Summary of BIOLASE TECHNOLOGY INC

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q 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, which involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause the results of Biolase Technology, Inc. (the "Company," "we", "us" or "our" ) to differ materially and adversely from those expressed or implied by such forward-looking statements. Such forward-looking statements include any statements, predictions and expectations regarding our earnings, revenue, sales and operations, operating expenses, anticipated cash needs, capital requirements and capital expenditures, needs for additional financing, use of working capital, plans for future products and services and for enhancements of existing products and services, anticipated growth strategies, ability to attract customers, sources of net revenue, anticipated trends and challenges in our business and the markets in which we operate, the adequacy of our facilities, the impact of economic and industry conditions on our customers and our business, customer demand, our competitive position, the outcome of any litigation against us, the perceived benefits of any technology acquisitions, critical accounting policies, the impact of recent accounting pronouncements, statements pertaining to financial items, 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 often 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. These forward-looking statements are based on the beliefs and assumptions of our management based upon information currently available to management. Such forward looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially and adversely from future results expressed or implied such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified under "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2010 (the "2010 Form 10-K") filed with the Securities and Exchange Commission (the "SEC"). Such forward-looking statements speak only as of the date of this report. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements for any reason except as otherwise required by law. Overview
We are a medical technology company that develops, manufactures and markets lasers, and markets and distributes dental imaging equipment and other products designed to improve technologies for applications and procedures in dentistry and medicine. In particular, our principal products provide dental laser systems that allow dentists, periodontists, endodontists, oral surgeons and other specialists to perform a broad range of dental procedures, including cosmetic and complex surgical applications. Our systems are designed to provide clinically superior performance for many types of dental procedures, with less pain and faster recovery times than are generally achieved with drills, scalpels and other dental instruments. We have clearance from the U.S. Food and Drug Administration ("FDA") to market our laser systems in the United States and also have the necessary approvals to sell our laser systems in Canada, the European Union and certain other international markets.
We offer two categories of laser system products: (i) Waterlase systems and
(ii) Diode systems. Our flagship product category, the Waterlase system, uses a patented combination of water and laser to perform most procedures currently performed using dental drills, scalpels and other traditional dental instruments for cutting soft and hard tissue. We also offer our Diode laser systems to perform soft tissue and cosmetic procedures, including tooth whitening. We have suffered recurring losses from operations and during the three fiscal years ended December 31, 2010 had declining revenues. As of December 31, 2010, we had a working capital deficit. For the nine months ended September 30, 2011, although our revenues increased compared to the same period in 2010, we still incurred losses from operations and a net loss. Our audited financial statements as of and for the year ended December 31, 2010, were prepared assuming that we would continue to operate as a going concern. Our need for additional capital and the uncertainties surrounding our ability to obtain such funding at December 31, 2010, raised substantial doubt about our ability to continue as a going concern, which contemplates that we will realize our assets and satisfy our liabilities and commitments in the ordinary course of business. Our financial statements do not include adjustments relating to the recoverability of recorded asset amounts or the amounts or classification of liabilities that might be necessary should we be unable to continue as a going concern.

