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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2002

OR

For the transition period from __________ to __________

Commission File Number:  000-19627

BIOLASE TECHNOLOGY, INC.
(Exact Name of Registrant as Specified in Its Charter)

          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.

          Number of shares outstanding of the registrant’s common stock, $.001 par value, as of November 4, 2002: 20,047,448.

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BIOLASE TECHNOLOGY, INC.
FORM 10-Q

INDEX

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

BIOLASE TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

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BIOLASE TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

See accompanying notes to consolidated financial statements.

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BIOLASE TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

See accompanying notes to consolidated financial statements.

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BIOLASE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
NINE MONTHS ENDED SEPTEMBER 30, 2002

NOTE 1 – BASIS OF PRESENTATION

          The unaudited consolidated financial statements included herein have been prepared on a basis consistent with the December 31, 2001 audited consolidated financial statements and include all material adjustments, consisting of normal recurring adjustments, 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 generally accepted accounting principles for complete financial statements.  Therefore, these financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2001 and notes thereto included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 1, 2002.

          The consolidated financial statements include the accounts of BioLase Technology, Inc. and its two wholly-owned subsidiaries: Societe Endo Technic, which is inactive and which we intend to dissolve, and BIOLASE Europe GmbH, a foreign subsidiary incorporated in Germany in December 2001. We have eliminated all material intercompany transactions and balances in the accompanying financial statements.

          We follow the provisions of all applicable Statements of Financial Accounting Standards (“SFAS”) and related accounting pronouncements to prepare the accompanying financial statements in accordance with GAAP.

          The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes.  Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may differ materially from those estimates.

          The results of operations for the nine months ended September 30, 2002 are not necessarily indicative of the results to be expected for the full fiscal year.

          Certain amounts in the prior period consolidated financial statements have been reclassified to be consistent with the current period presentation.

NOTE 2 – SUPPLEMENTARY BALANCE SHEET INFORMATION

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NOTE 3 – PROPERTY, PLANT AND EQUIPMENT

          In January 2002, our wholly owned subsidiary, BIOLASE Europe, purchased a production facility in Germany with ten employees.  We have recorded the transaction at the nominal or stated purchase price of $1,000,000 with the cost reflected in property, plant and equipment and the amount payable reflected in long-term debt.  The maximum effective purchase price will be $850,000 but could be less depending on the outcome of negotiations with a third party for that party to pay all or a portion of the first installment in exchange for certain rights that we would grant to the third party.  The scheduled amount of the first installment is expected to be between $300,000 and $500,000.  If we do not reach agreement with the third party, the stated purchase price and the first installment will be reduced from $1,000,000 to $850,000 and $300,000 to $150,000, respectively.  Due to the ongoing negotiations with the third party, the due date of the first installment has been extended from October 31, 2002 to September 30, 2003.  There is no assurance that we will be able to reach an agreement with the third party to pay any or all of the first installment.  The final purchase price is payable in Euros at the conversion rate in effect on the acquisition date.  In connection with this transaction, we entered into a forward contract to purchase approximately $700,000 of Euros at an exchange rate of 0.8591.  Regardless of the amount of the initial installment, we are obligated to pay an additional $500,000 by April 1, 2003 and the balance of the purchase price, if any, by December 1, 2003.

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NOTE 4 – LINE OF CREDIT

          At September 30, 2002, we had $1,792,000 outstanding under a revolving credit agreement with a bank. The agreement provides for borrowings up to $1,800,000 for financing inventories and is secured by substantially all of our accounts receivable and inventories.  The interest rate is based upon LIBOR plus 0.5% at the time of any borrowings.  At September 30, 2002, the interest rate on the outstanding balance was 2.3%.  The effective interest rate for the quarter ended September 30, 2002 was 1.9%, including the amortization of the fair value of stock issued in connection with extending our line of credit.  In June 2002, the expiration date of the credit agreement was extended from January 31, 2003 to July 31, 2003.

NOTE 5 – COMMITMENTS AND CONTINGENCIES

          In March 2001, we entered into a sale-leaseback transaction in which we sold and leased back our manufacturing facility in San Clemente, California.  The result of the sale was a $316,000 gain, which has been deferred and is being amortized over the four years remaining under the lease term.  The related lease is being accounted for as an operating lease.

          We also lease certain office equipment under operating lease arrangements.  Future minimum rental commitments under operating leases for each of the years ending September 30 are as follows:

          On October 31, 2002, the Company filed a lawsuit in the U.S. District Court for the Central District of California, Southern Division, against American Medical Technologies, Inc. (“AMT”). In the lawsuit, the Company alleges that AMT is infringing certain patents owned by the Company which relate to the use of laser technology in the medical and dental fields. The Company’s claims arise out of AMT’s offer to sell and sale in the United States of a dental device that uses laser technology. In the lawsuit, the Company is seeking an award of monetary damages and injunctive relief against AMT. While the Company believes that the case is meritorious, there is no assurance that the Company will achieve a favorable outcome.

