Item 1. Business
Overview
We are a biomedical company that develops, manufactures, and markets lasers in dentistry and medicine and also markets and distributes dental imaging equipment, including cone beam digital x-rays and CAD/CAM intra-oral scanners, and in-office, chair-side milling machines and three-dimensional (“3-D”) printers; products that are focused on technologies that advance the practice of dentistry and medicine. Our proprietary dental laser systems allow dentists, periodontists, endodontists, oral surgeons, and other specialists to perform a broad range of dental procedures, including cosmetic, restorative, 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 conventional instruments. We have clearance from the U.S. Food and Drug Administration (the “FDA”) to sell our laser systems in the United States and also have the necessary registration to sell our laser systems in Canada, the European Union, and various other international markets. Our licensed dental imaging equipment and other related products are designed to improve diagnoses, applications, and procedures in dentistry and medicine.
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, pain therapy, and cosmetic procedures, including teeth whitening. We currently have approximately 180 issued and 120 pending U.S. and international patents, the majority of which are related to our core WaterLase technology and dental and medical lasers. From 1998 through December 31, 2013, we sold over 10,200 WaterLase systems, including more than 6,200 WaterLase MD® and iPlus® systems, and more than 24,800 laser systems in over 70 countries around the world.
We currently operate in a single reportable business segment. We had net revenues of $56.4 million, $57.4 million, and $48.9 million in 2013, 2012, and 2011, respectively, and we had net losses of $11.5 million, $3.1 million, and $4.5 million for the same periods.
We were originally formed as Societe Endo Technic, SA (“SET”) in 1984 in Marseilles, France, to develop and market various endodontic and laser products. In 1987, SET merged into Pamplona Capital Corp., a public holding company incorporated in Delaware. In 1994, we changed our name to BIOLASE Technology, Inc. and to BIOLASE, Inc. (“BIOLASE”) in 2012. Since 1998, our primary objective has been to be the leading designer, manufacturer, and marketer of laser systems for the dental industry.
Recent Developments
New Product Offerings
In February 2014, we agreed to distribute Stratasys Ltd.’s (“Stratasys’”) Objet30 OrthoDesk and a number of its Design Series 3-D printers. The Objet30 OrthoDesk combines precise 3-D printing technology with a small footprint. It is easy to use, and includes specialized dental printing materials in convenient sealed cartridges. Dentists can fabricate stone models, orthodontic appliances, delivery and positioning trays, models for clear aligners, retainers and surgical guides on their desktop. We believe that 3-D printing will be a major factor for dental restorations in the new digital era of dentistry.
In November 2013, we introduced the Galaxy BioMill™ CAD/CAM system which enables dental practitioners to scan, design, mill, and finish crowns, inlays, onlays, and veneers in the dental office in a single appointment. The Galaxy BioMill was developed and designed by us in conjunction with German-based imes-icore GmbH for their milling technologies and Copenhagen-based 3Shape Corporation (“3Shape”) for their CAD/CAM intra-oral scanning technologies. We expect to begin shipping these systems in the second quarter of 2014. Also termed "chair-side" milling, the Galaxy BioMill System will utilize 3Shape’s fast and highly accurate Trios intra-oral scanner to capture high resolution 3-D digital images of the teeth and crown-preparation site, which are then processed through a CAD/CAM software program to design the dental restoration. The design is then transferred to the Galaxy BioMill to mill the crown.
We believe that the addition of the Galaxy BioMill and Objet30 OrthoDesk and Design Series 3-D printers to our suite of advanced technology solutions differentiates us compared to other fragmented product offerings in the marketplace and are an integral part of our strategy of becoming the premier Total Technology Solution™ provider in dentistry. By combining high-end digital imaging, first in class laser tissue management, intra-oral scanning, CAD/CAM design, chair-side milling, and 3-D printing, dental offices can accurately and rapidly produce a wide range of restorations and appliances.
In November 2013, we began shipping the Epic™ 10S in collaboration with Valam, Inc. (“Valam”) to develop, market, and sell office-based laser systems to otolaryngologists (also known as ‘Ear, Nose, and Throat” or “ENT” doctors) (the “Valam Agreement”). The Valam Agreement provides us with an exclusive worldwide license to Valam’s ENT related patents and related applications which complement our patent portfolio.
In June 2013, we began shipping the Epic V-Series which enables a wide range of veterinary applications, including surgical, dental, and pain therapy procedures. These laser systems are based on the Epic platform that we launched in late 2012, with software and delivery adaptations, and broadens our laser technology reach within the medical field.
In June 2013, we also expanded our line of digital imaging equipment with the NewTom Biolase VG3 (“VG3”), a readily upgradeable two-dimensional (“2-D”)/3-D hybrid system manufactured by Cefla Dental Group, which we began distributing in the United States. We believe that the digital imaging products included in our suite of technology product offerings are integral for dentists to provide accurate diagnoses to their patients.
Credit Facilities
On May 24, 2012, we entered into two revolving credit facility agreements with Comerica Bank (the “Credit Agreements”), as amended. As of December 31, 2013, the Credit Agreements provided for borrowings against certain domestic accounts receivable and inventory, as set forth in the $4.0 million revolving credit facility agreement (the “Domestic Revolver”), and borrowings against certain export related accounts receivable and inventory, as set forth in the $4.0 million revolving credit facility agreement (the “Ex-Im Revolver”), for a combined aggregate commitment of borrowings up to $8.0 million. The lines of credit mature on May 1, 2014, at which date any remaining borrowings and accrued interest under the lines of credit become due and payable. As of December 31, 2013, we had outstanding borrowings totaling approximately $4.6 million, which included $1.8 million under the Domestic Revolver and $2.8 million under the Ex-Im Revolver.
The Credit Agreements require us to maintain compliance with certain monthly financial and non-financial covenants, as defined therein. Any noncompliance with these covenants may result in default interest rates and penalties, and Comerica Bank could declare the amounts outstanding immediately due and payable. We were either in compliance with these covenants at December 31, 2013, or had received a waiver in the event of non-compliance. On March 4, 2014, we received a waiver for noncompliance with certain financial and nonfinancial covenants as of January 31, 2014 and December 31, 2013, which reduced the aggregate borrowing limits on the Credit Agreements to $5.0 million.
January 2014 Shelf Registration
On January 17, 2014, the Company filed a registration statement to register an indeterminate number of shares of common stock, preferred stock, and warrants with a total offering price not to exceed $12.5 million.
February 2014 Subscription Agreement
On February 10, 2014, the Company entered into a subscription agreement under which the Company offered an aggregate of 1,945,525 unregistered shares of common stock in a private placement at a price of $2.57 per share. Gross proceeds from the sale totaled $5 million, and net proceeds, after offering expenses of approximately $208,000, totaled approximately $4.8 million.
Industry Background
General
Dental procedures, including medical and cosmetic treatment, are performed on hard tissue, such as bone and teeth, and soft tissue, such as gum and other oral tissue.
A 2007 American Dental Association (“ADA”) Survey of Dental Services Rendered (the “ADA Study”) has estimated that more than 200 million hard tissue procedures are performed annually in the United States. Hard tissue procedures include cavity preparation, root canals, and other procedures involving bone or teeth. The ADA study also indicated that more than 1.2 million soft tissue procedures are performed annually in the United States. Soft tissue procedures include operations such as gum line alteration. According to statistics compiled in the ADA’s study, over 90% of hard tissue procedures and 60% of soft tissue procedures in the United States are performed by general dentists and the rest are performed by oral surgeons, endodontists, periodontists, and other specialists.
The ADA estimated that the demand for dental services in the United States will continue to grow due to population growth and the increased awareness of the benefits associated with preventive dentistry in reducing the incidence of oral and systemic disease. According to the 2007 Public Opinion Survey: Oral Health of the US Population, 48.7% of adults said they last saw a dentist less than six months ago, while an additional 18.9% saw a dentist between six months ago and a year.
We believe there is a growing awareness among consumers of the value and importance of a healthy smile and its connections to overall systemic health. There are studies that indicate a possible linkage between periodontitis and several other health conditions such as heart disease, diabetes, or stroke. Oral health care is a priority for many as evidenced by the significant number of dental practitioners both in the U.S. and abroad. According to the 2009 Distribution of Dentists in the U.S. by Region and State, as of 2009, there were 186,084 professionally active dentists, including 170,694 active private practitioners in the U.S. According to the World Health Organization in 2012, as of 2004, there were 1.8 million dentists worldwide, with the most dentists in the U.S., Brazil, and China. As many developing nations continue to experience fiscal growth we believe those nations will also experience higher demand for improved healthcare. Corresponding growth in dental practice competition for patients could create further demand for advanced technologies that allow dentists to perform simple or complex cosmetic dental procedures with minimal trauma, improved patient acceptance, and clinically superior results. We believe our product offerings correspond with this trend, and we expect incremental growth from these pressures in the marketplace.
Traditional Dental Instruments
Dentists and other specialists choose from a variety of instruments depending on the tissue involved and the type of procedure. Most procedures require the use of multiple instruments to achieve the desired result.
High Speed Drills. Most dentists use high speed drills for hard tissue procedures, such as preparing cavities for filling and gaining access for performing root canals or shaving and contouring oral bone tissue. Potentially adverse effects associated with drills include thermal heat transfer, vibration, pressure and noise. The cutting and grinding action of high speed drills can cause damage to the patient’s dental structure. The trauma caused to the surrounding tissues can lead to increased recovery times and the need for future crowns and root canals. Additionally, this grinding action of high speed drills may weaken the tooth’s underlying structure, leading to fractures and broken cusps. Procedures involving high-speed drills typically require anesthesia. Because many dentists do not recommend anesthetizing more than one or two quadrants of the mouth in a single session, patients may need to return several times to complete their treatment plan. Further, based on the results of several recent studies, autoclaving fails to completely decontaminate dental burs and approximately 15% of these “sterilized burs” carry pathogenic micro-organisms, which may be transferred from patient to patient.
Cutting Instruments. Soft tissue procedures, such as reshaping gum lines and grafting on new gum tissue, are typically performed by oral surgeons or periodontists using scalpels, scissors, and other cutting tools. Due to the pain and discomfort associated with procedures performed with these instruments, most soft tissue procedures require the use of local anesthetic which results in numbness and discomfort, and often require stitches. The use of scalpels, scissors, and other cutting tools typically cause bleeding, post-operative swelling, and discomfort. Bleeding can impair the practitioner’s visibility during the procedure, thereby reducing efficiency and is a particular problem for patients with immune deficiencies or blood disorders, and patients taking blood-thinning medications.
Film Radiography Equipment. Since the early twentieth century, dentists have relied on radiographic images produced by exposing photographic film to X-ray radiation as part of the examination and diagnosis of patients. These X-ray images can help reveal tooth decay, periodontal disease, bone loss, infections, hidden dental structures, abscesses or cysts, developmental abnormalities, some types of tumors, and other issues that might not be detected during a visual examination or upon probing with a handheld instrument. Due to the chemical development process required for film, however, this process is time-consuming, inefficient, and costly for dental offices, and not environmentally friendly. Mistakes in the development process can require retakes which expose patients to additional radiation. Film X-rays also restrict the abilities of doctors to enhance or further manipulate images for easier and more accurate analysis and treatment planning. Furthermore, one of the most critical limitations of film is that it is restricted to two-dimensional images, which can potentially lead to misdiagnosis.
Alternative Dental Instruments
Alternative technologies have been developed over the years to address the problems associated with traditional methods used in dentistry. Most alternatives have addressed either hard or soft tissue applications but not both. The predominant alternative technologies are discussed below.
