UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-Q





(Mark One)


x
QUARTERLY REPORTPURSUANT TOSECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934





For the quarterly period ended:          March 31,2010





o
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





OccuLogix, Inc.


(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.)





11025 Roselle 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 markwhether 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  ý   No  o





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


Yes  o   No  o





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 o
Accelerated filer oNon-accelerated filer   o (Do not check if a smaller reporting company)
Smaller reporting company ý







1


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





Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 14,765,794as of May 10, 2010





PART I.
FINANCIALINFORMATIONItem 1.
Consolidated Financial StatementsItem 2.
Management’s Discussion and Analysis of Financial Condition and Results of OperationsItem 3.
Quantitative and Qualitative Disclosures about Market RiskItem 4.
Controls and ProceduresPART II.
OTHER INFORMATIONItem 1.
Legal ProceedingsItem 2.
Unregistered Sales of Equity Securities and Use of ProceedsItem 3.
Defaults upon Senior SecuritiesItem 4.
”(Removed and Reserved”)Item 5.
Other InformationItem 6.
Exhibits


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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," “hope,” "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 current product;


·
The size and growth of the potential markets for our product 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 North American, European, Asian and Latin American countries;


·
Our anticipated expansion of United Stated and international sales and operations;


·
Our ability to obtain and protect our intellectual property and proprietary rights;


·
Our efforts to obtain certain FDA approvals;


·
The results of our clinical trials;


·
Our anticipated sales to additional customers in the United States if a CLIA waiver categorization is obtained;


·
The adequacy of our funding, 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 OccuLogix, Inc. and its subsidiaries. References to “$” or “dollars” shall mean U.S. dollars unless otherwise indicated.


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PART I.  FINANCIAL INFORMATION




ITEM 1.  CONSOLIDATED FINANCIAL STATEMENTS (unaudited)




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CONSOLIDATED BALANCE SHEETS


(expressed in U.S. dollars)





March 31,

2010


December 31,

2009(Unaudited)ASSETSCurrent assetsCash and cash equivalents

$
6,865,726


$
106,200Accounts receivable, net


184,994



149,039Inventory, net


244,302



196,461Prepaid expenses


262,888



337,602Deferred finance charges


16,563



23,679Other current assets


29,854



30,911Total current assets


7,604,327



843,892Fixed assets, net


124,895



139,589Patents and trademarks, net


213,561



220,583Other non-current assets


63,791



175,578Intangible assets, net


8,049,870



8,353,501Total assets

$
16,056,444


$
9,733,143LIABILITIES AND STOCKHOLDERS’ EQUITYCurrent liabilitiesAccounts payable

$
686,944


$
447,527Accrued liabilities


1,758,766



1,093,404Due to stockholders


28,422



38,422Deferred revenue


147,192



150,977Obligations under warrants


668,988



3,195Notes payable and accrued interest


1,441,826



1,242,403Total current liabilities


4,732,138



2,975,928Stockholders’ equityCapital stockPreferred Stock, par value $0.001, authorized 10,000,000, zero issued and outstanding at both March 31, 2010 and December 31, 2009


—



—Common stock, par value $0.001 per share, authorized 40,000,000, issued and outstanding: March 31, 2010 – 14,765,794; December 31, 2009 – 9,866,685


14,766



9,866Additional paid-in capital


385,432,151



378,789,938Accumulated deficit


(374,122,611
)


(372,042,589
)Total stockholders’ equity


11,324,306



6,757,215Total liabilities and stockholders’ equity

$
16,056,444


$
9,733,143





See accompanying notes to interim consolidated financial statements


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OccuLogix, Inc.





CONSOLIDATED STATEMENTS OF OPERATIONS


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


(Unaudited)





Three months endedMarch 31,2010


2009RevenueTearLab

$
274,995


$
243,258Total revenue


274,995



243,258Cost of goods soldTearLab – product cost


189,422



119,199Total cost of goods sold(excluding amortization of intangible assets)


189,422



119,199Gross profit


85,573



124,059Operating expensesAmortization of intangible assets


303,631



303,631General and administrative


965,471



982,978Clinical , regulatory and research & development


468,066



332,306Sales and marketing


274,456



214,304Total operating expenses


2,011,624



1,833,219Loss from operations


(1,926,051
)


(1,709,160
)Other income (expense)Interest income


1,441



1,830Changes in fair value of warrant obligations


70,978



21,695Interest expense


(52,502
)


—Amortization of deferred financing charges, warrants & beneficial conversion values


(154,037
)


—Other income (loss)


(19,851
)


14,163Total other income (expense)


(153,971
)


37,688Loss from continuing operations before income taxes


(2,080,022
)


(1,671,472
)Income tax recovery


—



668,881Net loss

$
(2,080,022
)

$
(1,002,591
)Weighted average number of shares outstanding attributable to OccuLogix, Inc. - basic and diluted


12,053,262



9,828,409Loss per share attributable to OccuLogix, Inc. – basic and diluted

$
(0.17
)

$
(0.10
)





See accompanying notes to interim consolidated financial statements


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OccuLogix, Inc.





CONSOLIDATED STATEMENTS OF CASH FLOWS


(expressed in U.S. dollars)


(Unaudited)





Three months ended

March 31,2010


2009OPERATING ACTIVITIESNet loss for the period

$
(2,080,022
)

$
(1,002,591
)Adjustments to reconcile net loss to cash used in operating activities:Stock-based compensation and stock-based restructuring charges


207,017



130,292Depreciation of fixed assets


16,478



19,700Amortization and write-down of patents and trademarks


7,022



7,419Amortization of intangible asset


303,631



303,630Amortization of deferred financing charges, warrants and beneficial conversion values


154,037



—Changes in fair value of warrant obligations


(70,978
)


(21,695
)Deferred tax liability, net


—



(668,881
)Non-cash interest accrued on convertible debt funding


52,502



—Gain on disposal of fixed assets


—



(3,119
)Net change in non-cash working capital balances related to operations


217,450



(64,221
)Cash used in operating activities


(1,192,863
)


(1,299,466
)INVESTING ACTIVITIESAdditions to fixed assets, net of proceeds


(1,784
)


(2,765
)Additions to patents and trademarks


—



(6,553
)Cash used in investing activities


(1,784
)


(9,318
)FINANCING ACTIVITIESProceeds from issuance of shares in a private placement financing


2,999,981



—Proceeds from issuance of shares and warrants in a registered direct financing


5,000,000



—Costs of issuance of shares in private placement and registered direct financings


(45,808
)


—Cash provided by financing activities


7,954,173



—Net increase (decrease) in cash and cash equivalents during the period


6,759,526



(1,308,784
)Cash and cash equivalents, beginning of period


106,200



2,565,277Cash and cash equivalents, end of period

$
6,865,726


$
1,256,493





See accompanying notes to interim consolidated financial statements


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OccuLogix, Inc.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)





1.
BASIS OF PRESENTATION AND GOING CONCERN UNCERTAINTY




Nature of Operations





OccuLogix, Inc. ("OccuLogix" or the "Company"), a Delaware corporation, is an ophthalmic device company that is commercializing a proprietary in vitro diagnostic tear testing platform, the TearLabTM 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.





On November 30, 2006, the Company acquired 50.1% of the capital stock, on a fully diluted basis, 57.62% on an issued and outstanding basis, of TearLab, Inc. (formerly OcuSense, Inc.), or TearLab, a San Diego-based company that is in the process of developing technologies that will enable eye care practitioners to test, at the point-of-care, for highly sensitive and specific biomarkers using nanoliters of tear film.  On October 6, 2008, the Company acquired the remaining non-controlling interest in TearLab.





The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. Intercompany accounts and transactions have been eliminated on consolidation. The Company currently operates in one segment.





