UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

      

FORM 10-Q

      

(Mark One)

 

For the quarterly period ended September 30, 2013

OR

 

For the transition period from ______ to ______

Commission File Number 000-19627

      

BIOLASE, INC.

(Exact name of registrant as specified in its charter)

      

   

 

4 Cromwell

Irvine, California 92618

(Address of principal executive offices, including zip code)

(949) 361-1200

(Registrant’s telephone number, including area code)

      

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

   

 

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

The number of shares of the issuer’s common stock, $0.001 par value per share, outstanding, as of October 18, 2013, was 34,851,648 shares.

      

      

   

   

                       

 

   

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BIOLASE, INC.

INDEX

   

 

   

   

   

 

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PART I. FINANCIAL INFORMATION

 

BIOLASE, INC.

CONSOLIDATED BALANCE SHEETS (Unaudited)

(in thousands, except per share data)

   

 

   

See accompanying notes to consolidated financial statements.

   

   

 

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BIOLASE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (Unaudited)

(in thousands, except per share data)

   

 

   

   

See accompanying notes to consolidated financial statements.

   

   

 

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BIOLASE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(in thousands)

   

 

   

   

See accompanying notes to consolidated financial statements.

   

   

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1—BASIS OF PRESENTATION

The Company

BIOLASE, Inc., (the “Company”) incorporated in Delaware in 1987, is a biomedical company operating in one reportable business segment that develops, manufactures, and markets proprietary lasers in dentistry and medicine and also markets and distributes two-dimensional (“2-D”) and three-dimensional (“3-D”) digital imaging equipment and CAD/CAM intra-oral scanners; products that are focused on technologies that advance the practice of dentistry and medicine.

Basis of Presentation

The unaudited consolidated financial statements include the accounts of BIOLASE, Inc. and its wholly-owned subsidiaries and have been prepared on a basis consistent with the December 31, 2012 audited consolidated financial statements and include all material adjustments, consisting of normal recurring adjustments and the elimination of all material intercompany transactions and balances, necessary to fairly present the information set forth therein. These unaudited, interim, consolidated financial statements do not include all the footnotes, presentations, and disclosures normally required by accounting principles generally accepted in the United States of America (“GAAP”) for complete consolidated financial statements. Certain amounts have been reclassified to conform to current period presentations.

The consolidated results of operations for the three and nine months ended September 30, 2013 are not necessarily indicative of the results for the full year. The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2012, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 (“2012 Form 10-K”) filed with the Securities and Exchange Commission on March 15, 2013.

Use of Estimates

The preparation of these consolidated financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect amounts reported in the consolidated financial statements and the accompanying notes. Significant estimates in these consolidated financial statements include allowances on accounts receivable, inventory, and deferred taxes, as well as estimates for accrued warranty expenses, indefinite-lived intangible assets, and the ability of goodwill to be realized, revenue deferrals for multiple element arrangements, effects of stock-based compensation and warrants, contingent liabilities, and the provision or benefit for income taxes. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may differ materially from those estimates.

Update to Significant Accounting Policies

There have been no material changes to the Company’s significant accounting policies which are described in the Company’s 2012 Form 10-K, except as noted below. See Note 2 – Recent Accounting Pronouncements for adoption of updated authoritative guidance.

Excise Tax

Commencing January 1, 2013, certain of the Company’s product sales are subject to the newly enacted medical device excise tax. The Company has included such taxes separately as a component of operating expense.

Income Tax

The income tax provision for the three and nine months ended September 30, 2013 was calculated using the discrete year-to-date method, which management determined to be more appropriate than the annual effective rate method which was used to calculate the income tax provision for the quarter ended March 31, 2013. See Note 12 – Income Taxes for additional disclosures related to the Company’s income tax.

 

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Fair Value of Financial Instruments

The Company’s financial instruments, consisting of cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities, approximate fair value because of the short maturity of these items. Financial instruments consisting of lines of credit approximate fair value, as the interest rates associated with the lines of credit approximates the market rates for debt securities with similar terms and risk characteristics.

Liquidity and Management’s Plans

The Company suffered recurring losses from operations during the three years ended December 31, 2012. The Company also incurred a loss from operations, a net loss, and used cash in operating activities for the three and nine months ended September 30, 2013. The available borrowing capacity on our lines of credit with Comerica Bank and the net proceeds from the below mentioned equity offering have been principal sources of liquidity during the nine months ended September 30, 2013. These credit facilities were amended in November 2013, as discussed further below, and expire May 1, 2014. At September 30, 2013, the Company had approximately $5.0 million in working capital. The Company’s principal sources of liquidity at September 30, 2013 consisted of approximately $4.2 million in cash and cash equivalents, $10.8 million of net accounts receivable, and $2.5 million of available borrowings under two revolving credit facility agreements.

