UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended September 30, 2017

or

For the transition period from                      to                     

Commission File Number: 001-36385

 

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  ☒    No  ☐

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

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

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

As of October 27, 2017, the registrant had 76,019,373 shares of common stock, $0.001 par value per share, outstanding.  

 

 

 

 

 

 

 

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BIOLASE, INC.

INDEX

 

 

 

 

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PART I. FINANCIAL INFORMATION

 

 

BIOLASE, INC.

CONSOLIDATED BALANCE SHEETS (Unaudited)

(in thousands, except share and per share data)

 

 

See accompanying notes to unaudited 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 unaudited consolidated financial statements.

 

 

 

 

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BIOLASE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(in thousands)  

 

See accompanying notes to unaudited consolidated financial statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1—DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

The Company

BIOLASE, Inc. (“BIOLASE” and, together with its consolidated subsidiaries, the “Company”), incorporated in Delaware in 1987, is a medical device company that develops, manufactures, markets, and sells laser systems in dentistry and medicine and also markets, sells, and distributes dental imaging equipment, including cone beam digital x-rays and three-dimensional CAD/CAM intra-oral scanners.  

Basis of Presentation

The unaudited consolidated financial statements include the accounts of BIOLASE and its wholly-owned subsidiaries and have been prepared on a basis consistent with the December 31, 2016 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, 2017 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, 2016, included in BIOLASE’s Annual Report on Form 10-K for the year ended December 31, 2016 filed with the Securities and Exchange Commission (the “SEC”) on March 10, 2017 (the “2016 Form 10-K”).

Liquidity and Management’s Plans

The Company incurred a loss from operations, incurred a net loss, and used cash in operating activities for the three and nine months ended September 30, 2017. The Company has also suffered recurring losses from operations during the three years ended December 31, 2016. The Company’s recurring losses, level of cash used in operations, and potential need for additional capital, along with uncertainties surrounding the Company’s ability to raise additional capital, raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

As discussed in Note 3, on April 18, 2017, the Company completed a private placement with several institutional and individual investors, and certain of its directors and officers, pursuant to which the Company generated gross proceeds of approximately $10.5 million, and net proceeds, after offering expenses of approximately $0.2 million, of approximately $10.3 million.  

The Company is using the proceeds from the private placement for working capital and general corporate purposes. In connection with the registration rights granted to these investors, the Company filed with the SEC a registration statement on Form S-3, which was declared effective on August 24, 2017.

As discussed in Note 3, the Company has filed with the SEC an amended registration statement relating to a proposed public offering of non-transferable subscription rights to purchase shares of BIOLASE common stock. As of the date of the filing of the quarterly report on Form 10-Q of which these financial statements are a part, such registration statement has not yet become effective. If the proposed rights offering is consummated, the Company expects to receive gross proceeds of approximately $8.0 million to $12.0 million before expenses.

As of September 30, 2017, the Company had working capital of approximately $14.7 million. The Company’s principal sources of liquidity as of September 30, 2017 consisted of approximately $4.7 million in cash and cash equivalents, and restricted cash and $9.7 million of accounts receivable.             

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In order for the Company to continue operations beyond the next 12 months and be able to discharge its liabilities and commitments in the normal course of business, the Company must increase sales of its products directly to end-users and through distributors, establish profitable operations through the combination of increased sales and decreased expenses, generate cash from operations or obtain additional funds when needed. 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 expand and develop its field 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 reducing expenses.

Additional capital requirements may depend on many factors, including, among other things, continued losses, the rate at which the Company’s business grows, demands for working capital, manufacturing capacity, and any acquisitions that the Company may pursue. From time to time, the Company could be required, or may otherwise attempt, to raise capital, through either equity or debt offerings, or enter into a line of credit facility. As discussed in Note 3, the Company has filed with the SEC an amended registration statement relating to a proposed public offering of non-transferable subscription rights to purchase shares of BIOLASE common stock. As of the date of the filing of this quarterly report on Form 10-Q, such registration statement has not yet become effective. If the proposed rights offering is consummated, the Company expects to receive gross proceeds of approximately $8.0 million to $12.0 million before expenses and to use such proceeds for the Company’s general working capital needs. The Company cannot provide assurance that it will be able to successfully consummate the rights offering, any other equity financing or any debt financing or enter into any line of credit facility in the future. The Company also cannot provide assurance that the required capital would be available on acceptable terms, if at all, or that any such financing activity would not be dilutive to our stockholders.

 

 

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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, the ability of goodwill to be realized, revenue deferrals, 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.

Critical Accounting Policies

Information with respect to the Company’s critical accounting policies, which management believes could have the most significant effect on the Company’s reported results and require subjective or complex judgments by management is contained in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of the 2016 Form 10-K. Management believes that there have been no significant changes during the three and nine months ended September 30, 2017 in the Company’s critical accounting policies from those disclosed in Item 7 of the 2016 Form 10-K.

Fair Value of Financial Instruments

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal market (or, if none exists, the most advantageous market) for the specific asset or liability at the measurement date (referred to as the “exit price”). The fair value is based on assumptions that market participants would use, including a consideration of nonperformance risk. Under the accounting guidance for fair value hierarchy there are three levels of measurement inputs. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. Level 2 inputs reflect input other than quoted prices included in Level 1 that are observable, either directly or through collaboration with observable market data, other than Level 1. Level 3 inputs are unobservable due to little or no corroborating market data.

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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.

Recent Accounting Pronouncements

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

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

Adopted Accounting Pronouncements

In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory (“ASU 2015-11”), as part of its simplification initiative. The standard requires inventory within the scope of ASU 2015-11 to be measured using the lower of cost and net realizable value.  The changes apply to all types of inventory, except those measured using the last-in, first-out method or the retail inventory method. ASU 2015-11 applies to all entities and is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2016, with early adoption permitted. The Company adopted ASU 2015-11 as of January 1, 2017. The adoption of ASU 2015-11 did not have a material effect on the Company’s consolidated financial statements.

In November 2015, FASB issued ASU 2015-17, Income Taxes (Topic 740) (“ASC 2015-17”).  Current GAAP requires an entity to separate deferred income tax liabilities and assets into current and noncurrent amounts in a classified statement of financial position. To simplify the presentation of deferred income taxes, the amendments in this ASU require that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments in this ASU apply to all entities that present a classified statement of financial position. The new standard is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years with early adoption permitted.  The Company adopted ASU 2015-17 as of January 1, 2017. The adoption of ASU 2015-17 did not have a material effect on the Company’s consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718) (“ASU 2016-09”). The updated standard simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The standard requires the recognition of the income tax effects of awards in the income statement when the awards vest or are settled, thus eliminating additional paid in capital pools. ASU 2016-09 is effective for public business entities for annual reporting periods beginning after December 15, 2016, including interim periods within those annual reporting periods. Early adoption is permitted. The Company adopted ASU 2016-09 as of January 1, 2017, and made the accounting policy election to estimate the number of awards expected to vest for stock-based compensation expense. The adoption of ASU 2016-09 and related accounting policy election did not have a material effect on the Company’s consolidated financial statements.

Recently Issued Accounting Standards

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which supersedes nearly all existing revenue recognition guidance under GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five-step process to achieve this core principle, and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing GAAP.

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The standard is effective for annual periods beginning after December 15, 2017, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). The Company has completed a scoping analysis of the effect of the standard to identify the revenue streams that may be affected by ASU 2014-09. The Company is evaluating if the adoption could result in a change in the timing of recognizing revenue for certain deliverables and the impact the adoption of ASU 2014-09 will have on the Company’s consolidated financial statements. The Company is currently evaluating which transition approach to use and will adopt this standard beginning January 1, 2018.

In February 2016, FASB issued ASU 2016-02, Leases (“ASU 2016-02”). The new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement.  The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.  The Company is currently evaluating the impact of its pending adoption of ASU 2016-02 on its consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) (“ASU 2016-15”). The updated standard addresses eight specific cash flow issues with the objective of reducing diversity in practice. ASU 2016-15 is effective for public business entities for annual reporting periods beginning after December 15, 2017, including interim periods within those annual reporting periods. Early adoption is permitted. The Company is assessing the impact of the adoption of ASU 2016-15 on the Company's consolidated financial statements.

In May 2017, the FASB issued ASU 2017-09, Compensation – Stock Compensation (Topic 718) (“ASU 2017-09”). The updated standard clarifies when an entity must apply modification accounting to changes in the terms or conditions of a share-based payment award. ASU 2017-09 is effective for public business entities for annual reporting periods beginning after December 15, 2017, including interim periods within those annual reporting periods. Early adoption is permitted. The Company does not expect that the adoption of this standard will have a material effect on its consolidated financial statements.

 

 

NOTE 3—STOCKHOLDERS’ EQUITY

2017 Private Placement

On April 18, 2017, the Company completed a private placement with several institutional and individual investors, and certain of its directors and officers, under which the Company sold an aggregate of 80,644 shares of BIOLASE Series D Participating Convertible Preferred Stock, par value $0.001 per share (“Preferred Stock”), and warrants (the “Warrants”) to purchase up to an aggregate of 3,925,871 unregistered shares of BIOLASE common stock at an exercise price of $1.80 per share (the “Exercise Price”), subject to customary anti-dilution adjustments. Each share of Preferred Stock converted automatically into 100 shares of BIOLASE common stock upon receipt of stockholder approval on June 30, 2017, reflecting a conversion price equal to $1.24 per share, which is the closing price of BIOLASE common stock quoted on the NASDAQ Capital Market on April 10, 2017. On June 30, 2017, BIOLASE’s stockholders also approved the issuance of common stock related to the exercise of the Warrants by certain holders whose Warrants were subject to a beneficial ownership limitation. Also on June 30, 2017, BIOLASE’s stockholders approved the amendment to the Company's Restated Certificate of Incorporation, as amended, to increase the number of authorized shares of BIOLASE common stock from 100,000,000 shares to 200,000,000 shares.

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The Warrants became exercisable on October 18, 2017 and expire on April 18, 2022 five years after the date of issuance, or, if earlier, five business days after the Company delivers notice that the closing price per share of BIOLASE common stock exceeded the Exercise Price for 30 consecutive trading days during the exercise period. Gross proceeds from the sale were approximately $10.5 million, and net proceeds, after offering expenses of approximately $0.2 million, were approximately $10.3 million. The Company is using the proceeds from the private placement for working capital and general corporate purposes. In connection with the registration rights granted to these investors, the Company filed with the SEC a registration statement on Form S-3, which was declared effective on August 24, 2017.

In accordance with applicable accounting standards, the $10.5 million gross proceeds from the private placement described above were allocated to the Preferred Stock and Warrants in the amount of $8.2 million and $2.3 million, respectively. The allocation was based on the relative fair values of the underlying common stock and Warrants as of the commitment date, with the fair value of the Warrants determined using a Black Scholes model. Assumptions used in the Black-Scholes model include an expected term of five years, a risk-free rate of 1.90% and a dividend yield of 0%. This transaction resulted in a discount from allocation of proceeds to separable instruments of $2.0 million and a beneficial conversion to common stock with a value of $2.0 million, which have been reflected as a deemed distribution to preferred shareholders for the nine months ended September 30, 2017.

2017 Rights Offering

On September 29, 2017, the Company filed a registration statement on Form S-1 with the SEC for a proposed rights offering to its existing shareholders. The registration statement was amended on October 10, 2017, but, as of the date of the filing of the quarterly report on Form 10-Q of which these financial statements are a part, the registration statement has not yet become effective. The proposed rights offering consists of a public offering of non-transferable subscription rights to purchase shares of BIOLASE common stock. If the Company proceeds with the proposed rights offering, its stockholders will receive (a) basic subscription rights to purchase their pro rata portion of the shares of BIOLASE common stock offered in the proposed rights offering and (b) over-subscription privileges, which will entitle the holders thereof who exercise their basic subscription rights in full the opportunity to purchase additional shares of BIOLASE common stock unclaimed by other holders of basic subscription rights in the proposed rights offering, subject to certain limitations and subject to allotment. Certain affiliates of Larry Feinberg and certain affiliates of Jack Schuler have each agreed with the Company to exercise their respective basic subscription rights and any available over-subscription privilege pursuant to the rights offering in an amount not less than $3.0 million each. The record date of the rights offering will be 5:00 p.m., Eastern Time on November 8, 2017.

If the rights offering is consummated, the Company expects to receive gross proceeds of approximately $8.0 million to $12.0 million before expenses. The purpose of the rights offering is to raise equity capital in a cost-effective manner that gives all of the Company’s existing stockholders the opportunity to participate on a pro rata basis. There can be no assurance that the Company will be successful in completing the rights offering, any other equity financing or any debt financing.

 

Stock-Based Compensation

The Company currently has one stock-based compensation plan, the 2002 Stock Incentive Plan (as amended effective as of May 26, 2004, November 15, 2005, May 16, 2007, May 5, 2011, June 6, 2013, October 30, 2014, April 27, 2015, and May 6, 2016) (the “2002 Plan”), which will expire on May 5, 2019. Persons eligible to receive awards under the 2002 Plan include officers, employees, and directors of the Company, as well as consultants. As of September 30, 2017, a total of 15,550,000 shares of BIOLASE common stock have been authorized for issuance under the 2002 Plan, of which 3,946,000 shares of BIOLASE common stock have been issued pursuant to options that were exercised and restricted stock units (“RSUs”) that were settled in common stock, 9,437,000 shares of BIOLASE common stock have been reserved for outstanding options and unvested RSUs, and 2,167,000 shares of BIOLASE common stock remain available for future grants.

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The Company recognized stock-based compensation expense of $464,000 and $688,000, for the three months ended September 30, 2017 and 2016, respectively, and $1.6 million and $2.5 million, for the nine months ended September 30, 2017 and 2016 respectively, based on the grant-date fair value.  Stock-based compensation expense for the nine months ended September 30, 2017 includes the reversal of $640,000 resulting from the reassessment of certain performance based equity awards. The net impact of stock-based compensation expense to earnings was $(0.01), and $(0.01) per basic and diluted share for the three months ended September 30, 2017 and 2016, respectively and $(0.02) and $(0.04) per basic and diluted share for the nine months ended September 30, 2017 and 2016, respectively. At September 30, 2017, the Company had approximately $4.1 million of total unrecognized compensation cost, net of estimated forfeitures, related to unvested share-based compensation arrangements. The Company expects that cost to be recognized over a weighted-average period of 2.1 years.  

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

 

 

The stock option fair values, under the 2002 Plan, were estimated using the Black-Scholes option-pricing model with the following assumptions:

 

A summary of option activity under the 2002 Plan for the nine months ended September 30, 2017 is as follows (in thousands, except per share data):  

 

(1) The intrinsic value calculation does not include negative values. This can occur when the fair market value on the reporting date is less than the exercise price of the grant.

 

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A summary of unvested stock option activity under the 2002 Plan for the nine months ended September 30, 2017 is as follows (in thousands, except per share data):

 

 

Cash proceeds, along with fair value disclosures related to grants, exercises, and vested options under the 2002 Plan are as follows for the three and nine months ended September 30 (in thousands, except per share amounts): 

 

 

(1) Excess tax benefits received related to stock option exercises are presented as financing cash inflows. The Company currently does not receive a tax benefit related to the exercise of stock options due to the Company’s net operating losses.

(2) The intrinsic value of stock options exercised is the amount by which the market price of the stock on the date of exercise exceeded the market price of the stock on the date of grant.

Effective February 6, 2017, the Compensation Committee of the BIOLASE board of directors (the “Board”) issued 611,000 non-qualified stock options to purchase shares of BIOLASE common stock to certain employees of the Company.  These awards were issued at $1.55 per share, the closing market price of BIOLASE common stock on the grant date, and expire 10 years from the grant date.  Vesting periods for options are as follows: (i) for the 586,000 options awarded to existing employees, one-half vest on the first anniversary of grant date and one-half vest on the second anniversary of the grant date and (ii) for the 25,000 options awarded to new employees, 25% vest on February 6, 2018 and the remainder vest ratably over the 36-month period, commencing on March 6, 2018.

On May 10, 2017, non-employee directors of the Company were granted a total of 525,528 non-qualified stock options to purchase shares of BIOLASE common stock.  These awards were issued at $1.21 per share, the closing market price of BIOLASE common stock on the grant date, and expire 10 years from the grant date.  The total grant vests in equal installments over a consecutive 12-month period, commencing on June 10, 2017.

On September 1, 2017, Paul N. Clark resigned from the Board, effective September 11, 2017, and as Chairman of the Board, effective September 1, 2017. Effective September 1, 2017, Dr. Jonathan T. Lord was appointed Chairman of the Board. On September 11, 2017, the Compensation Committee of the Board approved a modification to expiration dates applicable to Mr. Clark’s vested options. As a result of the modification, the Company recognized additional compensation expense of $44,000 for the three and nine months ended September 30, 2017. On September 11, 2017, Dr. Lord was granted 65,385 non-qualified stock options to purchase shares of BIOLASE common stock at $0.54 per share, the closing market price of BIOLASE common stock on the grant date, and expiring 10 years from grant date. On September 12, 2017, Dr. Lord was granted 65,891 non-qualified stock options to purchase shares of BIOLASE common stock at $0.61 per share, the closing market price of BIOLASE common stock on the grant date, and expiring 10 years from grant date. Both grants vest in equal installments over an eight-month period, commencing on October 10, 2017.

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Inducement Stock-Based Awards

On March 13, 2017, and as amended on April 19, 2017, in connection with the hiring of a new Vice President of Sales, the Compensation Committee of the Board awarded non-qualified stock options to purchase 400,000 shares of BIOLASE common stock.  This award was issued at $1.17 per share, the closing market price of BIOLASE common stock on the grant date, and expires 10 years from the grant date.  Vesting periods for the options are as follows: (i) two-fifths of the total grant is subject to time vesting with 25% vesting as of March 13, 2018 and the remaining 75% vesting ratably monthly over a 36-month period commencing on March 13, 2018, and (ii) three-fifths of the total grant is subject to specific 2017 and 2018 performance criteria, with vesting upon satisfaction of the applicable performance criteria.

On March 27, 2017, in connection with the hiring of a new Senior Vice President and Chief Financial Officer, the Compensation Committee of the Board awarded non-qualified stock options to purchase 600,000 shares of BIOLASE common stock.  This award was issued at $1.28 per share, the closing market price of BIOLASE common stock on the grant date, and expires 10 years from the grant date.  Vesting periods for the options are as follows: (i) two-thirds of the total grant is subject to time vesting with 25% vesting as of March 27, 2018 and the remaining 75% vesting ratably monthly over a 36-month period commencing on March 27, 2018, and (ii) one-third of the total grant is subject to specific 2017 and 2018 performance criteria, with vesting upon satisfaction of the applicable performance criteria. This award was forfeited upon the departure of the Senior Vice President and Chief Financial Officer in May 2017.

On July 13, 2015, the Compensation Committee of the Board awarded 870,000 stock-settled RSUs to the Company’s President and Chief Executive Officer in connection with his employment agreement with BIOLASE.  The RSUs were valued at $1.64 per share and vest upon the achievement of specific interim and annual Company performance criteria. As of September 30, 2017, no stock-settled RSUs remain outstanding.

Restricted Stock Units

Effective February 6, 2017, the Compensation Committee of the Board approved the grant of the following awards:

On May 9, 2017 and in connection with the 2017 compensation plan, 500,000 RSUs were awarded to certain employees and consultants of the Company.  These awards were valued at $1.22 per share, the closing market price of BIOLASE common stock on the grant date. The RSUs vest as follows: (i) one-half of the total grant is subject to time vesting with 50% vesting on May 9, 2018 and the remaining 50% vesting on May 9, 2019, and (ii) one-half of the total grant is subject to specific 2017 and 2018 performance criteria, with vesting upon satisfaction of the applicable performance criteria.

On May 10, 2017, non-employee directors of the Company were granted a total of 175,176 RSUs valued at $1.21 per share, the closing market price of BIOLASE common stock on the grant date.  These awards vest on May 10, 2018. On September 1, 2017, Paul N. Clark resigned from the Board, effective September 11, 2017, and as Chairman of the Board, effective September 1, 2017. On September 11, 2017, the Compensation Committee of the Board approved a modification to the vesting criteria applicable to Mr. Clark’s unvested RSUs. As a result of the modification, the Company recognized additional compensation expense of $12,000 for the three and nine months ended September 30, 2017.

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On September 11, 2017, members of the executive management team of the Company agreed to receive performance based RSUs in lieu of cash salary compensation totaling $265,000 for the period from September 3, 2017 through March 3, 2018. These RSUs vest on September 11, 2018 subject to satisfaction of Company specific performance criteria, and the quantity of RSUs granted will be calculated at vesting based on the closing price of BIOLASE common stock on the vesting date. As the Company may settle the value of compensation equivalent by issuing a variable number of RSUs at the vesting date, this award is classified as a liability, specifically within accrued liabilities, on the Company’s Consolidated Balance Sheets as of September 30, 2017.

 

A summary of unvested RSU activity under the 2002 Plan for the nine months ended September 30, 2017 is as follows (in thousands, except per share amounts): 

 

Warrants

The Company issues warrants to acquire shares of BIOLASE common stock as approved by the Board.  A summary of warrant activity for the nine months ended September 30, 2017 is as follows (in thousands, except exercise price amounts): 

 

See “2017 Private Placement” above for a description of the private placement transaction in which 3,925,871 Warrants were issued.

Net Loss Per Share – Basic and Diluted

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

 

Outstanding stock options, RSUs and warrants to purchase approximately 26,834,243 shares were not included in the calculation of diluted loss per share for the three and nine months ended September 30, 2017, as their effect would have been anti-dilutive.  For the same 2016 periods, anti-dilutive outstanding stock options and warrants to purchase 17,636,132 shares were not included in the computation of diluted loss per share.

 

 

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NOTE 4—INVENTORY

Inventory is valued at the lower of cost or market, with cost determined using 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 $1.7 million as of both September 30, 2017 and December 31, 2016.

 

 

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 $310,000 and $887,000 for the three and nine months ended September 30, 2017, respectively, and $274,000 and $734,000 for the three and nine months ended September 30, 2016, respectively.

 

The cost basis of assets held under capital lease was $378,000 and the accumulated depreciation related to assets held under capital lease was $340,000 as of September 30, 2017.  For additional information on the capital lease, see Note 8 – Commitments and Contingencies.

 

 

NOTE 6—INTANGIBLE ASSETS AND GOODWILL

The Company conducted its annual impairment test of goodwill as of June 30, 2017 and determined that there was no impairment. The Company also tests its intangible assets and goodwill between the annual impairment tests 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. For intangible assets subject to amortization, the Company performs its impairment test when indicators, such as reductions in demand or significant economic slowdowns, are present. No events have occurred since June 30, 2017 through the date of these consolidated financial statements that would trigger further impairment testing of the Company’s intangible assets and goodwill.

As of September 30, 2017 and December 31, 2016, the Company had goodwill (indefinite life) of $2.9 million. As of September 30, 2017 and December 31, 2016, all intangible assets have been fully amortized. There was no amortization expense for the three and nine months ended September 30, 2017. Amortization expenses for the three and nine months ended September 30, 2016 totaled $14,000 and $42,000, respectively.  

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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, 2017 and 2016 are included within accrued liabilities on the Consolidated Balance Sheets and were as follows (in thousands):

 

 

The Company’s Waterlase laser systems and Diode systems sold domestically are covered by a warranty against defects in material and workmanship for a period of up to two years from the date of sale by the Company or a distributor to the end-user. In 2017, for Waterlase systems sold domestically and purchased in 2017 or later, the Company decreased the warranty from two years to one year.

 

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

 

 

 

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NOTE 8—COMMITMENTS AND CONTINGENCIES

Leases

The Company leases its 57,000 square foot corporate headquarters and manufacturing facility located at 4 Cromwell, Irvine, California. In March 2015, the corporate headquarters and manufacturing facility lease was amended to extend the term through April 30, 2020, modify provisions for a tenant improvement allowance of up to $398,000, and adjust the basic rent terms. Future minimum rental commitments under operating lease agreements with non-cancelable terms greater than one year for the years ending December 31 are listed below.  The Company also leases certain office equipment and automobiles under various operating lease arrangements.

In February 2015, the Company entered into a 30-month capital lease agreement for information technology equipment.  Future minimum lease payments (using a 1.6% interest rate) under the capital lease, together with the present value of the net minimum lease payments and net of a $14,000 prepayment, for the year ending December 31, 2017 is $17,000.  The current obligation with respect to the present value of net minimum lease payments is reflected in the Consolidated Balance Sheets classified as an accrued liability, and there was no remaining portion of the present value of net minimum lease payments classified as a long-term obligation within capital lease obligations as of September 30, 2017.

Future minimum rental commitments under lease agreements, including both operating and capital leases (principle and interest), with non-cancelable terms greater than one year for each of the years ending December 31 are as follows (in thousands):  

 

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 $1.3 million, in the aggregate, at September 30, 2017. The Company also has agreements with certain employees to pay bonuses based on targeted performance criteria. As of September 30, 2017, approximately $67,000 was accrued for performance bonuses, which is included in accrued liabilities in the Consolidated Balance Sheets.

Purchase commitments

The Company generally purchases components and subassemblies for its products from a limited group of third-party suppliers through purchase orders.  As of September 30, 2017, the Company had $12.8 million of purchase commitments for which the Company has not received certain goods or services that are 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. Although open purchase orders are considered enforceable and legally binding, the Company may be able to cancel, reschedule or adjust requirements prior to supplier fulfillment.

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.

 

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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 (the “116 Patent”) regarding the Company’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 (the “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 responded to the USPTO’s ruling and on December 10, 2013, the USPTO issued a Right of Appeal Notice, finally rejecting some claims of the 116 Patent while finding that other claims appeared to be patentable. The Company appealed the USPTO’s findings on January 9, 2014 and on January 27, 2014, the USPTO declined to reconsider the finding of certain claims as patentable and instructed the parties to proceed to appeal to the Patent Trial and Appeal Board (the “Patent Board”).  On March 17, 2014, the Company filed its brief in support of its appeal of the USPTO’s decision not to reject certain claims of the 116 Patent. On March 24, 2014, CAO filed its brief in support of its appeal of the USPTO’s decision to reject certain claims of the 116 patent. On April 18, 2014, the Company filed a respondent brief in opposition to the CAO’s appeal arguments. On May 30, 2014, both parties filed rebuttal briefs in support of their appeals.  On June 30, 2014, the Company requested an oral hearing before the Patent Board.  On July 1, 2014, the Patent Board noted that request and docketed the case for consideration. A hearing on reconsideration was held in November 2014.  On July 1, 2015, the Patent Board issued a decision that was generally favorable to the Company.   On July 31, 2015, CAO requested a rehearing of the decision.  On November 27, 2015, the Patent Board issued its decision regarding CAO’s request for rehearing, partially granting CAO’s request.  On January 27, 2016, CAO filed its Notice of Appeal to the United States Court of Appeals for the Federal Circuit for review of the Patent Board’s decision dated July 1, 2015 and the Patent Board’s decision regarding CAO’s request for rehearing. CAO filed its opening appeal brief on June 1, 2016, and BIOLASE filed its responsive brief on July 25, 2016. CAO filed its reply brief on August 11, 2016. Oral argument before the Federal Circuit was held on January 11, 2017, and, on January 27, 2017, an order was entered by the Federal Circuit affirming all of the Patent Board’s findings. On February 9, 2017, the parties jointly filed a document with the court in the Utah litigation notifying it of the Federal Circuit’s decision and requesting that the stay remain in place until a reexamination certificate issues. The reexamination certificate issued on July 6, 2017, so the parties are preparing to notify the court and to request that the stay be lifted.

 

 

NOTE 9—SEGMENT INFORMATION

The Company currently operates in a single business segment. Management uses one measurement of profitability and does not segregate its business for internal reporting.  For the three and nine months ended September 30, 2017, sales to customers in the United States accounted for approximately 63% and 64% of net revenue, respectively, and international sales accounted for approximately 37% and 36% of net revenue, respectively. For the three and nine months ended September 30, 2016, sales to customers in the United States accounted for approximately 66% and 63% of net revenue, respectively, and international sales accounted for approximately 34% and 37% of net revenue, respectively.  No individual country, other than the United States, represented more than 10% of total net revenue during the three and nine months ended September 30, 2017 or 2016.

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