2.
SIGNIFICANT ACCOUNTING POLICIES




These unaudited interim 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, 2009. We evaluated the subsequent events through May 13, 2010, the date on which this Quarterly report on Form 10-Q was filed with the Securities and Exchange Commission.





Management believes that all adjustments necessary for the fair presentation of results, consisting of normally recurring items, have been included in the unaudited 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 and 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 the impairment of long-lived and intangible assets, valuation of investments in marketable securities and the value of stock options and warrants.





Recent Accounting Pronouncements





In September 2009, the FASB issued authoritative guidance regarding multiple-deliverable revenue arrangements. This guidance addresses how to separate deliverables and how to measure and allocate consideration to one or more units of accounting. Specifically, the guidance requires that consideration be allocated among multiple deliverables based on relative selling prices. The guidance establishes a selling price hierarchy of (1) vendor-specific objective evidence, (2) third-party evidence and (3) estimated selling price. This guidance is effective for annual periods beginning after June 15, 2010, but may be adopted earlier as of the beginning of an annual period. The Company is currently evaluating the effect, if any, that this guidance will have on its financial position and results of operations.


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OccuLogix, Inc.





3.
BALANCE SHEET DETAILS




Inventory





Inventory is recorded at the lower of cost and net realizable value and consists of finished goods. Cost is accounted for on a first-in, first-out basis. Deferred cost of sales (included in finished goods) consists of products shipped but not recognized as revenue because they did not meet the revenue recognition criteria.





March 31, 2010


December 31, 2009Finished goods

$
368,704


$
320,863368,704



320,863Less reserves for excess and obsolescence


(124,402
)


(124,402
)$
244,302


$
196,461





The Company evaluates inventory for estimated excess quantities and obsolescence, based on expected future sales levels and projections of future demand, with the excess inventory provided for.  In addition, the Company assesses the impact of changing technology and market conditions.




Prepaid Expenses





March 31,

2010


December 31, 2009Prepaid insurance

$
105,835


$
146,504Prepaid financing costs


—



81,571Prepaid regulatory fees


30,764



2,821Deferred royalty costs


40,500



40,500Other fees and services


85,789



66,206$
262,888


$
337,602




Fixed Assets





March 31, 2010


December 31, 2009Furniture and office equipment

$
25,312


$
24,812Computer equipment and software


146,418



145,134Medical equipment


330,219



330,219501,949



500,165Less accumulated depreciation


377,054



360,576$
124,895


$
139,589





Depreciation expense was $16,478 and $19,700 during the three months ended March 31, 2010 and 2009, respectively.




Patents and trademarks





March 31, 2010


December 31, 2009Patents

$
236,314


$
194,394Trademarks


32,154



79,413268,468



273,807Less accumulated amortization


54,907



53,224$
213,561


$
220,583





Amortization expense and write down of patents and trademarks was $7,022 and $7,419 during the three months ended March 31, 2010 and 2009, respectively


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The Company recorded patents and trademarks as of March 31, 2010 relate to the cost of pending applications for patents and trademarks for the TearLabTM technology.  These patents and trademarks are amortized, using the straight-line method, over an estimated useful life of 10 years from the date of approval of the patents and trademarks.




Accrued liabilities





March 31,


December 31,2010


2009Due to professionals

$
603,787


$
302,451Due to employees and directors


534,619



134,000Clinical trial accruals


174,013



194,800Amounts due for provision of capital transaction advisory services


100,000



100,000Corporate compliance


97,696



81,039Obligation to repay advances received


65,523



66,695Product development costs


5,106



13,746Other


178,022



200,673$
1,758,766


$
1,093,404





4.
INTANGIBLE ASSETS




The Company's intangible assets consist of the value of TearLabTM Technology acquired in the acquisition of OcuSense, Inc.  The TearLabTM 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 TearLabTM Technology is being amortized using the straight-line method over an estimated useful life of 10 years. The Company has no indefinite-lived intangible assets.





Intangible assets subject to amortization consist of the following:





As at March 31, 2010Cost


Accumulated

AmortizationTearLabTM technology

$
12,172,054


$
4,122,184





As at December 31, 2009Cost


Accumulated

AmortizationTearLabTM technology

$
12,172,054


$
3,818,553





Estimated amortization expense for the intangible assets for the balance of 2010 and each of the next four years and thereafter is as follows:





Amortization of intangible assetsRemainder of  2010

$
910,8922011


1,214,5232012


1,214,5232013


1,214,5232014


1,214,523Thereafter


2,280,886$
8,049,870





Amortization expense of $303,631 for each of the three months ended March 31, 2010 and 2009, are attributable to the TearLabTM technology.


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5.
RELATED PARTY TRANSACTIONS




The following are the Company's related party transactions:




TLC Vision





TLC Vision Corporation held a 5.1%, and 7.6% ownership interest in the Company, on an issued and outstanding basis, as of March 31, 2010 and December 31, 2009 respectively.





TLC provided computer and administrative support to the Company in the three months ended March 31, 2010 and 2009 respectively, for which the Company recorded expense of $3,000, and $7,635, respectively. The balances due to TLC Vision Corporation were $28,422 and $38,422 at March 31, 2010 and December 31, 2009, respectively.




Other





On August 20, 2009, we entered into a distribution agreement with Science with Vision, pursuant to which Science with Vision obtained exclusive Canadian distribution rights with respect to the Company’s products.  We began selling products through the Canadian distributor in 2010. Elias Vamvakas, the Company’s chairman of the Board and chief executive officer, has a material financial interest in Science with Vision.





Effective November 20, 2009, OccuLogix, Inc., entered into an agency agreement with Marchant.  Pursuant to the terms of the agreement, Marchant will acted as the Canadian placement agent in connection with our private placement of up $3,000,000 of the Company’s common stock. As a result of the closing of the private placement financings in January 2010 and March 2010, under the Agency agreement, the Company issued an aggregate of 101,548 shares to Marchant.





The Company has also agreed to indemnify Marchant, its affiliates and their respective directors, officers, employees, shareholders and agents against all expenses, losses, claims, actions, damages or liabilities, and the reasonable fees and expenses of their counsel, arising out of the provision of the services pursuant to the agreement.





On November 2, 2009, the Company, entered into a capital advisory agreement for a minimum of two years with Greybrook Capital Inc., or Greybrook.  On January 8, 2010, the Company and Greybrook entered into an amendment to the capital advisory agreement.  Pursuant to the terms of the agreement, as amended, Greybrook is entitled to receive in consideration of its provision of capital advisory services to the Company, within 90 days of the agreement and again on or before the first anniversary of the date of the agreement, compensation consisting of (i) $100,000 in cash or (ii) shares of the Company’s common stock equal to the quotient of (A) $100,000 and (B) $1.22, the closing consolidated bid price on the date of the original execution of the agreement.  All other terms and conditions of the agreement remain in full force and effect.  No shares were issued under this agreement at March 31, 2010. Elias Vamvakas, chairman of the Company’s board of directors and acting chief executive officer, is a principal with, and holds a material financial interest in Greybrook.





6.
INCOME TAXES




The Company records tax benefits related to tax losses as deferred income tax assets to offset deferred income tax liabilities arising from its intangible assets.




The Company reported a recovery of income taxes of zero for the three months ended March 31, 2010 of which $169,466 represented amortization of deferred tax liabilities in the three months ended March 31, 2010 offset by an increase to the valuation allowance against deferred tax assets of $169,466 reported for losses incurred in prior periods. The current deferred tax liability balance of $3,368,305 is offset by a deferred tax asset balance of the same amount. As the Company is uncertain of when it will utilize its tax losses, as the deferred tax liability is amortized, there will be a corresponding increase to the valuation allowance against  the deferred tax asset , this will maintain a net zero dollar balance for the deferred tax accounts.