The Company’s ability to meet its obligations in the ordinary course of business is dependent upon the Company’s ability to sell its products directly to end-users and through distributors, establish profitable operations through increased sales, decrease expenses, and to generate cash from operations or obtain additional funds when needed. If the Company is unsuccessful in its efforts to improve its financial position, there may be substantial doubt about its ability to adequately fund the minimum requirements of its business.

The Company intends to improve its financial condition and ultimately improve its financial results by increasing revenues through expansion of its product offerings, continuing to develop its direct sales force and distributor relationships both domestically and internationally, forming strategic arrangements within the dental and medical industries, educating dental and medical patients as to the benefits of its advanced medical technologies, and continuing cost reduction initiatives.

Management expects that the working capital and future borrowings available under the lines of credit should be sufficient to fund the minimum requirements of the Company; however, the Company cannot guarantee that it will be able to increase sales, reduce expenses, or obtain additional funds when needed or that such funds, if available, will be obtainable on terms satisfactory to the Company. Management will continue to monitor the liquidity of the Company and is prepared to implement cash saving measures or potentially issue debt or equity securities in the event that its plans to grow revenue do not materialize in the timeline anticipated by management.

Sale of common stock

On July 26, 2013, the Company filed a registration statement on Form S-3, File No. 333-190158 (“2013 Registration Statement”) with the Securities and Exchange Commission (“SEC”) to register an indeterminate number of shares of common stock, preferred stock, and warrants with a total offering price not to exceed $30 million. The Company subsequently amended the 2013 Registration Statement and lowered the total not to exceed offering price to $5 million. The 2013 Registration Statement, as amended, was declared effective by the SEC on September 19, 2013. On September 23, 2013, the Company entered into an agreement with Northland Securities, Inc. (“Northland”), pursuant to which Northland acted as placement agent in connection with the sale of shares of the Company’s common stock in a registered direct offering (the “September 2013 Registered Direct Offering”) pursuant to the 2013 Registration Statement and paid Northland a fee of 5.0% of the aggregate gross proceeds in connection therewith. On September 23, 2013, the Company entered into a subscription agreement (“2013 Subscription Agreement”) with Camber Capital Management, LLC, pursuant to which the Company agreed to sell 2,688,172 shares of its common stock at a price per share of $1.86 for gross proceeds of $5 million. The net proceeds to the Company were $4.6 million, after deducting associated costs of $408,000, which included Northland’s fee. The shares of common stock sold in connection with the 2013 Subscription Agreement were issued pursuant to a prospectus supplement to the 2013 Registration Statement, which was filed with the SEC September 26, 2013.

 

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Lines of credit

On September 6, 2013 and November 8, 2013, the Company amended its lines of credit with Comerica Bank. The amendments waive noncompliance with certain financial covenants, subject to additional requirements, and establish future covenants, restrictions, and penalties. The amendment on November 8, 2013 includes liquidity ratio and liquid asset covenants, and an equity raise requirement that established March 1, 2014 as the latest date by which the Company is required to raise at least $3.0 million. Any future noncompliance with these covenants may result in default interest rates and penalties, and Comerica Bank could declare the amounts outstanding immediately due and payable. Management is considering alternative financing solutions, including potentially issuing alternative debt securities, to mitigate any future liquidity constraints these covenants and restrictions may impose on the Company. Further discussion of the amendments is included in Note 8 – Lines of Credit and Other Borrowings.     

   

NOTE 2—RECENT ACCOUNTING PRONOUNCEMENTS

Changes to U.S. GAAP are established by the Financial Accounting Standards Board (“FASB”) in the form of accounting standards updates (“ASU’s”) to the FASB’s Accounting Standards Codification (“ASC”).

The Company considers the applicability and impact of all ASU’s. ASU’s not listed below were assessed and determined to not be applicable or are expected to have minimal impact on the Company’s consolidated financial position and results of operations.

Newly Adopted Accounting Standards

In July 2012, the FASB simplified guidance for testing for impairment of indefinite-lived intangible assets other than goodwill. The changes are intended to reduce compliance costs. The revised guidance allows a qualitative approach for testing indefinite-lived intangible assets for impairment, similar to the recently issued impairment testing guidance for goodwill and allows the option to first assess qualitative factors (events and circumstances) that could have affected the significant inputs used in determining the fair value of the indefinite-lived intangible asset to determine whether it is more likely than not (meaning a likelihood of more than 50 percent) that the indefinite-lived intangible asset is impaired. An organization may choose to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to calculating its fair value. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The adoption did not have a material impact on the Company’s consolidated financial statements.

In February 2013, the FASB issued guidance for reporting of amounts reclassified out of accumulated other comprehensive income. The revised guidance requires reporting the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required to be reclassified in its entirety to net income. For other amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures that provide additional detail about these amounts. The amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. The guidance is effective prospectively for reporting periods beginning after December 15, 2012. The adoption did not have a material impact on the Company’s consolidated financial statements.