Electrosurge Systems. Electrosurge systems use an electrical current to heat a shaped tip that simultaneously cuts and cauterizes soft tissue, resulting in less bleeding than occurs with scalpels. However, electrosurge is generally less precise than lasers and can damage surrounding tissue. Electrosurge is also not suitable for hard tissue procedures and, due to the depth of penetration, generally requires anesthesia and a lengthy healing process. Electrosurge generally cannot be used in areas near metal fillings and dental implants. Finally, electrosurge generally cannot treat patients with implanted pacemakers and defibrillators.
Traditional Laser Systems. More recently, lasers have gained acceptance for use in general and cosmetic dentistry. Most lasers used in dentistry have been adapted from other medical applications, such as dermatology, and are not designed to perform a wide range of common dental procedures. Most dental lasers use thermal energy to cut tissue and are used primarily for soft tissue procedures.
Our Solution
Due to the limitations associated with traditional and alternative dental instruments, we believe there is a large market opportunity for all-tissue dental laser systems that provide superior clinical results, help reduce the trauma, pain, and discomfort associated with dental procedures, and increase patient acceptance for treatment protocols. We also believe there is a large market opportunity for digital radiography systems that improve practice efficiency and accuracy of diagnosis, leading to superior treatment planning, increased practice revenue, and healthier outcomes for patients.
Our WaterLase systems precisely cut hard tissue and soft tissue with minimal or no damage to surrounding tissue and dental structure. Our Diode systems are designed to complement the WaterLase systems, and are used in soft tissue procedures, pain therapy, hygiene, and cosmetic applications, including teeth whitening. The Diode systems, together with our WaterLase systems, offer practitioners a broad product line with a range of features and price points.
The Biolase DaVinci Imaging and Cefla NewTom products are state-of-the-art digital radiography systems that provide both two- and three-dimensional X-ray images that allow doctors to visualize and manipulate significantly more information than previously available with film, without the time delay of film development or cost associated with chemicals and the film itself. These imaging systems have been designed to produce the highest quality images while exposing patients to the least amount of radiation necessary. The Trios intra-oral CAD/CAM scanning product offers diversity in our imaging product line with spray-free, high-speed, 3-D color impression capture as well as touch screen and online lab communication capabilities.
The Galaxy BioMill System is an open-architecture CAD/CAM system for scanning, designing, milling and finishing crowns, inlays, and veneers in the dental office in a single appointment. Also termed "chair-side" milling, the Galaxy BioMill System will utilize 3Shape’s fast and highly accurate Trios intra-oral scanner to capture color high resolution 3-D digital images of the teeth and crown-preparation site, which are then processed through a CAD/CAM software program to design the dental restoration. The design is then transferred to the Galaxy BioMill to mill the crown using the latest in aesthetically pleasing, biological compatible, and long-lasting tooth colored materials.
The Stratasys Objet30 OrthoDesk and Design Series 3-D printers combine accurate and precise 3-D printing technology with a small footprint. They are easy to use, and include specialized dental printing materials in convenient sealed cartridges. Dentists can fabricate stone models, orthodontic appliances, delivery and positioning trays, models for clear aligners, retainers and surgical guides on their desktop.
We believe that the addition of the Galaxy BioMill and Objet30 OrthoDesk and Design Series 3-D printers to our suite of advanced technology solutions is an integral part of our strategy to be the premier Total Technology Solution provider in dentistry. By combining high-end digital imaging, first in class laser tissue management, intra-oral scanning, CAD/CAM design, chair-side milling, and 3-D printing, dental offices can accurately and rapidly produce a wide range of restorations and appliances.
A small percentage of dental professionals worldwide currently use lasers. Our laser systems are more expensive than traditional dental tools; however, we believe that the significant clinical advantages of our systems, patient benefits, the potential return on investment that our systems offer practitioners, and the options available to finance the purchase of our systems will enable us to continue to penetrate the global dental market. Laser technologies with similar patient benefits have become standard of care in ophthalmology, dermatology, and other medical specialties. When combined with the improved information provided by digital imaging, dental lasers will give the doctor the best treatment options to perform more procedures in a minimally invasive manner. Further, in-office, chair-side milling and 3-D printing gives the doctor the ability to provide same-day restorations. Our combination of high-end digital imaging systems, laser tissue management, intra-oral scanning, chair-side milling, and 3-D printing makes us the only company to offer high-technology solutions for the diagnosis, treatment and restoration planning, and delivery of treatment, in the most minimally invasive manner possible: the Biolase Total Technology Solution™.
We believe the demand for our systems will continue to expand as we increase awareness of the benefits to patients and dental professionals.
Benefits to Dental Professionals
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Expanded range of procedures and revenue opportunities. Our laser systems often allow general dentists to perform surgical and cosmetic procedures that they are unable or unwilling to perform with conventional methods, and which would typically be referred to a specialist. Our systems allow dentists to perform these procedures easily and efficiently, increasing their range of skills, professional satisfaction, and revenues.
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Additional procedures through increased information and efficiency. Our digital imaging systems allow dentists to diagnose and discover cases that they might not be able to detect with film images and/or two-dimensional images, thereby giving them the ability to offer more treatment options for patients. Our laser systems can shorten and reduce the number of patient visits, providing dental professionals with the ability to service more patients. For hard tissue procedures, our WaterLase systems can reduce the need for anesthesia, which enables the dental practitioner to perform multiple procedures in one visit. For soft tissue procedures, the WaterLase and Diode systems allow tissue to be cut more precisely and with minimal bleeding when compared to traditional tools such as scalpels and electrosurge systems. We have FDA clearance for treatment protocols including Deep Pocket Therapy with New Attachment™ and subgingival calculus removal using the WaterLase system and the patented Radial Firing Perio Tip. This is a non-surgical alternative treatment for moderate to advanced gum disease, the leading cause for tooth loss for adults over age 35 and a condition impacting more than half of Americans over age 55. In addition, the Epic system can be used to quickly perform teeth whitening with our proprietary whitening gel and to provide temporary pain relief from minor muscle and joint pain and stiffness, minor arthritis pain or muscle spasm, and minor sprains and strains. The Galaxy BioMill System and Stratasys Objet30 OrthoDesk and Design Series 3-D printers will allow for same-day restorations.
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Increased loyalty and expanded patient base. We believe the improved patient comfort and convenience offered by our laser systems, the reduction in chair time and radiation exposure of our digital imaging systems, and the benefits of in-office, chair-side milling and 3-D printing will help improve patient retention, attract new patients, increase revenue per patient, increase demand for elective procedures, increase acceptance of treatment plans, and increase word-of-mouth referrals.
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Fewer post-operative complications. By providing more complete and accurate information, our digital imaging systems make it possible for the doctor to determine the optimal diagnosis and treatment plan. Our laser systems can then be used to reduce trauma, swelling, and general discomfort of the patient, resulting in fewer post-operative complications that require follow up treatment. In addition, our laser systems effectively reduce the risk of cross-contamination that can occur with traditional dental tools. Our chair-side milling machine and 3-D printers will further expand treatment options available to patients and allow for same-day restorations. These factors make it possible for practitioners to devote time to new cases, rather than treating complications from prior procedures.
Benefits to Patients
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Comfort. The WaterLase system is able to perform various types of dental procedures without causing the heat, vibration, microfractures, trauma, or pressure associated with traditional dental methods, without cross-contamination. Further, in many cases procedures can be performed without the need for local anesthesia.
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Convenience. Our WaterLase system does not require anesthesia in many cases, which allows dental practitioners to perform procedures in multiple quadrants of the mouth during a single office visit. Digital images are available almost immediately, so patients will not have to spend extra time in the dental chair waiting for film to be developed, which makes dentists more efficient. Combined with the diode lasers, these systems offer a variety of solutions for patients. Further, chair-side milling and 3-D printing will allow for same-day restorations.
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Reduced trauma. The WaterLase system avoids the thermal heat transfer, vibration, and grinding action associated with high speed dental drills. As a result, our systems can result in less trauma, swelling, bleeding, and general discomfort to the patient.
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Broader range of available procedures. Due to the improved comfort and convenience of our WaterLase system, we believe patients are more likely to consider cosmetic and other elective procedures that would generally be time consuming and uncomfortable, including osseous crown lengthening, periodontal surgeries, and numerous other procedures. Since digital images are displayed on computer monitors, doctors can make treatment planning a more personal experience with patients. Further, chair-side milling and 3-D printing will offer patients the benefits of same day restorations. We believe that these factors will lead to greater patient case acceptance.
Business Strategy
Our objectives are to increase our leadership position in the dental laser market, to establish our laser systems as essential tools in dentistry, and to leverage our existing technology platform into other medical markets where it can provide significant improvements over existing standards of care. Our business strategy includes the following key elements:
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Increasing awareness of our laser systems among dental practitioners and patients. We intend to further penetrate the dental market by educating dental practitioners and patients about the clinical benefits of WaterLase Dentistry. We plan to continue participation in key industry trade shows, the World Clinical Laser Institute® (“WCLI®”) (which we founded in 2002), dental schools, and other educational forums. We also intend to continue marketing our systems to dental practitioners through our laser specialists and advertising. Our technologies are also available for clinical research which may lead to publications from which we may benefit. We continue to explore marketing directly to patients and have embraced a number of social media platforms to deliver informative and entertaining content to this audience.
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Expanding sales and distribution capabilities. In the United States and Canada, we primarily distribute our products directly to dental practitioners utilizing a direct sales force. During 2012, we augmented our outside direct sales force by establishing an inside sales organization. The inside sales force is located at our corporate headquarters and is comprised of sales representatives and lead generators who work in partnership with the outside sales team to maximize sales by leveraging the existing installed customer base. In 2013, we also added regional imaging specialists to provide technical and clinical expertise in coordination with our laser sales representatives. In addition to our direct sales force in North America, we also have distribution agreements with various independent distributors to distribute our products in the United States, Canada, and various countries in Europe, the Middle East, Latin America, and Asia-Pacific. We continue to develop an infrastructure to support growth in sales and marketing both domestically and internationally. This infrastructure includes product management, information technology systems, and personnel to manage our sales force, compile sales and marketing data, and better serve our customers and non-exclusive distributors.
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Expanding product platform and applications. We plan to expand our product line and product applications by developing product enhancements and new laser technologies including new products for use in the medical community. To this end, we launched the Epic V-Series and Epic 10S in 2013 which improves and expands on certain capabilities previously offered by the Epic which was launched in late 2012 for use in the medical specialty markets, including sports medicine, orthopedics, podiatry, physical therapy, and chiropractics. We also have an objective to increase our sales of disposable products that are used by dental practitioners when performing procedures using our dental laser systems. Additionally, we are continuing to explore collaborations to bring new products to other medical markets utilizing our proprietary laser technologies and we may strategically acquire complementary products and technologies.
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Expanding our Er,Cr:YSGG and 940 nm diode technologies into the medical field. Our WaterLase and Diode lasers and their delivery systems and accessories have applications in many other medical and veterinary specialties, including ophthalmology, orthopedics, sports medicine, dermatology, and podiatry. We currently hold a strong patent position which is complemented by our FDA-cleared general indications for use of our lasers with ocular tissue. Our patented Er,Cr:YSGG WaterLase technology has the potential to address several areas in ophthalmology including dry eye, glaucoma, and presbyopia, as well as several other major medical applications in dermatology, cosmetic surgery, orthopedics, and urology. During 2011 we established Occulase, Inc., a wholly owned subsidiary, for the purpose of consolidating our ophthalmologic-specific intellectual property, which includes over 35 U.S. and international patents and pending patents, as we continue our efforts to expand in this area. In 2013 we launched our Occulase website at www.occulase.com to further our marketing efforts of this laser technology. We plan to commercialize or license these applications in the future and may use distribution partners or other strategic partnerships to enter into these markets. During 2013 we also entered into collaborative arrangements with Valam, resulting in the introduction of the Epic 10S, and with Auris Surgical Robotics, Inc. (“Auris”), to utilize our lasers in a robotic system.
