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BIOL > SEC Filings for BIOL > Form 10-K on 13-Mar-2012All Recent SEC Filings

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Form 10-K for BIOLASE TECHNOLOGY INC


13-Mar-2012

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis in conjunction with our Consolidated Financial Statements and related Notes thereto included in Part II, Item 8 of this Report and the "Risk Factors" included in Part I, Item 1A of this Report, as well as other cautionary statements and risks described elsewhere in this Report, before deciding to purchase, hold or sell our common stock.

Overview

We are a medical technology company that develops, manufactures, and markets lasers, and markets and distributes dental imaging equipment and other related products designed to improve technologies for applications and procedures in dentistry and medicine. 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 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 various other international markets. Since 1998, we have sold approximately 8,700 Waterlase systems, including over 4,700 Waterlase MD and iPlus systems, and more than 19,000 laser systems in over 60 countries.

We offer two categories of laser system products: Waterlase systems and Diode systems. Our flagship product category, the Waterlase system, uses a patented combination of water and laser energy 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.

In August 2006, we entered into a License and Distribution Agreement with HSIC, a large distributor of healthcare products to office-based practitioners, pursuant to which we granted HSIC the exclusive right to distribute our complete line of dental laser systems, accessories and services in the United States and Canada.

On September 23, 2010, we entered into the D&S Agreement with HSIC, effective August 30, 2010, which terminated all prior agreements with HSIC. Under the D&S Agreement, we granted HSIC certain non-exclusive distribution rights in North America and several international markets with respect to our dental laser systems, accessories, and related support and services in certain circumstances. In addition, we granted HSIC exclusivity in selected international markets subject to review of certain performance criteria. In connection with the D&S Agreement, HSIC placed two irrevocable purchase orders totaling $9 million for our products. The first purchase order, totaling $6 million, was for the purchase of iLase systems 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, was for the purchase of a combination of laser systems and was required to be fulfilled by August 25, 2011. The second purchase order was fully satisfied during the third quarter of 2011. The D&S Agreement also granted HSIC a security interest in our inventory and assets, including our intellectual property.

In February 2012, we entered into the "2012 Termination Agreement" with HSIC, to purchase the remaining inventory of Waterlase MD Turbo laser systems held by HSIC. This agreement terminates and supersedes all prior agreements with HSIC. On the closing date, HSIC will release all liens on our assets, an action which will give us greater financial options, including obtaining debt facilities. In addition, it will allow us to have greater control over the distribution of our products which we expect will allow us to have greater visibility into our operations on a quarterly basis.

In May 2010, we entered into a License Agreement (the "2010 P&G Agreement") with Procter & Gamble Company ("P&G"), which replaced an existing license agreement between us and P&G (the "2006 P&G Agreement). Pursuant to the 2010 P&G Agreement, we agreed to continue granting P&G an exclusive license to certain of our patents to enable P&G to develop products aimed at the consumer market and P&G agreed to pay royalties based on sales of products developed with such intellectual property. The prepaid royalty payments previously paid by P&G were applied to the new exclusive license period from January 1, 2009, through December 31, 2010. At this time, we had deferred royalty revenue totaling $1.9 million from the 2006 P&G Agreement. The 2010 P&G Agreement permitted us to recognize $1.5 million in royalty revenue for the year ended December 31, 2010 related to the 2009 and 2010 exclusivity period. As of December 31, 2010, $375,000 remained in long term deferred. On June 28, 2011, we entered into an amendment to the 2010 P&G Agreement (the "2011 P&G Amendment") which extended the effective period for the 2010 P&G Agreement from December 31, 2010 through June 30, 2011, which resulted in us to recognizing the previously deferred $375,000 of revenue as royalty revenue during the quarter ended June 30, 2011.