          From time to time, we are involved in legal proceedings incidental to our business.  We believe that pending actions, individually and in the aggregate, will not have a material adverse effect on our financial condition, results of operations or cash flows, and that adequate provision has been made for the resolution of such actions and proceedings.

NOTE 6 – EARNINGS PER SHARE

          We compute basic earnings (loss) per share by dividing the net income (loss) attributable to common stockholders by the weighted average number of shares outstanding.  We compute diluted earnings per share by dividing net income by the weighted average number of shares outstanding including stock options and warrants.  Stock options totaling 304,000 and 287,000 were not included in the diluted earnings per share amounts for the three and nine months ended September 30, 2002, respectively, and 880,000 were not included in the nine months ended September 30, 2001, as their effect would have been anti-dilutive.

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NOTE 7 – STOCKHOLDERS’ EQUITY

          Components of comprehensive income (loss) were as follows:

          Components of accumulated other comprehensive loss were as follows:

NOTE 8 – DERIVATIVE FINANCIAL INSTRUMENTS

          Our derivative financial instruments, consisting of forward exchange contracts in European Euros, are recorded at their fair value on the balance sheet, included in other assets.  Our foreign exchange forward contracts are not designated as hedges pursuant to SFAS 133.  Changes in the fair value of derivatives that do not qualify for hedge treatment must be recognized currently in earnings.

          At September 30, 2002, we had outstanding derivative financial instruments comprised of foreign exchange forward contracts with notional amounts of $697,000 and a fair market value of $799,000 with the fair value gain of $102,000 recognized into net income for the nine months ended September 30, 2002.

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ITEM 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Cautionary Statement With Respect to Forward-Looking Information

          You should read the following discussion and analysis in conjunction with our Unaudited Consolidated Financial Statements and related Notes thereto contained elsewhere in this Report. The information contained in this Report is not a complete description of our business or the risks associated with an investment in our common stock.  We urge you to carefully review and consider the various disclosures made by us in this Report and in our other reports filed with the Securities and Exchange Commission, including our Annual Report on Form 10-K for the year ended December 31, 2001, and our subsequent reports on Forms 10-Q and other filings that discuss our business in greater detail.  This Report contains forward-looking statements that can often be identified by words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “may,” “will,” “should,” “would,” “potential,” “continue,” and variations of these words or similar expressions. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. Examples of these forward-looking statements include, but are not limited to, statements concerning the application of our technology, the potential of our market and our position in it, our manufacturing capacity, estimates concerning asset valuation and loss contingencies and expectations concerning future costs and cash flow, and our ability to successfully finance our business or replace existing loans.  These forward-looking statements are based on our current expectations, estimates and projections about our industry, and reflect our beliefs and certain assumptions made by us.  These statements speak only as of the date of this Report and are based upon the information available to us at this time.  Such information is subject to change, and we will not necessarily inform you of such changes.  These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict.  Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, some of which are set forth in “Risk Factors,” below.  We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

Overview

          BioLase Technology, Inc. is a medical technology company that designs, develops, manufactures and markets advanced dental, cosmetic and surgical laser-based products. We currently market two primary products. The Waterlase™ system, utilizing our patented Hydrokinetic^® technology of combining water and laser energy, is a device which can be applied to the treatment of both hard and soft dental tissues.  The LaserSmile™ system incorporates a diode semiconductor laser for a broad range of soft tissue and cosmetic procedures. Most of our sales are derived from the shipment of the Waterlase system. Sales of the LaserSmile system commenced in the third quarter of 2001; prior to that time the LaserSmile system was sold as the Twilite soft tissue laser, which did not include the teeth whitening capability.

          In January 2002, we received from the United States Food and Drug Administration Section 510(k) clearance for the application of our Hydrokinetic technology to perform complete root canal therapy (EndoLase™).  In February 2002, we received Food and Drug Administration Section 510(k) clearance for the use of Hydrokinetic technology to cut oral bone tissue (OsseoLase™). We believe these clearances substantially broaden the application of our technology within the dental market.

          We have patents and have received clearances from the FDA for applications in markets other than dentistry, such as dermatology.  However, we currently plan to focus our business on the dental

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market because of what we believe to be both the significant potential of the dental market and our leading position in that market.

          In January 2002, we acquired a production facility in Germany to strengthen our international sales plan in Europe and neighboring regions. In our estimate, this transaction both significantly increased our overall manufacturing capacity and provided us with an improved ability to service European sales.

Critical Accounting Policies and Estimates

          Our discussion and analysis of our financial condition and results of operations are based upon our Unaudited Consolidated Financial Statements included in this Report which have been prepared in accordance with accounting principles generally accepted in the United States.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses for each period.