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Continuing high quality manufacturing and customer service. Our manufacturing operations are focused on producing high quality dental laser systems. We intend to continually develop and refine our manufacturing processes to increase both production efficiencies and product quality. We provide high quality maintenance and support services through our support hotline and dedicated staff of in-house and field service personnel. Additionally, we maintain a network of factory-trained service technicians to provide maintenance and support services to customers in markets within and beyond North America.
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Strengthening and defending technology leadership. We believe our proprietary WaterLase system and YSGG Laser technology represent significant advancements in dentistry. We will pursue the protection of our intellectual property rights by expanding our existing patent portfolio in the United States and internationally. We intend to strategically enforce our intellectual property rights worldwide.
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Strengthening training and development of our laser users. In 2012 we opened our technology and training center at corporate headquarters. The center provides introductory and specialized training sessions for dental professionals seeking proficiency and certification training utilizing our products, and will also be used for ongoing training and clinical education for both outside and inside sales teams and our service professionals. We also have established access to several training facilities around the U.S. through our network of key-opinion leaders and trainers.
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Expanding our Total Technology Solution to dental practitioners. In 2013 we unveiled the Galaxy BioMill CAD/CAM system which enables dental practitioners to complete scanning, designing, milling, and finishing crowns, inlays, and veneers in the dental office in a single appointment. We anticipate to begin shipping these systems in the second quarter of 2014. We also expanded the imaging systems under distribution by adding the VG3, a readily upgradeable 2-D/3-D hybrid system. In February 2014 we added several 3-D printers in order to enable dentists to fabricate stone models, orthodontic appliances, delivery and positioning trays, models for clear aligners, retainers and surgical guides on their desktop
Products
Our WaterLase Dentistry consists of two principal product lines: WaterLase systems and Diode systems. We developed the WaterLase and Diode systems through our own research and development, as well as intellectual property obtained through various acquisitions. During the second half of 2012, we introduced the Epic diode laser system which increases our customer base by providing an exceptional laser at an attractive value proposition. During the second half of 2011, we introduced the Biolase DaVinci Imaging line of imaging products which enabled us to offer high quality digital diagnostic solutions to complement the minimally invasive dental treatment solutions offered by our WaterLase and Diode dental systems. In 2012, we added the distribution of the NewTom 3-D cone beam and Trios intra-oral CAD/CAM scanning system which expanded our imaging product line and provides dental customers with a wider and more comprehensive choice of configurations and range of performance. The integration of our laser products with imaging offers dental professionals the Total Technology Solution which provides imaging capabilities for early diagnosis and minimally invasive treatment with our WaterLase and Diode laser technologies.
WaterLase systems. Our all-tissue WaterLase dental laser systems currently consist of the WaterLase iPlus, the WaterLase MD Turbo, and the WaterLase MDX 300 and 450, both introduced in February 2012. Each of these systems is designed around our patented YSGG Laser technology that refers to the unique laser crystal used in the WaterLase system, which contains the elements erbium and chromium doped yttrium, scandium, and gallium garnet crystal (Er,Cr: YSGG). This unique crystal laser produces energy with specific absorption and tissue interaction characteristics optimized for dental applications. HydroPhotonics refers to the interaction of YSGG lasers with water to produce energy to cut tissue. It is minimally invasive and can precisely cut hard tissue, such as bone and teeth, and soft tissue, such as gums or skin, without the heat, vibration, or pressure associated with traditional dental treatments. By eliminating heat, vibration, and pressure, our WaterLase systems reduce and, in some instances, eliminate the need for anesthesia and also result in faster healing times versus traditional methods of treatment.
The WaterLase systems incorporate an ergonomic handpiece and an extensive control panel located on the front of the system with precise preset functionality to control the mix of laser energy, air, and water, as well as the pulse rate. Each system also has been designed to be easily moved from operatory to operatory within a practice office.
The original WaterLase MD released in 2005 features white light-emitting diode (“LED”) handpiece illumination, a full color touch screen improving user friendliness (with a built in user “Help” system), a refined water spray that improves cutting, and a Windows CE operating system. In 2008, we introduced a new clinical procedure for endodontic root canal disinfection with radial firing tips. The WaterLase MD Turbo All-Tissue Dental Laser System was introduced in the first quarter of 2009 and increased the cutting speed compared to the original WaterLase MD. In 2009, we also obtained FDA clearance for a new treatment protocol called Deep Pocket Therapy with New Attachment using the WaterLase MD and the patented Radial Firing Perio Tip. This is a non-surgical alternative treatment for moderate to advanced gum disease, the leading cause of tooth loss for adults over 35 and a condition impacting more than half of Americans over age 55. The procedure assists in new attachment and subgingival calculus removal, and in most cases provides deep pocket treatments in a single visit without the use of a scalpel, stitches, or the conventional cutting of the gums. The WaterLase iPlus, introduced in January 2011, is our most advanced and powerful, yet most intuitive, dual-wavelength all-tissue dental laser system. It delivers all the benefits of our other WaterLases, but with more power, versatility, and ease of use, including an intuitive user interface and a significant increase in cutting speed that is comparable to a high speed drill. The WaterLase iPlus also incorporates the iLase wireless diode laser that can be utilized for unexpected soft-tissue cases in an adjacent treatment room, controlling bleeding, and temporary pain relief.
Diode systems. Our Diode laser systems in dentistry currently consist of the Epic and iLase, semiconductor diode lasers that perform soft tissue, hygiene, cosmetic procedures, teeth whitening, and temporary pain relief.
In February 2010, we introduced our iLase diode laser system, the first wireless, affordable dental diode laser that provides minimally invasive solutions for the most common everyday soft tissue surgical and hygiene procedures. Featuring patent-pending finger switch activation, battery power, our unique 940 nm wavelength, and ComfortPulse® cutting modality, we believe the wireless and highly portable iLase is a perfect complement for every dental operatory. In September 2012, we introduced our new Epic diode laser system, a portable touch screen system with applications in soft tissue surgery, dental hygiene, teeth whitening, and temporary pain relief. The iLase and Epic are FDA cleared in the United States and CE mark-approved in Europe.
Imaging systems. Our imaging systems include licensed state-of-the-art extra-oral and intra-oral dental digital imaging devices. Our expansion into digital imaging systems enables us to offer high quality diagnostic solutions to complement the minimally invasive dental treatment solutions offered by our WaterLase and Diode systems. We now provide both high-precision intuitive diagnosis and treatment planning solutions, fundamental to the delivery of quality dentistry, together with truly advanced laser treatment solutions thereby delivering, we believe, the best biological and therapeutic results for dentists and patients. Our Imaging systems include the CEFLA NewTom VGi and VG3, Biolase DaVinci D3D, 3-D Cone Beam Computed Tomography (“CBCT”) devices. We are currently selling these products as a distributor under the manufacturer’s FDA 510(k) clearance. Our 3-D CBCT devices produce stable and high quality 3-D images with low levels of radiation - critical features in dental implant, endodontic, orthodontic, and oral surgery cases.
The first CBCT system introduced to the dental market in 1996 was a NewTom. Since that time, the NewTom brand has been synonymous with providing the clearest, sharpest, and highest quality three-dimensional images. The NewTom VGi is a small-footprint CBCT system that offers medical grade imaging technology at a fraction of the cost and radiation exposure typically associated with medical CT equipment. In addition to producing up to 50% higher image resolution with medical grade rotating anode technology, its proprietary SafeBeam™ technology automatically adjusts radiation dosage to ensure patient safety. In 2013, we introduced the NewTom VG3, a readily upgradeable two-dimensional 2-D/3-D hybrid system to complement the VGi and to expand the range of features and price points to meet the needs of growing practices.
3Shape Trios CAD/CAM imaging systems. 3Shape unveiled this system at the International Dental Show in Germany in 2011. We immediately recognized this system as an advanced dental imaging product designed with technical solutions for the dental practitioner and comfort for patients. The 3Shape system offers a spray-free scanning device for optimal accuracy and patient comfort, high speed technology with accurate digital impression-taking with up to 1000 3-D pictures, a touchscreen interface with live 3-D visualization, online communication capability with labs, and additional benefits. We are currently selling this product as a distributor under the manufacturer’s regulatory market clearances.
In-office milling system. The Galaxy BioMill CAD/CAM system enables dental practitioners to complete scanning, designing, milling, and finishing crowns, inlays, and veneers in the dental office in a single appointment. We anticipate beginning to ship these systems in the second quarter of 2014.
3-D Printers. In February 2014, we agreed to distribute Stratasys’ Objet30 OrthoDesk and a number of their Design Series High End 3-D printers. The Objet30 OrthoDesk combines accurate and precise 3-D printing technology with a small footprint. It is easy to use, and includes specialized dental printing materials in convenient sealed cartridges. 3-D printers allow dentists to fabricate stone models, orthodontic appliances, delivery and positioning trays, models for clear aligners, retainers and surgical guides on their desktop. We anticipate beginning to ship these systems in the second quarter of 2014.
Medical systems. Our Medical systems include the Diolase 10™ Diode Laser for which we received FDA 510(k) clearance in April 2009 to use in our ezlase platform for both dental and medical pain relief applications. In late 2009 we broadened our product scope to include the use of lasers in a variety of health care and therapeutic markets outside of dentistry. The Diolase 10 was launched with a patented handpiece for therapeutic applications, including temporary pain relief, topical heating for the purpose of temporarily relieving minor muscle and joint pain and stiffness, minor arthritis pain, muscle spasm, minor sprains and strains, and minor muscular back pain; temporarily increasing local blood circulation; and temporarily relaxing muscles. The Diolase 10 was our first strategic expansion into the medical market (which includes sports medicine, orthopedics, podiatry, physical therapy, and chiropractics). We initially focused on the chiropractic market and in 2010 we expanded into physical therapy and sports medicine and introduced the Deep Tissue Handpiece. A continuation of our expansion into the medical market is also realized in our Epic diode laser, which was launched in late 2012 and has improved portability and value proposition with applications including temporary pain relief. The Epic V-Series launching in 2013 is based on the Epic platform with software and delivery adaptations enabling a wide range of veterinary applications, including surgical, dental, and pain therapy procedures. We anticipate further expansion of the Epic diode laser into additional medical markets in 2013.
Related Accessories and Disposable Products
We also manufacture and sell disposable products and accessories for our laser systems. Our WaterLase and Diode systems use disposable laser tips of differing sizes and shapes depending on the procedures being performed. We also market flexible fibers and hand pieces that dental practitioners will replace at some point after initially purchasing laser systems. For our Epic and ezlase systems, we sell teeth whitening gel kits.
Warranties
Our WaterLase laser systems sold domestically are covered by a warranty against defects in material and workmanship for a period of up to one-year while our Diode systems warranty is for a period of up to two years from the date of sale to the end-user by us or a distributor. 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 warranty covers parts and service for sales in our North American territories and parts only for international distributor sales. In North America and select international locations, we sell service contracts to our end users that cover the period after the expiration of our standard warranty coverage for our laser systems. Extended warranty coverage provided under our service contracts varies by the type of system and the level of service desired by the customer. Products or accessories remanufactured, refurbished, or sold by authorized parties, voids all warranties in place for such products and exempts us from liability issues relating to the use of such products. We offer extended warranties on certain products that we distribute, including our digital radiography products. All products that we distribute are initially covered by manufacturer’s warranties.