The Company reported a recovery of income taxes of $668,881 for the three months ended March 31, 2009 of which $547,529 represented deferred tax assets reported for losses incurred in the three months ended March 31, 2009, and $121,352 which represented amortization of deferred tax liabilities in the three months ended March 31, 2009.


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At December 31, 2009, we had federal net operating loss carryforwards of approximately $83.6 million, of which $65.1 million will expire due to the 382 limitation, and California net operating loss carryforwards of approximately $18.9 million, of which $14.7 million will expire due to 382 limitation. The federal net operating loss carryforwards begin to expire in 2012, and the California net operating loss carryforwards begin to expire in 2015.





In accordance with authoritative guidance, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained.




The Company’s policy is to recognize interest and penalties related to income tax matters in other expense. Because the Company has generated net operating losses since inception for both state and federal purposes, no additional tax liability, penalties or interest has been recognized for balance sheet or income statement purposes as of  and for the period ended March, 31, 2010.




When applicable, the Company recognizes accrued interest and penalties related to unrecognized tax benefits as other expense in its consolidated statements of operations, which is consistent with the recognition of these items in prior reporting periods.  As of March 31, 2010 and December 31, 2009, the Company did not have any liability for the payment of interest and penalties.




The Company does not expect a significant change in the amount of its unrecognized tax benefits within the next 12 months.  Therefore, it is not expected that the change in the Company’s unrecognized tax benefits will have a significant impact on the Company’s results of operations or financial position.





All of the federal income tax returns for the Company and its subsidiaries remain open since their respective dates of incorporation due to the existence of net operating losses.  The Company and its subsidiaries have not been, nor are they currently, under examination by the Internal Revenue Service or the Canada Revenue Agency.




State and provincial income tax returns are generally subject to examination for a period of between three and five years after their filing.  However, due to the existence of net operating losses, all state income tax returns of the Company and its subsidiaries since their respective dates of incorporation are subject to re-assessment.  The state impact of any federal changes remains subject to examination by various states for a period of up to one year after formal notification to the states.  The Company and its subsidiaries have not been, nor are they currently, under examination by any state tax authority.





7.
NOTES PAYABLE AND ACCRUED INTEREST





In the third quarter of 2009, the Company closed an agreement with certain investors whereby the investors agreed to provide financing (the “Financing”) to the Company through the purchase of convertible secured notes, in the aggregate amount of $1.75 million.  The convertible secured notes (the “Notes”) evidencing the Financing, mature on the second anniversary of their issuance (“the Maturity Date”), bear interest at a rate of 12% per annum and are convertible into shares of the Company’s common stock upon the request of holders of 51% or more of the outstanding principal amount of the Notes at any time after August 31, 2009 and prior to the Maturity Date.  The conversion price of the Notes (the “Discount Price”) is $1.3186 determined on August 31, 2009 and represents 80% of the volume weighted average price on the NASDAQ stock market for the ten trading days prior to August 31, 2009.  The Notes are secured by substantially all of the assets of the Company and the financing is subject to customary conditions to closing.





In connection with the Financing, the Company will issue warrants with a life of five years to purchase shares of common stock equal in value to ten percent of the aggregate principal amount of the notes (the “Warrants”).  The exercise price of the 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.  The warrants will not be issued until the convertible secured notes are converted to common shares of the Company. The Company has recorded $162,621 representing the fair value of the warrants in additional paid-in capital which has been calculated using the Black-Scholes value model. The value of the warrants are being accreted over the two year term of the Notes and in the three months ended March 31, 2010, an amortization charge of $26,886 is included in other income (expense).


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As the conversion price of the convertible secured debt reflects a price discounted from the fair market value of the Company’s common stock, there is a deemed beneficial conversion feature associated with the Financing. The Company has recorded $727,582 representing the value of the beneficial conversion feature in additional paid-in capital which has been determined by calculating the fair value of shares that could be acquired as the difference between the discounted conversion price and the fair value on the date of funding. The value of the beneficial conversion is being accreted over the two year term of the convertible secured debt and in the three months ended March 31, 2010, an amortization charge of $120,035 is included in other income (expense).





The Company incurred $87,199 in expenses related to the Financing which was allocated to deferred finance charges for $42,844 and cost of equity for $44,355 in proportion to the allocation of the Financing amount between equity and liabilities.  The value of the deferred financing is being accreted over the two year term of the Notes and in the three months ended March 31, 2010, an amortization charge of $7,116 is included in other income (expense).





Richard Lindstrom, M.D. and Tom Davidson, both of whom are directors of the Company, invested $100,000 each in the Financing.  Greybrook Corporation, an entity controlled by Elias Vamvakas, Chairman and Interim CEO of the Company, or members of his family, invested $310,000 in the Financing.





Accrued interest of $52,502 has been recorded in the three months ended March 31, 2010 and is included in notes payable and accrued interest on our balance sheet.





8.
FAIR VALUE MEASUREMENTS





The Company accounts for the methods of measuring fair value in accordance with the provisions of the FASB Topic 820 Fair Value Measurements and Disclosures. As defined in the guidance, fair value is based on the prices that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In order to increase consistency and comparability in fair value measurements, the guidance establishes a three-tier fair value hierarchy that prioritizes the inputs used to measure fair value. These tiers include:





·
Level 1, defined as observable inputs such as quoted prices in active markets;





·
Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and





·
Level 3, defined as unobservable inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.





At March 31, 2010, the Company has a liability for warrants to purchase 110,578 shares of common stock at an exercise price of $46.25 that are valued at $14,143, as well as a liability for warrants to purchase 621,118 shares of common stock at an exercise price of $4.00 that are valued at $654,845.  Both liabilities are classified under the level 3 hierarchy.





The following table provides activity for obligations under warrants measured at fair value using significant unobservable inputs (level 3) for the year ended March 31, 2010:





Fair Value Measurements Using Significant Unobservable Inputs (Level 3)Balance of warrant liability at January 1, 2010

$
3,195Purchases, issuances, and settlements


736,771Change in fair value of warrant liability included in other (income) / expense


(70,978
)Balance of warrant liability at March 31, 2010

$
668,988


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9.
CAPITAL STOCK





(a)  Authorized share capital





The total number of authorized shares of common stock of the Company is 40,000,000.  Each share of common stock has a par value of $0.001 per share.  The total number of authorized shares of preferred stock of the Company is 10,000,000.  Each share of preferred stock has a par value of $0.001 per share.





(b)  Common stock





On February 11, 2009, the Company filed with the Securities and Exchange Commission, or the SEC, a prospectus as part of a registration statement on Form S-3 using a "shelf" registration process.  Under the shelf process, if the registration statement is declared effective by the SEC, we may from time to time offer or sell any combination of common stock, preferred stock, debt securities, depository shares or warrants in one or more offering up to a total dollar value of $30,000,000.  The registration statement was declared effective by the SEC on July 20, 2009. The Company utilized $5,000,000 of the “shelf” in the registered direct financing which closed on March 18, 2010.





On April 21, 2009, having received the approval of the board of directors, the Company issued 38,276 shares valued at $110,000 under the terms and conditions of a settlement agreement.





On January 11, 2010, the Company sold 1,886,291 shares of its common stock for an aggregate of approximately $1,743,989. The Company also received commitments to purchase an additional 1,358,475 shares for an aggregate of approximately $1,256,011 subject to obtaining stockholder approval which it received March 3, 2010. The shares were issued on March 19, 2010. The per share price of the shares, $0.92456, is equal to 80% of the volume weighted average price of the Company’s common stock for the 10 trading days ending on the day immediately preceding the January 8, 2010 closing date.





Related to the 3,244,766 shares issued per the January 11, 2010 announcement, the Company issued 101,548 shares to Marchant.





