UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended:             SeptemberJune 30, 20162017

For the transition period from _______________ to _______________

Commission File Number: 000-51030

TearLab Corporation

(Exact name of registrant as

specified in its charter)

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

(Address of principal executive offices)

(858) 455-6006

(Registrant’s telephone number, including area code)

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

Yes [X] No [  ]

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

Yes [X] No [  ]

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes [  ] No [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 53,601,9905,742,453 as of October 31, 2016.August 7, 2017.

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:

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

TearLab Corporation

CONDENSED CONSOLIDATED BALANCE SHEETS

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

(Unaudited)

See accompanying notes to interim condensed consolidated financial statements

TearLab Corporation

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

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

(Unaudited)

See accompanying notes to interim condensed consolidated financial statements

TearLab Corporation

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

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

(Unaudited)

See accompanying notes to interim condensed consolidated financial statements

TearLab Corporation

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(expressed in thousands of U.S. dollars)

(Unaudited)

See accompanying notes to interim condensed consolidated financial statements

TearLab Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

1. BASIS OF PRESENTATION

Nature of Operations

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

The accompanying condensed consolidated financial statementsCondensed Consolidated Financial Statements include the accounts of the Company and all of its wholly owned subsidiaries. On April 8, 2016, OcuHub Holdings, Inc., a wholly-owned subsidiary of the Company, completed the sale of 10,167.5 units of OcuHub LLC (“OcuHub”), reducing OcuHub Holdings, Inc.’s ownership in OcuHub to 10.5% on a fully-diluted basis. Prior to the sale, the accounts of OcuHub were included in the condensed consolidated financial statements.Condensed Consolidated Financial Statements. In the three and ninesix months ended SeptemberJune 30, 2016, the Company recorded a gain on the sale of OcuHub of $75, included in Other income (expense) on the Condensed Consolidated StatementStatements of Operations and Comprehensive Loss. Intercompany accounts and transactions have been eliminated on consolidation.

On February 23, 2017, the Company’s stockholders authorized the board of directors to implement a reverse stock split, along with a corresponding reduction in the number of shares authorized. On February 27, 2017, the Company effected a 1-for-10 reverse stock split of its common stock. All common stock share amounts and prices per share of common stock in these Condensed Consolidated Financial Statements have been retroactively adjusted to reflect the reverse stock split.

Liquidity and Going Concern

The accompanying condensed consolidated financial statementsCondensed 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, theThe Company has sustained substantial losses of $15,579$8,315 and $11,598 for the ninesix months ended SeptemberJune 30, 2017 and 2016, respectively. Based on the Company’s current rate of cash consumption, the Company estimates it will need additional capital by the first quarter of 2018 and $33,229its prospects for the year ended December 31, 2015.obtaining that capital are uncertain. The Company has implemented plansmay be able to mitigate conditionsraise either additional debt financing or additional equity financing. However, the Company can make no assurances that it will be able to raise the required additional capital, either through debt or equity financing, on acceptable terms or at all. Unless the Company succeeds in raising additional capital or significantly reduces the cash consumed in the operations of the Company, the Company anticipates that it will be unable to continue operations through the end of the first quarter of 2018 without violating an existing covenant on the Term Loan Agreement (defined below). As a result of the Company’s historical losses and financial condition, there is substantial doubt about the Company’s ability to continue as a going concern. In February 2016, the Company underwent a strategic restructuring, including a staff reduction of 54 positions, designed to improve the Company’s overall cost structure. In April 2016, the Company finalized the divestment of OcuHub. In May 2016, the Company issued a combination of common stock, preferred stock, and warrants to purchase common stock for net proceeds of $15,457.  The Company’s working capital surplus at September 30, 2016, was $18,988 which represents a $4,849 increase from its working capital at December 31, 2015. Management believes the combination of restructuring the Company’s cost structure, the cash provided by the equity capital raise and anticipated cash flows provided by the sale of products, will be sufficient to fund the Company’s cash requirements for at least the next twelve months. The accompanying condensed consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

TearLab Corporation

2. SIGNIFICANT ACCOUNTING POLICIES

The consolidated balance sheetCondensed Consolidated Balance Sheet at December 31, 20152016 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States (“U.S. GAAP”) for complete financial statements. These unaudited interim condensed consolidated financial statementsCondensed Consolidated Financial Statements have been prepared using significant accounting policies that are consistent with the policies used in preparing the Company’s audited consolidated financial statements for the year ended December 31, 2015.2016. The audited financial statements for the year ended December 31, 2015,2016, filed with the SEC with ourthe Company’s annual report on Form 10-K on March 9, 201610, 2017 include a summary of our significant accounting policies and should be read in conjunction with this Form 10-Q. Management believes that all adjustments necessary for the fair presentation of results, consisting of normally recurring items, have been included in the unaudited condensed consolidated financial statementsCondensed Consolidated Financial Statements for the interim periods presented.

TearLab Corporation

Use of Estimates

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

Revenue recognition

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

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

The Company enters into contracts where revenue is derived either from agreements whereby the customer is provided the right to use the TearLab® Osmolarity System (reader equipment) at no separate cost to the customer in consideration for a minimum or implied purchase commitment of disposable test cards over the related contract term (“Use(referred to as either “Use Agreements”, “Masters Agreements” or “Flex Agreements”), or from agreements with separate sales of multiple deliverables, such as the reader equipment and disposable test cards (“Purchase(referred to as “Purchase Agreements”).

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

TearLab Corporation

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

Although the Company typically has a no return policy for its products, the Company has established a reserve for product sales that contain an implicit right of return. The Company reserves for estimated returns or refunds by reducing revenuerevenues at the time of shipment based on historical experience. The reserve of $16$12 and $67$13 as of SeptemberJune 30, 20162017 and December 31, 2015,2016, respectively, has reduced revenue and is included in accounts receivable.