New Accounting Standards Not Yet Adopted

In March 2013, the FASB issued guidance on a parent’s accounting for the cumulative translation adjustment upon de-recognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity. The revised guidance requires that the parent release any related cumulative translation adjustment into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. The guidance is effective prospectively for reporting periods beginning after December 15, 2013. Early adoption is permitted. Management believes that the adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.

 

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In July 2013, the FASB issued guidance to address the diversity in practice related to the financial statement presentation of unrecognized tax benefits as either a reduction of a deferred tax asset or liability when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This guidance is effective prospectively for reporting periods beginning after December 15, 2013. Early adoption is permitted. Management believes that the adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.

   

NOTE 3—STOCK-BASED AWARDS AND PER SHARE INFORMATION

Stock-Based Compensation

The Company currently has one stock-based compensation plan, the 2002 Stock Incentive Plan (the “2002 Plan”) which will expire on May 5, 2019. Eligible persons under the 2002 Plan include certain officers and employees of the Company, and directors of the Company, as well as consultants. Under the 2002 Plan, 7,750,000 shares of common stock have been authorized for issuance. As of September 30, 2013, 2,840,000 shares of common stock have been issued pursuant to options that were exercised, 4,374,000 shares of common stock have been reserved for options that are outstanding, and 536,000 shares of common stock remain available for future grant.

Compensation cost related to stock options recognized in operating results totaled approximately $491,000 and $357,000 for the three months ended September 30, 2013 and 2012, respectively; and $1.2 million and $1.3 million for the nine months ended September 30, 2013 and 2012, respectively. The net impact to earnings for those periods was $(0.02) and $(0.01) per basic and diluted share, and $(0.04) and $(0.04) per basic and diluted share, respectively. At September 30, 2013, the Company had approximately $2.7 million of total unrecognized compensation cost, net of estimated forfeitures, related to unvested share-based compensation arrangements granted under the 2002 Plan. The Company expects that cost to be recognized over a weighted-average period of 1.5 years.

The following table summarizes the income statement classification of compensation expense associated with share-based payments (in thousands):

   

 

The stock option fair values were estimated using the Black-Scholes option-pricing model with the following assumptions:

   

 

 

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A summary of option activity under the Company’s stock option plan for the nine months ended September 30, 2013 is as follows:

   

 

On June 6, 2013, the Board of Directors (the “Board”) granted stock options to purchase 350,000 shares of common stock to Alexander K. Arrow in connection with his appointment to President and Chief Operating Officer. These stock options were granted at an exercise price of $4.00 per share, vest and become exercisable in equal quarterly amounts over a four-year period beginning on June 6, 2014, and expire on June 6, 2020.

Cash proceeds along with fair value disclosures related to grants, exercises, and vesting options are provided in the following table (in thousands, except per share amounts):

   

 

Warrants

On July 12, 2013, the Company entered into a strategic agreement with Valam, Inc. (“Valam”) to develop, market, and sell office-based laser systems to otolaryngologists (also known as “Ear, Nose, and Throat” or “ENT” doctors) (the “Valam Agreement”). The Valam Agreement provides the Company with an exclusive worldwide license to Valam’s ENT related patents and pending patents which complements the Company’s patent portfolio and supports the Company’s planned launch into the ENT laser market in late 2013. In connection with the Valam Agreement, the Company issued a warrant to Valam to purchase up to 165,000 shares of the Company’s common stock, at a price per share of $6.00 (the “Valam Warrant”). The Valam Warrant is performance-based and will vest as follows: 30,000 warrant shares upon the launch of the Company’s first ENT laser; 55,000 warrant shares upon the receipt of certain specified clearances required from the U.S. Food and Drug Administration (the “FDA”); 40,000 warrant shares upon achieving $5 million in ENT laser revenues for a 12-month period; and 40,000 warrant shares upon achieving $10 million in ENT laser revenues for a 12-month period. Vested warrant shares may be exercised with a cash payment, or, in lieu of a cash payment, Valam may convert the vested warrant shares into a net number of whole common shares. The Valam Warrant expires on July 14, 2020. As of September 30, 2013, performance requirements for the Valam Warrant have not been achieved and no stock-based compensation has been recognized.

 

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On April 26, 2013, the Company issued a warrant to Sun Dental Laboratories, LLC (“Sun Dental Labs”) to purchase up to 500,000 shares of the Company’s common stock, at a price per share of $5.90 (the “Sun Dental Warrant”). The Sun Dental Warrant is performance-based and will vest at a rate of 1,000 shares per each 3Shape A/S (“3Shape”) Trios intraoral scanner (“Trios IOS”) that Sun Dental Labs assists in selling in conjunction with the agreement. For the purposes of the Sun Dental Warrant, a sale is defined as a Trios IOS that has been installed at the customer's place of business and is fully operational, where the customer has been trained, and the Trios IOS has been paid for in full by the customer. Any unvested warrant shares will expire on April 24, 2014. Vested warrant shares may be exercised with a cash payment, or, in lieu of a cash payment, Sun Dental Labs may convert the vested warrant shares into a net number of whole common shares. The Company recorded stock-based compensation expense of less than $1,000 related to the Sun Dental Warrant during the nine months ended September 30, 2013.