On March 18, 2010, the Company closed a registered direct financing in which it sold approximately 1,552,796 shares of its common stock and warrants to purchase approximately 621,118 shares of its common stock for gross proceeds of approximately $5,000,000.  The investors agreed to purchase the shares and warrants for $3.22 per unit (each unit consisting of one share and a warrant to purchase 0.4 shares of common stock).  The exercise price of the warrants is $4.00 per share. The warrants are exercisable at any time on or after the sixth-month anniversary of the closing date through and until the 18-month anniversary of the closing of the offering.





(c)  Stock Option Plan





The following table sets forth the total stock-based compensation expense resulting from stock options included in the Company's consolidated statements of operations:





Three months ended March 31,2010


2009General and administrative

$
141,568


$
72,645Clinical and regulatory


47,557



40,389Sales and marketing


17,892



17,258Stock-based compensation expense before income taxes

$
207,017


$
130,292


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As of March 31, 2010, the Company had granted 357,100 options to certain executives which require stockholder approval to increase the option pool by at least 357,100 options before the options granted to these certain executives become exerciseable. If stockholder approval is not obtained by December 2, 2010 to increase the option pool, then these options shall expire and will be returned to the Plan. 167,100 of these options were fully vested as at March 31, 2010, 150,000 of the options vest monthly and are fully vested at the end of 2010, 15,000 of the options vest over three months and are fully vested on June 18, 2010 and 25,000 of the options vest one-third annually on the anniversary of its grant date of September 30, 2009.





(d)  Warrants





On February 6, 2007, pursuant to the Securities Purchase Agreement 2007 between the Company and certain institutional investors, the Company issued warrants to these investors (the “Warrants”).  The Warrants are five-year warrants exercisable immediately into an aggregate of 106,838 shares of the Company's common stock at $46.25 per common share.  On February 6, 2007, the Company also issued the Cowen Warrant to Cowen and Company, LLC in partial payment of the placement fee payable for the services it had rendered as the placement agent in connection with the private placement of the Shares and the Warrants pursuant to the Securities Purchase Agreement 2007.  The Cowen Warrant is a five-year warrant exercisable into an aggregate of 3,740 shares of the Company's common stock.  The per share exercise price of the Cowen Warrants is $46.25, and the Cowen Warrants became exercisable on August 6, 2007.





The Company accounts for the Warrants and the Cowen Warrant in accordance with the provisions of FASB ASC Topic 815 Derivatives and Hedging.  The FASB guidance requires every derivative instrument within its scope (including certain derivative instruments embedded in other contracts) to be recorded on the balance sheet as either an asset or liability measured at its fair value, with changes in the derivative's fair value recognized currently in earnings unless specific hedge accounting criteria are met.  Based on applicable guidance from the FASB, the Company determined that the Warrants and the Cowen Warrant do not meet the criteria for classification as equity.  Accordingly, the Company classified the Warrants and the Cowen Warrant as current liabilities at March 31, 2010 and December 31, 2009, respectively.





The estimated fair value of the Warrants and the Cowen Warrant at March 31, 2010 was determined using the Black-Scholes option-pricing model with the following weighted average assumptions:





Volatility
109%Expected life of Warrants
1.83 yearsRisk-free interest rate
0.92%Dividend yield
0%





The Company is required to record the outstanding warrants at fair value at the end of each reporting period, resulting in an adjustment to the recorded liability of the derivative, with any gain or loss recorded in earnings of the applicable reporting period.  The Company, therefore, estimated the fair value of the Warrants and the Cowen Warrant as of March 31, 2010 and determined the aggregate fair value to be $14,143, an increase of approximately $10,947 over the measurement of the aggregate fair value of the Warrants and the Cowen Warrant on December 31, 2009. This increase was recorded in other income (expense) as changes in fair value of warrant obligations in the consolidated statement of operations during the three months ended March 31, 2010.





On March 18, 2010, the Company closed a registered direct financing in which it sold approximately 1,552,796 shares of its common stock and warrants (the “Warrants”) to purchase approximately 621,118 shares of its common stock for gross proceeds of approximately $5,000,000.  The investors agreed to purchase the shares and warrants for $3.22 per unit (each unit consisting of one share and a warrant to purchase 0.4 shares of common stock).  The exercise price of the warrants is $4.00 per share. The warrants are exercisable at any time on or after the sixth-month anniversary of the closing date through and until the 18-month anniversary of the closing of the offering.





The Company accounts for the Warrants in accordance with the provisions of ASC Topic 815. Based on applicable U.S. GAAP guidance, the Company determined that the Warrants do not meet the criteria for classification as equity.  Accordingly, the Company classified the Warrants as current liabilities at March 31, 2010.





The estimated fair value of the Warrants at March 18, 2010 was determined to be $736,770, using the Black-Scholes option-pricing model with the following weighted average assumptions:


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Volatility
113%Expected life of Warrants
1.50 yearsRisk-free interest rate
0.70%Dividend yield
0%





In addition, the Company is required to record the outstanding warrants at fair value at the end of each reporting period, resulting in an adjustment to the recorded liability of the derivative, with any gain or loss recorded in earnings of the applicable reporting period.  The Company, therefore, estimated the fair value of the Warrants as of March 31, 2010 and determined the aggregate fair value to be $654,845, a decrease of approximately $81,925 over the measurement of the aggregate fair value of the Warrants on March 18, 2010. This decrease was recorded in other income (expense) as changes in fair value of warrant obligations in the consolidated statement of operations during the three months ended March 31, 2010.





A summary of Warrants outstanding as of March 31, 2010 is set forth below:





Number of warrants outstanding


Weighted average exercise priceOutstanding, December 31, 2009


110,578


$
46.25Granted


621,118



4.00Forfeited


—



—Outstanding, March 31, 2010


731,696


$
10.39





In connection with the Financing which the Company was engaged in July and August 2009, the Company will issue 109,389 warrants (“Financing Warrants”) with a life of five years to purchase shares of common stock equal in value to ten percent of the aggregate principal amount of the notes issued in the Financing.  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.  The warrants will not be issued until the convertible secured notes are converted to common shares of the Company and will be exerciseable upon issuance. The Company has recorded $162,621 representing the fair value of the Financing Warrants at the issuance date which has been calculated using the Black-Scholes value model. The value of the Financing Warrants is being amortized over the two year term of the convertible secured debt and a charge of $26,886 is included in other income (expense).





10.
COMPREHENSIVE INCOME (LOSS)





For the three ended March 31, 2010 and 2009, comprehensive loss was equal to net loss for the period.





11.
NETLOSS PER SHARE





Loss per share, basic and diluted, is computed using the treasury method. Potentially dilutive shares have not been used in the calculation of loss per share as their inclusion would be anti-dilutive.





The following table summarizes the potentially dilutive securities which have not been used in the calculation of diluted loss per share as the effect is anti-dilutive:





Three months ended March 31,2010


2009Stock options


3,394,883



2,430,086Shares reserved for issuance on convertible debt obligations


1,327,212



—Warrants


731,696



110,578Total


5,453,791



2,540,664


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11.
CONSOLIDATED STATEMENTS OF CASH FLOWS





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





Three months ended

March 31,2009


2009Accounts receivable, net

$
(35,955
)

$
75,936Inventory


(47,841
)


27,246Prepaid expenses


74,714



37,693Other current assets


1,057



(4,738
)Other non-current assets


41,665



—Accounts payable


239,417



21,699Accrued liabilities


(41,822
)


(211,644
)Deferred revenue


(3,785
)


(15,048
)Due to stockholders


(10,000
)


4,635$
217,450


$
(64,221
)





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





Three months ended March 31,2010


2009Non-cash investing activitiesWarrant issued in Registered Direct financing

$
736,771


$
—Common stock issued to Marchant Securities Inc. for services provided in the equity issuance transaction.