Recent accounting pronouncements

In August 2016, the Financial Accountings Standards Board (the “FASB”) issued Accounting Standards Update No. 2016-15, Statement of Cash Flows (“ASU 2016-35”2016-15”), to reduce diversity in practice of how certain transactions are classified in the statement of cash flows. ASU 2016-15 is effective for fiscal and interim periods beginning after December 15, 2017. The Company is currently evaluating the impact the adoption of the new standard will have on its financial statements.

In March 2016, the FASB issued Accounting Standards Update No. 2016-09 Improvement to Employee Share-Based Payment AccountingCompensation–Stock Compensation (“ASU 2016-09”), which involves severalrequires that excess tax benefits and tax deficiencies be recorded in the income statement as a reduction or increase of income taxes when an award vests. It also requires excess tax benefits to be classified as an operating activity in the statement of cash flows. In addition, it simplifies other aspects of accounting for share-based payment transactions, including income tax consequences, classification of awards as liabilities or equity,that permit repurchase to satisfy statutory tax withholding requirements and classificationsclassification of tax payments on behalf of employees on the statement of cash flows. ASU 2016-09 is effective for fiscal and interim periods beginning after December 15, 2016. The Company is currently evaluatingadopted this guidance in the impactfirst quarter 2017, and it did not have a material effect on the adoption of the new standard will have on its financial statements.Company’s Condensed Consolidated Financial Statements.

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

In July 2015, the FASB issued Accounting Standards Update No. 2015-11, Inventory-Simplifying the Measurement of Inventory (“ASU 2015-11”). ASU 2015-11 became effective January 1, 2017. Under ASU 2015-11, the Company measures inventory at the lower of cost or net realizable value, where net realizable value is defined as the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. ASU 2015-11 was applied prospectively beginning January 1, 2017. The change to lower of cost or net realizable value had no impact on the Company’s financial statements.

TearLab Corporation

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. Early application is not permitted. On April 1, 2015, the FASB voted to propose a deferral of the effective date of the standard by one year which would result in the new standard being effective for the Company at the beginning of its first quarter of fiscal year 2018. The Company has not yet completedexpects to finalize its assessment of the impact of the new standard including possible transition alternatives,on its financial statements in 2017 so it can implement ASU 2014-09, on a modified retrospective basis, in the first quarter of 2018. The Company does not expect the guidance to have a material impact on the amounts reported in the financial statements, but it will require enhanced footnote disclosures regarding the Company’s financial statements.

TearLab Corporationrecognition of revenue.

3. BALANCE SHEET DETAILS

Accounts receivable

Inventory

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

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-termlong term purchase commitment to buy the test cards from MiniFAB (Aust) Pty Ltd (“MiniFAB”)(Note 8). The purchase commitment contains required minimum purchases based on periodic forecasts submitted to MiniFab, but the purchase commitment can fluctuate up or down depending on the Company’s forecast of future demand. 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.

TearLab Corporation

Prepaid expenses and other current assets

TearLab Corporation

Fixed assets

Depreciation expense was $1,816$1,026 and $1,431$1,236 for the ninesix months ended SeptemberJune 30, 20162017 and 2015,2016, respectively, and $580$505 and $538,$617, respectively, for the three months ended SeptemberJune 30, 20162017 and 2015.2016.

Accrued liabilities

4. INTANGIBLE ASSETS

The Company’s intangible assets consist primarily of the value of TearLab® Technology acquired in the acquisition of TearLab Research, Inc., a wholly-owned subsidiary of the Company.Company and a prescriber list. The TearLab Technology, which 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 beingCompany, included in amortization of intangibles line item in the Condensed Consolidated Statements of Operations and Comprehensive Loss, was fully amortized using the straight-line method over an estimated useful life of 10 years.in November 2016. Amortization expense for the three months ended SeptemberJune 30, 2017 and 2016 was $15 and 2015 was $359 and $389,$329, respectively. Amortization expense for the ninesix months ended SeptemberJune 30, 2017 and 2016 was $30 and 2015 was $966 and $1,166,$644, respectively.

TearLab Corporation

Intangible assets subject to amortization consist of the following:

TearLab Corporation

The estimated amortization expense for the intangible assets for the remainder of 20162017 and thereafter is as follows:

5.TERM5. TERM LOAN

On March 4, 2015, the Company executed a term loan agreement (the “Term Loan Agreement”) with CRG LP and certain of its affiliate funds (“CRG”) as lenders providing the Company with access of up to $35,000 under the arrangement. The Company received $15,000 in gross proceeds under the arrangement on March 4, 2015, and an additional $10,000 on October 6, 2015. The Term Loan Agreement matures on DecemberMarch 31, 20202021 and bears interest at 13% per annum, with quarterly payments of interest only for the first four years. While interest on the loan is accrued at 13% per annum, the Company may elect to make interest-only payments at 8.5% per annum. The unpaid interest of 4.5% is added to the principal of the loan and is subject to additional accrued interest (“PIK interest”). The accrued interest can be deferred and paid together with the principal in the fifth and sixth years.

TearLab Corporation

As part of the amended Term Loan Agreement, and funding of the second tranche, CRG received 350,00035,000 warrants dated as of October 6, 2015 to purchase common shares of the Company at a price of $5.00$50.00 per share (the “CRG Warrants”). The CRG Warrants have a five-year life. The CRG Warrants are classified as equity on the Condensed Consolidated Balance SheetSheets as of December 31, 2015June 30, 2017 and September 30, 2016. The CRG Warrants were valued at their issuance date using the Black-Scholes Merton model. The related reduction of the long-term debt will be amortized over the life of the debt.