On April 18, 2013, the Company issued a warrant to purchase up to 60,000 shares of the Company’s common stock to an investor relations firm, at a price per share of $5.10 (the “IR Warrant”). The IR Warrant vests and becomes exercisable only if the Company’s common stock closing price on NASDAQ reaches or exceeds $7.50. The IR Warrant expires April 17, 2018.  As of September 30, 2013, no stock-based compensation has been recognized for the IR Warrant. The Company will reassess whether achievement of the contingent exercise provisions are probable on a quarterly basis and recognize stock-based compensation when it is probable that the market performance requirements will be achieved.

On March 23, 2013, the Company issued two tranches of warrants to purchase up to 100,000 shares of the Company’s common stock to a consultant, at a price per share of $4.50 (the “CMR Warrant”). The first tranche of 50,000 warrant shares vests and becomes exercisable only if the Company’s common stock closing price on NASDAQ reaches or exceeds $7.50. The second tranche of 50,000 warrant shares vests and becomes exercisable only if the Company’s common stock closing price on NASDAQ reaches or exceeds $10.00. The CMR Warrant expires March 22, 2018. As of September 30, 2013, no stock-based compensation has been recognized for the CMR Warrant. The Company will reassess whether achievement of the contingent exercise provision is probable on a quarterly basis and recognize stock-based compensation when it is probable that the market performance requirements will be achieved.

The initial warrant issued in connection with the lines of credit with Comerica Bank was exercised during the nine months ended September 30, 2013. In connection with amendments to the lines of credit, the Company issued additional warrants to Comerica Bank during September 2013 and November 2013. See Note 8 – Lines of Credit and Other Borrowings for further discussion.

Net Loss Per Share – Basic and Diluted

Basic net loss per share is computed by dividing loss available to common stockholders by the weighted-average number of common shares outstanding for the period. In computing diluted net loss per share, the weighted average number of shares outstanding is adjusted to reflect the effect of potentially dilutive securities.

Outstanding stock options and warrants to purchase 6,022,000 shares were not included in the computation of diluted loss per share for the three and nine months ended September 30, 2013 as a result of their anti-dilutive effect. For the same 2012 periods, anti-dilutive outstanding stock options and warrants to purchase 4,504,000 shares were not included in the computation of diluted loss per share.

Stock Dividends

The Company intends to pay a 2% annual stock dividend, in quarterly installments, for the year ending December 31, 2013. Stock dividends are discussed quarterly by the Board and management. The actual declaration of future stock dividends and the establishment of the record and payment dates are subject to final determination by the Board after its review of the Company’s financial performance, the expected results of future operations, availability of shares, and other factors that the Board may deem relevant. The Company’s dividend policy may be changed at any time by the Board, and there is no assurance, with respect to the amount or frequency, that any stock dividend will be declared in the future.

 

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The Board declared one-half percent stock dividends during each of the first three quarters of 2013. The stock dividend declared during the quarter ended September 30, 2013 was payable September 13, 2013 to shareholders of record on August 30, 2013, the stock dividend declared during the quarter ended June 30, 2013 was payable June 28, 2013 to shareholders of record on June 14, 2013, and the stock dividend declared during the quarter ended March 31, 2013 was payable March 29, 2013 to shareholders of record on March 15, 2013. All stock information presented, other than that related to stock options and warrants, has been adjusted to reflect the effects of stock dividends.

   

NOTE 4—INVENTORY

Inventory is valued at the lower of cost or market (determined by the first-in, first-out method) and is comprised of the following (in thousands):

   

 

Inventory is net of a provision for excess and obsolete inventory totaling $2.7 million and $1.9 million as of September 30, 2013 and December 31, 2012, respectively.

   

NOTE 5—PROPERTY, PLANT, AND EQUIPMENT

Property, plant, and equipment, net is comprised of the following (in thousands):

   

 

Depreciation and amortization expense related to property, plant, and equipment totaled $124,000 and $339,000 for the three and nine months ended September 30, 2013, respectively, and $93,000 and $275,000 for the three and nine months ended September 30, 2012, respectively.

   

NOTE 6—INTANGIBLE ASSETS AND GOODWILL

The Company conducted its annual impairment test of intangible assets and goodwill as of June 30, 2013, and determined that there was no impairment. The Company also tests its intangible assets and goodwill between the annual impairment test if events occur or circumstances change that would more likely than not reduce the fair value of the Company or its assets below their carrying amounts.