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The 2011 P&G Amendment also provided that effective July 1, 2011, P&G's exclusive license to our patents converted to a non-exclusive license unless P&G paid us a license payment in the amount of $187,500 by the end of the third quarter of 2011, and at the end of each quarter thereafter, throughout the term of the 2010 P&G Agreement. As a result of P&G not making any payments to us in the third or fourth quarters during the year ended December 31, 2011, their license converted to a non-exclusive license. We are currently engaged an active collaboration with P&G to commercialize a consumer product utilizing.

We have suffered recurring losses from operations and have not generated cash from operations for the three years ended December 31, 2011. Our inability to generate cash from operations, the potential need for additional capital, and the uncertainties surrounding our ability to raise additional capital, raises substantial doubt about our ability to continue as a going concern. Accordingly, the accompanying financial statements have been prepared assuming that we will continue as a going concern, which contemplates that we will continue in operation for the next twelve months and will be able to realize our assets and discharge our liabilities and commitments in the normal course of business. The financial statements do not include any adjustments to reflect the possible future effects of recoverability and classifications of assets or the amounts and classifications of liabilities that may result from our inability to continue as a going concern.

In order for us to continue operations beyond the next twelve months and be able to discharge our liabilities and commitments in the normal course of business, we must sell our products directly to end-users and through multiple distributors; establish profitable operations through increased sales and reduced operating expenses; and potentially raise additional funds, principally through the additional sales of our securities or debt financings to meet our working capital needs.

We intend to increase sales by increasing our product offerings, by expanding our direct sales force and our distributor relationships both domestically and internationally. In connection with this strategy, we intend to provide assistance to our domestic and international distribution partners to maximize revenue. However, we cannot guarantee that we will be able to increase sales, reduce expenses or obtain additional funds when needed or that such funds, if available, will be obtainable on terms satisfactory to us. If we are unable to increase sales, reduce expenses or raise sufficient additional capital we may be unable to continue to fund our operations, develop our products or realize value from our assets and discharge our liabilities in the normal course of business. These uncertainties raise substantial doubt about our ability to continue as a going concern.

Critical Accounting Policies

The preparation of consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires us to make judgments, assumptions and estimates that affect the amounts reported. The following is a summary of those accounting policies that we believe are necessary to understand and evaluate our reported financial results.

Revenue Recognition. From September 2006 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 direct to customers in certain countries. Sales are recorded upon shipment from our facility and payment of our invoices is generally due within 90 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.

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 the 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: (i) vendor-specific objective evidence ("VSOE"), if available, (ii) third-party evidence if vendor-specific objective evidence is not available, and (iii) 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


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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 contract, 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 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. Historically, 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.

From time to time, 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.

Accounting for Stock-Based Payments. We recognize compensation cost related to all stock-based payments based on the grant-date fair value.

Valuation of Accounts Receivable. We maintain an allowance for uncollectible accounts receivable to estimate the risk of extending credit to customers. We evaluate our allowance for doubtful accounts based upon our knowledge of customers and their compliance with credit terms. The evaluation process includes a review of customers' accounts on a regular basis which incorporates input from sales, service, and finance personnel. The review process evaluates all account balances with amounts outstanding 90 days and other specific amounts for which information obtained indicates that the balance may be uncollectible. The allowance for doubtful accounts is adjusted based on such evaluation, with a corresponding provision included in general and administrative expenses. Account balances are charged off against the allowance when we believe it is probable the receivable will not be recovered. We do not have any off-balance-sheet credit exposure related to our customers.

Valuation of Inventory. Inventory is valued at the lower of cost, determined using the first-in, first-out method, or market. We periodically evaluate the carrying value of inventory and maintain an allowance for excess and obsolete inventory to adjust the carrying value as necessary to the lower of cost or market. We evaluate quantities on hand, physical condition and technical functionality, as these characteristics may be impacted by anticipated customer demand for current products and new product introductions. Unfavorable changes in estimates of excess and obsolete inventory would result in an increase in cost of revenue and a decrease in gross profit.