The loan is collateralized by all assets of the Company. Additionally, the terms of the Term Loan Agreement contain various affirmative and negative covenants agreed to by the Company. Among them, the Company must attain minimum certain annual revenue and minimum cash threshold levels. On April 7, 2016, the Company amended the Term Loan Agreement to change the required minimum revenue levels. The amended minimum revenue is $27,000 for 2016, $31,000 for 2017, $36,000 for 2018, $45,000 for 2019 and $55,000 for 2020. The minimum cash balance required is $5,000 subject to certain conditions. The amendment also reduced the exercise price of the CRG Warrants from $5.00$50.00 per share to $1.50$15.00 per share and the Company issued CRG additional warrants to purchase 350,00035,000 common shares of the Company’s stock at $1.50$15.00 per share, which expire 5 years after issuance. See Note 6 for further discussion of the CRG Warrants.

TearLab Corporation

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

At SeptemberJune 30, 2016,2017, the Company was in compliance with all of the covenants.

As part of the amended Term Loan Agreement, on the earlier of the maturity date or the date the term loan is paid off in full, the Company will pay a facility fee equal to 6.5% of the aggregate principal amount of the loan, excluding accrued PIK interest (the “Facility Fee”). The Facility Fee is being accrued to interest expense using the effective interest method.

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

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

The following is a summary of the Term Loan Agreement as of SeptemberJune 30, 20162017 and related maturities of outstanding principal:

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

TearLab Corporation

6. STOCKHOLDERS’ EQUITY

(a) Authorized share capital

On February 23, 2017, the Company’s stockholders authorized the board of directors to implement a reverse stock split, along with a corresponding reduction in the number of shares authorized. On February 27, 2017, the Company effected a 1-for-10 reverse stock split of its common stock. All common stock share amounts and prices per share of common stock have been retroactively adjusted to reflect the reverse stock split.

On June 24, 2016, the Company’s stockholders approved an amendment to the Company’s certificate of incorporation to increase the total number of authorized shares of common stock of the Company to 95,000,0009,500,000 from 65,000,000.6,500,000. Each share of common stock has a par value of $0.001 per share. The total number of authorized shares of preferred stock of the Company is 10,000,000. Each share of preferred stock has a par value of $0.001 per share.

(b) Common and preferred shares

On May 9, 2016 the Company issued 18,610,9001,861,090 shares of common stock, 3,291.8 shares of Series A Convertible Preferred Stock (“Preferred Stock”) and Series A warrants to purchase 11,500,0001,150,000 shares of common stock (“Series A Warrants”) for gross proceeds of $17,250, less issuance costs of $1,793. TheAdditionally, the Company granted the placement agent warrants to purchase 103,500 shares of common stock with an exercise price of $11.25 per share. All the Preferred Stock is convertible, subject to certain limitations,converted into an aggregate of 4,389,100438,910 shares of common stock contains no voting rights, participates in any common stock dividends, and is treated as if converted upon any ordinary liquidation event.prior to June 30, 2017. The common stock, the Series A Convertible Preferred Stock, and the Series A Warrants are all included in equity in the Company’s Condensed Consolidated Balance Sheets as of SeptemberJune 30, 2017 and December 31, 2016. The net proceeds were allocated to common stock, Preferred Stock, and Series A Warrants based on their relative fair values, as follows:

On August 2, 2016, 527.5 shares of Series A Convertible Preferred stock were converted into 703,334 shares of commons stock.

TearLab Corporation

(c) Stock incentive plan

The Company has a stock incentive plan,On June 23, 2017 the Company’s stockholders approved an amendment to the 2002 Stock Incentive Plan (the “Stock Incentive Plan”), under which up to 7,200,000 optionsincrease the total number of shares reserved for issuance to 1,070,000 from 720,000. Stock Incentive Plan shares are available for grant to employees, directors and consultants. OptionsShares granted under the Stock Incentive Plan may be either incentive stock options, or non-statutory stock options.options, stock appreciation rights, restricted stock or restricted share units. Under the terms of the Stock Incentive Plan, the exercise price per share for an incentive stock option shall not be less than the fair market value of a share of stock on the effective date of grant and the exercise price per share for non-statutory stock options shall not be less than 85% of the fair market value of a share of stock on the date of grant. No option granted to a holder of more than 10% of the Company’s common stock shall have an exercise price per share less than 110% of the fair market value of a share of stock on the effective date of grant.

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

TearLab Corporation

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

The following table sets forth the total stock-based compensation expense resulting from stock options and the employee stock purchase plan included in the Company’s condensed consolidated statementsCondensed Consolidated Statements of operationsOperations and comprehensive lossComprehensive Loss (in thousands):

(d) Employee Stock Purchase Plan

In July 2014, the Company’s Board of Directors adopted the 2014 Employee Stock Purchase Plan (the “ESPP”) which was approved by the Company’s stockholders in June 2014 at the Company’s Annual Meeting of Stockholders. A total of 671,50067,150 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 purchaseinvest more than $25 worth of stock in the plan during each calendar year or purchase more than 5,000500 shares per offering period. During the three months ended SeptemberJune 30, 20162017 and 2015,2016, the Company recorded $2 and $27$4, of expense, respectively, under the ESPP. During the ninesix months ended SeptemberJune 30, 20162017 and 2015,2016, the Company recorded $8$5 and $66$7 of expense, respectively, under the ESPP. During the ninesix months ended SeptemberJune 30, 20162017 and 2015,2016, the Company issued 141,0527,512 and 54,2116,774 shares of common stock, respectively, under the ESPP. On July 3, 2017, the Company issued an additional 6,721 shares of common stock under the ESPP.