          The following represents a summary of our critical accounting policies, defined as those policies that we believe are: (a) the most important to the portrayal of our financial condition and results of operations, and (b) that require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain

          Sales.  We record sales in accordance with SEC Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (“SAB 101”), as amended by SAB 101A and 101B.  SAB 101 requires that four basic criteria must be met before revenue can be recognized:

          We record sales when we have received a valid customer purchase order for product at a fixed price, the customer’s credit is approved and we have shipped the product to the customer.

          Valuation of Accounts Receivable.  We maintain an allowance for uncollectible accounts receivable to measure the risk of extending credit to customers.  The allowance is estimated based on customer compliance with credit terms, the financial condition of the customer and collection history where applicable.  Additional allowances could be required if the financial condition of our customers were to be impaired beyond our estimates and would result in an increase in general and administrative expense.

          Valuation of Inventory.  Inventory is valued at the lower of cost (estimated using the first-in, first-out method) or market.  We periodically evaluate the carrying value of inventories and maintain an allowance for obsolescence to adjust the carrying value as necessary to the lower of cost or market. The allowance is based on physical and technical functionality as well as other factors affecting the recoverability of the asset through future sales.  Unfavorable changes in estimates of obsolete inventory would result in an increase in the allowance and a decrease in gross profit.

          Valuation of Long-Lived Assets.  Property, plant and equipment, intangible and certain other long-lived assets are amortized over their 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. Long-

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lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable through future business operations. In our estimate, no provision for impairment is required on any of our long-lived assets.

          Warranty Cost.  Products sold are generally covered by a warranty against defects in material and workmanship for a period of one year.  We accrue a warranty reserve to measure the risk of incurring costs to provide warranty services.  The accrual is based on historical experience and 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.  We are not presently affected by any litigation or other contingencies that have had, or are currently anticipated to have, a material impact on our results of operations or financial position.  As additional information about current or future litigation or other contingencies becomes available, we will assess whether such information warrants the recording of additional expense relating to its contingencies.  To be recorded as expense, a loss contingency must generally be both probable and measurable.  If a loss contingency is material but is not both probable and measurable, we will disclose it in notes to the financial statements.

Results of Operations 

          In the following discussion of the results of operations, unless otherwise noted, the three and nine month periods ended September 30, 2002 are compared to the three and nine-month periods ended September 30, 2001.

          The following table sets forth certain statement of operations data expressed as a percentage of net sales:

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          Comparing the results of operations between the current year and the corresponding periods in the prior year, the most significant change affecting operating results is the increase in sales.  Third quarter 2002 sales increased 56% over third quarter 2001 and nine month 2002 sales have increased 63% over nine month 2001 sales. 

          Net Sales.  Net sales for the three months ended September 30, 2002 were $7.3 million, an increase of $2.6 million or 56%, as compared with net sales of $4.7 million for the three months ended September 30, 2001.  Net sales for the nine months ended September 30, 2002 were $19.7 million, an increase of $7.6 million or 63%, as compared with net sales of $12.1 million for the nine months ended September 30, 2001. The increase in both the three and nine month periods was resulted from increased number of units sold of our Waterlase and LaserSmile systems. Average selling price for these products in the periods being compared has not varied significantly.

          International sales increased in the third quarter of 2002 to 29% of total sales compared to 16% in the same period last year. Year-to-date international sales have increased to 21% of total sales from 17% in the same period last year. Most of our international sales are made through distributors.  In the three months ended June 30, 2002, we began making direct sales to dentists in Germany with the support of our current distributor there, as well as continuing to sell through distributor channels in Germany and elsewhere. In connection with increased credit uncertainty related to these direct sales, we have increased our allowance on accounts receivable from $100,000 at June 30, 2002 to $381,000 at September 30, 2002.

          Gross Profit.  Gross profit for the three months ended September 30, 2002 was $4.6 million or 62% of net sales, an increase of $1.7 million or 62% from gross profit of $2.8 million or 60% of net sales for the three months ended September 30, 2001.  Gross profit for the nine months ended September 30, 2002 was $12.0 million or 61% of net sales, an increase of $4.9 million or 68% from gross profit of $7.1 million or 59% of net sales for the nine months ended September 30, 2001.  The increase in gross profit is primarily attributable to leveraging the increase in net sales against fixed and partially fixed manufacturing costs, reflecting better absorption of fixed manufacturing costs.  To a lesser extent, the increase in gross profit is also due to increased manufacturing efficiencies and design changes, which have reduced the cost of materials.  These efficiencies and cost savings have been partially offset by the start-up costs for our German production and service facility and the addition of production resources to support anticipated sales growth.