Insurance
We maintain product liability insurance on a claims-made-and-reported basis with a limit of $10 million per occurrence and $10 million in the aggregate for all occurrences. The insurance is subject to various standard coverage exclusions, including damage to the product itself, losses from recall of our product, and losses covered by other forms of insurance such as workers compensation. We cannot be certain that we will be able to successfully defend any claims against us, nor can we be certain that our insurance will cover all liabilities resulting from such claims. In addition, we cannot assure you that we will be able to obtain such insurance in the future on terms acceptable to us, or at all.
Manufacturing
Our strategy is to manufacture products in-house when it is efficient for us to do so. We currently manufacture, assemble, and test all of our WaterLase products and diode lasers at our corporate headquarters facility in Irvine, California. The 57,000 square foot facility has approximately 20,000 square feet dedicated to manufacturing and warehousing. The facility is ISO 13485 certified. ISO 13485 certification provides guidelines for our quality management system associated with the design, manufacturing, installation, and servicing of our products. In addition, our U.S. facility is registered with the FDA and is compliant with the FDA’s Quality System Regulation.
We use an integrated approach to manufacturing, including the assembly of tips, laser hand pieces, fiber assemblies, laser heads, electro-mechanical subassembly, final assembly, and testing. We obtain components and subassemblies for our products from third party suppliers, the majority of which are located in the United States. We generally purchase components and subassemblies from a limited group of suppliers through purchase orders. In general, we rely on these purchase orders and do not have written supply contracts with many of our key suppliers. Three key components used in our WaterLase system: handpieces, laser crystals, and fiber components are each supplied by separate single-source suppliers. In recent years, we have not experienced material delays from the suppliers of these three key components. However, in the event that we experience an unexpected interruption from a single source supplier, manufacturing delays, re-engineering, significant costs, and sales disruptions could occur, any of which could have a material adverse effect on our operations. We are currently in the process of identifying and qualifying alternate source suppliers for our key components, including but not limited to those noted above. There can be no assurance, however, that we will successfully identify and qualify an alternate source supplier for any of our key components or that we could enter into an agreement with any such alternate source supplier on terms acceptable to us.
Marketing and Sales
Marketing
We currently market our laser systems in the United States and worldwide. Our marketing efforts are focused on increasing brand and specific product awareness among dental practitioners. We continue to explore methods to increase awareness of the benefits of our products by marketing directly to patients.
Dental Practitioners. We currently market our laser systems to dental practitioners through regional, national, and international trade publications, educational events, individual meetings, the internet, and seminars. We also use brochures, direct mailers, press releases, posters, and other promotional materials, as well as print and electronic media news coverage. In 2010, we introduced the Biolase Store for online purchase of lasers, consumables, accessories, and service contracts in North America. In 2002, we founded the World Clinical Laser Institute (the “WCLI”) to formalize our efforts to educate and train dental practitioners in laser dentistry. The WCLI conducts and sponsors educational programs domestically and internationally for dental practitioners, researchers, and academicians, including one, two, and three-day seminars and training sessions involving in-depth presentations on the use of lasers in dentistry. In 2012, the organization was expanded to include digital imaging. In addition, we have developed relationships with research institutions, dental schools, and laboratories which use our products in training and demonstrations. We believe these relationships will increase awareness of our products. In 2012 we formalized a 5 year agreement with Professor Norbert Gutknecht and the Aachen Center for Laser Dentistry (“AALZ”), the acknowledged leader in dental laser education since its founding in 1992. We expect the AALZ and related World Academy for Laser Education in Dentistry Network (“WALED”) to continue expanding the availability of postgraduate advanced wavelength clinical laser education while also taking major steps toward standardizing laser dental education for all our owners worldwide.
Chiropractors, Sports Medicine. We market to chiropractors, physical therapists, and other pain management specialists through trade advertising, seminars, and trade shows. Our marketing activities are primarily executed by our network of independent sales representatives who are managed by our internal sales management team.
Patients. We market the benefits of our laser systems directly to patients through marketing and advertising programs, including the internet, social networks, print and broadcast media, local television news and radio spots, as well as product placements of our laser systems on television programs. We believe that making patients aware of our laser systems and their benefits will increase demand for our products. We can be found online at www.biolase.com, Facebook at www.facebook.com/biolase, Twitter at www.twitter.com/biolaseinc, Pinterest at www.pinterest.com/biolase, LinkedIn at www.linkedin.com/company/biolase, Google+ at www.google.com/+BIOLASEIrvine, Instagram at www.instagram.com/biolaseinc, and YouTube at www.youtube.com/biolasevideos.
Sales
We currently sell our products primarily to dentists in general practice through our direct sales force and our distributor network. The majority of the dentists in the United States and the majority of our end-user customers are sole practitioners. We expect our laser systems to continue to gain acceptance among periodontists, endodontists, oral surgeons, and other dental specialists as they become better aware of the clinical benefits and new treatment options available through the use of our laser systems. Sales to dental specialists will also benefit from the introduction of our NewTom, 3Shape, Galaxy, and Stratasys products into our Total Technology Solution. Outside of the dental market, we expect that our initial sales of lasers will be to pain management specialists, which include chiropractors and physical therapists, otolaryngologists, those who work with the ear, nose, and throat (“ENT”), and the veterinary market.
The following table summarizes our net revenues by category for the years ended December 31, 2013, 2012, and 2011 (dollars in thousands):
Net revenue by geographic location based on the location of customers was as follows (in thousands):
International revenue accounts for a significant portion of our total revenue and accounted for approximately 37%, 29%, and 33% of our net revenue in 2013, 2012, and 2011, respectively. No individual country outside the United States represented more than 10% of net revenue during the years ended December 31, 2013, 2012, and 2011.
For financial information about our long-lived assets, see Note 2 and Note 9 to the Notes to the Consolidated Financial Statements - Summary of Significant Accounting Policies and - Segment Information.
North American Sales. In the United States and Canada, we primarily sell our products directly to dental practitioners utilizing a direct sales force consisting of laser sales representatives, imaging specialists, and regional managers. During 2012, we augmented our outside direct sales force by establishing an inside sales organization. The inside sales force is located at our corporate headquarters and is comprised of sales representatives and lead generators who work in partnership with the outside sales team to maximize sales by leveraging the existing installed customer base.
International Sales. Our distributors purchase laser systems and disposables from us at wholesale dealer prices and resell them to dentists in their sales territories. All sales to distributors are final and we can terminate our arrangements with dealers and distributors for cause or non-performance. In some select territories we have granted certain distributors the right to be our exclusive distributor in that territory. These distributors are generally required to satisfy certain minimum purchase requirements to maintain their exclusivity. In 2011, we began selling our products directly to end users in Germany and other countries where we have non-exclusive distribution arrangements. In 2012, we began selling our products directly to end users in India and neighboring countries.
Customer Concentration. We sell our products through our direct sales force and non-exclusive distributor relationships. For the years ended December 31, 2013, 2012, and 2011, sales to our largest distributor worldwide accounted for approximately 5%, 3%, and 19%, respectively, of our net revenue.
Customer Service. We provide maintenance and support services through our support hotline, field and factory service technicians, and our network of factory-trained third-party service technicians. We currently provide maintenance and support services in the United States and Canada through our employee service technicians. We maintain a network of service technicians who provide maintenance and support services in all other countries where we do business. Our international distributors are responsible for providing maintenance and support services for products sold by them. We provide parts to distributors at no additional charge for products covered under warranty.
Financing Options. Many dentists finance their purchases through third-party financial institutions, including leasing companies and banks. In the United States and Canada, third-party customers enter into a financing agreement with a financial institution who purchases the product from us or one of our distributors. We are not party to these financing agreements, so if the customer agrees to pay the financial institution in installments we do not bear the credit risk that the dentist might not make payments. The financial institutions do not have recourse to us for a customer’s failure to make payments, nor do we have any obligation to take back the product.
Seasonality. Historically, we have experienced fluctuations in revenue from quarter to quarter due to seasonality. Revenue in the first quarter typically is lower than average and revenue in the fourth quarter typically is stronger than average due to the buying patterns of dental professionals. We believe that this trend exists because a significant number of dentists purchase their capital equipment towards the end of the calendar year in order to maximize their practice earnings while seeking to minimize their taxes. This can be accomplished by utilizing certain tax incentives, such as accelerated depreciation methods for purchasing capital equipment, as part of their year-end tax planning. In addition, revenue in the third quarter may be affected by vacation patterns which can cause revenue to be flat or lower than in the second quarter of the year. Our historical seasonal fluctuations may also be impacted by sales procedures employed by large dental distributors that encourage end-of-quarter and end-of-year buying in our industry. Because of these seasonal fluctuations, historically we have often used less cash in operations for the six months ended December 31 as compared to the six months ended June 30.
Engineering and Product Development
Engineering and product development activities are essential to maintaining and enhancing our business. We believe our engineering and product development team has demonstrated its ability to develop innovative products that meet evolving market needs. Our research and product development group consists of approximately 14 individuals with medical device and laser development experience, including two Ph.Ds. During the years ended December 31, 2013, 2012, and 2011, our engineering and product development expenses totaled approximately $4.0 million, $4.7 million, and $4.3 million, respectively. Our current engineering and product development activities are focused on improving our existing products and technology and extending our product range in order to provide dental practitioners and patients with less painful and clinically superior laser systems. Some examples of the improvements we are pursuing for our dental lasers include faster cutting speed, ease of use, less need for anesthesia injections, interconnectivity, and an expanded portfolio of consumable products for use with our laser systems.
We also devote engineering and development resources toward markets outside of dentistry in which we might exploit our technology platform and capabilities. We believe our laser technology and developments capabilities could be applicable in several other medical markets, including ophthalmology, otolaryngology, orthopedics, podiatry, pain management, aesthetics/dermatology, veterinary, and consumer products. We have already started to enter the otolaryngology, pain management, and veterinary markets to varying degrees.
We have a non-exclusive license agreement with Procter & Gamble Company (“P&G”), granting P&G non-exclusive license rights to certain of our patents, enabling P&G to develop certain products aimed at the consumer market, and requiring P&G to pay royalties based on sales of products developed with such intellectual property. The term of the arrangement continues until the underlying patents expire unless terminated earlier by either party. We are exploring alternative product development opportunities.
Intellectual Property and Proprietary Rights
We believe that in order to maintain a competitive advantage in the marketplace, we must develop and maintain protection of the proprietary aspects of our technology. We rely on a combination of patents, trademarks, trade secrets, copyrights and other intellectual property rights to protect our intellectual property. We have developed a patent portfolio internally, and to a lesser extent through acquisitions and licensing, that covers many aspects of our product offerings. As of December 31, 2013, we had approximately 180 issued patents and 120 pending patent applications in the United States, Europe and other countries around the world. While we hold a variety of patents that cover a broad range of technologies and methods, the majority of these patents provide market protection for our core technologies incorporated in our laser systems and related accessories. Existing patents related to our core technology, which are at various stages of being incorporated into our products, are scheduled to expire as follows: four in 2014, 18 in 2015, nine in 2016, two in 2017, and 18 in 2018, with the majority having expiration dates ranging from 2019 to 2032. With approximately 120 patent applications pending, we expect the number of new grants to exceed the number of patents expiring. We do not expect the expiration of the expired or soon-to-expire patents to have a material adverse effect on our business.
There are risks related to our intellectual property rights. For further details on these risks, see Item 1A
Item 1A. Risk Factors
The following risk factors and other information included in this Form 10-K should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we presently deem less significant may also impair our business operations. If any of the following risks come to fruition, our business, financial condition, results of operations and future growth prospects would likely be materially and adversely affected. In these circumstances, the market price of our stock could decline, and you could lose all or part of your investment.