154,797



—Equity issuance costs accrued at March 31, 2010


707,184



—





12.  SUBSEQUENT EVENTS





There were no subsequent events to report at the date of filing.





ITEM2.
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 restated 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 TearLabTM 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.  We refer to the results of our TearLab testing platform as our Point-of-Care business division in the discussion of our operating results below.  Commercializing our Point-of-Care tear testing platform is now the focus of our business.


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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, Germany, Italy, France, Turkey, Ukraine, Bulgaria, Belgium, Netherlands, Switzerland, Korea, Australia, Russia, Hungary, Greece, Canada, Slovakia, Czech Republic, United Kingdom and the United States and a sales representation agreement in Japan.





On May 19, 2009, we announced that we received 510(k) clearance from the FDA.  The 510(k) clearance allows us to market the TearLabTM Osmolarity System to those reference and physician operated laboratories with CLIA certifications allowing them to perform moderate and high complexity tests.  Considering that most of our target customers are eye care practitioners without such certifications, we intend to seek a CLIA waiver from the FDA for the TearLabTM Osmolarity System.  We anticipate receiving the CLIA waiver during the second half of 2010.  A CLIA waiver would greatly reduce the regulatory compliance for our future customers and permit them to perform the TearLabTM Osmolarity test in their offices.  If we receive a CLIA waiver, we will be able to market our product to the approximately 50,000 eye care practitioners in the United States that are candidates to operate under a CLIA waiver certification.





On December 8, 2009 we announced that Health Canada issued a Medical Device License for the TearLab Osmolarity System. The Health Canada license allowed us to immediately begin marketing the system in Canada.  On August 20, 2009, we entered into an agreement with a distributor, Science with Vision, for exclusive distribution of the TearLab Osmolarity System in Canada.  We began selling products through the Canadian distributor in 2010.





Our success is highly dependent on our ability to increase sales of our testing platform in European and other countries recognizing the CE mark, in Canada where we have a Medical Device License and on our receipt of a CLIA waiver which will enable us to begin full commercialization efforts in the United States.  Meeting these objectives requires that we have sufficient capital to fund our operations.  Subsequent to the equity transactions in the first quarter of 2010 in which a gross aggregate of $8.0 million was raised, 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.





Recent Developments





On January 11, 2010, the Company announced the sale of 1,886,291 shares of its common stock for an aggregate of approximately $1,743,989 and had received additional commitments to purchase an additional 1,358,475 shares for an aggregate of $1,255,992. These equity transactions totaling $2,999,981 closed prior to March 31, 2010. The Company intends to use the net proceeds of the offering for working capital and general corporate purposes.





On March 3, 2010, at a special meeting of the stockholders of the Company, the issuance of 1,358,475 shares of stock was approved for issuance. As a result of this approval, on March 19, 2010, the Company completed the sale of an additional 1,358,475 shares for an aggregate of approximately $1,256,011. The per share price of the shares, $0.92456, is equal to 80% of the volume weighted average price of the Company’s common stock for the 10 trading days ending on the day immediately preceding the January 8, 2010 closing date. The Company intends to use the net proceeds of the offering for working capital and general corporate purposes.





On March 15, 2010, the Company announced that it has obtained commitments from several investors to purchase approximately 1,552,796 shares of its common stock and warrants to purchase approximately 621,118 shares of its common stock for gross proceeds of approximately $5,000,000.  The investors have agreed to purchase the shares and warrants for $3.22 per unit (each unit consisting of one share and a warrant to purchase 0.4 shares of common stock).  The exercise price of the warrants is $4.00 per share. The warrants are exercisable at any time on or after the sixth-month anniversary of the closing date through and until the 18-month anniversary of the closing of the offering.  The closing of the offering took place on March 18, 2010.


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RESULTS OF OPERATIONS





Revenue, Cost of Sales and Gross Margin





Three Months Ended March 31,

(in thousands)2010

2009


Change$

$


$TearLab revenue


275



243



32TearLab – cost of sales


189



119



70TearLab gross margin (loss)


86



124



(38
)Percentage of TearLab revenue


31
%


51
%


(20
%)





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 DED.





The TearLab Osmolarity System consists of the following three components: (1) the TearLab disposable, which is a single-use microfluidic labcard; (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 $32,000 or 13% for the three months ended March 31, 2010 as compared to the prior year period, reflecting an increase in sales activity following the launch of the TearLab Osmolarity system in North America during the fourth quarter of fiscal 2009.





TearLab Cost of Sales





TearLab cost of sales includes costs of goods sold, warranty, and royalty costs.  Our cost of goods sold consists primarily of costs for the manufacture of the TearLab 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 costs of sales for the three months ended March 31, 2010 increased by $70,000 or 59% over the prior year fiscal period as a result of approximately $50,000 of promotions to promote research and clinical use of our test cards and $20,000 of additional shipping and warranty costs in the current period.





TearLab Gross Margin





TearLab gross margin for the three months ended March 31, 2010 decreased by $38,000 or 31% compared to the prior fiscal period, as a result of the marketing promotion activity and additional shipping and warranty costs previously mentioned.


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Operating Expenses





Three months ended March 31

(in thousands)2010


2009


ChangeAmortization of intangible assets

$
304


$
304


$
—General and administrative


965



983



(18
)Clinical and regulatory


468



332



136Sales and marketing


274



214



60Operating expenses

$
2,011


$
1,833


$
178





Amortization of Intangible Assets





Amortization expense of intangible assets was unchanged for the three months ended March 31, 2010 and 2009, as there were no adjustments to the Company’s cost basis or estimated useful life of the underlying assets.





General and Administrative Expenses





General and administrative expenses decreased by $18,000 or 7% during the three months ended March 31, 2010, as compared with the corresponding period in 2009, primarily due to approximately $55,000 in reduced administrative and public company costs offset by increased non-cash option expenses.  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 and regulatory expenses increased by $136,000 or 41% during the three months ended March 31, 2010, as compared with the corresponding prior year period.  Regulatory costs in support of the Company’s goal of obtaining CLIA waiver certification increased by $60,000 over the prior year comparable period.  Additionally the Company’s costs related to patents expense increased by $40,000 over the prior period.  The Company also realized an increase in employee compensation  costs in the current period of approximately $30,000 as a result of executive bonuses granted in the current year.





Sales and Marketing Expense





Sales and marketing expenses decreased by $60,000 or 28% during the three months ended March 31, 2010, as compared with the comparable period in fiscal 2009. The increase is due to $90,000 in sales and business development costs that were not present in the prior year.  These expenses were offset by corresponding decreases in marketing and advertising expenses of approximately $30,000, reflecting a shift in focus to sales oriented activities following the launch of the TearLab product in Europe, Asia, and North America.





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 commercialization in Europe and developing plans to do the same in North America when we receive the CLIA waiver. We will continue to develop and execute our conference and podium strategy to ensure visibility and evidence-based positioning of the TearLabTM Osmolarity System among eye care professionals.


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Other Income (Expense)





Three Months Ended March 30, (in thousands)2010


2009


Change$


$


$Interest income


1



2



(1
)Changes in fair value of warrant obligation


71



22



49Interest expense


(52
)


―



(52
)Amortization of deferred financing charges, warrants and beneficial conversion values


(154
)


―



(154
)Other income (loss)


(20
)


14



(34
)(154
)


38



(192
)





Interest Income





Interest income consists of interest income earned in as a result of the Company’s cash and short-term investment position following the raising of capital and debt.  The decrease in interest income in the three months ended March 31, 2010 is indicative of the Company earning lowers rates of interest on its cash accounts as a result of the current economic environment.