TearLab Corporation

(e) Warrants

On June 30, 2011, the Company closed a private placement financing in which 3,846,154 shares of common stock and warrants (’’2011 Warrants’’) to purchase 3,846,154 shares of common stock for gross proceeds of approximately $7,000. The exercise price of the warrants was $1.86 per share. The 2011 Warrants expired on June 30, 2016. There were 219,604 of the 2011 Warrants that expired unexercised. Prior to their expiration, the 2011 Warrants were recorded as a liability on the Company’s balance sheet and remeasured each period using the Black-Scholes Merton option-pricing model. There were no exercises of 2011 Warrants during the nine months ended September 30, 2016 or 2015. The liability for the 2011 Warrants outstanding as of December 31, 2015 had a value of $29. The value of the 2011 Warrants outstanding as of December 31, 2015 was recorded as a Change in fair value of warrant obligations in the Consolidated Statements of Operations and Comprehensive Loss during the nine months ended September 30, 2016, reflecting the expiration of the instruments and the associated liability.

TearLab Corporation

On October 8, 2015, as part of the second amendment to the Term Loan Agreement and funding of the $10,000 tranche, CRG received warrants to purchase 350,00035,000 common shares in the Company at a price of $5.00$50.00 per share (the “CRG Warrants”). The CRG Warrants are exercisable any time prior to October 8, 2020. The CRG Warrants are classified as equity on the Condensed Consolidated Balance Sheets as of June 30, 2017 and December 31, 2015 and September 30, 2016. The CRG Warrants were valued at $290 upon issuance using the Black-Scholes Merton model assuming volatility of 73%, an expected life of 5.0 years, a risk-free interest rate of 1.71%, and 0% dividend yield. No CRG Warrants were exercised during the ninesix months ended SeptemberJune 30, 2017 or 2016.

On April 8, 2016, the Company further amended its Term Loan Agreement. As part of the amendment, the exercise price of the CRG Warrants was changed to allow the holder to purchase 350,00035,000 common shares in the Company at a price of $1.50$15.00 per share and CRG was issued an additional 350,00035,000 warrants to purchase common shares at an exercise price of $1.50$15.00 (the “2016 CRG Warrants”). The modification to the terms of the CRG Warrants resulted in a change in fair value of $54 which was included as interest expense for the nine months ended September 30, 2016.expense. The change in fair value was calculated using the Black-Scholes Merton model with both exercise prices, assuming volatility of 76%, an expected life of 4.5 years, a risk-free interest rate of 1.06%, and 0% dividend yield. The 2016 CRG Warrants were valued at $106 upon issuance using the Black-Scholes Merton model assuming volatility of 76%, an expected life of 5.0 years, a risk-free interest rate of 1.30% and 0% dividend yield.

On May 9, 2016, the Company issued Series A Warrants to purchase 11,500,0001,253,500 shares of common stock for $1.125$11.25 per common share attached to shares of common and Series A Convertible Preferred Stock issued on the same date. The Series A Warrants can be exercised after May 9, 2017 (the “Initial Exercise Date”) and expire 5 years after the Initial Exercise Date. Fair value of the Series A Warrants, for purposes of allocating the net proceeds of the equity offering, was determined using the Black-Scholes Merton model assuming volatility of 76%, an expected life of 6.0 years, a risk-free interest rate of 1.30%, and 0% dividend yield.

(e)(f) Exchange Right

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

7. NET INCOME (LOSS) PER SHARE

Basic income (loss)earnings per share (“EPS”) excludes dilutive securities and is calculatedcomputed by dividing net income (loss)loss available to common stockholders by the weighted average number of shares of common shares and vested restricted stock units outstanding. Diluted income (loss) per share is computed by dividing net income (loss), less any dilutive amounts recorded during the periodoutstanding for the change in fair value of warrant liabilities, byyear. Diluted EPS reflects the weighted average number ofpotential dilution that could occur if securities or other contracts to issue common shares and vested restricted stock units outstandingwere exercised or converted and the weighted average numberresulting additional shares are dilutive because their inclusion decreases the amount of dilutive common stock equivalents, from stock options, warrants, and non-vested restricted stock units. Common stock equivalents are only included in the diluted earnings per share calculation when their effect is dilutive. Diluted loss per share for the three and nine months ended September 30, 2015 includes the dilutive impact of the gain recorded from the Company’s June 30, 2011 warrants.EPS.

TearLab Corporation

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

8. COMMITMENTS AND CONTINGENCIES

Commitments

The Company has commitments relating to operating leases recognized on a straight line basis over the term of the lease for rental of office space and equipment from unrelated parties, expiring at various times through June 30, 2018. The Company leases office facilities under an operating lease agreement. The initial term of the lease is five years and includes periodic rent increases and a renewal option.

Effective October 1, 2006, the Company entered into a patent license and royalty agreement with the University of California San Diego to obtain a second exclusive license to make, use, sell, offer for sale, and import existing TearLab technology. The Company is required to make royalty payments of $35 or 5.5% of gross sales per year, whichever is higher. Additionally, the Company is required to pay a royalty of 30% of any sublicense fees it receives prior to receiving FDA approval and 25% of any sub-license fees it receives after FDA approval.

Future minimum royalty payments under this agreement as of June 30, 2017 are as follows:

On March 12, 2003, the Company entered into a patent license and royalty agreement with the University of California San Diego to obtain an exclusive license to make, use, sell, offer for sale, and import TearLab technology in development. Starting in 2009, the Company was required to make minimum royalty payments of $35 or 5.5% of gross sales per year, whichever is higher. However, if this new technology is combined with existing technology, the maximum royalty payable on the sale of the combined products would be 5.5% of gross sales per year. As the new technology is currently in development, there is no revenue and the minimum royalty payment of $35 is applicable.