Risks Related to Our Revenue
Although our financial statements have been prepared assuming the Company will continue as a going concern, our management and our independent registered public accounting firm, in its report accompanying our consolidated financial statements as of and for the year ended December 31, 2013, believe that our recurring losses from operations and other factors have raised substantial doubt about our ability to continue as a going concern as of December 31, 2013.
Our audited financial statements for the fiscal year ended December 31, 2013, were prepared on a going concern basis in accordance with United States generally accepted accounting principles. The going concern basis of presentation assumes 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 and do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from our inability to continue as a going concern. Our need for additional capital and the uncertainties surrounding our ability to raise such funding, raises substantial doubt about our ability 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 distributors; establish profitable operations through increased sales and a reduction of 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, expanding our direct sales force and expanding our distributor relationships both domestically and internationally. 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. If we become unable to continue as a going concern, we may have to liquidate our assets, and might realize significantly less than the values at which they are carried on our financial statements, and stockholders may lose all or part of their investment in our common stock.
Continued global economic uncertainty and volatility in financial markets may continue to adversely affect our liquidity, operating results, and financial condition.
Our business is highly sensitive to changes in general economic conditions as a seller of capital equipment to end users in dental professional practices. Financial markets inside the United States and internationally have experienced extreme disruption in recent times, including, among other things, extreme volatility in security prices, severely diminished liquidity and credit availability, and declining valuations of investments. These disruptions are likely to have an ongoing adverse effect on the world economy. A continuing economic downturn and financial market disruptions may:
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reduce demand for our products and services, increase order cancellations and result in longer sales cycles and slower adoption of new technologies;
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increase the difficulty of collecting accounts receivable and the risk of excess and obsolete inventories;
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increase price competition in our served markets; and
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result in supply interruptions, which could disrupt our ability to produce our products.
We have experienced net losses for each of the past three years and we may experience additional losses and have difficulty achieving profitability in the future.
We had an accumulated deficit of approximately $123.8 million at December 31, 2013. We recorded net losses of approximately $11.5 million, $3.1 million, and $4.5 million for the years ended December 31, 2013, 2012, and 2011, respectively. In order to achieve profitability, we must control our costs and increase net revenue through new sales. Failure to increase our net revenue and decrease our costs could cause our stock price to decline.
Our business is capital intensive and the failure to obtain capital could require that we curtail capital expenditures.
To remain competitive, we must continue to make significant investments in the development of our products, the expansion of our sales and marketing activities and the expansion of our operating and management infrastructure as we increase sales domestically and internationally. If cash generated from our operations is insufficient to fund such growth, we may be required to raise additional funds through further debt or equity financings, which may dilute the percentage ownership of existing holders of common stock and which 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 market price of our common stock thereby resulting in dilution to our existing stockholders. If we raise additional funds through debt financing, we may be subject to debt covenants which could place limitations on our operations. We may not be able to raise additional capital on reasonable terms, or at all, or we may use capital more rapidly than anticipated. If we cannot raise the required capital when needed, we may not be able to satisfy the demands of existing and prospective customers and may lose revenue and market share.
The following factors, among others, could affect our ability to obtain additional financing on favorable terms, or at all:
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our results of operations;
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general economic conditions and conditions in the dental or medical device industries;
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the perception of our business in the capital markets;
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our ratio of debt to equity;
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our financial condition;
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our business prospects; and
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interest rates.
If we are unable to obtain sufficient capital in the future, we may have to curtail our capital expenditures. Any curtailment of our capital expenditures could result in a reduction in net revenue, reduced quality of our products, increased manufacturing costs for our products, harm to our reputation, reduced manufacturing efficiencies or other harm to our business.
Our distributors may cancel, reduce or delay orders of our products, any of which could reduce our revenue.
We rely on exclusive and non-exclusive independent distributors for a portion of our sales in North America and a majority of our sales in countries outside of the United States and Canada. For the fiscal years ended December 31, 2013, 2012, and 2011 revenue from distributors accounted for approximately 30%, 23%, and 42% of our total net revenue, respectively. Our ability to maintain or increase our revenue will depend in large part on our success in developing and maintaining relationships with our current distributors and developing relationships with new distributors. Our distributors have significant discretion in determining the efforts and resources they apply to the sale of our products. Our distributors may not commit the necessary resources to market and sell our products to the level of our expectations and, regardless of the resources they commit, they may not be successful. From time to time, we may face competition or pricing pressure from one or more of our non-exclusive distributors in certain geographic areas where those distributors are selling inventory to the same customer base as us. Additionally, most of our distributor agreements can be terminated with limited notice, and we may not be able to replace any terminating distributor in a timely manner or on terms agreeable to us, if at all. If we are not able to maintain our distribution network, if our distribution network is not successful in marketing and selling our products, or if we experience a significant reduction in, cancellation, or change in the size and timing of orders from our distributors, our revenues could decline significantly.
Dentists and patients have been hesitant in adopting laser technologies and our inability to overcome this hesitancy could limit the market acceptance of our products and market share.
Our dental laser systems represent relatively new technologies in the dental market. Currently, only a small percentage of dentists use lasers to perform dental procedures. Our future success will depend on our ability to increase demand for our products by demonstrating the potential performance advantages of our laser systems over traditional methods of treatment and over competitive laser systems to a broad spectrum of dentists and patients. Historically, we have experienced long sales cycles because dentists have been, and may continue to be, slow to adopt new technologies on a widespread basis. As a result, we generally are required to invest a significant amount of time and resources to educate dentists about the benefits of our products in comparison to competing products and technologies before completing a sale, if any.
Factors that may inhibit adoption of laser technologies by dentists include cost and concerns about the safety, efficacy and reliability of lasers. In order to invest in a WaterLase system, a dentist generally needs to invest time to understand the technology, consider how patients may respond to the new technology, assess the financial impact the investment may have on the dentist’s practice and become comfortable performing procedures with our products. Absent an immediate competitive motivation, a dentist may not feel compelled to invest the time required to learn about the potential benefits of using a laser system. Dentists may not accept or adopt our products until they see additional clinical evidence supporting the safety and efficiency of our products or recommendations supporting our laser systems by influential dental practitioners. In addition, economic pressure, caused, for example, by an economic slowdown, changes in healthcare reimbursement or by competitive factors in a specific market, may make dentists reluctant to purchase substantial capital equipment or invest in new technologies. Patient acceptance will depend on the recommendations of dentists and specialists, as well as other factors, including without limitation, the relative effectiveness, safety, reliability and comfort of our systems as compared to other instruments and methods for performing dental procedures. The failure of dental lasers to achieve broad market acceptance would limit sales of our products and have an adverse effect on our business and results of operations.
Any failure in our efforts to train dental practitioners could reduce the market acceptance of WaterLase Dentistry and reduce our revenues.
There is a learning process involved for dental practitioners to become proficient users of our laser systems. It is critical to the success of our sales efforts to adequately train a sufficient number of dental practitioners. Following completion of training, we rely on the trained dental practitioners to advocate the benefits of our products in the broader marketplace. Convincing dental practitioners to dedicate the time and energy necessary for adequate training is challenging, and we cannot assure you that we will be successful in these efforts. If dental practitioners are not properly trained, they may misuse or ineffectively use our products, or may be less likely to appreciate our laser systems. This may also result in unsatisfactory patient outcomes, patient injury, negative publicity, or lawsuits against us, any of which could negatively affect our reputation and sales of our laser systems.
If future data proves to be inconsistent with our clinical results or if competitors’ products present more favorable results our revenues may decline.
If new studies or comparative studies generate results that are not as favorable as our clinical results, our revenues may decline. Additionally, if future studies indicate that our competitors’ products are more effective or safer than ours, our revenues may decline. Furthermore, physicians may choose not to purchase our laser systems until they receive additional published long-term clinical evidence and recommendations from prominent physicians that indicate our laser systems are effective for dental applications.
We face competition from other companies, many of which have substantially greater resources than we do. If we do not successfully develop and commercialize enhanced or new products that remain competitive with products or alternative technologies developed by others, we could lose revenue opportunities and customers and our ability to grow our business would be impaired.
A number of competitors have substantially greater capital resources, larger customer bases, larger technical, sales and marketing forces and have established stronger reputations with target customers than ours. We compete with a number of domestic and foreign companies that market traditional dental products, such as dental drills, as well as companies that market laser technologies in the dental and medical markets. The marketplace is highly fragmented and very competitive. We expect that the rapid technological changes occurring in the healthcare industry may lead to the entry of new competitors, particularly if dental and medical lasers gain increasing market acceptance. If we do not compete successfully, our revenue and market share may decline.
Our long-term success depends upon our ability to (i) distinguish our products through improving our product performance and pricing, protecting our intellectual property, continuously improving our customer support, accurately timing the introduction of new products, and developing sustainable distribution channels worldwide; and (ii) develop and successful commercialize new products, new or improved technologies, and additional applications for our existing dental and medical lasers.
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 have various billing practices and patient mixes. Such practices range from primarily private pay to those who rely heavily on third party payors, such as private insurance or government programs. In the United States, third party payors review and frequently challenge the prices charged for medical services. In many foreign countries, the prices for dental services are predetermined through government regulation. Payors may deny coverage and reimbursement if they determine that the procedure was not medically necessary or that the device used in the procedure was investigational. We believe that most of the procedures being performed with our current products generally are reimbursable, with the exception of cosmetic applications, such as teeth whitening. For the portion of dentists who rely heavily on third party reimbursement, 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 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 could act as disincentives for capital investments by dental and medical professionals and could have a negative impact on our business and results of operations.
Our ability to use net operating loss carryforwards may be limited.
Section 382 of the Internal Revenue Code (“IRC”) of 1986 generally imposes an annual limitation on the amount of net operating loss carryforwards that may be used to offset taxable income when a corporation has undergone significant changes in its stock ownership. In 2006, we completed an analysis to determine the applicability of the annual limitations imposed by IRC Section 382 caused by previous changes in our stock ownership and determined that such limitations should not be significant. Based on our analysis, we believe that, as of December 31, 2013, approximately $77.9 million of net operating loss carryforwards were available to us for federal income tax purposes. A detailed analysis will be required at the time we begin utilization of any net operating losses to determine if there is an IRC Section 382 limitation. In addition, any ownership changes qualifying under IRC Section 382, including changes resulting from or affected by public offerings or stock repurchase plans, may adversely affect our ability to use our remaining net operating loss carryforwards. If we lose our ability to use net operating loss carryforwards, any income we generate will be subject to tax earlier than it would be if we were able to use net operating loss carryforwards, resulting in lower profits.
Risks Related to Our Intellectual Property
If the patents that we own or license, or our other intellectual property rights, do not adequately protect our technologies, we may lose market share to our competitors and be unable to operate our business profitably.
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. We currently possess a number of issued patents and patent applications with respect to our products and technology; however, we cannot assure that any additional patents will be issued, that the scope of any patent protection will be effective in helping us address our competition, or that any of our patents will be held valid if subsequently challenged. It is also possible that our competitors may independently develop similar or more desirable products, duplicate our products, or design products that circumvent our patents. The laws of foreign countries may not protect our products or intellectual property rights to the same extent as the laws of the United States. In addition, there have been recent changes in patent laws and rules of the U.S. Patent and Trademark Office, and there may be future proposed changes which, if enacted, may have a significant impact on our ability to protect our technology and enforce our intellectual property rights. If we fail to protect our intellectual property rights adequately, our competitive position and financial condition may be adversely affected.
If third parties claim that we infringe their intellectual property rights, we may incur liabilities and costs and may have to redesign or discontinue selling certain products.