Changes in Fair Value of Warrants Obligations





The Company has a total of 731,696 warrants subject to fair value re-measurement of which 621,118 warrants were issued during the three months ended march 31, 2010. The value of the warrants vary primarily due to the market price of our common stock.





On February 6, 2007, pursuant to the Securities Purchase Agreement between the Company and certain institutional investors, the Company issued five-year warrants exercisable into an aggregate of 110,578 shares of the Company’s common stock. The Company estimated the fair value of the warrants as of March 31, 2010 and determined the aggregate fair value to be $14,143, an increase of $10,947 from the nominal value calculated as at December 31, 2009.





On March 18, 2010, the Company closed a registered direct financing in which it sold approximately 1,552,796 shares of its common stock and warrants (the “Warrants”) to purchase approximately 621,118 shares of its common stock for gross proceeds of approximately $5,000,000.  Based on applicable guidance from the FASB, the Company determined that the Warrants do not meet the criteria for classification as equity.  Accordingly, the Company classified the Warrants as current liabilities at March 31, 2010. The estimated fair value of the Warrants at March 18, 2010 was determined to be $736,770  The Company, estimated the fair value of the Warrants as of March 31, 2010 to be $654,845, a decrease of approximately $81,925 over the measurement of the aggregate fair value of the Warrants on March 18, 2010.





This net combined decrease of  $70,978 in the fair value of warrant obligations is recorded as a gain in other income during the three months ended March 31, 2010. In the three months ended March 31, 2009, a gain of $21,695 was reported.





Interest Expense





Accrued interest of $52,502 has been recorded in the three months ended March 31, 2010 arising from the Notes payable issued in Q3 of 2009 and is included in notes payable and accrued interest on our balance sheet. There was no similar charge in the three months ended March 31, 2009.





Amortization of Deferred Financing Charges, Warrants and Beneficial Conversion values





As a result of the Financing that the Company entered into and which resulted in the purchase of $1.75 million in convertible secured notes by the investors, investors were in a position to convert the notes at a conversion price of $1.3186 per share at a time when the common shares of the Company were trading at $1.75 (July 15th) and $1.70 (August 31st) providing them with a beneficial conversion feature. The Company has valued this feature as $727,528 and the amortization of this amount as an expense over the two year life of the Notes for  the three months ended March 31, 2010 was $120,035. No similar expense was reported in the three months ended March 31, 2009.


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Investors in the Financing will receive warrants at an exercise price of $1.60 upon conversion of the convertible secured notes. The Company has valued these warrants using the Black-Scholes value model at a value of $162,621. The amortization of this amount as an expense over the two year life of the convertible secured notes in the three months ended March 31, 2010 was $26, 886. No similar expense was reported in the three months ended March 31, 2009.





Issuance costs of the Financing totaled $87,199 and have been allocated to cost of equity and to deferred finance charges. The amortization of the deferred finance charges as an expense over the two year life of the Notes in the three months ended March 31, 2010 was $7,116.  No similar expense was reported in the three months ended March 31, 2009.





Other





Other income for the three months ended March 31, 2010 and 2009 consists of foreign exchange gains and losses, based on fluctuations of the Company’s foreign denominated currencies.





Recovery of Income Taxes





Recovery of income taxes decreased by $668,881 to zero during the three months ended March 31, 2010, as compared with a recovery of income taxes of $668,881 in the three months ended March 31, 2009. At December 31, 2009, deferred tax liabilities equaled deferred tax assets and therefore in the three months ended March 31, 2010, it was necessary to offset the amortization of deferred tax liabilities of $169,466 with an increase to the valuation allowance associated for the deferred tax assets to an equal amount to maintain a net deferred tax balance of zero. As the Company does not know when it will be able to use tax losses to offset taxable income it can not allow deferred taxes to reflect an asset position.  In the three months ended March 31, 2009, there was sufficient deferred tax liabilities to allow the Company to report $668,881 in deferred tax assets representing tax losses benefited in the three months ended March 31, 2009.





To date, the Company has recognized income tax benefits in the aggregate amount of $3.4 million associated with the recognition of the deferred tax asset from the availability of net operating losses in the United States which may be utilized to reduce taxes in future years. The benefits associated with the balance of the net operating losses are subject to a full valuation allowance since it is not more likely than not that these losses can not be utilized in future years. A portion of the Company’s net operating losses may, however, be subject to annual limitations as a result of the Company’s initial public offering and prior changes of control. Accordingly, until a formal analysis of the effect of the changes of control is performed, a portion of the income tax benefits recognized to date may be affected.





Recovery of income taxes for the three ended March 31, 2010 and 2009, respectively also includes the amortization of the deferred tax liability which was recorded based on the difference between the fair value of intangible assets acquired and their tax bases. The amounts recorded for the three months ended March 31, 2010 and March 31, 2009 were $169,466 and 169,466, respectively.





The deferred tax liability recorded upon the acquisition of TearLab, Inc. of $5.2 million represents the difference between the fair value of the intangible assets acquired by the Company upon its acquisition of TearLab, Inc. and their respective tax bases. The deferred tax liability is being amortized over an average period of 10 years, the estimated weighted-average useful life of the intangible assets.





The deferred tax liability recorded upon the closing of the Financing of $0.4 million represents the difference between the value of the funding received from investors in the Financing and the book value recorded after allocating value to the warrants and beneficial conversion feature associated with the Financing. The deferred tax liability is being amortized over an average period of two years, the term of the short-term liabilities if not converted.





Review of Intangible Assets for Impairment


The Company determined that, as of March 31, 2010, there have been no significant events which may affect the carrying value of TearLab, Inc.’s (“TearLab”) TearLabTM technology. However, the Company’s prior history of losses and losses incurred during the current fiscal year reflect a potential indication of impairment, thus requiring management to assess whether the TearLabTM technology was impaired as at March 31, 2010. Based on management’s estimates of forecasted undiscounted cash flows as at March 31, 2010, the Company concluded that there is no indication of an impairment of TearLab's TearLabTM technology. Therefore, no impairment charge was recorded during the three months ended March 31, 2010.


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OccuLogix, Inc.





Liquidity and Capital Resources


(in thousands)





March 31,


December 31,2010


2009


ChangeCash and cash equivalents

$
6,866


$
106


$
6,760Percentage of total assets


43%



1%Working capital

$
2,872


$
(2,132
)

$
5,004





Financial Condition





Management believes that our cash, cash equivalents and short-term will be sufficient to meet our operating activities and other demands for at least the next 12 months.





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:





·
the cost and results of continuing development of TearLab, Corp's TearLab Osmolarity System;





·
the cost and results, and the rate of progress, of the clinical trials of the TearLab Osmolarity System that will be required to support TearLab, Corp's application to obtain a CLIA waiver approval from the FDA;





·
TearLab, Corp's ability to obtain a CLIA waiver approval from the FDA for the TearLab Osmolarity System and the timing of such approval, if any;





·
whether government and third-party payors agree to reimburse the TearLab Osmolarity System;





·
the costs and timing of building the infrastructure to market and sell the TearLab Osmolarity System;





·
the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; and





·
the effect of competing technological and market developments.





At the present time, our only product is the TearLab Osmolarity System, and while we have received 510(k) approval from the FDA which allows us to commercialize our product in the United States, we are currently limited to selling to facilities that have moderate and high complexity CLIA certifications.  Obtaining a CLIA waiver approval from the FDA will enable us to market our product to the approximately 50,000 eye care practitioners that do not operate with moderate and high complexity CLIA certifications.  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 until the Company becomes cash flow positive from operations but if we are not able to achieve a cash positive operating position in 2011 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.  However, we believe that cash and cash equivalents at March 31, 2010 will be sufficient to allow the Company to operate for a minimum of 12 months.