Table of Contents

Accordingly, we have taken steps during the year ending December 31, 2011 ("Fiscal 2011") which we believe have improved our financial condition and will ultimately improve our financial results. These steps include: raising additional equity, principally through the sales of securities, to meet our working capital needs; repaying our credit facility; and restructuring our exclusive distribution agreements and expanding our direct sales force and distributor relationships both domestically and internationally. Additional Equity
The 2010 Shelf Registration Statement. On April 16, 2010, we filed a shelf registration statement (the "2010 Shelf Registration Statement") with the Securities and Exchange Commission (the "SEC") in order to offer for sale, from time to time, in one or more offerings, an unspecified amount of common stock, preferred stock or warrants up to an aggregate public offering price of $9.5 million. The 2010 Shelf Registration Statement was declared effective by the SEC on April 29, 2010.
In accordance with the terms of a Controlled Equity Offering Agreement (the "Offering Agreement") entered into with Ascendiant Securities, LLC ("Ascendiant"), as sales agent, on December 23, 2010, we may issue and sell up to 3,000,000 shares of common stock pursuant to the 2010 Shelf Registration Statement. Sales of shares of our common stock, may be made in a series of transactions over time as we may direct Ascendiant in privately negotiated transactions and/or any other method permitted by law, including sales deemed to be an "at the market" offering as defined in Rule 415 under the Securities Act of 1993, as amended (the "1933 Act"). "At the market" sales include sales made directly on the NASDAQ Capital Market, the existing trading market for our common stock, or sales made to or through a market maker other than on an exchange.
During the quarter ended March 31, 2011, we sold approximately 2.2 million shares of common stock with gross proceeds of approximately $7.5 million and net proceeds of approximately $7.1 million, net of commission and direct costs, through the Offering Agreement with Ascendiant. No additional sales under the Offering Agreement have been made since the quarter ended March 31, 2011 and no additional sales will be made under the Offering Agreement.
On April 7, 2011, we entered into an agreement with Rodman & Renshaw, LLC ("Rodman & Renshaw"), pursuant to which Rodman & Renshaw agreed to arrange for the sale of shares of our common stock in a registered direct public offering (the "April 2011 Registered Direct Placement") pursuant to the 2010 Shelf Registration Statement with a fee of 4.5% of the aggregate gross proceeds. In addition, on April 7, 2011, we and certain institutional investors entered into a securities purchase agreement arranged by Rodman & Renshaw, pursuant to which we agreed to sell in the April 2011 Registered Direct Placement an aggregate of 320,000 shares of our common stock with a purchase price of $5.60 per share for gross proceeds of approximately $1.8 million. The net proceeds to us from the April 2011 Registered Direct Placement totaled approximately $1.7 million. The costs associated with the April 2011 Registered Direct Placement totaled approximately $124,000 and were paid in April 2011 upon the closing of the transaction. The shares of common stock sold in connection with the April 2011 Registered Direct Placement were issued pursuant to a prospectus supplement dated April 11, 2011 to the 2010 Shelf Registration Statement, which was filed with the SEC.
The transactions described above exhausted the securities available for sale under our 2010 Shelf Registration Statement.
The Selling Stockholders Registration Statement. On June 24, 2011, we entered into a securities purchase agreement (the "June 2011 Securities Purchase Agreement") with certain institutional investors (the "June 2011 Purchasers") whereby we agreed to sell, and on June 29, 2011 sold, an aggregate 1,625,947 shares of our common stock at a price of $5.55 per share, together with five-year warrants to purchase 812,974 shares of our common stock having an exercise price of $6.50 per share, first exercisable six month after issuance (the "June 2011 Warrants"). Net proceeds totaled approximately $8.4 million, after commissions and other offering expenses totaling approximately $610,000. The common stock and the June 2011 Warrants were offered and sold, and the common stock issuable upon exercise of the June 2011 Warrants were offered, pursuant to exemptions from registration set forth in section 4(2) of the 1933 Act and Rule 506 of Regulation D promulgated under the 1933 Act. The common stock, the June 2011 Warrants and the common stock issuable upon exercise of the June 2011 Warrants may not be re-offered or resold absent either registration under the 1933 Act or the availability of an exemption from the registration requirements.