We face substantial uncertainty regarding the impact that other parties’ intellectual property positions will have on the markets for dental and other medical lasers. The medical technology industry has in the past been characterized by a substantial amount of litigation and related administrative proceedings regarding patents and intellectual property rights. From time to time, we have received, and expect to continue to receive, notices of claims of infringement, misappropriation, or misuse of other parties’ proprietary rights. Some of these claims may lead to litigation. 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, may be time-consuming and distracting to management, result in costly litigation, or cause product shipment delays. Adverse determinations in litigation could subject us to significant liability and could result in the loss of proprietary rights. A successful lawsuit against us could also force us to cease selling or redesign products that incorporate the infringed intellectual property. Additionally, we could be required to seek a license from the holder of the intellectual property to use the infringed technology, and it is possible that we may not be able to obtain a license on acceptable terms, or at all. Any of the foregoing adverse events could seriously affect our business.
Risks Related to Our Regulatory Environment
Changes in government regulation or the inability to obtain or maintain necessary government approvals could harm our business.
Our products are subject to extensive government regulation, both in the United States and in other countries. To clinically test, manufacture and market products for human use, we must comply with regulations and safety standards set by the FDA and comparable state and foreign agencies. Regulations adopted by the FDA are wide ranging and govern, among other things, product design, development, manufacture and control testing, labeling control, storage, advertising, and sales. Generally, products must meet regulatory standards as safe and effective for their intended use before being marketed for human applications. The clearance process is expensive, time-consuming, and uncertain. Failure to comply with applicable regulatory requirements of the FDA can result in an enforcement action which may include a variety of sanctions, including fines, injunctions, civil penalties, recall or seizure of our products, operating restrictions, partial suspension, or total shutdown of production and criminal prosecution. The failure to receive or maintain 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.
Should we develop new products and applications or make any significant modifications to our existing products or labeling, we will need to obtain additional regulatory clearances or approvals to market such products. Any modification that could significantly affect a product’s safety or effectiveness, or that would constitute a change in its intended use, will require a new FDA 510(k) clearance, or could require a PMA application. The FDA requires each manufacturer to make this determination initially, but the FDA can review any such decision and can disagree with a manufacturer’s determination. If the FDA disagrees with a manufacturer’s determination, the FDA can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance or PMA is obtained. If 510(k) clearance is denied and a pre-market approval application is required, we could be required to submit substantially more data, may be required to conduct human clinical testing and would very likely be subject to a significantly longer review period.
Products sold in international markets are also subject to the regulatory requirements of each respective country or region. The regulations of the European Union require that a device have a CE Mark, indicating conformance with European Union laws and regulations before it can be sold in that market. The regulatory international review process varies from country to country. We rely on our distributors and sales representatives in the foreign countries in which we market our products to comply with the regulatory laws of such countries. Failure to comply with the laws of such countries could have a material adverse effect on our operations and, at the very least, could prevent us from continuing to sell products in such countries. In addition, unanticipated changes in existing regulatory requirements or the adoption of new requirements could impose significant costs and burdens on us, which could increase our operating expenses and harm our financial condition.
Changes in the health care industry in the U.S. and elsewhere could adversely affect the demand for our products as well as the way in which we conduct our business. Significantly, President Obama signed health care reform legislation into law that will require most individuals to have health insurance, establish new regulations on health plans, and create insurance pooling mechanisms and other expanded public health care measures. In general, an expansion in government’s role in the U.S. health care industry may lower reimbursements for our products or the procedures for which our products are used, reduce demand for innovative products, reduce volumes for dental and medical procedures, and adversely affect our business and results of operations, possibly materially. In addition, as a result of the focus on health care reform, there is risk that Congress may implement changes in laws and regulations governing health care service providers, including measures to control costs, or reductions in reimbursement levels.
We may be subject to or otherwise affected by federal and state health care laws, including fraud and abuse and health information privacy and security laws, and could face penalties if we are unable to fully comply with such regulations, we could face substantial penalties.
We are directly or indirectly, through our customers, subject to extensive regulation by both the federal government and the states and foreign countries in which we conduct our business. The laws that directly or indirectly affect our ability to operate our business include, but are not limited to, the following:
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the Federal Food, Drug, and Cosmetic Act, which regulates the design, testing, manufacture, labeling, marketing, distribution, and sale of prescription drugs and medical devices;
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state food and drug laws;
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the federal Anti-Kickback Law, which prohibits persons from knowingly and willfully soliciting, offering, receiving, or providing remuneration, directly or indirectly, in cash or in kind, to induce either;
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the referral of an individual, or furnishing or arranging for a good or service, for which payment may be made under federal healthcare programs such as the Medicare and Medicaid Programs;
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Medicare laws and regulations that prescribe the requirements for coverage and payment, including the amount of such payment, and laws prohibiting false claims for reimbursement under Medicare and Medicaid;
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the federal physician self-referral prohibition, commonly known as the Stark Law, which, in the absence of a statutory or regulatory exception, prohibits the referral of Medicare patients by a physician to an entity for the provision of designated healthcare services, if the physician or a member of the physician’s immediate family has a direct or indirect financial relationship, including an ownership interest in, or a compensation arrangement with, the entity and also prohibits that entity from submitting a bill to a federal payor for services rendered pursuant to a prohibited referral;
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federal provisions of HIPAA that established federal crimes for knowingly and willfully executing a scheme to defraud any health care benefit program or making false statements in connection with the delivery of or payment for health care benefits, items or services;
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federal and state false claims laws that prohibit anyone from presenting, or causing to be presented, claims for payment to third-party payers that are false or fraudulent;
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state laws that prohibit the practice of medicine by non-physicians and fee-splitting arrangements between physicians and non-physicians, as well as state law equivalents to the Anti-Kickback Law and the Stark Law, which may not be limited to government reimbursed items; and
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the Federal Trade Commission Act and similar laws regulating advertising and consumer protection.
If our past or present operations are found to be in violation of any of the laws described above or the other governmental regulations to which we or our customers are subject, we may be subject to the applicable penalty associated with the violation, including civil and criminal penalties, damages, fines, exclusion from the Medicare and Medicaid programs, and the curtailment or restructuring of our operations. If we are required to obtain permits or licensure under these laws that we do not already possess, we may become subject to substantial additional regulation or incur significant expense. Any penalties, damages, fines, or curtailment or restructuring of our operations would adversely affect our ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by applicable regulatory authorities or the courts, and their provisions are open to a variety of interpretations and additional legal or regulatory change. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses, divert our management’s attention from the operation of our business and damage our reputation.
Product sales or introductions may be delayed or canceled as a result of the FDA regulatory process which could cause our sales or profitability to decline.
The process of obtaining and maintaining regulatory approvals and clearances to market a medical device from the FDA and similar regulatory authorities abroad can be costly and time consuming, and we cannot assure you that such approvals and clearances will be granted. Pursuant to FDA regulations, unless exempt, the FDA permits commercial distribution of a new medical device only after the device has received 510(k) clearance or is the subject of an approved pre-market approval application. The FDA will clear marketing of a medical device through the 510(k) process if it is demonstrated that the new product is substantially equivalent to other 510(k)-cleared products. The pre-market approval application process is more costly, lengthy and uncertain than the 510(k) process, and must be supported by extensive data, including data from preclinical studies, and human clinical trials. Because we cannot assure you that any new products, or any product enhancements, that we develop will be subject to the shorter 510(k) clearance process, significant delays in the introduction of any new products or product enhancement may occur. We cannot assure you that the FDA will not require a new product or product enhancement to go through the lengthy and expensive pre-market approval application process. Delays in obtaining regulatory clearances and approvals may:
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delay or eliminate commercialization of products we develop;
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require us to perform costly procedures;
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diminish any competitive advantages that we may attain; and
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reduce our ability to collect revenues or royalties.
Although we have obtained 510(k) clearance from the FDA to market our dental laser systems, we cannot assure you that the clearance of these systems will not be withdrawn or that we will not be required to obtain new clearances or approvals for modifications or improvements to our products.
Our products are subject to recall even after receiving FDA clearance or approval; any recalls would harm our reputation, business and financial results.
The FDA and similar governmental bodies in other countries have the authority to require the recall of our products in the event of material deficiencies or defects in design or manufacture. A government mandated or voluntary recall by us could occur as a result of component failures, manufacturing errors, or design defects, including defects in labeling. Any recall would divert management’s attention and financial resources and harm our reputation with customers. Any recall involving our laser systems would be particularly harmful to our business and financial results because the laser systems compose such an important part of our portfolio of products.
Our business and results of operations may be adversely affected by provisions of the Affordable Care Act.
Under the Affordable Care Act, we are subject to a 2.3% excise tax payable semi-monthly on U.S. revenues of certain medical devices beginning in January 2013. A significant portion of our revenue is generated from medical devices sold in the U.S. and these taxes are imposed on us whether or not we earn a profit. The Affordable Care Act also contains reporting requirements of certain payments made by us to medical and dental practitioners and teaching hospitals (the “Physician Payment Sunshine Act”) which will be published on a publicly available website annually beginning in 2014. This requirement is expected to increase the administrative costs for both manufacturers and health care providers and may result in a decline in our collaborative efforts. A decline in these collaborations may adversely affect advances in our laser technology or may reduce attendance at events at which our technology is demonstrated, which could reduce demand for our products and lead to sales price pressures.
Additionally, the Affordable Care Act may adversely impact third-party reimbursements received by our end-user customers, which may reduce demand for our products. There may be other provisions in the law that could adversely affect our business, and we cannot predict with any certainty the full impact this legislation may have on our business.
Risks Related to Our Business and Operations
Any failure to significantly expand sales of our products with our distribution partners will negatively impact our business.
We currently handle a significant portion of the marketing, distribution, and sales of our products. We also utilize our relationships with domestic and international distributors to market, distribute, and sell our products. We face significant challenges and risks in expanding, training, managing, and retaining our sales and marketing teams, including managing geographically dispersed operations. We rely on independent distributors to market and sell our products in a number of countries outside of the United States. These distributors may not commit the necessary resources to effectively market and sell our products, and they may terminate their relationships with us at any time with limited notice. If we are unable to expand our sales and marketing capabilities domestically and internationally, or if the relationship with our distribution partners does not produce the expected results, we may not be able to effectively commercialize our products, which could harm our business and cause the price of our common stock to decline.
We may incur problems in manufacturing our products which may harm our business.
In order to grow our business, we must expand our manufacturing capabilities to produce the systems and accessories necessary to meet any demand we may experience. We may encounter difficulties in increasing the production of our products, including problems involving production capacity and yields, quality control and assurance, component supply, and shortages of qualified personnel. In addition, before we can begin commercial manufacture of our products, we must ensure our manufacturing facilities, processes, and quality systems, and the manufacture of our laser systems comply with FDA regulations governing facility compliance, quality control, and documentation policies and procedures. In addition, our manufacturing facilities are continuously subject to periodic inspections by the FDA, as well as various state agencies and foreign regulatory agencies. From time to time, we may expend significant resources in obtaining, maintaining, and remedying our compliance with these requirements. Our success will depend in part upon our ability to manufacture our products in compliance with the FDA’s QSR and other regulatory requirements. We have experienced quality issues with components of our products supplied by third parties. If we do not succeed in manufacturing our products on a timely basis with acceptable manufacturing costs, while at the same time maintaining good quality control and complying with applicable regulatory requirements, our business could be harmed.
Components used in our products are complex in design and any defects may not be discovered prior to shipment to customers. These defects could result in warranty obligations which would increase our cost and may negatively affect our operating results and our reputation.
In manufacturing our products, we depend upon third parties for the supply of various components. Many of these components require a significant degree of technical expertise to design and produce. If we fail to adequately design, or if our suppliers fail to produce components to specification, or if the suppliers, or we, use defective materials or workmanship in the manufacturing process, the reliability and performance of our products will be compromised. We have experienced such non-compliance with manufacturing specifications in the past and may continue to experience such non-compliance in the future, which could lead to higher costs and reduced gross margins.