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On January 8, 2010, we raised $1,743,989 in the first tranche of a private placement transaction in which 1,886,291 shares of common stock were issued at a share price of $0.92456. On March 19, 2010, we raised an additional $1,256,011 in the second tranche of the private placement transaction in which 1,358,475 shares of common stock were issued at a share price of $0.92456 as these funds were in escrow prior to the first closing on January 8, 2010.





Additionally on March 18, 2010, we closed a registered direct financing in which 1,552,795 shares of common stock and warrants to purchase 621,118 shares of common stock for gross proceeds of approximately $5,000,000 were purchased.  The investors purchased the shares and warrants for $3.22 per unit (each unit consisting of one share and a warrant to purchase 0.4 shares of common stock).  The exercise price of the warrants is $4.00 per share. The warrants are exercisable at any time on or after the sixth-month anniversary of the closing date through and until the 18-month anniversary of the closing of the offering.





Ongoing Sources and Uses of Cash





We anticipate that our cash and cash equivalents will be sufficient to sustain our operations of the Company for at least a period of 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 and investment balances.  Our accounts receivable collections will be impacted by our ability to grow our point-of-care revenue, any bad debts we experience and our overall collection rates on the related accounts receivable.





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





Changes in Cash Flows





Three months ended March 31,

(in thousands)2010


2009


ChangeCash used in operating activities

$
(1,192
)

$
(1,300
)

$
108Cash used in investing activities


(2
)


(9
)


7Cash provided by financing activities


7,954



―



7,954Net increase in cash and cash equivalents during the period

$
6,760


$
(1,309
)

$
8,069





Cash Used in Operating Activities





Net cash used to fund our operating activities during the three months ended March 31, 2010 was $1,192,000.  Net loss during the three month period was $2,080,000. The non-cash sources which comprise a portion of the net loss during that period consist primarily of the amortization of intangible assets, fixed assets, patents and trademarks, stock-based compensation, amortization of prepaid or deferred finance charges, accretion of warrant and beneficial conversion values and accrued interest from the convertible secured note financing in the aggregate total of $740,000. Offsetting additional non-cash amounts which comprise a portion of the net loss during that period include changes in the fair value of warrant obligations $71,000.


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The net change in non-cash working capital balances related to operations for the three months ended March 31, 2010 and 2009 consists of the following:





Cash provided (used)

Three months ended

March 31,

(in thousands)2010


2009$


$Amounts receivable, net


(36
)


76Inventory


(48
)


27Prepaid expenses


74



38Other current assets


1



(5
)Other non-current assets


42



―Accounts payable


240



22Accrued liabilities


(42
)


(212
)Deferred revenue


(4
)


(15
)Due to stockholders


(10
)


5217



(64
)





·
Accounts receivable increased due to slower collection of receivables.


·
Inventory increased, reflecting sales of the TearLabTMOsmolarity System at a slower rate than production inventory acquired.


·
Prepaid expenses decreased primarily due to the amortization of prepaid insurance and allocation of capital costs to costs of equity transactions.


·
Other current assets decreased due to the amortization of deferred finance charges associated with the Financing.


·
Other non-current assets decreased as advisory fee costs were amortized over period.


Accounts payable increased due primarily to the timing of payment cycles in the monthly accounting process and incurring costs regarding equity financings.


·
Accrued liabilities (other than accruals for equity transactions) decreased primarily due to reduction in 2009 public company costs.


·
Deferred revenue decreased, reflecting the shipment of TearLab products for which customers had paid in advance.


·
Amounts due to stockholders decreased, reflecting payments related to administrative services provided by TLC Vision Corporation.





Cash Used in Investing Activities





Net cash used in investing activities for the three months ended March 31, 2010 was $2,000. Cash used in investing activities during the period consists of $2,000 used to acquire fixed assets.





Net cash used in investing activities for the three months ended March 31, 2009 was $9,000. Cash used in investing activities during the period consisted of cash in the amount of $6,000 used to acquire fixed assets net of proceeds of $3,000 on sale of fixed assets and cash in the amount of $6,000 used for capitalizable patents and trademark costs.





Cash Provided by Financing Activities




During the three months ended March 31, 2010, the Company issued common stock in a private placement funding for $3,000,000 and in a registered direct funding for $5,000,000, offset by costs paid in the three months ended March 31, 2010 of $46,000. There were no similar transactions in the three months ended March 31, 2009.





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 three months ended March 31, 2010 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, 2009.


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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 three months ended March 31, 2010 included in Item 1.





ITEM3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





Currency Fluctuations and Exchange Risk


All of our sales are in U.S. dollars, while a portion of our expenses are in Canadian dollars and Australian dollars.  We cannot predict any future trends in the exchange rate of the Canadian dollar or Australian dollar against the U.S. dollar.  Any strengthening of the Canadian dollar or Australian dollar 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 both Canadian dollars and Australian dollars to meet short term operating requirements.  Based on the balances in the Canadian dollar and Australian dollar denominated bank accounts at September 30, 2009, hypothetical increases of $0.01 in the value of the Canadian dollar and the Australian dollar in relation to the U.S. dollar would not have a material impact on the results of our operations.  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 investments, 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 investment grade securities 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 three months ended March 31, 2010 would reduce interest income by under $10,000 annually.


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ITEM 4.
CONTROLS AND PROCEDURES





(a)
Disclosure Controls and Procedures.


The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports under the Securities Exchange Act of 1934, as amended, or the Exchange Act, is recorded, processed, summarized and reported within the time reports specified in the SEC’s rules and forms and that such information is accumulated and communicated to the Company’s management, including our principal executive officer, or the CEO, and our principal financial officer, or the CFO, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating 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 three-month period ended March 31, 2010, 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 Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act).Based on that evaluation, our chief executive officer and chief financial officer concluded that, as of the end of that fiscal period, the Company’s disclosure controls and procedures are effective to provide reasonable assurance of achieving the desired control objectives.





(b)
Changes in Internal Control over Financial Reporting.


During the three-month period ended March 31, 2010, 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.


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PARTII.
OTHER INFORMATION





ITEM 1.
LEGAL PROCEEDINGS





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





ITEM 1A.  RISK FACTORS





Risks Relating to our Business





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





The TearLabTM 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 TearLabTM Osmolarity System to those reference and physician operated laboratories with moderate and high complexity, Clinical Laboratory Improvement Act, or CLIA, certifications.  We intend to seek a CLIA waiver from the U.S. Food and Drug Administration, or the FDA, which will allow us to sell to those eye care professionals in the United States who do not have CLIA certifications to perform moderate and high complexity tests.  Even if the TearLabTM Osmolarity System receives all regulatory approvals in the United States, it may never be successfully commercialized.  If the TearLabTM Osmolarity System does not receive all regulatory approvals or is not successfully commercialized, we may not be able to generate revenue, become profitable or continue our operations.  Any failure of the TearLabTM Osmolarity System to receive regulatory approvals or 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 limited working capital and history of losses have resulted in our auditors expressing doubts in prior years  as to whether we will be able to continue as a going concern.





In the years ended December 31, 2006, 2007 and 2008, we had prepared our consolidated financial statements on the basis that we will continue as a going concern.  The Company's working capital deficit at December 31, 2009 is $2,132,036.  In the period subsequent to December 31, 2009, the Company raised gross proceeds of $8.0 million in private placement and registered direct financings.  Our net working capital at March 31, 2010 was $2,872,189, which represents a $5,004,225 increase from our working capital at December 31, 2009.Although current levels of cash flows are negative, management believes the Company’s existing cash as well as the proceeds from the funding received in the three months ended March 31, 2010 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.