Table of Contents

In connection with the June 2011 Securities Purchase Agreement, we entered into a registration rights agreement with the June 2011 Purchasers pursuant to which we undertook to file a resale registration statement, on behalf of the June 2011 Purchasers with respect to the resale of the common stock and the common stock issuable upon the exercise of the June 2011 Warrants (collectively, the "Registerable Securities"), no later than July 19, 2011 and to use our reasonable best efforts to cause such registration statement to be declared effective by the SEC not later than September 7, 2011 (or October 7, 2011, if the SEC comments upon the registration statement). If we are unable to timely satisfy such deadlines, we could incur penalties of up to 3.0% of the offering proceeds for such non-compliance.
On July 19, 2011, we filed a registration statement on Form S-3 (the "Selling Stockholders Registration Statement") with the SEC to register the Registerable Securities which was declared effective by the SEC on August 25, 2011. On August 2, 2011, we repurchased 90,000 of the June 2011 Warrants for $99,900 or $1.11 per underlying share, plus expenses of $30,000. Repayment of Credit Facility Debt
On February 8, 2011, we repaid all outstanding balances under a Loan and Security Agreement dated May 27, 2010, as amended, (the "Loan and Security Agreement") with MidCap Financial, LLC (whose interests were later assigned to its affiliate MidCap Funding III, LLC) and Silicon Valley Bank, which included $2.6 million in principal, $30,000 of accrued interest and $169,000 of loan related expenses. In connection with the repayment, MidCap Funding III, LLC and Silicon Valley Bank released their security interest in our assets. Unamortized costs totaling approximately $225,000, excluding interest, associated with the term loan payable were expensed in February 2011. MidCap Financial, LLC and Silicon Valley Bank also exercised all of their warrants on a cashless basis during February 2011 for 78,172 shares of common stock. As of November 10, 2011, we do not have a credit agreement.
Restructuring Exclusive Distribution Agreement On September 23, 2010, we entered into a Distribution and Supply Agreement (the "D&S Agreement") with Henry Schein, Inc. ("HSIC"), effective August 30, 2010. In connection with the D&S Agreement, as amended, HSIC placed two irrevocable purchase orders for our products totaling $9 million. The first purchase order, totaling $6 million, was for the iLase system and was required to be fulfilled by June 30, 2011. The first purchase order was fully satisfied during the first quarter of 2011. The second purchase order, totaling $3 million, required that the products ordered there under be delivered by August 25, 2011, and was also for the iLase system, but could be modified without charge and applied to other laser products. During April 2011, HSIC modified the type of laser systems ordered on the second purchase order. The second purchase order was fully satisfied during the third quarter of 2011. Critical Accounting Policies
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America 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 which we believe could have the most significant effect on our reported results and require subjective or complex judgments by management is contained on pages 41 to 43 in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of the 2010 Form 10-K. Management believes that there have been no significant changes during the nine months ended September 30, 2011 in our critical accounting policies from those disclosed in Item 7 of on the 2010 Form 10-K, except as noted below.
Revenue Recognition. Through August 2010, we sold our products in North America through an exclusive distribution relationship with HSIC. Effective August 30, 2010, we began selling our products in North America directly to customers through our direct sales force and through non-exclusive distributors, including HSIC. We sell our products internationally through exclusive and non-exclusive distributors as well as to direct customers in certain countries. Sales are recorded upon shipment from our facility and payment of our invoices is generally due within 30 days or less. Internationally, we sell products through independent distributors, including HSIC in certain countries. We record revenue based on four basic criteria that must be met before revenue can be recognized:
(i) persuasive evidence of an arrangement exists; (ii) delivery has occurred and title and the risks and rewards of ownership have been transferred to our customer, or services have been rendered; (iii) the price is fixed or determinable; and (iv) collectability is reasonably assured.