Our products may contain defects that cannot be repaired easily and inexpensively, and we have experienced in the past and may experience in the future some or all of the following:
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loss of customer orders and delay in order fulfillment;
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damage to our brand reputation;
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increased cost of our warranty program due to product repair or replacement;
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inability to attract new customers;
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diversion of resources from our manufacturing and research and development departments into our service department; and
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legal action.
The occurrence of any one or more of the foregoing could materially harm our business.
Product liability claims against us could be costly and could harm our reputation.
The sale of dental and medical devices involves the risk of product liability claims against us. Claims could exceed our product liability insurance coverage limits. Our insurance policies are subject to various standard coverage exclusions, including damage to the product itself, losses from recall of our product, and losses covered by other forms of insurance such as workers compensation. We cannot be certain that we will be able to successfully defend any claims against us, nor can we be certain that our insurance will cover all liabilities resulting from such claims. In addition, there is no assurance that we will be able to obtain such insurance in the future on terms acceptable to us, or at all. Regardless of merit or eventual outcome, any product liability claim brought against us could result in harm to our reputation, decreased demand for our products, costs related to litigation, product recalls, loss of revenue, an increase in our product liability insurance rates, or the inability to secure coverage in the future, and may cause our business to suffer.
Our suppliers may not supply us with a sufficient amount of materials and components or materials and components of adequate quality.
We frequently do not use written supply contracts with our key suppliers; instead, we purchase certain materials and components included in our products from a limited group of suppliers using purchase orders. Our business depends, in part, on our ability to obtain timely deliveries of materials and components in acceptable quality and quantities from our suppliers. Certain components of our products, particularly specialized components used in our lasers, are currently available only from a single source or limited sources. For example, the crystal, fiber, and hand pieces used in our WaterLase systems are each supplied by a separate single supplier. Our dependence on single-source suppliers involves several risks, including limited control over pricing, availability, quality, and delivery schedules. If any one or more of our single-source suppliers cease to provide us with sufficient quantities of our components in a timely manner or on terms acceptable to us, or cease to manufacture components of acceptable quality, we would have to seek alternative sources of manufacturing. We could incur delays while we locate and engage alternative qualified suppliers and we might be unable to engage acceptable alternative suppliers on favorable terms. Any such disruption or increased expenses could harm our business efforts and adversely affect our ability to generate sales. Our reliance on these outside manufacturers and suppliers also subjects us to other risks that could harm our business, including:
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we may not be able to obtain adequate supply in a timely manner or on commercially reasonable terms;
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we may have difficulty locating and qualifying alternative suppliers for the various components in our laser systems;
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switching components may require product redesign and submission to the FDA of a 510(k) application, which could significantly delay production;
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our suppliers manufacture products for a range of customers, and fluctuations in demand for the products those suppliers manufacture for others may affect their ability to deliver components for us in a timely manner; and
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our suppliers may encounter financial hardships, be acquired, or experience other business events unrelated to our demand for components, which could inhibit or prevent their ability to fulfill our orders and meet our requirements.
Any interruption or delay in the supply of components or materials, or our inability to obtain components or materials from alternate sources at acceptable prices in a timely manner, could impair our ability to meet the demand of our customers and cause them to cancel orders or switch to competitive procedures. We are currently in the process of identifying and qualifying alternate source suppliers for our key components. There can be no assurance, however, that we will successfully identify and qualify an alternate source supplier for any of our key components or that we could enter into an agreement with any such alternate source supplier on terms acceptable to us.
Rapidly changing standards and competing technologies could harm demand for our products or result in significant additional costs.
The markets in which our products compete are subject to rapid technological change, evolving industry standards, changes in the regulatory environment, and frequent introductions of new devices and evolving dental and surgical techniques. Competing products may emerge which could render our products uncompetitive or obsolete. 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 cannot guarantee that we will successfully identify new product opportunities, identify new and innovative applications of our technology, or be financially or otherwise capable of completing the research and development required to bring new products to market in a timely manner. An inability to expand our product offerings or the application of our technology could limit our growth. In addition, we may incur higher manufacturing costs if manufacturing processes or standards change, and we may need to replace, modify, design, or build and install equipment, all of which would require additional capital expenditures.
Failure to effectively manage and implement our growth strategies could negatively affect our business, financial condition, and results of operations.
Our growth strategy includes adding new vendors and products to further expand our offerings within existing product markets and developing new product offerings leveraging our patented laser technologies and strategic relationships for entry into new product markets. Expansion of our existing product markets and entry into new product markets divert the use of our resources and systems, require additional resources that might not be available (or available on acceptable terms), require additional country-specific regulatory approvals, result in new or increasing competition, may require longer implementation times or greater start-up expenditures than anticipated, and may otherwise fail to achieve the desired results in a timely fashion, if at all. These efforts may also require that we successfully commercialize new technologies in a timely manner, price them competitively and cost-effectively, and manufacture and deliver sufficient volumes of new products of appropriate quality on time. If we are unable to increase our sales and earnings by expanding our product offerings in a cost effective manner, if we fail to accurately predict future customer needs and preferences, or if we fail to produce viable technologies, then our revenues may not grow, which would adversely affect our profitability. In addition, we may invest heavily in research and development of products that do not lead to significant revenue, which would adversely affect our profitability. Even if we successfully innovate and develop new products and product enhancements, we may incur substantial costs in doing so, and our profitability may suffer. In addition, promising new products may fail to reach the market or realize only limited commercial success because of efficacy or safety concerns, failure to achieve positive clinical outcomes, or uncertainty over third-party reimbursement, which could also adversely affect our profitability.
Our failure to effectively manage our growth could have an adverse effect on our business, financial condition, or results of operations. Additionally, our growth may increase our working capital requirements and as a result, we may require additional equity or debt financing. Such financing may not be available on terms that are favorable to us, if at all.
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 revenue and we intend to continue to pursue and expand our international business activities. For the fiscal years ended December 31, 2013, 2012, and 2011, international sales accounted for approximately 37%, 29%, and 33% of our net revenue, respectively. Political and economic conditions outside the United States could make it difficult for us to increase our international revenue or to operate abroad. International operations are subject to many inherent risks, including among others:
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adverse changes in tariffs and trade restrictions;
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political, social, and economic instability and increased security concerns;
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fluctuations in foreign currency exchange rates;
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longer collection periods and difficulties in collecting receivables from foreign entities;
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exposure to different legal standards;
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transportation delays and difficulties of managing international distribution channels;
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reduced protection for our intellectual property in some countries;
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difficulties in obtaining domestic and foreign export, import, and other governmental approvals, permits, and licenses, and compliance with foreign laws;
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the imposition of governmental controls;
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unexpected changes in regulatory or certification requirements;
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difficulties in staffing and managing foreign operations; and
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potentially adverse tax consequences and the complexities of foreign value-added tax systems.
We believe that international sales will continue to represent a significant portion of our net revenue, and we intend to expand our international operations further. In international markets where our sales are denominated in U.S. dollars, an increase in the relative value of the dollar against the currency in such markets could indirectly increase the price of our products in those markets and result in a decrease in sales. We do not currently engage in any transactions as a hedge against risks of loss due to foreign currency fluctuations, although we may consider doing so in the future.
Risks generally associated with our information systems could adversely affect our results of operations.
We rely on information systems (“IS”) in our business to obtain, rapidly process, analyze and manage data to, among other things:
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facilitate the purchase and distribution of thousands of inventory items through numerous distributors;
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receive, process and ship orders on a timely basis;
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accurately bill and collect from thousands of customers;
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process payments to suppliers; and
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provide technical support to our customers.
A cyber-attack that bypasses our IS security causing an IS security breach may lead to a material disruption of our IS and/or the loss of business information, which could adversely affect our business. These risks may include, among others, the following:
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future results could be adversely affected due to the theft, destruction, loss, misappropriation or release of confidential data or intellectual property;
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operational or business delays resulting from the disruption of IS and subsequent clean-up and mitigation activities; and
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liability for a breach of personal financial and health information belonging to our customers and their patients.
Our results of operations could be adversely affected if our IS are interrupted, damaged by unforeseen events, incur cyber-attacks or fail for any extended period of time.
Fluctuations in our revenue and operating results on a quarterly and annual basis could cause the market price of our common stock to decline.
Our revenue and operating results fluctuate from quarter to quarter due to a number of factors, many of which are beyond our control. Historically, we have experienced fluctuations in revenue from quarter to quarter due to seasonality. Revenue in the first quarter typically is lower than average and revenue in the fourth quarter typically is stronger than average due to the buying patterns of dental professionals. We believe that this trend exists because a significant number of dentists purchase their capital equipment towards the end of the calendar year in order to maximize their practice earnings while seeking to minimize their taxes. This can be accomplished by utilizing certain tax incentives, such as accelerated depreciation methods for purchasing capital equipment, as part of their year-end tax planning. In addition, revenue in the third quarter may be affected by vacation patterns which can cause revenue to be flat or lower than in the second quarter of the year. Our historical seasonal fluctuations may also be impacted by sales procedures employed by large dental distributors that encourage end-of-quarter and end-of-year buying in our industry. If our quarterly revenue or operating results fall below the expectations of investors, analysts, or our previously stated financial guidance, the price of our common stock could decline substantially. Other factors that might cause quarterly fluctuations in our revenue and operating results include the following:
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variation in demand for our products, including seasonality;
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our ability to research, develop, market, and sell new products and product enhancements in a timely manner;
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our ability to control costs;
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our ability to control quality issues with our products;
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regulatory actions that impact our manufacturing processes;
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the size, timing, rescheduling, or cancellation of orders from distributors;
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the introduction of new products by competitors;
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the length of and fluctuations in sales cycles;
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the availability and reliability of components used to manufacture our products;
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changes in our pricing policies or those of our suppliers and competitors, as well as increased price competition in general;
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legal expenses, particularly related to litigation matters;
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general economic conditions including the availability of credit for our existing and potential customer base to finance purchases;
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the mix of our domestic and international sales and the risks and uncertainties associated with international business;
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costs associated with any future acquisitions of technologies and businesses;
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limitations on our ability to use net operating loss carry-forwards under the provisions of IRC Section 382 and similar state laws;
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developments concerning the protection of our intellectual property rights;
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catastrophic events such as hurricanes, floods, and earthquakes, which can affect our ability to advertise, sell, and distribute our products, including through national conferences held in regions in which these disasters strike; and
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global economic, political, and social events, including international conflicts and acts of terrorism.
The expenses we incur are based, in large part, on our expectations regarding future net revenue. Since many of our costs are fixed in the short term, we may be unable to reduce expenses quickly enough to avoid losses if we experience a decrease in net revenue. Accordingly, you should not rely on quarter-to-quarter comparisons of our operating results as an indication of our future performance.
The recent financial crisis and general slowdown of the economy may adversely affect the credit availability and liquidity of our customers and suppliers.
The credit availability and liquidity of our customers and suppliers may be materially affected by the ongoing credit crisis. If our suppliers experience credit or liquidity problems, important sources of raw materials or manufactured goods may be affected. We currently sell our products primarily to dentists in general practice. These dentists often purchase our products with funds they secure through various financing arrangements with third party financial institutions, including credit facilities and short-term loans. If interest rates increase or the availability of credit is otherwise negatively impacted by market conditions, these financing arrangements will be more expensive to our dental customers, which would effectively increase the overall cost of owning our products for our customers and, thereby, may decrease demand for our products. The recent recession made, and may continue to make, such funding less readily available. Any reduction in the sales of our products would cause our business to suffer.
We are subject to a variety of litigation in the course of our business that could adversely affect our results of operations and financial condition.