          Operating Expenses.  Operating expenses for the three and nine months ended September 30, 2002 were 51% and 53% of net sales, compared to 58% and 65% in the comparable periods of the prior year.  Approximately 80% of the increase in operating expenses for the three and nine months ended September 30, 2002 are sales and marketing costs that have been incurred to generate the increase in net sales.

          Sales and marketing expenses generally includes salaries and commissions for our direct sales force, advertising costs and expenses related to trade shows, conventions and seminars.  Sales and marketing expense for the three months ended September 30, 2002 was $2.7 million or 36% of net sales, an increase of $853,000 or 47%, as compared with sales and marketing expense for the three months ended September 30, 2001 of $1.8 million or 39% of net sales. Sales and marketing expense for the nine months ended September 30, 2002 was $7.3 million or 37% of net sales, an increase of $2.0 million or 39%, as compared with sales and marketing expense for the three months ended September 30, 2001 of $5.3 million or 44% of net sales. The increase in absolute dollars was primarily due to higher commission expense related to the increased sales and additional sales personnel in the United States, and to a lesser extent, the expansion of the scope of our nationwide seminar marketing program in 2002.

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          General and administrative expenses generally include the salaries of administrative personnel as well as professional and regulatory fees.  General and administrative expense for the three months ended September 30, 2002 was $739,000 or 10% of net sales, an increase of $167,000 or 29%, as compared with general and administrative expense for the three months ended September 30, 2001 of $572,000 or 12% of net sales. General and administrative expense for the nine months ended September 30, 2002 was $2.1 million or 11% of net sales, an increase of $537,000 or 35%, as compared with general and administrative expense for the three months ended September 30, 2001 of $1.5 million or 13% of net sales.  The increase in absolute dollars for both the three and nine months was principally due to cumulative increases in the infrastructure needed to support the growth of our business including increases in the cost of regulatory compliance, administrative costs associated with the operations of BIOLASE Europe and increases in the allocated costs of insurance.

          Engineering and development expenses generally include engineering personnel salaries, prototype supplies and contract services.  Engineering and development expense for the three months ended September 30, 2002 was $360,000 or 5% of net sales, a slight increase of $20,000 or 6%, as compared with engineering and development expense for the three months ended September 30, 2001 of $340,000 or 7% of net sales.  Engineering and development expense for the nine months ended September 30, 2002 was $1.1 million or 6% of net sales, an increase of $84,000 or 8%, as compared with general and administrative expense for the three months ended September 30, 2001 of $1.1 million or 9% of net sales.  The increase in absolute dollars for the nine months ended September 30, 2002 is prototype material costs and consulting fees related to product development.  The change in research and development expense as a percent of net sales reflects the larger sales base and normal fluctuations in the  scope of current research and development projects.

          In September we renewed our insurance policies for the period October 1, 2002 to September 30, 2003 for a total premium increase of $245,000, driven both by adverse pricing conditions in the insurance market  and by the expected growth in our sales. The premium increase will raise operating expenses as it is amortized to expense during the coverage period.

          Gain on Sale of Assets.  The gain on sale of assets for the three and nine months ended September 30, 2002 of $15,000 and $47,000, respectively, are related to the sale and leaseback of our manufacturing facility in San Clemente, California in March 2001.  This sale resulted in a gain of $316,000, which will be recognized over the remaining term of the lease expiring in 2006.

          Unrealized Gain on Forward Exchange Contract.  In the nine months ended September 30, 2002, we recognized an unrealized gain on forward contracts of $102,000, due to the increase in the fair market value of our forward exchange contract as described more fully in Part I, Item 3 of this Report.

          Interest Income/Interest Expense.   Interest income primarily relates to interest earned on our cash balances, and interest expense primarily relates to interest expense on our line of credit and our prior mortgage on the San Clemente facility.  Interest income for the three and nine months ended September 30, 2002 was $6,000 and $13,000, a decrease of 40% and 46% from interest income of $10,000 and $24,000 in the comparable periods of the prior year, due principally to lower interest rates in 2002.  Interest expense increased $12,000 or 55% from $22,000 to $34,000 for the three months ended September 30, 2002 compared to the same period last year as the result of the amortization of loan guarantee fees to interest expense over the renewal term of our line of credit in 2002. Interest expense decreased by $32,000 or 24% from to $100,000 for the nine months ended September 30, 2002, which reflects the repayment of the mortgage on our San Clemente facility upon its sale in March 2001 as well as lower interest rates on our line of credit in 2002

          Provision for Income Tax.  No provision for income tax was recognized for the three and nine-month periods ended September 30, 2002 due to the availability of net operating loss carry forwards.  No

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income tax benefit was recognized in the three and nine-month periods ended September 30, 2001 as there was no assurance that the benefit of the net operating loss carry forwards would be realized.  As of December 31, 2001, we had net operating loss carry forwards for federal and state purposes of approximately $37.8 million and $6.4 million, respectively, which began expiring in 2001.