Amortization expense for the three and nine months ended September 30, 2013 totaled $17,000 and $100,000, respectively, and $33,000 and $98,000, respectively, for the same periods in 2012. Other intangible assets primarily include acquired customer lists and non-compete agreements.

 

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The following table presents details of the Company’s intangible assets, related accumulated amortization, and goodwill (in thousands):

   

 

   

NOTE 7—ACCRUED LIABILITIES AND DEFERRED REVENUE

Accrued liabilities are comprised of the following (in thousands):

   

 

Changes in the initial product warranty accrual, and the expenses incurred under the Company’s initial and extended warranties, for the three and nine months ended September 30, 2013 and 2012 were as follows (in thousands):

   

 

Deferred revenue is comprised of the following (in thousands):

   

 

   

 

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NOTE 8—LINES OF CREDIT AND OTHER BORROWINGS

Lines of Credit

During the year ended December 31, 2012, the Company entered into and amended two revolving credit facility agreements with Comerica Bank (the “Credit Agreements”), which provide for borrowings against certain domestic accounts receivable and inventory, as set forth in the $4.0 million revolving credit facility agreement (the “Domestic Revolver”), and borrowings against certain export related accounts receivable and inventory, as set forth in the $4.0 million revolving credit facility agreement (the “Ex-Im Revolver”), for a combined aggregate commitment of borrowings up to $8.0 million. On May 7, 2013, the Company amended the Credit Agreements (“Amendment No. 2”) with Comerica Bank to increase the borrowing capacity under the Domestic Revolver from $4.0 million to $6.0 million, resulting in a combined aggregate commitment of borrowings up to $10.0 million. On September 6, 2013, the Company amended the Credit Agreements (“Amendment No. 3”) with Comerica Bank which decreased the borrowing capacity under the Domestic Revolver from $6.0 million to $4.0 million, resulting in a combined aggregate commitment of borrowings up to $8.0 million. The lines of credit mature on May 1, 2014, at which date any remaining borrowings and accrued interest under the lines of credit become due and payable. As of September 30, 2013, the Company had aggregate outstanding borrowings totaling approximately $5.5 million, which included $3.5 million under the Domestic Revolver and $2.0 million under the Ex-Im Revolver, as compared with aggregate outstanding borrowings totaling approximately $1.6 million as of December 31, 2012.

Lockbox arrangements under the revolving bank facilities provide that substantially all of the income generated is deposited directly into lockbox accounts and then swept into cash management accounts for the benefit of Comerica Bank. Cash is disbursed from Comerica Bank to the Company only after payment of the applicable debt service and principal. At September 30, 2013 and December 31, 2012, there were no restricted cash amounts. The Company’s obligations are generally secured by substantially all of the Company’s assets now owned or hereinafter acquired.

The outstanding principal balance of the Credit Agreements bears interest at annual percentage rates equal to the daily prime rate, plus 2.00% for the Domestic Revolver and 1.50% for the Ex-Im Revolver. The daily prime rate is subject to a floor of the daily adjusting LIBOR rate plus 2.50% per annum, or if LIBOR is undeterminable, 2.50% per annum. The Company is also required to pay an unused commitment fee of 0.25% based on a portion of the undrawn lines of credit, payable quarterly in arrears. During the three and nine months ended September 30, 2013, the Company incurred interest expense associated with the credit facilities of $181,000 and $381,000, respectively, including $71,000 and $152,000, respectively, of amortization of deferred debt issuance costs and $43,000 and $79,000, respectively, of amortization of the discount on lines of credit. During the three and nine months ended September 30, 2012, the Company incurred interest expense associated with the credit facilities of $98,000 and $133,000, respectively, including $38,000 and $53,000, respectively, of amortization of deferred debt issuance costs and $18,000 and $25,000, respectively, of amortization of the discount on lines of credit. Interest expense payable was approximately $9,000 and $19,000 at September 30, 2013 and December 31, 2012, respectively, and was included in accrued liabilities in the accompanying consolidated financial statements.

The Credit Agreements require the Company to maintain compliance with certain financial and non-financial covenants, as defined therein. Amendment No. 3 resulted in certain new and amended financial covenants for the quarters ending September 30, 2013 and December 31, 2013. As of September 30, 2013, the Company was in compliance with these covenants with the exception of the earnings before income tax, depreciation, and amortization (“EBITDA”) covenant. On November 8, 2013, the Company amended the Credit Agreements (“Amendment No. 4”) with Comerica Bank to waive the noncompliance with the minimum EBITDA covenant, reset the EBITDA covenant for the quarter ending December 31, 2013, and establish covenants for the remaining term of the agreements. Amendment No. 4 includes liquidity ratio and liquid asset covenants, and an equity raise requirement that established March 1, 2014 as the latest date the Company is required to raise at least $3.0 million. Any future noncompliance with these covenants may result in default interest rates and penalties, and Comerica Bank could declare the amounts outstanding immediately due and payable. Management is considering alternative financing solutions to mitigate any future liquidity constraints this may impose on the Company.  

