 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.

 

 

TearLab Corporation

 

 

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

 

Our annual revenue and results of operations have varied in the past and may continue to vary significantly from year-to-year. The variability in our annual 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 to 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 and 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.

 

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;

 

 

TearLab Corporation

 

 

●

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 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 revenues to meet all operating cash needs for at least several years, if at all.  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.

 

 

TearLab Corporation

 

 

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 10,000,000 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.

 

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.

 

 

TearLab Corporation

 

 

ITEM 6.

EXHIBITS

 

Exhibit Number		Exhibit Description		Incorporated by Reference
3.1		Amended and Restated Certificate of Incorporation of the Registrant currently in effect.		Exhibit 3.3 to the Registrant's Current Report on Form 8-K filed with the Commission on October 9, 2008 (file no. 000-51030)
3.2		Amended and Restated By-Laws of the Registrant currently in effect.		Exhibit 3.4 to the Registrant's Registration Statement on Form S-1/A No. 3, filed with the Commission on November 16, 2004 (file no. 333-118024)
3.3		Certificate of Amendment to Amended and Restated Certificate of Incorporation.		Exhibit 3.2 to the Registrant's Current Report on Form 8-K filed with the Commission on October 9, 2008 (file no. 000-51030)
3.4		Certificate of Amendment to Amended and Restated Certificate of Incorporation.		Exhibit 3.1 to the Registrant's Current Report on Form 8-K filed with the Commission on May 19, 2010 (file no. 000-51030)
3.5		Certificate of Amendment to Amended and Restated Certificate of Incorporation.		Exhibit 3.4 to the Registrant's Post-Effective Amendment No. 1 to Form S-3 filed with the Commission on July 15, 2013 (file no. 333-189372)
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

 

 

#Management compensatory plan, contract or arrangement

 

*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

 

 

TearLab Corporation 

 

 

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:		November 6, 2014		/s/ Elias Vamvakas
				Elias Vamvakas
				Chief Executive Officer

 

 

 

41