Liquidity and Capital Resources

          At September 30, 2002, we had $3.0 million in net working capital as compared to $1.1 million at December 31, 2001.  Our principal source of liquidity at September 30, 2002 consisted of our cash balance of $2.9 million.  Historically, we have financed the development of our products and our operations principally through the private placement of common stock and the exercise of stock options and warrants, though we have generated cash from net income excluding the effects of changes in working capital, in each of the last five quarters.  For the nine months ended September 30, 2002, from December 1, 2002 to June 30, 2003 our primary sources of cash were from net income of $1.6 million, and the exercise of stock options and warrants of $762,000.  These sources of cash were offset by increases in accounts receivable and inventory of $1.7 million, other working capital items and investments in property and equipment of $335,000.  The net effect on cash of operating, investing and financing transactions for the nine months ended September 30, 2002 was an increase of $250,000.  For further details see the Consolidated Statements of Cash Flows included in this Form 10-Q.

          Accounts receivable, net increased 66% to $3.5 million at September 30, 2002 from $2.1 million at December 31, 2001.  This increase was primarily due to the higher sales volume experienced in the third quarter of 2002.  Inventories, net increased 24% to $2.3 million at September 30, 2002 from $1.9 million at December 31, 2001.  This increase was primarily due to increased production estimates to meet expected 2002 sales demand.

          In June 2002, we extended the expiration date of warrants to purchase 522,500 shares of common stock from September 30, 2002 to June 30, 2003.  These warrants have an exercise price of $2.50 and were issued in connection with a private placement in 2000.  In June 2002, we also extended the expiration date of warrants to purchase 50,000 shares of common stock from December 1, 2002 to June 30, 2003.  These warrants have an exercise price of $3.00 per share and were issued in connection with previous annual extensions of our credit facility.

          At September 30, 2002, we had $1.8 million outstanding under a $1.8 million revolving credit facility with a bank, the same amount that was outstanding at December 31, 2001.  In June 2002, the expiration date on this credit facility was extended from January 31, 2003 to July 31, 2003, at which point we will be required to pay any remaining balance, refinance or replace the credit facility. We cannot assure you that we will be able to renew this facility in a timely manner, on acceptable terms or at all.  The credit facility is collateralized by all of our accounts receivable and inventories.

          In connection with the acquisition of our production facility in Germany, as discussed in Note 3 to the Unaudited Consolidated Financial Statements, BIOLASE Europe incurred a maximum liability of $850,000 payable in Euros at the conversion rate of 0.8591 (Euros 989,407).  If we are not able to reach an agreement with a third party to pay all or part of the scheduled first installment of between $300,000 and $500,000, we will be required to make the initial installment of $150,000 (Euros 174,601) on September 30, 2003. We are required to make a payment of $500,000 (Euros 582,004) by April 1, 2003 and the balance, if any, by December 1, 2003. We are considering obtaining a long-term, secured real estate financing to refinance this debt as it matures, but we cannot assure you that such financing will be available in a timely manner, on acceptable terms or at all.

          We had no material commitments for capital expenditures as of September 30, 2002.

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          Our liquidity and cash requirements fluctuate based on the timing and extent of a number of factors.  For instance, during periods of recent sales growth, net changes in our assets and liabilities generally have represented a use of cash because we have incurred costs and expended cash in advance of receiving cash from our customers. We believe that our current cash balances, cash expected to be generated from our operations, together with additional cash expected to be received through the exercise of warrants and stock options will be adequate to meet our debt service requirements and sustain our operations for at least the next twelve months.  Should we require further capital resources in the next twelve months, we may address such requirement through the refinancing of debt and/or the sale of equity securities.  If such additional debt or equity is needed, we cannot assure you that we would be able to obtain such additional capital resources in a timely manner, on acceptable terms, or at all.  If we are unable to raise additional funds, we may have to defer the creation or satisfaction of various commitments, defer the introduction of various products or entry into various markets, or otherwise scale back our operations.  If we were unable to raise such additional capital or defer certain costs as described above, such inability would have an adverse effect on our financial position, results of operations and cash flows.

Risk Factors

          Our business is subject to a number of risks, some of which are discussed below.  Other risks are presented elsewhere in this report and in our other filings with the Securities and Exchange Commission.  Before deciding to invest in our company or to maintain or increase your investment, you should carefully consider the risks described below, in addition to the other information contained in this report and in our other filings with the Securities and Exchange Commission.  The risks and uncertainties described below are not the only ones facing our company.  Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations.  If any of these risks actually occur, our business, financial condition or results of operations could be seriously harmed.  In that event, the market price for our common stock could decline and you may lose all or part of your investment.

Dentists and Physicians May Be Slow to Adopt Laser Technologies, Which Could Limit the Market Acceptance of Our Products.