Table of Contents

Sales of our laser systems include separate deliverables consisting of the product, disposables used with the laser systems, installation and training. For these sales, effective January 1, 2011, we apply the relative selling price method, which requires that arrangement consideration be allocated at the inception of an arrangement to all deliverables using the relative selling price method. This requires us to use (estimated) selling prices of each of the deliverables in the total arrangement. The sum of those prices is then compared to the arrangement, and any difference is applied to the separate deliverable ratably. This method also establishes a selling price hierarchy for determining the selling price of a deliverable, which includes: (1) vendor-specific objective evidence ("VSOE") if available, (2) third-party evidence if vendor-specific objective evidence is not available, and (3) estimated selling price if neither vendor-specific nor third-party evidence is available. VSOE is determined based on the value we sell the undelivered element to a customer as a stand-alone product. Revenue attributable to the undelivered elements is included in deferred revenue when the product is shipped and is recognized when the related service is performed. Disposables not shipped at time of sale and installation services are typically shipped or installed within 30 days. Training is included in deferred revenue when the product is shipped and is recognized when the related service is performed or upon expiration of time offered under the agreement, typically within six months from date of sale. The adoption of the relative selling price method does not significantly change the value of revenue recognized.
The key judgments related to our revenue recognition include the collectability of payment from the customer, the satisfaction of all elements of the arrangement having been delivered, and that no additional customer credits and discounts are needed. We evaluate a customer's credit worthiness prior to the shipment of the product. Based on our assessment of the available credit information, we may determine the credit risk is higher than normally acceptable, and we will either decline the purchase or defer the revenue until payment is reasonably assured. Future obligations required at the time of sale may also cause us to defer the revenue until the obligation is satisfied. Although all sales are final, we accept returns of products in certain, limited circumstances and record a provision for sales returns based on historical experience concurrent with the recognition of revenue. The sales returns allowance is recorded as a reduction of accounts receivable and revenue. Extended warranty contracts, which are sold to our non-distributor customers, are recorded as revenue on a straight-line basis over the period of the contracts, which is typically one year.
For sales transactions involving used laser trade-ins, we recognize revenue for the entire transaction when the cash consideration is in excess of 25% of the total transaction. We value used lasers received at their estimated fair market value at the date of receipt.
We recognize revenue for royalties under licensing agreements for our patented technology when the product using our technology is sold. We estimate and recognize the amount earned based on historical performance and current knowledge about the business operations of our licensees. Our estimates have been consistent with amounts historically reported by the licensees. Licensing revenue related to exclusive licensing arrangements is recognized concurrent with the related exclusivity period.
We may offer sales incentives and promotions on our products. We recognize the cost of sales incentives at the date at which the related revenue is recognized as a reduction in revenue, increase in cost of revenue or as a selling expense, as applicable, or later, in the case of incentives offered after the initial sale has occurred.

Table of Contents

Results of Operations
The following table presents certain data from our consolidated statements of
operations expressed as percentages of net revenue:

                                                Three Months Ended           Nine Months Ended
Consolidated Statements of Operations Data:        September 30,               September 30,
                                                2011           2010          2011          2010
Net revenue                                       100.0 %       100.0 %        100.0 %      100.0 %
Cost of revenue                                    59.3          71.2           55.8         75.8

Gross profit                                       40.7          28.8           44.2         24.2

Operating expenses:
Sales and marketing                                24.6          33.9           24.3         47.4
General and administrative                         15.2          21.4           16.6         30.5
Engineering and development                         8.1          12.5            9.1         18.1

Total operating expenses                           47.9          67.8           50.0         96.0

Loss from operations                               (7.2 )       (39.0 )         (5.8 )      (71.8 )
Non-operating loss, net                             0.3          (4.4 )         (0.9 )       (1.8 )

Loss before income tax provision                   (6.9 )       (43.4 )         (6.7 )      (73.6 )
Income tax provision                                0.4           0.4            0.2          0.3

Net loss                                           (7.3 )%      (43.8 )%        (6.9 )%     (73.9 )%

The following table summarizes our net revenue by category (dollars in thousands):

                            Three Months Ended September 30,                        Nine Months Ended September 30,
                              2011                       2010                       2011                        2010
Waterlase
systems             $     8,214           63 %    $ 1,896          31 %    $   20,204           57 %    $  4,586          28 %
Diode systems             2,169           17 %      2,098          34 %         7,643           21 %       4,311          26 %
Imaging systems             100            1 %          -           0 %           100            0 %           -           0 %
Consumables and
Service                   2,564           19 %      2,008          32 %         7,335           21 %       6,188          37 %

Products and
services                 13,047          100 %      6,002          97 %        35,282           99 %      15,085          91 %
License fee and
royalty                      14            0 %        218           3 %           419            1 %       1,422           9 %

Net revenue         $    13,061          100 %    $ 6,220         100 %    $   35,701          100 %    $ 16,507         100 %