Valuation of Long-Lived Assets. Property, plant and equipment, and certain intangibles with finite lives are amortized over their estimated useful lives. Useful lives are based on our estimate of the period that the assets will generate revenue or otherwise productively support our business goals. We monitor events and changes in circumstances which could indicate that the carrying balances of long-lived assets may exceed the undiscounted expected future cash flows from those assets. If such a condition were to exist, we would determine if an impairment loss should be recognized by comparing the carrying amount of the assets to their fair value.


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Valuation of Goodwill and Other Intangible Assets. Goodwill and other intangible assets with indefinite lives are not amortized but are evaluated for impairment annually or whenever events or changes in circumstances indicate that the asset might be impaired. We conducted our annual impairment analysis of our goodwill as of June 30, 2011 and concluded there had been no impairment in goodwill. We closely monitor our stock price and market capitalization and perform such analysis when events or circumstances indicate that there may have been a change to the carrying value of those assets.

Warranty Cost. Waterlase systems sold domestically are covered by a warranty against defects in material and workmanship for a period of one year while our Diode systems warranty period is for two years from date of sale by us or the distributor to the end-user. Estimated warranty expenses are recorded as an accrued liability, with a corresponding provision to cost of revenue. This estimate is recognized concurrent with the recognition of revenue on the sale to the distributor or end-user. Warranty expenses expected to be incurred after one year from the time of sale to the distributor are classified as a long term warranty accrual. Waterlase systems sold internationally are generally covered by a warranty against defects in material and workmanship for a period of sixteen months while our Diode systems warranty period is up to twenty eight months from date of sale to the international distributor. Our overall accrual is based on our historical experience and our expectation of future conditions. An increase in warranty claims or in the costs associated with servicing those claims would result in an increase in the accrual and a decrease in gross profit.

Litigation and Other Contingencies. We regularly evaluate our exposure to threatened or pending litigation and other business contingencies. Because of the uncertainties related to the amount of loss from litigation and other business contingencies, the recording of losses relating to such exposures requires significant judgment about the potential range of outcomes. As additional information about current or future litigation or other contingencies becomes available, we will assess whether such information warrants the recording of expense relating to contingencies. To be recorded as expense, a loss contingency must be both probable and reasonably estimable. If a loss contingency is material but is not both probable and estimable, we will disclose the matter in the notes to the consolidated financial statements.

Income Taxes. Based upon our operating losses during 2011 and 2010 and the available evidence, management has determined that it is more likely than not that the deferred tax assets as of December 31, 2011 will not be realized in the near term, excluding a portion of the foreign deferred tax assets totaling approximately $11,000. Consequently, we have established a valuation allowance against our net deferred tax asset totaling approximately $33.8 and $34.3 million as of December 31, 2011 and 2010, respectively. In this determination, we considered factors such as our earnings history, future projected earnings and tax planning strategies. If sufficient evidence of our ability to generate sufficient future taxable income tax benefits becomes apparent, we may reduce our valuation allowance, resulting in tax benefits in our statement of operations and in additional paid-in-capital. Management evaluates the potential realization of our deferred tax assets and assesses the need for reducing the valuation allowance periodically.

Fair Value of Financial Instruments

Our financial instruments, consisting of cash, accounts receivable, accounts payable, and other accrued expenses, approximate fair value because of the short maturity of these items. Financial instruments consisting of short term debt approximate fair value since the interest rate approximates the market rate for debt securities with similar terms and risk characteristics.

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 should be based on assumptions that market participants would use, including a consideration of nonperformance risk. Level 1 measurement of fair value is quoted prices in active markets for identical assets or liabilities.

Money market securities. Money market securities are cash equivalents, which are included in cash and cash equivalents, and consist of highly liquid investments with original maturities of three months or less. We use quoted active market prices for identical assets to measure fair value. We had no investments at December 31, 2011 or 2010.