          Although our sales have increased year over year, our products represent new technologies in the dental market and currently only represent a very small portion of the dental and medical markets. Our future success will depend on our ability to demonstrate to a broad spectrum of dentists and physicians the potential cost and performance advantages of our laser systems over traditional methods of treatment and, to a lesser extent, over competitive laser systems.  Dental practitioners may be slow to adopt new technologies on a widespread basis.  Factors that may inhibit mass adoption of laser technologies by dentists and physicians include the cost of the products, concerns about the safety, efficacy and reliability of lasers and the ability to obtain reimbursement of laser procedures under health plans.  Current economic pressure may make dentists and physicians reluctant to purchase substantial capital equipment or invest in new technologies.  The failure of medical lasers to achieve broad market acceptance would have an adverse effect on our business, financial condition and results of operations.  We cannot assure you that we will have sufficient resources to continue to successfully market our products to achieve broad market acceptance.

We Depend on a Limited Number of Suppliers and If We Cannot Secure Alternate Suppliers, the Amount of Sales in Any Period Could Be Adversely Affected.

          We purchase certain materials and components included in our products from a limited group of qualified suppliers, and we do not have long-term supply contracts with any of our key suppliers.  Our growth and ability to meet customer demand depends in part on our ability to obtain timely deliveries of

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materials and components in acceptable quality from our suppliers.  Certain components of our products are currently available only from a single source or limited sources, particularly specialized components used in our lasers.  Although we believe that alternate sources of supply are available for most of our single-sourced materials and components, a change in a single or limited source supplier, or an inability to find an alternate supplier, would create manufacturing delays, disrupt sales and cash flow, and harm our reputation, any of which would adversely affect our business, financial condition and results of operations.

Our Quarterly Sales and Operating Results May Fluctuate in Future Periods and We May Fail to Meet Expectations, Which May Cause the Price of Our Common Stock to Decline.

          Our quarterly sales and operating results have fluctuated and are likely to continue to vary from quarter to quarter due to a number of factors, many of which are not within our control.  If quarterly sales or operating results fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially.  Factors that might cause quarterly fluctuations in our sales and operating results include the factors described in the subheadings below as well as:

          A significant amount of our sales in any quarter may consist of sales through a single distributor.  As a result, the timing of orders by distributors may impact our quarter-to-quarter results.  The loss of or a substantial reduction in orders from distributors could seriously harm our business, financial condition and results of operations.  In addition, we have in the past experienced fluctuations due to seasonality.  Typical of the seasonality we have experienced is that the first quarter is slower than average and the fourth quarter is stronger than average due to the buying patterns of dental professionals.  Vacation schedules also have typically had an effect on sales in the third quarter.  Since many of our costs are fixed in the short term, if we have a shortfall in sales, we may be unable to reduce our expenses quickly enough to avoid losses.  Due to all of the factors listed above and other risks, some of which are

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discussed in this report, you should not rely on quarter-to-quarter comparisons of our operating results as an indication of our future performance.

We May Not Be Able to Secure Additional Financing to Meet Our Future Capital Needs.

          Our secured line of credit expires on July 31, 2003.  If we are unable to renew or replace our secured line of credit at or before that time on acceptable terms, or at all, and we are required to repay the secured line of credit, absent sufficient cash flow from operations or the sale of securities, the diversion of resources for that purpose would adversely affect our operations and financial condition and our ability to achieve future growth in our net sales, and our security may be at risk.  In addition, during 2003, all of our long-term debt related to the acquisition of our German production facility will become due and payable.  It is our intention to refinance that debt as it matures with long-term secured real estate financing.  There is no assurance that we will be able to obtain such financing on acceptable terms, in a timely manner, or at all.  If we are unable to obtain such financing, we will have to repay our debt obligations with cash, which may adversely affect our operations and financial condition and our ability to achieve future growth in our net sales.

          Although we believe that we can generate sufficient cash flow from sustained profitability to meet our future operating and capital needs, there is no assurance that we will be able to do so.  If we are unable to do so, we will continue to be dependent on the availability of external financing to meet our operating and capital needs, including the repayment of current debt obligations.  We may not be able to secure additional debt or equity financing on terms acceptable to us, or at all, at the time when we need such funding.  If we do raise funds by issuing additional equity or convertible debt securities, the ownership percentages of existing stockholders would be reduced, and the securities that we issue may have rights, preferences or privileges senior to those of the holders of our common stock or may be issued at a discount to the current market price of our common stock which would result in dilution to our existing stockholders.  If we raise additional funds by issuing debt, we may be subject to debt covenants, which could place limitations on our operations including our ability to declare and pay dividends.  Our inability to raise additional funds on a timely basis would make it difficult for us to achieve our business plan and would have a material adverse effect on our business, financial condition and results of operations.