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

                    Three Months Ended September 30,             Nine Months Ended September 30,
                      2011                     2010                2011                  2010
United States   $           6,551         $         3,984     $        23,685       $         9,739
International               6,510                   2,236              12,016                 6,768

Net revenue     $          13,061         $         6,220     $        35,701       $        16,507

Three months ended September 30, 2011 and 2010 Net Revenue. Net revenue for the three months ended September 30, 2011 was $13.1 million, an increase of $6.9 million, or 110%, as compared to net revenue of $6.2 million for the three months ended September 30, 2010.
Laser system net revenue (Waterlase and Diode systems combined) increased by approximately $6.4 million, or 160%, for the three months ended September 30, 2011 compared to the three months ended September 30, 2010. Sales of our Waterlase systems increased $6.3 million, or 333%, in the three months ended September 30, 2011 compared to the three months ended September 30, 2010 primarily due to sales of the Waterlase iPlus system after its introduction in early 2011 in connection with the Company's return to a direct and multi-distributor sales model. Revenues from our diode systems increased $71,000, or 3%, during the three months ended September 30, 2011 compared to the three months ended September 30, 2010. The increase resulted primarily from increased direct sales of our ezlase systems.
Imaging system net revenue was $100,000 for the three months ended September 30, 2011. We did not sell any Imaging Systems prior to the quarter ended September 30, 2011.

Table of Contents

Consumables and service net revenue (which includes consumable products, advanced training programs and extended service contracts) and shipping revenue increased by approximately $556,000 or 28% for the three months ended September 30, 2011, as compared to the three months ended September 30, 2010. This was primarily driven by an increase of $362,000, or 33%, in the sales of our consumables products while services revenues increased $194,000 or 21% for the three months ended September 30, 2011, as compared to the three months ended September 30, 2010. This increase in consumable and service net revenue is primarily a result of our decision to recommence selling our products in North America directly to consumers and through non-exclusive distributor arrangements (rather than exclusively through a single distributor) and the launch of our Biolase Store in late 2010.
License fees and royalty revenue decreased $204,000, or 94%, for the three months ended September 30, 2011, as compared to the three months ended September 30, 2010. The decrease resulted primarily from the recognition of deferred Proctor & Gamble ("P&G") royalties of $187,500 in the three months ended September 30, 2010.
Cost of Revenue. Cost of revenue for the three months ended September 30, 2011 increased by $3.3 million, or approximately 75%, to $7.7 million, compared with cost of revenue of $4.4 million for the three months ended September 30, 2010. This increase is primarily attributable to increases in sales. Although cost of revenue increased during the three months ended September 30, 2011 on an absolute basis as compared to the three months ended September 30, 2010, cost of revenue actually decreased, when expressed as a percentage of net revenues, from 71% of net revenues in the three months ended September 30, 2010 to 59% of net revenues in the three months ended September 30, 2011.
Gross Profit. Gross profit for the three months ended September 30, 2011 increased by $3.5 million to $5.3 million, or 41% of net revenue, during the three months ended September 30, 2011 from $1.8 million, or, 29% of net revenue, for the three months ended September 30, 2010. The increase was primarily due to higher sales volumes, better utilization of fixed costs and reduced expenses, partially offset by the decline in P&G royalties and reduced margins from a higher volume of international revenue.
Operating Expenses. Operating expenses for the three months ended September 30, 2011 increased by $2.1 million, or 48%, to $6.3 million as compared to $4.2 million for the three months ended September 30, 2010 and decreased as a percentage of net revenue from 68% to 48%. This increase was primarily attributable to costs necessary to grow our top line revenue as explained in the following expense categories:
Sales and Marketing Expense. Sales and marketing expenses for the three months ended September 30, 2011 increased by $1.1 million to $3.2 million, or 25% of net revenue, as compared with $2.1 million, or 34% of net revenue, for the three months ended September 30, 2010. The increase in expenses resulted primarily from increased payroll and related expenses of $191,000, increased commissions . . .