TearLab Corporation

Future minimum royalty payments under this agreement as of June 30, 2017 are as follows:

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

In April 2014, the Company guaranteed a marketing agreement entered into by OcuHub LLC, which was a wholly-owned subsidiary of the Company at the time.OcuHub. The underlying marketing agreement calls for an annual marketing fee of $100, with payments due quarterly through March 31, 2019. ShouldIf OcuHub LLC failfails to perform its obligations under the terms of the marketing agreement, the Company couldwould be required to make the $25 quarterly payments, through the March 31, 2019 initial term of the agreement. The Company has not accrued for any liability under the guarantee.

In the normal course of business, the Company enters into purchase obligations for future goods and services needed for the operations of the business. Such commitments are not in excess of expected requirements and are not reasonably likely to result in performance penalties or payments that would have a material adverse effect on the Company’s liquidity.

9. SUBSEQUENT EVENTSContingencies

On October 13, 2016,During the ordinary course of business activities, the Company may be contingently liable for litigation and Physician Recommended Nutriceuticals (“PRN”) entered into a cooperative marketing agreement (the “Marketing Agreement”) wherebyparty to claims. Currently the Company and PRN will jointly promote PRN’s proprietary omega-3 formulations. PRN’s marketed omega-3 formulations have been shownis not party to reduce osmolarity levels in dry eye patients utilizing the TearLab Osmolarity System as an objective assessment.any material litigation.

The Marketing Agreement has a 30 month term. Upon successful completion of a six month demonstration period, the Company will earn a marketing fee based on a percentage of revenue of the promoted products that varies over both the term of the agreement and by different customer channels. The Marketing Agreement contains an option for mutual renewal by both parties, non-compete provisions and provisions for termination upon a change of control.

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 anin-vitro diagnostic company based in San Diego, California. We have commercialized a proprietary tear testing platform, the TearLab® Osmolarity System that enables eye care practitioners to test for highly sensitive and specific biomarkers using nanoliters of tear film at the point-of-care. Our first product measures tear film osmolarity for the diagnosis of Dry Eye Disease, or DED.

We develop technologies to enable eye care practitioners to test a wide range of biomarkers (chemistries, metabolites, genes and proteins) at the point-of-care. Commercializing and further development of that tear testing platform is now the focus of our business.

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

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

We enter into contracts where revenue is derived either from agreements whereby the customer is provided the right to use the TearLab® Osmolarity System at no separate cost to the customer in consideration for a minimum or implied purchase commitment of disposable test cards over the related contract term (referred to as either “Use Agreements”, “Masters Agreements” or “Flex Agreements”), or from agreements with separate sales of the reader equipment and disposable test cards (“Purchase Agreements”). Purchase commitments for Use Agreements and Flex Agreements are expressed in the agreement for a specified period of time (generally one to three years). The purchase commitment for Masters Agreements is implied for large physician practices with an expectation of purchasing certain levels of test cards.

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

Recent Developments

On October 13, 2016 the Company entered into a cooperative marketing agreement (the “Marketing Agreement)” with Physician Recommended Nutriceuticals (“PRN”). Pursuant to the Marketing Agreement, PRN and the Company will jointly promote PRN’s proprietary omega-3 formulations, including Dry Eye Omega Benefits®. The Marketing Agreement is expected to initiate in November 2016 and has a 30 month term with an option for mutual renewals by both parties.

TearLab Corporation

RESULTS OF OPERATIONS

Revenue, Cost of Sales and Gross MarginProfit

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 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 $0.6$0.1 million or 9%2% for the three months ended SeptemberJune 30, 20162017 compared to the three months ended SeptemberJune 30, 2015.2016. The increase is the result of an increase in test card sales of $0.3 million when compared to the three months ended September 30, 2015 because of higher test card volume associatedrevenue from a joint marketing agreement with more accounts on our FLEX card program. We also had an increase of $0.3 million in reader sales when compared to the three months ended September 30, 2015, attributable to converting selected accounts to a purchase model.PRN Physicians Recommended Nutriceuticals (“PRN”). The agreement with PRN was terminated effective June 23, 2017.

TearLab revenue increased by $2.5 million or 14%was flat for the ninesix months ended SeptemberJune 30, 20162017 as compared to the prior year period. The increase is driven from an increase in test card sales volume representing $1.7 millionsix months ended June 30, 2016, as new business acquired during the first six months of the total increaseyear offset a slight decline in utilization of existing customers. Revenue from the prior year period as well as an increase in reader revenue of $0.9 million. The increase in test card volumeour agreement with PRN was offset by a decline in the current year is duevolume of test cards sold to existing customers that we experienced in part to bringing in new accounts, increasing utilization in our FLEX accounts and converting existing accounts to our FLEX card program.the first quarter of 2017.

Cost of Sales

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

TearLab costs of sales for the three months ended SeptemberJune 30, 2016 decreased $0.22017 increased $0.1 million, or 6%4%, compared to the three months ended SeptemberJune 30, 2015. The per unit cost2016. Costs of sales was higher due to some one-time savings onrealized in the 2016 period from a renegotiated agreement with our test cards were offset in part by higher sales volumes.card supplier.

For the ninesix months ended SeptemberJune 30, 2016,2017, TearLab cost of sales decreased by $0.1 million or 1% overwas flat when compared to the same prior year fiscal period. Per unit cost savings on our test cards were offset by the higher volume of test card sales, higher royalty costs associated with higher sales volume and increased depreciation costs associated with more active readers in place.