We Have Significant International Sales and Are Subject to Risks Associated with Operating in International Markets.

          International sales comprise a significant portion of our net sales.  Political and economic conditions outside the United States could make it difficult for us to increase our international sales or to operate abroad.  In addition, as part of our plan to grow sales internationally, in January 2002, we purchased a production facility in Germany to manufacture and service devices to be sold in Europe.

          In the future, we intend to continue to pursue and expand our international business activities.  International operations, including our production facility in Germany, are subject to many inherent risks, including:

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          We believe that international sales will continue to represent a significant portion of our net sales, and that continued growth and profitability may require further expansion of our international operations.  A substantial percentage of our international sales are denominated in the local currency.  As a result, an increase in the relative value of the dollar could make our products more expensive and potentially less price competitive in international markets.  Other than a forward contract to offset the risk related to the amounts payable for the German production facility, we do not currently engage in any transactions as a hedge against risks of loss due to foreign currency fluctuations.  Any of these factors may adversely affect our future international sales and, consequently, affect our business, financial condition and operating results.

If We Are Not Successful in Generating and Increasing Sales from Our German Production Facility, Our Business and Financial Condition May Be Materially Adversely Affected.

          In January 2002, we made a significant investment in purchasing a German production facility with ten employees.  The production facility is a new operation and we will face significant challenges in integrating it with our existing business and operations, including but not limited to the following:

          Although the German facility has begun manufacturing our products and making installations for customers in Europe, it has a very limited operating history upon which to assess whether it will be able to meet all of the challenges required to successfully operate and generate and increase sales.  If we are not able to generate and increase sales and profits at the German facility, we will not receive the

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anticipated benefits of our investment in the German facility and our business, financial condition and results of operations would be materially and adversely affected.

We Are Exposed to Risks Associated with the Recent Worldwide Economic Slowdown and Related Uncertainties.

          Concerns about decreased consumer and investor confidence, reduced corporate profits and capital spending, and recent international conflicts and terrorist and military activity have resulted in a downturn in the equity markets and a slowdown in economic conditions, both domestically and internationally, and have caused concern about the strength or longevity of an economic recovery.  These unfavorable conditions could ultimately cause a slowdown in customer orders or cause customer order cancellations.  In addition, recent political and social turmoil related to international conflicts and terrorist acts may put further pressure on economic conditions in the U.S. and worldwide.  Unstable political, social and economic conditions make it difficult for our customers, our suppliers and us to accurately forecast and plan future business activities.  If such conditions continue or worsen, our business, financial condition and results of operations could be materially and adversely affected.

If We Are Unable to Protect Our Intellectual Property Rights, Our Competitive Position Could Be Harmed or We Could Be Required to Incur Expenses to Enforce Our Rights.

          We anticipate that our future success will depend, in part, on our ability to obtain and maintain patent protection for our products and technology, to preserve our trade secrets and to operate without infringing the intellectual property of others.  We rely on patents to establish and maintain proprietary rights in our technology and products.  While we hold a number of issued patents and have other patent applications pending on our products and technology, we cannot assure you that any additional patents will be issued, that the scope of any patent protection will exclude competitors or that any of our patents will be held valid if subsequently challenged.  In addition, other companies may independently develop similar products, duplicate our products or design products that circumvent our patents.

          Competitors may claim that we have infringed their current or future intellectual property rights.  We may not prevail in any future intellectual property infringement litigation given the complex technical issues and inherent uncertainties in litigation.  Any claims, with or without merit, could be time-consuming and distracting to management, result in costly litigation, cause product shipment delays, or require us to enter into royalty or licensing agreements.  Additionally, in the event an intellectual property claim against us is successful, we might not be able to obtain a license on acceptable terms or license a substitute technology or redesign our products to avoid infringement.  Any of the foregoing adverse events could seriously harm our business, financial condition and results of operations.

Product Liability Claims Against Us Could Be Costly and Could Harm Our Reputation.

          The sale of dental and medical products involves the inherent risk of product liability claims against us. While we currently maintain product liability insurance coverage in an amount that we believe is adequate for our level of sales, this insurance is expensive, is subject to various coverage exclusions and may not be obtainable in the future on terms acceptable to us, or at all. We do not know whether claims against us, if any, with respect to our products would be successfully defended or whether our insurance would be sufficient to cover liabilities resulting from such claims.

Rapid Changes in Technology Could Harm the Demand for Our Products or Result in Significant Additional Costs.