 

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During the year ended December 31, 2012, the Company issued and amended a warrant to Comerica Bank (“2012 Comerica Warrant”) to purchase up to 80,000 shares of the Company’s common stock at an amended exercise price per share of $2.00. During the three months ended March 31, 2013, Comerica Bank exercised all 80,000 of the 2012 Comerica Warrant shares on a cashless basis pursuant to the Notice of Exercise resulting in a net issuance of 40,465 shares of common stock.

On September 6, 2013, the Company issued an additional warrant to Comerica Bank (the “September 2013 Comerica Warrant”) to purchase up to 100,000 shares of the Company’s common stock at an exercise price per share of $2.00. The September 2013 Comerica Warrant vests in four equal quarterly tranches commencing on December 31, 2013 and shares are exercisable once vested. The 2013 Comerica Warrant may be exercised with a cash payment from Comerica Bank, or, in lieu of a cash payment, Comerica Bank may convert the warrant shares into a number of shares, in whole or in part. These warrant shares will expire if unexercised on September 6, 2018. The fair value of the September 2013 Comerica Warrants was estimated using the Black-Scholes option-pricing model with the following assumptions: expected term of 5.00 years; volatility of 105.32%; annual dividend per share of $0.00; and risk-free interest rate of 1.77%; and resulted in an estimated fair value of $143,000 which was recorded as equity and resulted in a discount to the credit facilities at issuance. The discount is being amortized on a straight-line basis to interest expense over the remaining term of the Credit Agreements.

In connection with Amendment No. 4, the Company incurred an amendment fee of $10,000 and issued an additional warrant to Comerica Bank (the “November 2013 Comerica Warrant”) to purchase up to 100,000 shares of the Company’s common stock at an exercise price per share of $2.00. The November 2013 Comerica Warrant includes an accelerated vesting clause that may be triggered by certain events described therein, but otherwise vests in four equal quarterly tranches commencing on December 31, 2013, and shares are exercisable once vested. The November 2013 Comerica Warrant may be exercised with a cash payment from Comerica Bank, or, in lieu of a cash payment, Comerica Bank may convert the warrant shares into a number of shares, in whole or in part. These warrant shares will expire if unexercised on November 8, 2018.

Other Borrowings

The Company finances a portion of its annual insurance premiums which it pays in installments over nine months. As of September 30, 2013 and December 31, 2012, $0 and $379,000 at an annual interest rate of 3.0%, respectively, was outstanding under this arrangement and was included in accrued liabilities in the accompanying consolidated financial statements. The Company incurred interest expense associated with the financed insurance premiums of approximately $1,000 and $5,000 during the three and nine months ended September 30, 2013, respectively, and approximately $0 and $4,000 during the three and nine months ended September 30, 2012, respectively.

   

NOTE 9—COMMITMENTS AND CONTINGENCIES

Leases

The Company leases its corporate headquarters and manufacturing facility in Irvine, California and also leases certain other facilities, office equipment, and automobiles under various operating lease arrangements. Future minimum rental commitments under operating lease agreements with non-cancelable terms greater than one year for the years ending December 31, 2013, 2014, and 2015, is $408,000, $661,000, and $192,000, respectively.

Employee arrangements and other compensation

Certain members of management are entitled to severance benefits payable upon termination following a change in control, which would approximate $716,000 at September 30, 2013. The Company also has agreements with certain employees to pay bonuses based on targeted performance criteria. No amount was required to be accrued at September 30, 2013.

 

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Purchase commitments

The Company generally purchases components and subassemblies for its products from a limited group of third party suppliers through purchase orders. The Company had $12.8 million of purchase commitments as of September 30, 2013, for which the Company has not received the goods or services and which is expected to be purchased within one year. These purchase commitments were made to secure better pricing and to ensure the Company will have the necessary parts to meet anticipated near term demand.

Litigation

The Company discloses material loss contingencies deemed to be reasonably possible and accrues for loss contingencies when, in consultation with its legal advisors, management concludes that a loss is probable and reasonably estimable. The ability to predict the ultimate outcome of such matters involves judgments, estimates, and inherent uncertainties. The actual outcome of such matters could differ materially from management’s estimates.