TearLab Corporation

Gross Profit

TearLab gross profit for the three months ended SeptemberJune 30, 2016 increased by $0.8 million or 25%2017 was flat when compared to the three months ended SeptemberJune 30, 2015. The increase is due to a combination of higher sales volume and improved gross margin.2016. The gross marginprofit percentage of revenue for the three months ended SeptemberJune 30, 20162017 was 57%55% as compared to 50%56% for the three months ended SeptemberJune 30, 2015. Gross margin improvement2016. The gross profit percentage for the three months ended SeptemberJune 30, 20162017 was lower due in part to the conversion and addition of our more productive Flex accounts, improvements onone-time savings realized in the per unit cost of2016 period from a renegotiated agreement with our test cards, and a two year moratorium, beginning January 1, 2016, on the 2.3% medical device excise tax on sales in the United States.card supplier.

TearLab gross marginprofit for the ninesix months ended SeptemberJune 30, 2016 increased by $2.6 million or 29%2017 was flat compared to the same prior year fiscal period. The increase is due to higher sales volume and improved gross margin. The gross marginGross profit as a percentage of revenue for both the ninesix month period ending SeptemberJune 30, 2017 and 2016 was 56% as compared to 49% for the prior year fiscal period. The improvement in gross margin is attributable to an increase in the make-up of accounts under the FLEX program and the moratorium in the United States on the medical device excise tax.55%.

Operating Expenses

Sales and Marketing Expense

Sales and marketing expenses decreased by $1.5$0.1 million or 32%2% in the three months ended SeptemberJune 30, 2016,2017, as compared with the comparable period in fiscal 2015.2016. The reduction in sales and marketing expenses is attributabledue to cost savings from our February 2016 organizational restructuringthe timing and $0.2 millioncosts of cost savings from the divestiture of our OcuHub subsidiary.sales training events.

Sales and marketing expenses decreased by $3.8$1.4 million or 26%17% for the ninesix months ended SeptemberJune 30, 20162017 compared to the same prior year fiscal period. The decrease in sales and marketing expenses is attributable to cost savings from our February 2016 organizational restructuring.

Clinical, Regulatory and Research and Development Expenses

Total clinical, regulatory and research and development expenses decreased $0.8increased $0.4 million or 44%68% in the three months ended SeptemberJune 30, 20162017 as compared with the three months ended SeptemberJune 30, 2015.2016. The decreaseincrease when compared to the prior fiscal period was due to a decreasean increase in external product development costs related to the timingdevelopment and testing of our next generationthe TearLab Discovery™ platform which we expect to file with the U.S. Food and Drug Administration in the second half of diagnostic products.2017.

Total clinical, regulatory and research and development expenses decreased $2.1increased $0.9 million or 43%49% during the ninesix months ended SeptemberJune 30, 20162017 as compared with the comparable prior year fiscal period. The decreaseincrease is due to a decreasean increase in external product development costs related to the timingdevelopment and testing of our next generation of diagnostic products.the TearLab Discovery™ platform.

TearLab Corporation

General and Administrative Expenses

Total general and administrative expenses decreased $1.5$0.7 million or 36%22% in the three months ended SeptemberJune 30, 20162017 as compared with the three months ended SeptemberJune 30, 2015.2016. The decrease when compared to the prior fiscal period was primarily attributabledue to $0.6 millionreduced equity compensation in the current period related to the vesting of reduced professional services costs and $0.6 millioncertain grants of cost savings from the divestiture of our OcuHub subsidiary.options.

Total general and administrative expenses decreased $1.9$2.4 million or 17%35% for the ninesix months ended SeptemberJune 30, 20162017 as compared with the comparable prior year fiscal period. The decrease is due to the decrease in equity compensation in 2017, lower legal and professional service fees in 2017 because of a planned common stock offering we withdrew in the first quarter of 2016 and operating cost savings of $1.1 million from the divestiture of our OcuHub subsidiary and approximately $0.4 million of reduced professional services costs.in April 2016.

Amortization of Intangible Assets

Amortization expense of intangible assets for the three and six months ended SeptemberJune 30, 2017 was $0, compared to $0.3 million and $0.6 million in the three and six months ended June 30, 2016, respectively. The TearLab® technology fully amortized during 2016 so there was $359,000, as compared to the $389,000 in the prior year fiscal period. Amortizationno comparable expense of intangible assets for the nine months ended September 30, 2016 was $966,000 compared to $1,166,000 for the nine month period ended September 30, 2015. The decrease of $30,000 and $200,000 for the three and ninesix month periods, respectively, resulted from the amortization of certain OcuHub related intangibles in the prior year fiscal period.period ended June 30, 2017.

Other Income (Expense)

Interest Income (Expense)

Interest expense for the three months ended SeptemberJune 30, 20162017 and 20152016 was from the interest for the CRG term loan. Interest expense increasedwas flat for the three and nine months ended SeptemberJune 30, 20162017 when compared to the same periodsperiod in the previous fiscal year and increased 8% for the six months ended June 30, 2017 when compared to the same period in the previous year on larger average balances of long-term debt outstanding during the period, and becauseoffset in part by $54,000 charged to interest expense in 2016 from the revaluation of the impactCRG Warrants generated by an amendment to the exercise price of the detachable warrants issued to the lendersCRG Warrants in October 2015 on interest expense.April 2016.

Changes in Fair Value of Warrants Obligations

The Company records outstanding warrants considered liabilities at fair value at the end of each reporting period, resulting in an adjustment to the warrant obligations, with any gain or loss recorded in earnings for the applicable period. The Company had no warrants with liability treatment outstanding during the three and six months ended SeptemberJune 30, 20162017, and, accordingly, had no associated fair value adjustment during the period. TheFor the three and six month periods ended June 30, 2016, the Company recorded income related to a decrease in the fair value of warrant obligations of $17,000 for the three months ended September 30, 2015. The Company recorded income related to a decrease in the fair value of warrant obligations of$2,000 and $29,000 and $133,000 for the nine months ended September 30, 2016 and 2015, respectively.