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Results of Operations

The following table sets forth certain data from our operating results for each of the years ended December 31, 2011, 2010 and 2009, expressed as percentages of revenue:

                                                    September 30,         September 30,         September 30,
                                                                   Years Ended December 31,
                                                       2011                  2010                  2009

Net revenue                                                 100.0 %               100.0 %               100.0 %
Cost of revenue                                              56.4                  66.3                  53.7

Gross profit                                                 43.6                  33.7                  46.3

Operating expenses:
Sales and marketing                                          26.8                  37.9                  25.5
General and administrative                                   16.2                  25.0                  18.0
Engineering and development                                   8.8                  14.5                   9.6
Impairment of property, plant and equipment                    -                    0.1                    -

Total operating expenses                                     51.8                  77.5                  53.1

Loss from operations                                         (8.2 )               (43.8 )                (6.8 )
Non-operating (loss) income, net                             (0.8 )                (1.8 )                 0.3

Loss before income taxes                                     (9.0 )               (45.6 )                (6.5 )
Income tax provision                                          0.2                   0.2                   0.3

Net loss (9.2 )% (45.8 )% (6.8 )%

The following table summarizes our net revenues by category for the years ended December 31, 2011, 2010 and 2009 (dollars in thousands):

                                                            September 30,        September 30,        September 30,        September 30,        September 30,       September 30,
                                                                                                         Years Ended December 31,
                                                                          2011                                      2010                                     2009

Waterlase systems                                         $        29,288                   60 %    $         8,241                   32 %    $        22,950                  53 %
Diode systems                                                       9,172                   19 %              7,907                   30 %              8,813                  20 %
Imaging systems                                                       238                    0 %                 -                     0 %                 -                    0 %
Consumables and service                                             5,177                   11 %              4,268                   16 %              5,718                  13 %
Warranty and training                                               4,544                    9 %              4,164                   16 %              4,656                  11 %

Products and services                                              48,419                   99 %             24,580                   94 %             42,137                  97 %
License fees and royalty                                              439                    1 %              1,645                    6 %              1,210                   3 %

Net revenue                                               $        48,858                  100 %    $        26,225                  100 %    $        43,347                 100 %

Year Ended December 31, 2011 Compared With Year Ended December 31, 2010

Net Revenue. Net revenue for the year ended December 31, 2011 ("Fiscal 2011") was $48.9 million, an increase of $22.7 million, or 87%, as compared with net revenue of $26.2 million for the year ended December 31, 2010 ("Fiscal 2010"). Domestic revenues were $32.8 million, or 67% of net revenue, for Fiscal 2011 compared to $16.9 million, or 64% of net revenue, for Fiscal 2010. International revenues for Fiscal 2011 were $16.1 million, or 33% of net revenue compared to $9.3 million, or 36% of net revenue for Fiscal 2010.

Laser system net revenues (Waterlase and Diode systems combined) increased by approximately $22.3 million, or 138%, in Fiscal 2011 compared to Fiscal 2010. Sales of our Waterlase systems increased $21.0 million, or 255%, in Fiscal 2011 compared to Fiscal 2010 primarily due to the Company's return to a direct and multi-distributor sales model in North America and sales of the Waterlase iPlus system after its introduction in early 2011. Sales of our Diode systems increased $1.3 million, or 16%, in Fiscal 2011 compared to Fiscal 2010. The increase resulted primarily from volume sales of the ilase system and increased direct sales of our ezlase system.


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Imaging system net revenue was $238,000 in Fiscal 2011. We did not sell any Imaging Systems prior to Fiscal 2011.

Consumables and service net revenue, which includes consumable products and service revenue, increased approximately $909,000, or 21%, for Fiscal 2011, as compared to Fiscal 2010. This increase in consumable and service net revenue is primarily a result of 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.

Warranty and training revenue, which includes advanced training programs, extended service contracts, and shipping revenue, increased by approximately $380,000, or 9%, for Fiscal 2011, as compared to Fiscal 2010, primarily from selling our products and related warranties and training in North America directly to consumers and through non-exclusive distributor arrangements (rather than exclusively through a single distributor).

License fees and royalty revenue decreased approximately $1.2 million to . . .

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