Class Action Lawsuits

On August 23, 2013 and August 26, 2013, two putative securities class action lawsuits were filed against the Company and certain of its officers and directors in the United States District Court for the Central District of California, one of which seeks unspecified damages on behalf of a putative class of persons who purchased or otherwise acquired the Company’s common stock between January 7, 2013 and August 12, 2013, and the other of which seeks similar remedies on behalf of a putative class of persons who purchased or otherwise acquired the Company's common stock between November 5, 2012 and August 12, 2013. Both complaints allege that the Company and certain of its officers and directors violated the federal securities laws by making allegedly materially false and misleading statements and/or material omissions during the putative class periods. On October 22, 2013, four individual plaintiffs each filed motions to consolidate these actions and to be appointed as lead plaintiff pursuant to the Private Securities Litigation Reform Act of 1995. Those motions are currently scheduled to be heard on December 13, 2013. No other dates have been set. As of September 30, 2013, the Company has accrued $250,000 for legal costs expected to be incurred in connection with these matters. The Company believes that the claims contained in the lawsuits are without merit and intends to vigorously defend against the claims.

Intellectual Property Litigation

On April 24, 2012, CAO Group, Inc. (“CAO”) filed a lawsuit against the Company in the District of Utah for patent infringement of U.S. Patent No. 7,485,116 regarding BIOLASE’s EZlase dental laser. On September 9, 2012, CAO filed its First Amended Complaint, which added claims for (1) business disparagement/injurious falsehood under common law and (2) unfair competition under 15 U.S.C. Section 1125(a). The additional claims stem from a press release that the Company issued on April 30, 2012, which CAO claims contained false statements that are disparaging to CAO and its diode product. The First Amended Complaint seeks injunctive relief, treble damages, attorneys’ fees, punitive damages, and interest. On November 13, 2012, the Court stayed the lawsuit for 120 days to allow the United States Patent and Trademark Office (“USPTO”) to consider the Company’s request for reexamination of the patent-in-suit. The USPTO granted the request to reexamine the asserted claims of the patent-in-suit and, on February 28, 2013, the Court stayed the lawsuit until the termination of the reexamination proceedings. On April 23, 2013, the USPTO issued an office action rejecting all of the asserted claims over the prior art, and CAO responded to the office action. On August 28, 2013, the USPTO issued an Action Closing Procedure, rejecting all of CAO’s patent claims. CAO has responded to the USPTO’s latest ruling.

The Company filed a patent infringement lawsuit against Fotona dd. (“Fotona”) in Düsseldorf District Court alleging infringement with respect to the Fotona Fidelis dental laser system. Oral proceedings are currently scheduled for spring 2014. Fotona denies liability and seeks the reimbursement of statutory fees from the Company. Together with its response brief, Fotona also filed a nullity action against the patent in dispute, patent number EP 1 560 470. The nullity action is pending at the German Federal Patent Court (the “Patent Court”), Docket No. 1 Ni 58/13 (EP). On September 2, 2013, the Company filed its counterplea in the infringement proceedings and phrased its arguments defending the validity of the patent. These arguments were also the subject of the defense brief to the Patent Court in the parallel nullity action proceedings. On September 9, 2013, the Company filed its response to the Patent Court.

 

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Other Matters

In the normal course of business, the Company is subject to other legal proceedings, lawsuits, and other claims. Although the ultimate aggregate amount of probable monetary liability or financial impact with respect to these matters is subject to many uncertainties and is therefore not predictable with assurance, the Company’s management believes that any monetary liability or financial impact to the Company from these other matters, individually and in the aggregate, would not be material to the Company’s financial condition, results of operations or cash flows. However, there can be no assurance with respect to such result, and monetary liability or financial impact to the Company from these other matters could differ materially from those projected.

   

NOTE 10—SEGMENT INFORMATION

The Company currently operates in a single reportable segment. For the three and nine months ended September 30, 2013, sales in the United States accounted for approximately 62% of net revenue and international sales accounted for approximately 38% of net revenue. For the three and nine months ended September 30, 2012, sales in the United States accounted for approximately 68% of net revenue and international sales accounted for approximately 32% of net revenue.

Net revenue by geographic location based on the location of customers was as follows (in thousands):

   

 

No individual country, other than the United States, represents more than 10% of total net revenue.

Long-lived assets located outside of the United States at our foreign subsidiaries totaled $442,000 and $412,000 as of September 30, 2013 and December 31, 2012, respectively.

   

NOTE 11—CONCENTRATIONS

Revenue from laser systems, the Company’s core product, which includes the iPlus, MD Turbo, and Epic, comprised 66% and 68% of total net revenues for the three and nine months ended September 30, 2013, respectively, and 74% and 73% of total net revenue, respectively, for the same periods in 2012. Revenue from consumables and other comprised 13% and 12% of total revenue for the same periods in 2013, and 11% and 12% for the same periods in 2012, respectively. Revenue from imaging systems comprised 8% and 8% of total net revenue for the same periods in 2013, and 5% and 5% for the same periods in 2012, respectively. Revenue from services comprised 13% and 12% of total net revenue for the same periods in 2013, and 10% and 10% for the same periods in 2012, respectively. Revenue from license fees and royalties comprised 0% and 0% of total net revenue for the same periods in 2013, and 0% and 0% for the same periods in 2012, respectively.