TearLab Corporation

Other (net)

Other income (loss) for the three and ninesix months ended SeptemberJune 30, 20162017 consists primarily of foreign exchange transaction gains and losses, based on fluctuations of the Company’s foreign denominated currencies. The nine months ended September 30, 2016 also includes a $75,000 gain on the sale of OcuHub.currencies and trade payables. For the three and ninesix months ended SeptemberJune 30, 20152016 other income (loss) consists primarily of foreign exchange transaction gains and losses. The nine months ended September 30, 2015 also includeslosses and a one-time gain of $147,000$75,000 on the cancellation of an accrued liability related to the acquisition of the net assetssale of OcuHub.

Liquidity and Capital Resources

Financial Condition

Based on our current rate of cash consumption, we estimate we will need additional capital during the first quarter of 2018 and our prospects for obtaining that capital are uncertain. The Company has sustained substantial losses of $15.6 million formay be able to raise either additional debt financing or additional equity financing. However, the nine months ended September 30, 2016 and $33.2 million forCompany can make no assurances that it will be able to raise the year ended December 31, 2015 and has a history of net cash usedrequired additional capital, either through debt or equity financing, on acceptable terms or at all. Unless we succeed in its operations. We have introduced steps toraising additional capital or we significantly reduce the rate of our use of cash in our operations, including a strategic restructuring in February 2016 and the divestiture of our OcuHub subsidiary. These steps contributed to reduce the net cash used in operating activities to $2.3 million and $10.7 million for the three and nine months ended September 30, 2016, respectively, compared to $4.3 and $18.1 million for the three and nine months ended September 30, 2015. On May 9, 2016, we issued a combination of common stock, preferred stock and warrants to purchase common stock in exchange for $15.5 million in cash (net of fees and expenses) to provide cash for future operating needs. The proceeds from the issuance of equity and the reduced amount of cash used in operations for the current three month period resulted in a working capital surplus of $19.0 million at September 30, 2016 which represents a $4.8 million increase from our working capital at December 31, 2015. We believe these steps takenconsumed in the first halfoperations of fiscal 2016, including the expectationCompany, we anticipate that we will continuebe unable to generate cash from the sales of our product, will provide us the liquidity necessary to supportcontinue our operations for at leastthrough the next 12 months.end of the first quarter of 2018, without violating an existing covenant on the Term Loan Agreement. As a result of the Company’s historical losses and financial condition, there is substantial doubt about the Company’s ability to continue as a going concern.

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

TearLab Corporation

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 will generate revenue from the TearLab Osmolarity System in the United States sufficient to fully fund our operations. If events or circumstances occur such that we do not meet our plans to fund the business, we may be required to reduce operating expenses and reduce the planned levels of inventory and fixed assets which could have an adverse impact on our ability to achieve our intended business objectives.

TearLab Corporation

Indebtedness

On March 4, 2015, we executed the Term Loan Agreement with CRG as lenders providing us with access of up to $35.0 million under the Term Loan Agreement. We entered into a second amendment to the Term Loan Agreement with CRG on August 6, 2015. We received $15.0 million in gross proceeds under the Term Loan Agreement on March 4, 2015, and an additional $10.0 million on October 6, 2015. We were unable to access a third tranche of $10.0 million because we did not attain at least $38.0 million in twelve month revenue prior to June 30, 2016, as required to access the third tranche. We entered into a second amendment to the Term Loan Agreement with CRG on August 6, 2015. As part of the second amendment to the Term Loan Agreement and funding of the $10.0 million tranche, CRG received warrants to purchase 350,00035,000 common shares in the Company at a price of $5.00$50.00 per share. The warrants have a life of five years. On April 7, 2016, the Term Loan Agreement was further amended, under the fourth amendment, to change the required minimum revenue levels. In addition, the fourth amendment reduced the exercise price of the warrants CRG received under the second amendment to $15.00 per share and granted CRG additional warrants to purchase an additional 35,000 common shares in the Company at a price of $15.00 per share. The Term Loan Agreement has a term of six years and bears interest at 13% per annum, with quarterly payments of interest only for the first four years. At our option, during the first four years a portion of the interest payments amounting to a 4.5% per annum rate may be deferred and paid together with the principal in the fifth and sixth years.

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

The Term Loan Agreement is collateralized by all our assets. Additionally, the terms of the Term Loan Agreement contain various affirmative and negative covenants. Among them, we must attain minimum certain annual revenue and minimum cash threshold levels. The minimum annual revenue threshold level required by the Term Loan Agreement for calendar year 2017 is $31.0 million. The minimum cash balance required is $5.0 million, subject to certain conditions.

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

TearLab Corporation

Ongoing Sources and Uses of Cash

We anticipate that our cash on hand and cash generated from increased sales of the TearLab Osmolarity Systemrevenue will be sufficient to sustain our operations beyondinto the next 12 months.first quarter of 2018. In the first quarter of 2018, we will likely need to raise additional capital. We continually evaluate various financing possibilities but we typically expect our primary sourcesources of cash will be related to the collection of accounts receivable. 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 costs of sales, 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 next generation products using our lab-on-a-chip technology.