          The markets in which our laser products compete are subject to rapid technological change, evolving industry standards, changes in the regulatory environment, frequent new device and

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pharmaceutical introductions and evolving dental and surgical techniques.  These changes could render our products noncompetitive or obsolete.  The success of our existing and future products is dependent on the differentiation of our products from those of our competitors, the timely introduction of new products and the perceived benefit to the customer in terms of patient service and return on investment.  The process of developing new medical devices is inherently complex and requires regulatory approvals or clearances that can be expensive, time-consuming and uncertain.  We have in the past experienced delays in product development.  We cannot assure you that we will successfully identify new product opportunities, be financially or otherwise capable of the research and development to bring new products to market in a timely manner or that product and technologies developed by others will not render our products obsolete.

We May Not Be Able to Compete Successfully Against Our Current and Future Competitors.

          We compete with a number of foreign and domestic companies, including companies that market traditional dental products such as dental drills, as well as other companies that market laser technologies in the dental and medical markets that we address.  Some of our competitors have greater financial, technical, marketing or other resources than us, which may allow them to respond more quickly to new or emerging technologies and to devote greater resources to the acquisition or development and introduction of enhanced products than we can.  In addition, the rapid technological changes occurring in the healthcare industry are expected to lead to the entry of new competitors, especially as dental and medical lasers gain increasing market acceptance. Our ability to anticipate technological changes and to introduce enhanced products on a timely basis will be a significant factor in our ability to grow and remain competitive. New competitors or technology changes in laser products and methods could cause commoditization of such products, require price discounting or otherwise adversely affect our gross margins.

Changes in Government Regulation or the Inability to Obtain Necessary Government Approvals Could Harm Our Business.

          Our products are subject to extensive government regulation, both in the United States and other countries. To clinically test, manufacture and market products for human diagnostic and therapeutic use, we must comply with regulations and safety standards set by the U.S. Food and Drug Administration and comparable state and foreign agencies. Generally, products must meet regulatory standards as safe and effective for their intended use prior to being marketed for human applications. The clearance process is expensive, time-consuming and uncertain. The failure to receive requisite approvals for the use of our products or processes, or significant delays in obtaining such approvals, could prevent us from developing, manufacturing and marketing products and services necessary for us to remain competitive.

If Our Customers Cannot Obtain Third Party Reimbursement for Their Use of Our Products, They May Be Less Inclined to Purchase Our Products.

          Our products are generally purchased by dental or medical professionals who may bill various third party payors, such as government programs or private insurance plans, for all or a portion of the procedures conducted using these products.  In the United States, third party payors review and frequently challenge the prices charged for medical services.  In many foreign countries, the prices are predetermined through government regulation.  Payors may deny coverage and reimbursement if they determine that the procedure was not medically necessary (for example, cosmetic) or that the device used in the procedure was investigational.  We believe that most of the procedures being performed with our current products generally have been reimbursed, with the exception of cosmetic applications such as tooth whitening.  For the portion of dentists who rely on third party reimbursement and take assignment of patient insurance claims, the inability to obtain reimbursement for services using our products could deter them from purchasing or using our products.  We cannot predict the effect of future healthcare

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reforms or changes in financing for health and dental plans.  Any such changes could have an adverse effect on the ability of a dental or medical professional to generate a return on investment using our current or future products.  Such changes would act as disincentives for capital investments by dental and medical professionals and could have an adverse effect on our business, financial condition and results of operations.

The Failure to Attract and Retain Key Personnel Could Adversely Affect Our Business.

          Our future success depends in part on the continued service of certain key personnel, including Jeffrey Jones, our Chief Executive Officer, Edson Rood, our Chief Financial Officer, Ioana Rizoiu, our Vice President of Clinical Research, and Keith Bateman, our Vice President of Global Sales. We do not have employment agreements with any of our key employees, other than with Mr. Jones, whose employment agreement was renewed in January 2002 for a two-year term.

          Our success will also depend in large part on our ability to continue to attract, retain and motivate qualified engineering and other highly skilled technical personnel.  Competition for certain employees, particularly development engineers, is intense despite the effects of the economic slowdown. We may not be able to continue to attract and retain sufficient numbers of such highly skilled employees. Our inability to attract and retain additional key employees or the loss of one or more of our current key employees could adversely affect our business, financial condition and results of operations.

Potential Future Acquisitions Could Have Unintended Negative Consequences Which Could Harm Our Business and Cause Our Stock Price to Decline.

          We may consider pursuing additional acquisitions of businesses, products or technologies in the future as a part of our growth strategy.  Acquisitions could require significant capital infusions and could involve many risks, including but not limited to the following:

          We cannot assure you that we will be able to identify or consummate any future acquisitions on acceptable terms, or at all.  In the event we do pursue any acquisitions, it is possible that we may not realize the anticipated benefits from such acquisitions.

We May Not Be Able to Sustain or Increase Our Net Income in the Future, Which May Cause the Trading Price of Our Common Stock to Decline.

          Although we expect to  be able to sustain net income, there is no assurance that we will be able to do so.  Even if we sustain net income, we may not be able to increase net income on a quarterly or

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