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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 December 31, 2009, we had an accumulated deficit of $372.0 million and have incurred an additional $2.1 million in losses in the three months ended March 31, 2010.  Our losses have resulted primarily from expenses incurred in research and development of our product candidates from our discontinued businesses.  We do not know when or if we will receive CLIA waiver approval from the FDA for the TearLab Osmolarity System or successfully commercialize it 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 candidate to obtain regulatory approval and any failure to become and remain profitable would adversely affect the price of our common stock and our ability to raise capital and continue operations.





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





As of March 31, 2010, our total indebtedness was approximately $4.7 million.  Our significant debt and debt 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 debt presents the following risks:





·
our substantial leverage increases our vulnerability to economic downturns and adverse competitive and industry conditions and could place us at a competitive disadvantage compared to those of our competitors that are less leveraged;





·
our debt service 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 more money for operations or capital in the future and implement our business strategies; and





·
our level of debt may restrict us from raising additional financing 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 indebtedness when payment is due, we may be required to attempt to renegotiate the terms of the instruments relating to the indebtedness, seek to refinance all or a portion of the indebtedness or obtain additional 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 2008 common stock and debt bridge financings, 2009 convertible secured debt financings and the 2010 private placement and registered direct common stock financings.  As of the date of this Quarterly report on Form 10-Q, we estimate that we have sufficient resources to fund operations 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.


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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 the submission of our application for the sought-after CLIA waiver from the FDA or prevent its submission altogether.





·
We may not receive the CLIA waiver for the TearLabTM Osmolarity System from the FDA, in which case our ability to market the TearLabTM Osmolarity System in the United States will be hindered severely.





·
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 TearLabTM Osmolarity System and other matters.  If our suppliers or we fail to comply with these regulatory requirements, the TearLabTM Osmolarity System could be subject to restrictions or withdrawals from the market and we could become subject to penalties.





·
Even if we succeed in obtaining the sought-after FDA approvals, we may be unable to commercialize the TearLabTM 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 TearLabTM 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.





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 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 any of these enforcement actions were to be taken by the government, our business could be harmed.





We are required to demonstrate and maintain compliance with the FDA's Quality System Regulation, or the QSR.  The QSR is a complex regulatory scheme that covers the methods and documentation of the design, testing, control, manufacturing, labeling, quality assurance, packaging, storage and shipping of our products.  The FDA must determine that the facilities which manufacture and assemble our products that are intended for sale in the United States, as well as the manufacturing controls and specifications for these products, are compliant with applicable regulatory requirements, including the QSR.  The FDA enforces the QSR through periodic unannounced inspections.  Our facilities have not yet been inspected by the FDA, 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.


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Our patents may not be valid, and we may not be able to obtain and enforce patents to protect our proprietary rights from use by would-be competitors.  Patents of other companies 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 be able to 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 TearLabTM 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 TearLabTM 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 be able to sustain the costs of such litigation more effectively than we can because of their substantially greater financial resources.  Litigation may also 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 to, 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 RHEOTM 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 TearLabTM 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 coverage limits of $2,000,000 in the aggregate annually.  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 be able to 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.


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We have entered into a number of 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 several 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 are able to successfully develop enhancements or new generations of our products, these enhancements or new generations of products may not produce revenue in excess of the costs of development and they may be quickly rendered obsolete by changing customer preferences or the introduction by our competitors of products embodying new technologies or features.





We rely on a 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 TearLabTM 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 TearLabTM Osmolarity System.  If any of these events should occur, our business, financial condition, cash flows and results of operations could be materially adversely affected.


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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, as well as industry participants developing and marketing point-of-care tests, such as the technology being developed by the Aborn Eye Clinic, which is reportedly able to measure the osmolarity of nanoliter tear samples, 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 are unable to 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 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 be able to effectively recruit, train and retain additional qualified personnel.  If we are unable to retain key personnel or manage our growth effectively, we may not be able to implement our business plan.





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





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





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





Maintaining proper and effective internal controls will require substantial management time and attention and may result in our incurring substantial incremental expenses, including with respect to increasing the breadth and depth of our finance organization to ensure that we have personnel with the appropriate qualifications and training in certain key accounting roles and adherence to certain control disciplines within the accounting and reporting function.  Any failure in internal controls or any additional 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.


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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 a control deficiency 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 we will be able to implement our planned processes and procedures 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.





The trading price of our common stock may be volatile.





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





·
the results of pre-clinical testing and clinical trials by us, our collaborators and/or our competitors;





·
technological innovations or new diagnostic products;





·
governmental regulations;





·
developments in patent or other proprietary rights;





·
litigation;





·
public concern regarding the safety of products developed by us or others;





·
comments by securities analysts;





·
the issuance of additional shares to obtain financing or for acquisitions;





·
general market conditions in our industry or in the economy as a whole; and





·
political instability, natural disasters, war and/or events of terrorism.





In addition, the stock market 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 companies’ stock, including ours, regardless of actual operating performance.  In the past, following periods of volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often been instituted against these companies.  This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.


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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 do not expect to earn any material revenues 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 an amendment is proposed to our charter or bylaws requiring stockholder approval and the record date for determining the stockholders of record entitled to vote on the amendment occurs prior to the date you are deemed to be the owner of the shares of our common stock due upon exercise of your warrants, you will not be entitled to vote on the amendment, although you will nevertheless be subject to any changes in the powers, preferences or special rights of our common stock.





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





Our certificate of incorporation authorizes us to issue up to 10,000,000 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.





ITEM2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS





None.





ITEM3.
DEFAULTS UPON SENIOR SECURITIES





There has not been any default upon our senior securities.





ITEM4.      Removed and Reserved.





ITEM5.
OTHER INFORMATION





None.


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ITEM 6.
EXHIBITS





2.1

Form of Plan of Reorganization (incorporated by reference to Exhibit 2.1 to the Registrant’s Registration Statement on Form S-1/A No. 4, filed with the Commission on December 6, 2004 (file no. 333-118024)).3.1

Amended and Restated Certificate of Incorporation of the Registrant as currently in effect (incorporated by reference to Exhibit 10.4 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)).3.2

Amended and Restated By-Laws of the Registrant as currently in effect (incorporated by reference to Exhibit 10.4 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)).10.1

2002 Stock Option Plan, as amended and restated on September 30, 2008.10.2

Amending Agreement, dated as of October 6, 2008, between the Registrant and William G. Dumencu, amending the Employment Agreement between the Registrant and William G. Dumencu dated as of February 25, 2008.10.3

Termination Agreement, dated as of October 6, 2008, between Suh Kim and the Registrant, terminating the Employment Agreement between the Registrant and Suh Kim dated as of March 12, 2007.10.4

Termination Agreement, dated as of October 6, 2008, between Elias Vamvakas and the Registrant, terminating the Employment Agreement between the Registrant and Elias Vamvakas dated as of September 1, 2004.10.5

Securities Purchase Agreement, dated July 15, 2009 (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on July 16, 2009).10.6

Form of 12% Convertible Secured Note (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K, filed with the Commission on July 16, 2009).10.7

Form of Warrant (incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K, filed with the Commission on July 16, 2009).10.8

Security Agreement, dated July 15, 2009 (incorporated by reference to Exhibit 10.4 to the Registrant’s Current Report on Form 8-K, filed with the Commission on July 16, 2009).10.9

Form of Director and Affiliate Letter Agreement (incorporated by reference to Exhibit 10.5 to the Registrant’s Current Report on Form 8-K, filed with the Commission on July 16, 2009).10.10

Capital Advisory Agreement with Greybrook Capital Inc., dated November 3, 2009(incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, filed with the Commission on November 3, 2009).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 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2

CFO’s Certification of periodic financial reports pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


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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.





OccuLogix, Inc.(Registrant)Date:
May 13, 2010

/s/ Elias VamvakasElias VamvakasChief Executive Officer






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