TearLab Corporation

Changes in Cash Flows

Cash Used in Operating Activities

Net cash used to fund our operating activities during the ninesix months ended SeptemberJune 30, 20162017 was $10.7$4.7 million compared to $18.1$8.4 million during the ninesix months ended SeptemberJune 30, 2015.2016. Net cash used in operating activities during the ninesix months ended SeptemberJune 30, 20162017 was less than our net loss of $15.6$8.3 million primarily due to the amortization of intangible assets, depreciation of fixed assets, stock-based compensation, interest deferred on our long-term debt and changes in the fair value of warrant obligations. Inobligations in the aggregate these non-cash items total $6.1 million. This was offset in part byof $2.5 million plus a $1.1 million net decreasesdecrease in our investment in working capital accounts during the nine months ended September 30, 2016 of $1.2 million.accounts. Net cash used in operating activities during the ninesix months ended SeptemberJune 30, 20152016 was less than our net loss of $24.3$11.6 million due to the amortization of intangible assets, depreciation of fixed assets, stock-based compensation, interest deferred on our long-term debt and changes in the fair value of warrant obligations in the aggregate total of $6.1$4.1 million andoffset in part by a $0.1$1.0 million net increase in working capital accounts.

The net change in working capital and non-current asset balances related to operations for the ninesix months ended SeptemberJune 30, 20162017 and 20152016 consists of the following:

TearLab Corporation

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

Cash Used in Investing Activities

Net cash used in investing activities for the ninesix months ended SeptemberJune 30, 2017 and 2016 and 2015 was $1.2$0.6 million and $2.4$0.8 million respectively, to acquire fixed assets, primarily TearLab Osmolarity systems.

Cash Provided by Financing Activities

Net cash provided by financing activities during the ninesix months ended SeptemberJune 30, 2017 and 2016 was $15.6$32,000 and $15.5 million and was almost allrespectively, of proceeds from the issuance of equity. For the nine months ended September 30, 2015, net cash provided by financing activities of $14.7 million consisted primarily of $14.5 million of proceeds from the term loan.

TearLab Corporation

Off-Balance-Sheet Arrangements

As of SeptemberJune 30, 2016,2017, we did not have any material off-balance-sheet arrangements as defined in Item 303(1)(4)(ii) of SEC Regulation S-K.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statementsCondensed 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 ninethree months ended SeptemberJune 30, 20162017 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.2016. For further clarification with regards to the Company’s specific policies for revenue recognition, see Note 2 of the Notes to the Unaudited Condensed Consolidated Financial Statements for the three and ninesix months ended SeptemberJune 30, 20162017 included in Item 1.

TearLab Corporation

Recent Accounting Pronouncements

For information on the recent accounting pronouncements impacting our business, see Note 2 of the Notes to the unaudited Condensed Consolidated Financial Statements for the three and ninesix months ended SeptemberJune 30, 20162017 included in Item 1.

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Currency Fluctuations and Exchange Risk

Our sales are denominated primarily in U.S. dollars with minimal sales in euros and pound sterling. Most of our expenses are denominated in U.S. dollars, however, some of the development work on new products is in Australian dollars and a minor portion of our other expenses are in Australian dollars, Canadian dollars euros and pounds sterling. We cannot predict any future trends in the exchange rate of the AustralianCanadian dollar, CanadianAustralian dollar, euro or pound sterling against the U.S. dollar. Any strengthening of the AustralianCanadian dollar, CanadianAustralian 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 to meet short term operating requirements. We do not engage in any hedging or other transactions intended to manage these risks. In the future, we may undertake hedging or other similar transactions or invest in market risk sensitive instruments if we determine that it is advisable to offset these risks.

TearLab Corporation

Interest Rate Risk

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

ITEM 4.CONTROLS AND PROCEDURES.

(a)Disclosure Controls and Procedures.

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

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based on that evaluation, our chief executive officer and chief financial officer concluded that, as at Septemberof June 30, 20162017 our disclosure controls and procedures were effective at the reasonable assurance level.

TearLab Corporation

(b)Changes in Internal Control over Financial Reporting.

During the thirdsecond quarter of 2016,2017, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

From time to time, we may be involved in various other claims and legal proceedings relating to claims arising out of our operations. We are not currently a party toaware of any legal proceedingsmaterial litigation involving us that in the opinion of our management, are likely to have a material adverse effect on our business. Regardless of outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.is outstanding, threatened or pending.

TearLab Corporation

ITEM 1A. RISK FACTORS.

Risks Relating to Our Financial Condition

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

We have prepared our consolidated financial statementsCondensed 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.inception and will need to raise additional capital prior to the end of the first quarter of 2018, and cannot assure you that we will be able to do so. We do not currently have any available borrowing under our term loan or credit facility.

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

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

We have incurred losses in each year since our inception. As of SeptemberJune 30, 2016,2017, we had an accumulated deficit of $508.4$521.0 million. Our losses have resulted primarily from expenses incurred in research and development of our product candidates from the former retina and glaucoma business divisions. We do not know when or if we will successfully commercialize the TearLab® Osmolarity System in the United States or in international markets. As a result, and because of the numerous risks and uncertainties facing us, it is difficult to provide the extent of any future losses or the time required to achieve profitability, if at all. Any failure to become and remain profitable would require us to undertake a review of the potential business alternatives discussed above.

We maywill need to raise additional capital at some point in the future if we do not achieve our business objectives.near future. Such capital, if needed, 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 may be requiredexpect that we will need to raise additional capital from timeprior to time in the future if we do not execute on our current business objectives and continue to grow our revenue at a rate sufficient to fund our operations with our current cash on hand.end of the first quarter of 2018. 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

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

TearLab Corporation

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

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

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

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

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

TearLab Corporation

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

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

TearLab Corporation

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

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

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 quarterly operating results in the quarter ending September 30 of each fiscal year could be adversely affected by summer or holiday 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.

TearLab Corporation

Risks Related to Our Business

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

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

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

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

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

As of SeptemberJune 30, 2016,2017, our total liabilities were $31.2$33.7 million including $26.0$27.4 million of long-term obligations under our Term Loan Agreement. Our significant liability service requirements could adversely affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities. For example:example, our liabilities present the following risks: