UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended September 30, 2016

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 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  ☒

The number of shares of the issuer’s common stock, $0.001 par value per share, outstanding, as of November 1, 2016, was 67,565,951 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 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”) 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 CAD/CAM intra-oral scanners, in-office, and chair-side milling machines.

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, 2015 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, 2016 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, 2015, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015 filed with the Securities and Exchange Commission (the “SEC”) on March 11, 2016 (the “2015 Form 10-K”).

Liquidity and Management’s Plans

The Company incurred a loss from operations, a net loss, and used cash in operating activities for the three and nine months ended September 30, 2016. The Company has also suffered recurring losses from operations during the three years ended December 31, 2015. The Company’s recurring losses, level of cash used in operations, the potential need for additional capital, and the uncertainties surrounding the Company’s ability to raise additional capital, raises 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.

On August 8, 2016, 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 88,494 shares of its Series C Participating Convertible Preferred Stock (“Preferred Stock”) and warrants to purchase up to an aggregate of 2,035,398 unregistered shares of its common stock at an exercise price of $2.00 per share. Each share of Preferred Stock convert was, automatically upon receipt of stockholder approval convertible into 100 shares of common stock, reflecting a conversion price equal to $1.13 per share, which is the closing price of the common stock quoted on the NASDAQ Capital Market on July 29, 2016. On September 30, 2016, the Company held a meeting of its shareholders and received requisite stockholder approval with respect to the issuance of 8,849,400 shares of common stock upon automatic conversion of the Preferred Stock and the issuance of common stock related to the exercise of the warrants by certain holders whose warrants were subject to a beneficial ownership limitation. Gross proceeds from the sale were $10.0 million, and net proceeds, after offering expenses of approximately $0.5 million, were approximately $9.5 million. The warrants become exercisable on February 8, 2017, six months after the closing of the private placement, and have a term of five years from the date of issuance. The Company is using the proceeds from the sale for working capital and general corporate purposes. In connection with the registration rights granted to these investors, the Company filed a registration statement on Form S-3 with the SEC, which was declared effective on November 3, 2016.

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As of September 30, 2016, the Company had working capital of approximately $20.8 million. The Company’s principal sources of liquidity as of September 30, 2016 consisted of approximately $12.9 million in cash, cash equivalents and restricted cash and $9.9 million of net accounts receivable.             

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. The Company cannot provide assurances that it will be able to successfully enter into any such equity or debt financings or line of credit facility in the future or that the required capital would be available on acceptable terms, if at all, or that any such financing activity would not be dilutive to its stockholders.

 

 

NOTE 2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates

The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U. S. 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, goodwill and 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 2015 Form 10-K. Management believes that there have been no significant changes during the three and nine months ended September 30, 2016 in the Company’s critical accounting policies from those disclosed in Item 7 of the 2015 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.

Convertible Preferred Stock and Warrant Transaction

On August 8, 2016, 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 88,494 shares of its Preferred Stock and warrants to purchase up to an aggregate of 2,035,398 unregistered shares of its common stock at an exercise price of $2.00 per share. Each share of Preferred Stock converts automatically upon receipt of stockholder approval and was convertible into 100 shares of common stock, reflecting a conversion price equal to $1.13 per share, which is the closing price of the common stock quoted on the NASDAQ Capital Market on July 29, 2016. On September 30, 2016, the Company held a meeting of its shareholders and received requisite stockholder approval with respect to the issuance of 8,849,400 shares of common stock upon automatic conversion of the Preferred Stock and the issuance of common stock related exercise of the warrants by certain holders whose warrants were subject to a beneficial ownership limitation. In accordance with applicable accounting standards, the $10.0 million gross proceeds from sale were allocated to the convertible preferred stock and warrants in the amount of $8.9 million and $1.1 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. This transaction resulted in a beneficial conversion to common stock with a value of $1.1 million which has been reflected as a deemed distribution to preferred shareholders in the three and nine months ended September 30, 2016.

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 not to be applicable or are expected to have minimal impact on the Company’s consolidated financial position and results of operations.

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 U.S. 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 U.S. GAAP.

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 is currently evaluating the impact of the pending adoption of ASU 2014-09 on its consolidated financial statements and has not yet determined the method by which it will adopt the standard during the year ending December 31, 2018.

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In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern. The standard requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued and provides guidance on determining when and how to disclose going concern uncertainties in the financial statements. Certain disclosures will be required if conditions give rise to substantial doubt about an entity’s ability to continue as a going concern. ASU 2014-15 applies to all entities and is effective for annual and interim reporting periods ending after December 15, 2016, with early adoption permitted. The Company will follow this guidance beginning in fiscal 2017.

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 does not expect that the adoption of this standard will have a material effect on its financial statements. The Company will follow this guidance beginning in fiscal 2017.

In November 2015, FASB issued ASU 2015-17, Income Taxes (Topic 740).  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 will follow the guidance for fiscal year 2017. The Company does not expect that the adoption of this standard will have a material effect on its financial statements.

In February 2016, FASB issued ASU 2015-17, Leases. 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 the new standard on its 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. 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 will follow this guidance beginning in fiscal 2017. The Company is currently evaluating the impact of its pending adoption of the new standard 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.

 

 

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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 (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, 2016, a total of 15,550,000 shares have been authorized for issuance under the 2002 Plan, of which 3,557,000 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, 6,230,000 shares of BIOLASE common stock have been reserved for outstanding options and unvested RSUs, and 5,763,000 shares of BIOLASE common stock remain available for future grants.

The Company recognized stock-based compensation cost of $688,000 and $621,000, for the three months ended September 30, 2016 and 2015 respectively, and $2.5 million and $2.3 million, for the nine months ended September 30, 2016 and 2015 respectively, based on the grant-date fair value.  The net impact to earnings was $(0.01), and $(0.01) per basic and diluted share for the three months ended September 30, 2016 and 2015, respectively, and $(0.04) and $(0.04) per basic and diluted share for the nine months ended September 30, 2016 and 2015, respectively. At September 30, 2016, the Company had approximately $4.3 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 2.5 years.  

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

 

 

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

 

 

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A summary of option activity under the 2002 Plan for the nine months ended September 30, 2016 is as follows:

 

 

(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.

 

A summary of unvested stock option activity under the 2002 Plan for the nine months ended September 30, 2016 is as follows:

 

 

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.

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On February 26, 2016 in connection with the Company’s new 2016 compensation plan, the Compensation Committee of the Board of Directors (the “Board”), awarded to certain employees and consultants of the Company a total of 295,000 non-qualified stock options to purchase shares of BIOLASE common stock.  These awards were issued at $0.86 per share, the closing market price of the BIOLASE common stock on the grant date, and expire 10 years from the grant date.  Vesting periods for options are as follows: (i) 185,000 options, awarded to existing employees, vest ratably over a 48 month period, commencing one month from the grant date, and (ii) 110,000 options, awarded to new 2016 employees, vest 25% on the one-year anniversary of the grant date and the remainder ratably over the 36-month period, commencing 13 months after of the grant date.

On April 18, 2016, in connection with the hiring of the two new Vice Presidents, the Compensation Committee of the Board awarded 325,000 non-qualified stock options to purchase shares of BIOLASE common stock.  These awards were issued at $1.43 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 the options are as follows: (i) one-half of the total grant is subject to time vesting, with 25% vesting as of April 18, 2017 and the remaining 75% vesting ratably monthly over a thirty-six month period commencing on April 18, 2017, and (ii) one-half of the total grant is subject to specific 2016 and 2017 performance criteria, with vesting upon completion of the applicable performance criteria.

 

On May 6, 2016, non-employee directors of the Company were granted a total of 597,757 non-qualified stock options to purchase shares of BIOLASE common stock.  These awards were issued at $1.41 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 twelve month period, commencing on June 6, 2016.

On August 29, 2016, in connection with the hiring of a new Senior Director, the Compensation Committee of the Board awarded 60,000 non-qualified stock options to purchase shares of BIOLASE common stock.  This award was issued at $1.65 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) one-half of the total grant is subject to ratable time vesting over a forty-eight month period commencing on September 29, 2016, and (ii) one-half of the total grant is subject to specific 2017 performance criteria, with vesting upon completion of the applicable performance criteria.

On September 15, 2016, in connection with the hiring of a new Vice President, the Compensation Committee of the Board awarded 250,000 non-qualified stock options to purchase shares of BIOLASE common stock.  This award was issued at $1.78 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) one-half of the total grant is subject to time vesting with 25% vesting as of September 15, 2017 and the remaining 75% vesting ratably monthly over a thirty-six month period commencing on September 15, 2017, and (ii) one-half of the total grant is subject to specific 2017 and 2018 performance criteria, with vesting upon completion of the applicable performance criteria.

 

Restricted Stock Units

In accordance with the 2002 Plan, the Company approved restricted stock units (“RSUs”) to acquire shares of BIOLASE common stock as approved by the Board.  Effective February 26, 2016, the Compensation Committee of the Board issued the following awards:

Under the 2015 compensation plan, 388,500 RSUs were awarded to certain employees and consultants of the Company.  These awards were valued at $0.86 per share, the closing market price of BIOLASE common stock on the grant date, and fully vested on July 1, 2016.

Under the new 2016 compensation plan, 140,000 RSUs were awarded to certain employees and consultants of the Company.  These awards were valued at $0.86 per share, the closing market price of BIOLASE common stock on the grant date, and vest 25% on each of the first, second, third, and fourth anniversaries of the grant date.

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In connection with the President and Chief Executive Officer’s employment agreement, the maximum performance bonus was awarded, consisting of (i) $100,000 paid in cash during the nine months ended September 30, 2016, and (ii) 59,523 RSUs, valued at $0.86 per share, the closing market price of BIOLASE common stock on the grant date.  Half of these RSUs vested on March 30, 2016 and half of these RSUs will vest on February 18, 2017.  

On March 10, 2016, under the 2015 compensation plan, the Compensation Committee of the Board approved the grant of 70,000 RSUs to the Company’s Chief Financial Officer.  These awards were valued at $1.23 per share, the closing market price of BIOLASE common stock on the grant date, and fully vested on July 1, 2016.

 

On May 6, 2016, non-employee directors of the Company were granted a total 248,750 RSUs valued at $1.41 per share, the closing market price of BIOLASE common stock on the grant date.  These awards vest on May 6, 2017.

 

A summary of unvested RSU activity under the 2002 Plan for the nine months ended September 30, 2016 is as follows:

 

 

Warrants

The Company issues warrants as stock-based compensation to acquire shares of BIOLASE common stock as approved by the Board.  A summary of warrant activity for the nine months ended September 30, 2016 is as follows:

 

 

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.

 

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Outstanding stock options, restricted stock units and warrants to purchase approximately 17,636,000 shares (including approximately 2,035,000 shares underlying warrants issued in connection with the private placement completed by the Company on August 8, 2016) were not included in the calculation of diluted loss per share for the three and nine months ended September 30, 2016 as their effect would have been anti-dilutive.  For the same 2015 period, anti-dilutive outstanding stock options and warrants to purchase 15,536,000 shares were not included in the computation of diluted loss per share.

 

 

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 $2.1 million and $2.1 million as of September 30, 2016 and December 31, 2015, 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 $274,000 and $734,000 for the three and nine months ended September 30, 2016, respectively, and $251,000 and $540,000 for the three and nine months ended September 30, 2015, 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 $189,000 as of September 30, 2016.  For additional information on the capital lease, see Note 8 – Commitments and Contingencies.  

 

 

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NOTE 6—INTANGIBLE ASSETS AND GOODWILL

The Company conducted its annual impairment test of goodwill as of June 30, 2016 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, 2016 through the date of these consolidated financial statements that would trigger further impairment testing of the Company’s intangible assets and goodwill.

Amortization expenses for the three and nine months ended September 30, 2016 totaled $14,000 and $42,000, respectively, and $14,000 and $49,000, respectively, for the same periods in 2015. Other intangible assets primarily include acquired customer lists and non-compete agreements.

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, 2016 and 2015 are included within accrued liabilities on the Consolidated Balance Sheets and were as follows (in thousands):

 

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

 

 

In connection with the Company’s initiatives to measure and improve customer satisfaction and concurrent with the launch of WaterLase iPlus 2.0 in February 2015, the Company introduced its exclusive Practice Growth Guarantee, which is a program to assist with growth in the Company’s clients’ dental practices through training on a select number of clinical procedures and with billing and marketing support for dentists included. Consistent with the Company’s standard terms and conditions applicable to all of its products, the Practice Growth Guarantee does not give the customer the right to return purchased laser systems or receive a refund of any amount of the purchase price. However, the Practice Growth Guarantee does provide for additional training opportunities and certain billing and marketing support activities to the customer.  The Company has estimated and recorded additional deferred revenue related to the Practice Growth Guarantee for all WaterLase iPlus 2.0 system sales for the nine months ending September 30, 2016 and 2015 to be approximately $125,000 and $133,000, respectively.

 

 

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, for the years ending December 31, 2016 and 2017 are $29,000 and $160,000, respectively.  The current obligation with respect to the present value of net minimum lease payments of $169,000 is reflected in the Consolidated Balance Sheets classified as an accrued liability, and the remaining portion of the present value of net minimum lease payments is classified as a long-term obligation within capital lease obligations in the amount of $32,000, as of September 30, 2016.

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):  

 

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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 $1.8 million, in the aggregate, at September 30, 2016. The Company also has agreements with certain employees to pay bonuses based on targeted performance criteria. As of September 30, 2016, approximately $68,000 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, 2016, the Company had $19.1 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.

 

Class Action Lawsuits

On August 23, 2013, a purported class action lawsuit entitled Brady Adams v. Biolase, Inc., et al., Case No. 13-CV-1300 JST (FFMx), was filed in the United States District Court for the Central District of California against BIOLASE and its then Chief Executive Officer, Federico Pignatelli, and its then Chief Financial Officer, Frederick D. Furry. On August 26, 2013, a purported class action lawsuit entitled Ralph Divizio v. Biolase, Inc., et al., Case No. 13-CV-1317 DMG (MRWx), was filed in the same court against BIOLASE, Messrs. Pignatelli and Furry, and its then President and Chief Operating Officer, Alexander K. Arrow. Each of the lawsuits alleges violations of the federal securities laws and asserts causes of action against the defendants under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. In accordance with the Private Securities Litigation Reform Act of 1995, on December 10, 2013, the court entered an order consolidating the lawsuits, appointing a lead plaintiff, and approving the lead plaintiff’s selection of lead counsel. On February 24, 2014, the lead plaintiff filed a consolidated complaint against the Company and Messrs. Pignatelli, Furry, and Arrow, alleging violations of the federal securities laws and asserting causes of action against the defendants under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934.

On June 5, 2015, the United States District Court for the Central District of California approved, on a preliminary basis, the settlement of the consolidated securities class action lawsuit. The hearing on the final approval of the settlement was held on October 9, 2015, and the court entered final judgment and ordered the case dismissed on October 30, 2015.

On February 24, 2016, a purported class action lawsuit entitled Dr. Charles Shulruff v. Biolase, Inc., Case No. 1:16-cv-02533, was filed in the United States District Court for the Northern District of Illinois.  The case alleges that the Company violated the federal Telephone Consumer Protection Act (TCPA) and other related Illinois state statutes, by sending unsolicited marketing communications via fax machine to a Chicago dentist, Dr. Shulruff.  The plaintiff and his counsel seek to certify a nation-wide class of comprised of other dentists who received the same or similar faxes from BIOLASE.  BIOLASE responded to the case on April 14, 2016 and denied liability on all claims.  BIOLASE also denies that class certification is appropriate.  The case is in the early stages of discovery and no substantive motion practice has been conducted by either side at this time.

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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. The Company is awaiting the scheduling of the oral argument on the appeal, which oral argument is expected to take place before the end of 2016.

The Company filed a patent infringement lawsuit against Fotona dd. (“Fotona”) in Düsseldorf District Court (the “Düsseldorf Court”) on April 12, 2012 alleging infringement with respect to the Fotona Fidelis dental laser system. Fotona has denied liability and sought 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. Fotona filed a rejoinder on February 3, 2014, including its counterplea on nullity.

On April 29, 2014, the Düsseldorf Court rendered a first instance decision whereby Fotona must cease and desist from selling its Fidelis and Lightwalker dental laser systems, render accounts on past sales, recall respective products, and pay damages on infringement. Additionally, the Company was awarded statutory fees, court costs, and attorneys’ fees.  In Germany, damages can be calculated based on the profits made by the infringer after the formal announcement of the granting of a patent, in this case beginning January 1, 2009, without considering direct labor or any other operational costs. This could amount to several million euros. In the two additional first instance cases following the extension of the initial lawsuit against Fotona, the Düsseldorf Court also required the Company to provide a statutory bond totaling €146,000. Such bonds are traditionally imposed on foreign plaintiffs to cover all statutory, court, and attorneys’ fees.  Fotona submitted its responses to the action and filed respective invalidation actions against the rights of the Company.  

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Subsequent to the foregoing responses, on March 24, 2015 the parties reached an agreement to settle the foregoing litigation and to dismiss the litigation with prejudice.  As part of the settlement, Fotona agreed to pay the Company a total of $1.4 million, with $550,000 payable within 10 days of March 24, 2015 and the remaining, $825,000 payable in three increments of $275,000 each to be paid no later than the first, second, and third anniversary of the effective date of the agreement. Pursuant to the settlement agreement, the Company (i) granted Fotona a three-year, non-exclusive, paid-up license in the United States market and a five-year, non-exclusive, paid-up license in markets outside of the United States and (ii) agreed to grant Fotona a non-exclusive, royalty-based license following the expiration of the paid-up licenses.  The Company calculated the present value of the settlement amount to be $1.2 million and allocated such amount to each significant element of the settlement on a relative fair value basis. $731,000 and $68,000 were allocated towards the recovery of the Company’s legal expenses and as settlement for the dismissal of the patent infringement lawsuit and are reflected as legal settlement and license fees and royalty revenue, respectively, on the Consolidated Statements of Operations and Comprehensive Loss. The remaining amount of $379,000 was allocated towards the three-year, non-exclusive, paid-up license in the United States market and the five-year, non-exclusive, paid-up license in markets outside of the United States which was reflected within other assets and long-term deferred revenue on the Consolidated Balance Sheets.  The deferred revenue is being recognized as license revenue over the terms of the paid-up licenses.  

 

 

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, 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.  For the three and nine months ended September 30, 2015, sales in the United States accounted for approximately 59% and 59% of net revenue, respectively, and international sales accounted for approximately 41% and 41% 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, 2016 or 2015.

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

 

 

Long-lived assets by geographic location was as follows (in thousands):

 

 

 

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NOTE 10—CONCENTRATIONS

Revenue from the Company’s products for the three and nine months ended September 30, 2016 and 2015 are as follows:  

 

 

No individual customer represented more than 10% of the Company’s revenue for the three and nine months ended September 30, 2016 or 2015.

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.

No individual customer represented more than 10% of the Company’s accounts receivable at September 30, 2016 or December 31, 2015.  

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 business, results of operations, and financial condition.

 

 

NOTE 11—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. Based on the Company’s net losses in prior years, management has determined that a full valuation allowance against the Company’s net deferred tax assets is appropriate.

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 de-recognition, 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 did not record a liability for unrecognized tax benefits for the three and nine months ended September 30, 2016 and 2015. The Company does not expect any changes to its unrecognized tax benefit for the next twelve months that would materially impact its consolidated financial statements.

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During the three and nine months ended September 30, 2016, the Company recorded an income tax provision of $40,000 and $117,000, respectively, resulting in an effective tax rate of (1.3)% and (1.1)%, respectively. During the three and nine months ended September 30, 2015, the Company recorded an income tax provision of $44,000 and $127,000, respectively, resulting in an effective tax rate of (0.8)% and (0.7)%, respectively. The income tax provisions for the three and nine months ended September 30, 2016 and 2015 were calculated using the discrete year-to-date method. The effective tax rate differs from the statutory tax 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 foreign tax liability.

 

 

NOTE 12—SUBSEQUENT EVENT

On October 3, 2016, in connection with the employment of a new Vice President of Clinical and Dental Affairs and Chief Dental Officer, the Compensation Committee of the Board awarded 125,000 non-qualified stock options to purchase shares of BIOLASE common stock.  This award was issued at $1.72 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) one-half of the total grant is subject to time vesting with 25% vesting as of October 3, 2017 and the remaining 75% vesting ratably monthly over a thirty-six month period commencing on October 3, 2017, and (ii) one-half of the total grant is subject to specific 2017, 2018 and 2019 performance criteria. For additional information regarding stock-based compensation, see Part I, Item I, Note 3 – Stock-Based Awards and Per Share Information.

 

 

 

 

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The following information should be read in conjunction with the unaudited consolidated financial statements and related notes of BIOLASE, Inc. (“BIOLASE”) and its consolidated subsidiaries (together with BIOLASE, the “Company,” “we,” “our,” or “us”) included elsewhere in this Quarterly Report on Form 10-Q (this “Form 10-Q”) and our audited consolidated financial statements and related notes included in the Annual Report on Form 10-K for the year ended December 31, 2015 filed with the Securities and Exchange Commission (the “SEC”) on March 11, 2016 (the “2015 Form 10-K”).  In addition to historical information, this discussion and analysis contains “forward-looking statements” as defined in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Such forward-looking statements include any statements, predictions, or expectations regarding our plans to expand product line, operating expenses, anticipated cash needs, needs for additional financing, use of working capital, anticipated trends and challenges in our business and the markets in which we operate, plans to explore potential collaborations, effects of engineering and development efforts, critical accounting policies, the impact of recent accounting pronouncements, recording tax benefits or other financial items in the future, plans, strategies, expectations or objectives of management for future operations, our financial condition or prospects, and any other statement that is not historical fact. Forward-looking statements are identified by the use of words such as “may,” “might,” “will,” “intend,” “should,” “could,” “can,” “would,” “continue,” “expect,” “believe,” “anticipate,” “estimate,” “predict,” “potential,” “plan,” “seek,” and similar expressions and variations or the negativities of these terms or other comparable terminology.

The forward-looking statements contained in this Item 2 are based on the expectations, estimates, projections, beliefs, and assumptions of our management based on information available to management as of the date on which this Form 10-Q was filed with the SEC, all of which are subject to change. Forward-looking statements are subject to risks, uncertainties, and other factors that are difficult to predict and could cause actual results to differ materially from those stated or implied by our forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to:

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Further information about factors that could materially affect the Company, including our results of operations and financial condition, is contained under “Risk Factors” in Item 1A in the 2015 Form 10-K. Except as required by law, we undertake no obligation to revise or update any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events, new information or changes to future results over time or otherwise.

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Overview

We are 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 CAD/CAM intra-oral scanners, in-office, and chair-side milling machines. Our products advance the practice of dentistry and medicine for patients and health care professionals. Our proprietary dental laser systems allow dentists, periodontists, endodontists, oral surgeons, and other dental specialists to perform a broad range of minimally invasive dental procedures, including cosmetic, restorative, and complex surgical applications. Our laser systems are designed to provide clinically superior results for many types of dental procedures compared to those achieved with drills, scalpels, and other conventional instruments, in most cases without the need for local or general anesthesia. We have clearance from the FDA to market and sell our laser systems in the United States and also have the necessary registrations to market and sell our laser systems in Canada, the European Union, and many other countries outside the U.S. Additionally, our in-licensed imaging equipment and related products improve diagnoses, applications, and procedures in dentistry and medicine.

We offer two categories of laser system products: WaterLase (all-tissue) systems and Diode (soft tissue) systems. Our flagship brand, WaterLase, uses a patented combination of water and laser energy to perform most procedures currently performed using drills, scalpels, and other traditional dental instruments for cutting soft and hard tissue. We also offer our Diode laser systems to perform soft tissue, pain therapy, and cosmetic procedures, including teeth whitening. We have approximately 255 issued and 90 pending U.S. and international patents, the majority of which are related to WaterLase technology. From 1998 through September 30, 2016, we sold approximately 32,800 laser systems in over 90 countries around the world. Contained in this total are approximately 11,700 WaterLase systems, including approximately 7,700 WaterLase MD and WaterLase iPlus systems. We were originally formed as Societe Endo Technic, SA (“SET”) in 1984 in Marseilles, France, to develop and market various endodontic and laser products. In 1987, SET merged into Pamplona Capital Corp., a public holding company incorporated in Delaware. In 1994, we changed our name to BIOLASE Technology, Inc., and in 2012, we changed our name to BIOLASE, Inc.  Since 1998, we have been the global leading innovator, manufacturer, and marketer of dental laser systems.

Business and Outlook

Our WaterLase systems precisely cut hard tissue, bone, and soft tissue with minimal or no damage to surrounding tissue and dental structures. Our Diode systems, which include the EPIC system, are designed to complement our WaterLase systems, and are used only in soft tissue procedures, pain therapy, hygiene, and cosmetic applications, including teeth whitening. The Diode systems, together with our WaterLase systems, offer practitioners a broad product line with a range of features and price points.

We also manufacture and sell consumable products and accessories for our laser systems. Our WaterLase and Diode systems use disposable laser tips of differing sizes and shapes depending on the procedure being performed. We also market flexible fibers and hand pieces that dental practitioners replace at some point after initially purchasing laser systems. For our EPIC systems, we sell teeth whitening gel kits.

Due to the limitations associated with traditional and alternative dental instruments, we believe there is a large market opportunity for all-tissue dental laser systems that provide superior clinical outcomes, reduce the need to use anesthesia, help reduce trauma, pain, and discomfort associated with dental procedures, and increase patient acceptance for treatment protocols. We also believe there is a large market opportunity for digital radiography systems that improve practice efficiency and accuracy of diagnosis, leading to superior treatment planning, increased practice revenue, and healthier outcomes for patients.

Our strategy is to increase awareness and demand for (i) our products among dental practitioners by educating dental practitioners and patients about the clinical benefits of our product suite and (ii) our laser systems among patients by educating patients about the clinical benefits of the WaterLase and Diode systems. An important goal of ours is to increase consumables revenue by selling more single-use accessories used by dental practitioners when performing procedures using our dental laser systems. In the short term, we are striving for operating excellence through lean enterprise initiatives, with a specific focus on our sales strategy and cash flow management, coupled with optimizing our engineering capabilities to develop innovative new products.

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We also seek to create value through innovation and leveraging existing technologies into adjacent medical applications. We plan to expand our product line and clinical applications by developing enhancements and transformational innovations, including new clinical solutions for dental applications and for other adjacent medical applications. In particular, we believe that our existing technologies can provide significant improvements over existing standards of care in fields including ophthalmology, otolaryngology, orthopedics, podiatry, pain management, aesthetics/dermatology, veterinary, and consumer products. We plan to continue to explore potential collaborations to bring our proprietary laser technologies with expanded FDA-cleared indications for other medical applications in the future.    

Recent Developments

New Leadership Additions

Throughout 2016 and to date, we have made strategic personnel additions to our senior management team, including a Vice President and Managing Director for Europe, the Middle East and Africa, a Vice President of Clinical and Dental Affairs and Chief Dental Officer, and a Vice President of Marketing to lead our international sales, educational dental and clinical matters, and marketing efforts, respectively. We have also added a new Vice President of Human Resources at our headquarters in Irvine, California to support our key initiatives. With a solid senior management team, we are better suited to achieve our goals of strengthening our worldwide market presence, sales, and competitiveness.

Private Placement

On August 8, 2016, we completed a private placement with several institutional and individual investors, and certain of our directors and officers, under which we sold an aggregate of 88,494 shares of our Preferred Stock and warrants to purchase up to an aggregate of 2,035,398 unregistered shares of our common stock at an exercise price of $2.00 per share. Each share of Preferred Stock was automatically upon receipt of stockholder approval convertible into 100 shares of common stock, reflecting a conversion price equal to $1.13 per share, which was the closing price of the common stock quoted on the NASDAQ Capital Market on July 29, 2016. On September 30, 2016, we held a meeting of our shareholders and received requisite stockholder approval with respect to the issuance of 8,849,400 shares of common stock upon automatic conversion of the Preferred Stock and the issuance of common stock related to exercise of the warrants by certain holders whose warrants were subject to a beneficial ownership limitation. Gross proceeds from the sale were $10.0 million, and net proceeds, after offering expenses of approximately $0.5 million, were approximately $9.5 million. The warrants become exercisable on February 8, 2017, six months after the closing of the private placement, and have a term of five years from the date of issuance. We are using the proceeds of the sale for working capital and general corporate purposes. In connection with the registration rights granted to these investors, we filed a registration statement on Form S-3 with the SEC, which was declared effective on November 3, 2016.

Critical Accounting Policies

The unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and revenues and expenses reported during the period. Information with respect to our critical accounting policies that we believe could have the most significant effect on our 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 2015 Form 10-K. There have been no significant changes during the nine months ended September 30, 2016 in our critical accounting policies from those disclosed in Item 7 of the 2015 Form 10-K.

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Results of Operations

The following table sets forth certain data from our unaudited consolidated statements of operations expressed as percentages of net revenue:

 

 

Non-GAAP Disclosure

In addition to the financial information prepared in conformity with GAAP, we provide certain historical non-GAAP financial information. Management believes that these non-GAAP financial measures assist investors in making comparisons of period-to-period operating results and that, in some respects, these non-GAAP financial measures are more indicative of the Company’s ongoing core operating performance than their GAAP equivalents.

Management believes that the presentation of this non-GAAP financial information provides investors with greater transparency and facilitates comparison of operating results across a broad spectrum of companies with varying capital structures, compensation strategies, derivative instruments, and amortization methods, which provides a more complete understanding of our financial performance, competitive position, and prospects for the future. However, the non-GAAP financial measures presented in this Form 10-Q have certain limitations in that they do not reflect all of the costs associated with the operations of our business as determined in accordance with GAAP. Therefore, investors should consider non-GAAP financial measures in addition to, and not as a substitute for, or as superior to, measures of financial performance prepared in accordance with GAAP. Further, the non-GAAP financial measures presented by the Company may be different from similarly named non-GAAP financial measures used by other companies.

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Non-GAAP Net Loss

Management uses non-GAAP net loss (defined as net loss before interest, taxes, depreciation and amortization and stock-based compensation) in its evaluation of the Company’s core results of operations and trends between fiscal periods and believes that these measures are important components of its internal performance measurement process. Management believes that this non-GAAP financial information reflects an additional way of viewing aspects of our business that, when viewed with our GAAP results, provides a more complete understanding of factors and trends affecting our business. The following table contains a reconciliation of non-GAAP net loss to GAAP net loss attributable to common shareholders (in thousands).

 

 

Comparison of Results of Operations

Three months ended September 30, 2016 and 2015

Net Revenue: The following table summarizes our net revenues by category, including each category’s percentage of our total revenue, for the three months ended September 30, 2016 (“Third Quarter 2016”) and the three months ended September 30, 2015 (“Third Quarter 2015”), as well as the amount of change and percentage of change in each revenue category (dollars in thousands):

 

 

Typically, we experience fluctuations in revenue from quarter to quarter due to seasonality. Revenue in the first quarter typically is lower than average and revenue in the fourth quarter typically is stronger than average due to the buying patterns of dental practitioners. We believe that this trend exists because a significant number of dentists purchase their capital equipment towards the end of the calendar year in order to maximize their practice earnings while seeking to minimize their taxes. They often use certain tax incentives, such as accelerated depreciation methods for purchasing capital equipment, as part of their year-end tax planning. In addition, revenue in the third quarter may be affected by vacation patterns which can cause revenue to be flat or lower than in the second quarter of the year. Our historical seasonal fluctuations may also be impacted by sales promotions used by large dental distributors that encourage end-of-quarter and end-of-year buying in our industry.

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Total revenue by geographic location based on the location of customers for the three months ended September 30, 2016 and 2015, as well as the amount of change and percentage of change in each geographic revenue category, were as follows (dollars in thousands):

 

 

The overall increase in quarter-over-quarter net revenue resulted primarily from laser systems sales, which increased by $2.2 million, or 30%, in the Third Quarter 2016 compared to the Third Quarter 2015. Sales of our core laser products improved 60% domestically and 1% internationally, largely resulting from the continued realization associated with changes to our sales cycle that were implemented late in 2015.  The increase in quarter-over-quarter net revenue also resulted from increases in consumables and other revenue, which consists of consumable products such as disposable tips, and services revenue, which consists of extended warranty service contracts, advanced training programs, and other services. Consumables and other revenue and services revenue increased by $161,000 and $33,000, respectively, or 11% and 2%, respectively, in the Third Quarter 2016 compared to the Third Quarter 2015.  

Partially offsetting the increased laser systems, consumables and other, and services revenue were decreases in domestic and international imaging systems revenue of $371,000, or 52%, and domestic license fees and royalty revenue of $4,000, or 12%, during the Third Quarter 2016 compared to the Third Quarter 2015.

Cost of Revenue and Gross Profit: The following table summarizes our cost of revenue and gross profit for the Third Quarter 2016 and the Third Quarter 2015, as well as the amount of change and percentage of change (dollars in thousands):  

 

 

Gross profit as a percentage of revenue typically fluctuates with product and regional mix, selling prices, product costs and revenue levels. The 66% improvement in gross profit as a percentage of revenue for the Third Quarter 2016, as compared to Third Quarter 2015, reflected a larger mix of domestic laser sales, specifically the WaterLase iPlus, which typically have higher product margins due to higher pricing.

Operating Expenses: The following table summarizes our operating expenses as a percentage of net revenue for the three months ended September 30, 2016 and 2015, as well as the amount of change and percentage of change (dollars in thousands):

 

 

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The quarter-over-quarter total operating expenses is explained in the following expense categories:

Sales and Marketing Expense. Sales and marketing expenses in the Third Quarter 2016 compared to the Third Quarter 2015 increased by $221,000, or 6%, primarily due to increases in commissions of $177,000, supplies expense of $120,000, stock-based compensation expense of $130,000 and convention related expenses of $60,000, partially offset by decreases in payroll and consulting related expenses of $179,000 and media, advertising, and printing expenses of $138,000. The increase in commissions resulted from increased sales of our products quarter-over-quarter. The increase in stock-based compensation resulted from grants to existing and new employees. The decrease in payroll and consulting-related expenses was primarily attributable to the corporate organizational and restructuring activities implemented during September 2015 (the “September 2015 Corporate Restructure”), where we streamlined operations and reduced payroll, payroll-related and consulting-related expenses. As we have continued in 2016, we have maintained our focus on (i) enhancing customer acquisition, retention, and global brand awareness, and (ii) rebuilding our sales and marketing team domestically and internationally.  In striving to transform and maintain revenue growth, we expect sales and marketing expenses to continue decreasing as a percentage of revenue for the remainder of 2016.

General and Administrative Expense. General and administrative expenses in the Third Quarter 2016 compared to the Third Quarter 2015 decreased by $82,000, or 3%, primarily due to a $160,000 decrease in payroll and consulting-related expenses originating from the September 2015 Corporate Restructure and a $72,000 decrease in stock-based compensation expense, partially offset by a $162,000 increase in patent expenses resulting from efforts to protect our intellectual property. We expect general and administrative expenses to remain consistent as a percentage of revenue through the remainder of 2016.

Engineering and Development Expense. Engineering and development expenses in the Third Quarter 2016 compared to the Third Quarter 2015 decreased by $41,000, or 2%, primarily due to a $141,000 decrease in operating supplies, partially offset by a $86,000 increase in payroll and consulting related expenses and a $25,000 increase in stock-based compensation expense.  We expect to increase our investment in engineering and development activity as we continue our efforts on new product development for the remainder of 2016.

Excise Tax Expense. Beginning in 2013, the Affordable Care Act imposed a 2.3% medical device excise tax on certain product sales to customers located in the U.S.  Excise tax expenses for the Third Quarter 2016 was $0, compared to $78,000, or 0.7% of net revenue, for the Third Quarter 2015. The decrease of $78,000 was directly associated with the Protecting Americans from Tax Hikes Act of 2015 (the “PATH Act”), which suspended the medical device excise tax for calendar years 2016 and 2017.  Due to the PATH Act, we do not anticipate any excise tax expenses on our products during the remainder of 2016.

Gain (Loss) on Foreign Currency Transactions. We realized a $24,000 gain on foreign currency transactions during the Third Quarter 2016, compared to a $32,000 gain on foreign currency transactions during the Third Quarter 2015 due to exchange rate fluctuations between the U.S. dollar and other currencies, primarily the Euro.  

Interest Income, Net.  Interest income during the Third Quarter 2016 represented interest recognized from the discounted present value of the settlement in connection with the patent infringement lawsuit against Fotona Proizvodnja Optoelektronskih Naprav D.D. and Fotona LLC (collectively, “Fotona”) that we filed in Düsseldorf District Court in April 2012 alleging infringement with respect to the Fotona Fidelis dental laser system (the “Fotona Litigation”). Interest income, net totaled $18,000 for Third Quarter 2016, as compared to $21,000 for Third Quarter 2015.

Income Tax Provision. We use a discrete year-to-date method in calculating quarterly provision for income taxes. Our provision for income taxes was $40,000 for Third Quarter 2016, compared to a provision of $44,000 for Third Quarter 2015. The decrease of $4,000, or 9%, in income tax provision was primarily due to a $24,000 decrease in net foreign profit during the Third Quarter 2016 as compared to the Third Quarter 2015.  For additional information regarding income taxes, see Part I, Item I, Note 11 – Income Taxes.

Net Loss. Our net loss totaled approximately $3.1 million for the Third Quarter 2016 compared to a net loss of $5.3 million for the Third Quarter 2015. The $2.2 million, or 42%, decrease in net loss was due to overall business improvements including a $2.0 million increase in net revenue and a $229,000, or 3%, reduction in cost of revenue.  

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Nine months ended September 30, 2016 and 2015

Net Revenue: The following table summarizes our net revenues by category, including each category’s percentage of our total revenue, for the nine months ended September 30, 2016 (“YTD September 2016”) and the nine months ended September 30, 2015 (“YTD September 2015”), as well as the amount of change and percentage of change in each revenue category (dollars in thousands):

 

 

Total revenue by geographic location based on the location of customers for the nine months ended September 30, 2016 and 2015, as well as the amount of change and percentage of change in each geographic revenue category, were as follows (dollars in thousands):

 

 

The overall increase in period-over-period net revenue resulted primarily from laser systems sales, which increased by $4.0 million, or 18%, for YTD September 2016 compared to YTD September 2015.  The laser systems sales increase was driven by a 36% domestic improvement and a 1% international improvement.  Imaging systems revenue increased by $134,000, or 8%, for YTD September 2016 compared to YTD September 2015, which was primarily driven by a 19% improvement in domestic imaging system sales period-over-period. Services revenue, which consists of extended warranty service contracts, advanced training programs, and other services, increased by $131,000, or 3%, period-over-period.

Partially offsetting the increased laser systems, imaging systems, and services revenue was a decrease in consumables and other revenue of $134,000, or 3%, and in domestic license fees and royalty revenue of $56,000 or 33% during YTD September 2016 compared to YTD September 2015, due to our patent infringement lawsuit settlement during the first half of 2015.

Cost of Revenue and Gross Profit: The following table summarizes our cost of revenue and gross profit for the nine months ended September 30, 2016 and 2015, as well as the amount of change and percentage of change (dollars in thousands):  

 

 

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Gross profit as a percentage of revenue typically fluctuates with product and regional mix, selling prices, product costs and revenue levels. The 45% improvement in gross profit as a percentage of revenue for YTD September 2016 compared to YTD September 2015 was due to a larger mix of domestic laser sales, specifically the WaterLase iPlus, which typically have higher product margins due to higher pricing.

Operating Expenses: The following table summarizes our operating expenses as a percentage of net revenue for the nine months ended September 30, 2016 and 2015, as well as the amount of change and percentage of change (dollars in thousands):

 

 

The $2.2 million or 8% overall decrease in period-over-period operating expenses is explained in the following expense categories:

Sales and Marketing Expense. Sales and marketing expenses for YTD September 2016 compared to YTD September 2015 decreased by $984,000, or 7%, primarily due to a $724,000 decrease in payroll and consulting-related expenses originating from the September 2015 Corporate Restructure and a $657,000 decrease in media, advertising, and printing expenses, partially offset by a $203,000 increase in commissions resulting from year-over-year increased sales of our products and a $86,000 increase in licensing fees. The overall decrease in sales and marketing expenses was expected following the September 2015 Corporate Restructure.  The Company plans to continue to focus on (i) enhancing customer acquisition, retention, and global brand awareness, and (ii) rebuilding our sales and marketing team domestically and internationally.  In striving to transform and maintain revenue growth, we expect sales and marketing expenses to continue decreasing as a percentage of revenue for the remainder of 2016.

General and Administrative Expense. General and administrative expenses for YTD September 2016 compared to YTD September 2015 decreased by $1.7 million, or 18%, primarily due to a $719,000 decrease in payroll and consulting related expenses, a $313,000 decrease in patent and legal expenses, a $387,000 decrease in provision for doubtful accounts, and a $158,000 decrease in investor relations expense.  The decline in payroll and consulting related expenses is primarily due to the September 2015 Corporate Restructure and severance and recruiting expenses related to the change in CEO and CFO for YTD September 2015.  The decrease in patent and legal expenses resulted from the settlement of our patent infringement lawsuit during YTD September 2015.  The decrease in provision for doubtful accounts is due to our improvement in the collection process of receivables. We expect general and administrative expenses to remain consistent as a percentage of revenue through the remainder of 2016.

Engineering and Development Expense. Engineering and development expenses for YTD September 2016 compared to YTD September 2015 decreased by $32,000, or 1%, primarily due to a $273,000 decrease in operating supplies, partially offset by a $99,000 increase in payroll and consulting related expenses and a $62,000 increase in stock-based compensation expense. As we continue to focus our efforts to accelerate innovation of both our existing products and technologies as well as to develop new products and technologies that we believe will further strengthen our worldwide leadership position, we expect to increase our investment in engineering and development activity for the remainder of 2016.

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Excise Tax Expense. Beginning in 2013, the Affordable Care Act imposed a 2.3% medical device excise tax on certain product sales to customers located in the U.S.  Excise tax expenses for YTD September 2016 was $0, compared to $231,000, or 0.7% of net revenue, for YTD September 2015. The decrease of $231,000 was directly associated with the Protecting Americans from Tax Hikes Act of 2015 (the “PATH Act”), which suspended the medical device excise tax for calendar years 2016 and 2017.  Due to the PATH Act, we do not anticipate any excise tax expenses on our products during the remainder of 2016.

Legal Settlement. On March 24, 2015, we entered into a settlement agreement with Fotona in the Fotona Litigation, at which time we recorded a $731,000 credit toward the recovery of our legal expenses. For a more detailed discussion of the intellectual property litigation, see Part I, Item I, Note 8 – Commitments and Contingencies.

Gain (Loss) on Foreign Currency Transactions. We realized a $30,000 loss on foreign currency transactions during YTD September 2016, compared to a $97,000 loss on foreign currency transactions during YTD September 2015 due to exchange rate fluctuations between the U.S. dollar and other currencies, primarily the Euro.  

Interest Income, Net.  Interest income during YTD September 2016 represented interest recognized from the discounted present value of the settlement in connection with the Fotona Litigation. Interest income, net totaled $51,000 for YTD September 2016, as compared to $44,000 for YTD September 2015.   

Income Tax Provision. We use a discrete year-to-date method in calculating YTD quarterly provision for income taxes. Our provision for income taxes was $117,000 for YTD September 2016, compared to a provision of $127,000 for YTD September 2015. The decrease of $10,000, or 8%, in income tax provision was primarily due to a $62,000 decrease in net foreign profit during YTD September 2016 as compared to YTD September 2015.  For additional information regarding income taxes, see Part I, Item I, Note 11 – Income Taxes.

Net Loss. Our net loss totaled approximately $10.9 million for YTD September 2016 compared to a net loss of $17.8 million for YTD September 2015. The $6.9 million or 39% decrease in net loss was due to overall business improvements including a $4.1 million increase in net revenue, a $522,000 reduction in cost of revenue, and a $2.2 million decrease in operating expenses.

Liquidity and Capital Resources

At September 30, 2016, the Company had approximately $12.9 million in cash and cash equivalents, including restricted cash equivalents. Management defines cash and cash equivalents as highly liquid deposits with original maturities of 90 days or less when purchased. The increase in our cash and cash equivalents of $1.0 million at September 30, 2016 as compared to December 31, 2015, was primarily due to cash used in operating and investing activities of $7.5 million and $1.1 million, respectively, offset by cash provided by financing activities of $9.4 million and the effect of exchange rates on cash of $60,000.  The $7.5 million of net cash used in operating activities was primarily driven by the Company’s net loss of $10.9 million for YTD September 2016.  

The following table summarizes our change in cash and cash equivalents (in thousands):

 

 

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Operating Activities

Net cash used in operating activities consists of our net loss, adjusted for our non-cash charges, plus or minus working capital changes. Cash used in operating activities for YTD September 2016, totaled $7.5 million and was primarily comprised of our net loss of $10.9 million, partially offset by non-cash adjustments for stock-based compensation expenses of $2.5 million and depreciation and amortization expenses of $776,000.  The $326,000 net increase in our operating assets and liabilities was primarily due to an increase in accounts payable and accrued liabilities of $2.1 million related to the timing of our payments and a decrease in prepaid expenses and other current assets of $688,000, partially offset by an increase in restricted cash of $51,000, an increase in accounts receivable of $863,000 related to the timing of our collections, an increase in inventory of $1.4 million, a decrease in deferred revenue of $202,000 resulting from less deferred services revenue and a decrease in customer deposits of $7,000.

Investing Activities

Cash used in investing activities for YTD September 2016 consisted of $1.1 million of capital expenditures. The period-over-period decrease was primarily due to YTD September 2015 capital expenditures of information technology equipment and the commencement of a new enterprise resource planning system implementation, partially offset by construction in progress purchases during YTD September 2016.

Financing Activities

Net cash provided by financing activities for YTD September 2016 of $9.4 million resulted from proceeds received from our equity offering in August 2016, net of expenses of $9.5 million, partially offset by payments on our capital lease obligations of $143,000.

Effect of Exchange Rate

The $60,000 effect of exchange rate on cash for YTD September 2016 was primarily due to a recognized gain on foreign currency transactions due to a stronger Euro compared to the YTD September 2015.

Future Liquidity Needs

As of September 30, 2016, the Company had working capital of approximately $20.8 million. Our principal sources of liquidity as of September 30, 2016 consisted of approximately $12.9 million in cash, cash equivalents and restricted cash and $9.9 million of net accounts receivable.           

In order for us to continue operations beyond the next 12 months and be able to discharge our liabilities and commitments in the normal course of business, we must increase sales of our products directly to end-users and through distributors, establish profitable operations through the combination of increased sales and decreased expenses, and generate cash from operations or obtain additional funds when needed. We intend to improve our financial condition and ultimately improve our financial results by increasing revenues through expansion of our product offerings, continuing to expand and develop our fields sales force and distribution relationships both domestically and internationally, forming strategic arrangements within the dental and medical industries, educating dental and medical patients as to the benefits of our advanced medical technologies, and reducing expenses.  Additional capital requirements may depend on many factors, including, among other things, continued losses, the rate at which our business grows, demands for working capital, manufacturing capacity, and any acquisitions that we may pursue. From time to time, we could be required, or may otherwise attempt, to raise capital, through either equity or debt offerings, or enter into a line of credit facility. We cannot provide assurance that we will be able to successfully enter into any such equity or debt financings or line of credit facility in the future or 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.

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Recent Accounting Pronouncements

For a description of recently issued and adopted accounting pronouncements, including the respective dates of adoption and expected effects on our results of operations and financial condition, please refer to Part I, Item 1, Note 2 – Summary of Significant Accounting Policies, which is incorporated herein by this reference.

Additional Information

BIOLASE^®, ZipTip^®, ezlase^®, eztips^®, MD Flow^®, ComfortPulse^®, WaterLase^®, iLase^®, iPlus^®, WCLI^®, World Clinical Laser Institute^®, WaterLase MD^®, WaterLase Dentistry^®, Proprietary MD^®, and EZLase It’s So Easy^® are registered trademarks of BIOLASE, and Diolase™, HydroPhotonics™, LaserPal™, HydroBeam™, Occulase™, Diolase 10™, Body Contour™, Radial Firing Perio Tips™, Deep Pocket Therapy with New Attachment™, 2R™ , Comfortprep^™ , Rapidprep^™ , Bondprep^™ , Occulase iPlus™, Flavorflow™, Occulase MD™, Epic Laser™, Epic™, Dermalase™, Deltalaser™, Delta™, iStarlaser™, iStar™, Biolase DaVinci Imaging™, Oculase™, WaterLase MDX™, Total Technology Solution™, Geyserlaser™, Geyser™, eplus™, elase™, and Galaxy BioMill™ are trademarks of BIOLASE. All other product and company names are registered trademarks or trademarks of their respective owners.

 

 

 

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There have been no material changes in the information disclosed in Part II, Item 7a “Quantitative and Qualitative Disclosures about Market Risk” in the 2015 Form 10-K.

Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this report (the “Evaluation Date”). Based on this evaluation, our principal executive officer and principal financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the information relating to the Company, including our consolidated subsidiaries, required to be disclosed in our SEC reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company’s management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during our most recently completed fiscal quarter. Based on that evaluation, our principal executive officer and principal financial officer concluded that there has not been any change in our internal control over financial reporting during the quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

For a description of our legal proceedings, please refer to Part I, Item 1, Note 8 – Commitments and Contingencies, which is incorporated herein by reference in response to this Item.

There have been no material changes to the risk factors as disclosed in Part I, Item 1A “Risk Factors” in the 2015 Form 10-K.

 

 

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: November 8, 2016

 

 

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