No individual customer represented more than 10% of the Company’s revenue in the three and nine months ended September 30, 2013 and 2012.

The Company maintains its cash and cash equivalent accounts with established commercial banks. Such cash deposits periodically exceed the Federal Deposit Insurance Corporation insured limit.

As of September 30, 2013, one distributor represented 10% of the Company’s accounts receivable. No individual customer represented more than 10% of the Company’s accounts receivable at December 31, 2012.

 

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The Company currently purchases certain key components of its products from single suppliers. Although there are a limited number of manufacturers of these key components, management believes that other suppliers could provide similar key components on comparable terms. A change in suppliers, however, could cause delays in manufacturing and a possible loss of sales, which could adversely affect the Company’s results of operations.

   

NOTE 12—INCOME TAXES

The Company accounts for income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Management evaluates the need to establish a valuation allowance for deferred tax assets based upon the amount of existing temporary differences, the period in which they are expected to be recovered, and expected levels of taxable income. A valuation allowance to reduce deferred tax assets is established when it is “more likely than not” that some or all of the deferred tax assets will not be realized. Management has determined that a full valuation allowance against the Company’s net deferred tax assets is appropriate.

As of September 30, 2013, the Company had net operating loss (“NOL”) carryforwards for federal and state purposes of approximately $83.7 million and $59.5 million, respectively, which begin to expire in 2013. The utilization of NOL and credit carryforwards may be limited under the provisions of the Internal Revenue Code (“IRC”) Section 382 and similar state provisions. IRC Section 382 generally imposes an annual limitation on the amount of NOL carryforwards that may be used to offset taxable income where a corporation has undergone significant changes in stock ownership. During the year ended December 31, 2006, the Company completed an analysis to determine the potential applicability of any annual limitations imposed by IRC Section 382. Based on the analysis, management determined that there was no significant IRC Section 382 limitation. The Company has not assessed whether any ownership changes have occurred since the completion of the 2006 analysis. As of September 30, 2013, the Company had research and development tax credit carryforwards for federal and state purposes of approximately $1.3 million and $815,000, respectively, which will begin to expire in 2018 for federal purposes and will carryforward indefinitely for state purposes. An updated analysis may be required at the time the Company begins utilizing any of its net operating losses to determine if there is an IRC Section 382 limitation.

Accounting for uncertainty in income taxes prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Company has elected to classify interest and penalties as a component of its income tax provision. With respect to the liability for unrecognized tax benefits, including related estimates of penalties and interest, the Company recorded increases of $0 and $1,000 for the three and nine months ended September 30, 2013, respectively, and $2,000 and $4,000 for the three and nine months ended September 30, 2012, respectively.    

For the three and nine months ended September 30, 2013, the Company recorded an income tax provision of $22,000 and benefit of $182,000, respectively, related to the current year tax provision. For the three and nine months ended September 30, 2012, the Company recorded an income tax provision of $34,000 and $97,000, respectively. During the nine months ended September 30, 2013, the Company reversed certain deferred tax liabilities associated with unrecognized tax benefits related to international operations due to expiring statutes and recognized tax benefits of $107,000 and recognized deferred tax assets related to certain indefinite lived assets (federal alternative minimum tax credits and California R&D credits) that were used to offset deferred tax liabilities related to indefinite-lived intangible assets of $107,000 resulting in an overall tax benefit of $214,000. Management does not expect to record additional significant tax benefits in the foreseeable future.

 

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The tax expense differs from expense derived from statutory rate of 34% primarily due to the existence of valuation allowances against net deferred tax assets and current liabilities resulting from the estimated state income tax liabilities and federal alternative minimum tax liability. The income tax provision for the three and nine months ended September 30, 2013 was calculated using the discrete year-to-date method, which management determined to be more appropriate than the annual effective rate method which was used to calculate the income tax provision for the quarter ended March 31, 2013.

Recently enacted tax laws may also affect the tax provision on the Company’s financial statements. The state of California requires the use of a single sales factor apportionment formula for tax years beginning on or after January 1, 2013. During the nine months ended September 30, 2013, the Company’s state deferred tax assets were revalued to account for the change in the tax law; however, the Company records a full valuation allowance against the state deferred tax assets therefore the California apportionment mandate did not have a material impact on the Company’s consolidated financial statements.

   

NOTE 13—SUBSEQUENT EVENT

Credit Agreements

On November 8, 2013, the Company amended the Credit Agreements with Comerica Bank to waive its noncompliance with the minimum EBITDA covenant for the quarter ended September 30, 2013, reset the EBITDA covenant for the quarter ending December 31, 2013, and establish covenants for the remaining term of the agreements. In connection with this amendment, the Company issued Comerica Bank the November 2013 Comerica Warrant and incurred an amendment fee of $10,000. See Note 8 – Lines of Credit and Other Borrowings for further discussion.

   

   

   

 

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