We are subject to a variety of litigation incidental to our business, including claims for damages arising out of the use of our products or services and claims relating to intellectual property matters, employment matters, commercial disputes, competition, sales and trading practices, environmental matters, personal injury, and insurance coverage. Some of these lawsuits include claims for punitive as well a compensatory damages. The defense of these lawsuits may divert our management’s attention, we may incur significant expenses in defending these lawsuits, and we may be required to pay damage awards or settlements or become subject to equitable remedies that could adversely affect our business, financial condition, and results of operations. Moreover, any insurance or indemnification rights that we may have may be insufficient or unavailable to protect us against potential loss exposures. In addition, developments in legal proceedings in any given period may require us to record loss contingency estimates in our financial statements, which could adversely affect our results of operations in any period.
Our operations are consolidated primarily in one facility. A disruption at this facility could result in a prolonged interruption of our business and adversely affect our results of operation and financial condition.
Substantially all of our administrative operations and our manufacturing operations are located at our facility in Irvine, California, which is near known earthquake fault zones. We have taken precautions to safeguard our facilities including disaster recovery planning and off-site backup of computer data; however, a natural disaster such as an earthquake, fire, or flood, could seriously harm our business, adversely affect our operations, and damage our reputation with customers. Additionally, labor disputes, maintenance requirements, power outages, equipment failures, civil unrest, or terrorist attacks affecting our Irvine, California facility may materially and adversely affect our operating results. Our business interruption insurance coverage may not cover all or any of our losses from natural disasters or other disruptions.
If we lose the services of our key personnel, or if we are unable to attract other key personnel, we may not be able to manage our operations or meet our growth objectives.
We are highly dependent on our senior management, especially Federico Pignatelli, our Chief Executive Officer, Fred Furry, our Chief Financial Officer, and other key employees. We are also heavily dependent on our engineers, sales and marketing personnel, and other highly skilled technical personnel. Our success will depend on our ability to retain our current management, engineers, marketing and sales team, and other technical personnel and to attract and retain qualified like personnel in the future. Competition for senior management, engineers, marketing and sales personnel, and other specialized technicians is intense and we may not be able to retain our personnel. The loss of the services of members of our key personnel could prevent the implementation and completion of our objectives, including the development and introduction of our products. In general, our officers may terminate their employment at any time without notice for any reason.
Existing or future acquisitions of businesses could negatively affect our business, financial condition, and results of operations if we fail to integrate the acquired businesses successfully into our existing operations or if we discover previously undisclosed liabilities.
Successful acquisitions depend upon our ability to identify, negotiate, complete, and integrate suitable acquisitions and to obtain any necessary financing. We expect to continue to consider opportunities to acquire or make investments in other technologies, products and businesses that could enhance our capabilities, complement our current products, or expand the breadth of our markets or customer base. We have limited experience in acquiring other businesses and technologies. Even if we complete acquisitions, we may experience:
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difficulties in integrating any acquired companies, personnel, products, and other assets into our existing business;
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delays in realizing the benefits of the acquired company, product, or other assets;
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diversion of our management’s time and attention from other business concerns;
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limited or no direct prior experience in new markets or countries we may enter;
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higher costs of integration than we anticipated; and
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Difficulties in retaining key employees of the acquired business who are necessary to manage these acquisitions.
In addition, an acquisition could materially impair our operating results by causing us to incur debt or requiring us to amortize expenses and acquired assets. We may also discover deficiencies in internal controls, data adequacy and integrity, product quality, regulatory compliance, and product liabilities that we did not uncover prior to our acquisition of such businesses, which could result in us becoming subject to penalties or other liabilities. Any difficulties in the integration of acquired businesses or unexpected penalties or liabilities in connection with such businesses could have a material adverse effect on our business, financial condition, and result of operations.
If we fail to comply with the reporting obligations of the Securities Exchange Act of 1934 and Section 404 of the Sarbanes Oxley Act of 2002, or if we fail to maintain adequate internal control over financial reporting, our business, results of operations and financial condition and investors’ confidence in us could be materially and adversely affected.
As a public company, we are required to comply with the periodic reporting obligations of the Securities Exchange Act of 1934, as amended, or the Exchange Act, including preparing annual reports, quarterly reports, and current reports. Our failure to prepare and disclose this information in a timely manner and meet our reporting obligations in their entirety could subject us to penalties under federal securities laws and regulations of The Nasdaq Stock Market LLC, expose us to lawsuits, and restrict our ability to access financing on favorable terms, or at all.
Section 1502 of the Dodd-Frank Wall Street Reform and Consumer Protection Act added Section 13(p) to the Securities Exchange Act of 1934 which requires us to disclose annually whether any conflict minerals, including tantalum, tin, gold, and tungsten, that are necessary to the functionality or production of a product manufactured by us originated in the Democratic Republic of the Congo or an adjoining country. Components of our products containing these minerals are sourced through various vendors who may have complex supply chains which may change from time to time due to the influence of availability, pricing, or other factors in their purchasing decisions. We are required to conduct a good faith and reasonable effort to determine the source of these materials; however, there can be no assurance that members in the supply chain will be willing or able to provide this information or further identify their sources of supply or notify us timely of changes. We must comply with the final rule for the calendar year beginning January 1, 2013 with the first reports due May 31, 2014.
In addition, pursuant to Section 404 of the Sarbanes Oxley Act of 2002, as amended (the “Sarbanes Oxley Act”), we are required to evaluate and provide a management report of our systems of internal control over financial reporting. During the course of the evaluation of our internal control over financial reporting, we may identify areas requiring improvement and may be required to design enhanced processes and controls to address issues identified through this review. This could result in significant delays and costs to us and require us to divert substantial resources, including management time, from other activities. In addition, if we fail to maintain the adequacy of our internal controls over financial reporting, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with the Sarbanes Oxley Act. Moreover, effective internal controls are necessary for us to produce reliable financial reports and are important to help prevent fraud. Any failure to maintain the requirements of Section 404 on a timely basis could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business, negatively impact the trading price of our stock, and adversely affect investors’ confidence in our company and our ability to access capital markets for financing.
Climate change initiatives may materially and adversely affect our business.
Our manufacturing processes require that we purchase significant quantities of energy from third parties, which results in the generation of greenhouse gases, either directly on-site or indirectly at electric utilities. Both domestic and international legislation to address climate change by reducing greenhouse gas emissions and establishing a price on carbon could create increases in energy costs and price volatility. Considerable international attention is now focused on development of an international policy framework to address climate change. Proposed and existing legislative efforts to control or limit greenhouse gas emissions could affect our energy source and supply choices as well as increase the cost of energy and raw materials derived from sources that generate greenhouse gas emissions. If our suppliers are unable to obtain energy at a reasonable cost in the future, the cost of our raw materials may be negatively impacted which could result in increased manufacturing costs.
Risks Related to Our Stock
Our stock price may be volatile, and your investment in our stock could suffer a decline in value.
There has been significant volatility in the market price and trading volume of equity securities, which is often unrelated to the financial performance of the companies issuing the securities. These broad market fluctuations may negatively affect the market price of our stock. The market price and volume of our common stock may fluctuate, and in the past has fluctuated, more dramatically than the stock market in general. You may not be able to resell your shares at or above the price you paid for them due to fluctuations in the market price of our stock caused by changes in our operating performance or prospects and other factors. Some specific factors, in addition to the other risk factors identified above, that may have a significant effect on our stock market price, many of which we cannot control. These include but are not limited to:
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actual or anticipated fluctuations in our operating results or future prospects;
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our announcements or our competitors’ announcements of new products;
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the public’s reaction to our press releases, our other public announcements, and our filings with the SEC;
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strategic actions by us or our competitors, such as acquisitions or restructurings;
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new laws or regulations or new interpretations of existing laws or regulations applicable to our business;
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changes in accounting standards, policies, guidance, interpretations, or principles;
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changes in our growth rates or our competitors’ growth rates;
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developments regarding our patents or proprietary rights or those of our competitors;
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our inability to raise additional capital as needed;
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concerns or allegations as to the safety or efficacy of our products;
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changes in financial markets or general economic conditions;
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sales of stock by us or members of our management team, our Board, or certain institutional stockholders; and
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changes in stock market analyst recommendations or earnings estimates regarding our stock, other comparable companies or our industry generally.
You could experience substantial dilution of your investment as a result of subsequent exercises of our outstanding convertible securities, future sales of our equity, or the future grant of equity by us.
You could experience substantial dilution of your investment as a result of subsequent exercises of outstanding options and warrants issued as incentive compensation for services performed by employees, directors, consultants, and others, future sales of our equity, or the grant of future equity awarded by us. As of December 31, 2013, an aggregate of 7,750,000 shares of common stock were reserved for future issuance under our equity incentive plan, 4,441,000 of which were subject to options outstanding as of that date at a weighted average exercise price of $3.51 per share. In addition, as of December 31, 2013, 1,598,000 shares of our common stock were subject to warrants at a weighted average exercise price of $5.66 per share. Of the 4,441,000 outstanding stock options at December 31, 2013, 2,688,000 stock options were exercisable. To the extent that outstanding options are exercised, our existing stockholders may incur dilution. We rely heavily on equity awards to motivate current employees and to attract new employees. The grant of future equity awards by us to our employees and other service providers may further dilute our stockholders. We also expect to issue additional shares of our equity securities to raise capital. During 2013, we sold approximately 2.7 million shares of common stock through a registered direct offering for gross proceeds totaling approximately $5.0 million, and sold 340,000 shares of common stock through an unregistered direct offering for gross proceed totaling approximately $612,000. During 2011, we sold approximately 2.5 million shares of common stock through a controlled equity offering for gross proceeds totaling approximately $9.3 million and we also sold an aggregate of 1.6 million shares in a private placement for gross proceeds totaling approximately $9 million. Our Board declared a 0.5% stock dividend in each of the four quarters in 2013 and 2012 and a 1% stock dividend in each of the four quarters in 2011 which resulted in the issuance of 667,342 shares, 634,162 shares, and 1,165,715 shares, respectively.
Our corporate documents and Delaware law contain provisions that could discourage, delay, or prevent a change in control of our company and reduce the market price of our stock.
Provisions in our restated certificate of incorporation and amended and restated bylaws may discourage, delay, or prevent a merger or acquisition involving us that our stockholders may consider favorable. For example, our restated certificate of incorporation authorizes our Board to issue up to 500,000 shares of “blank check” preferred stock. As a result, without further stockholder approval, the Board has the authority to attach special rights, including voting and dividend rights, to this preferred stock. With these rights, preferred stockholders could make it more difficult for a third party to acquire us.
We are also subject to the anti-takeover provisions of the Delaware General Corporation Law. Under these provisions, if anyone becomes an “interested stockholder,” we may not enter into a “business combination” with that person for three years without special approval, which could discourage a third party from making a takeover offer and could delay or prevent a change in control of us. An “interested stockholder” generally means (subject to certain exceptions as described in the Delaware General Corporation Law) someone owning 15% or more of our outstanding voting stock or an affiliate of ours that owned 15% or more of our outstanding voting stock during the past three years.
In addition, we have adopted a stockholder rights plan. Under the stockholder rights plan, if any party acquires 20% or more, as amended February 4, 2014, of our outstanding common stock while the stockholder rights plan remains in place, subject to a number of exceptions set forth in the plan, the holders of these rights, other than the party acquiring the 20% position, will be able to purchase shares of our common stock, or other securities or assets, at a discounted price, causing substantial dilution to the party acquiring the 20% position. Following the acquisition of 20% or more of our stock by any person, without a redemption of the rights or a termination of the stockholder rights plan by the Board, if we are acquired by or merged with any other entity, holders of these rights, other than the party acquiring the 20% position, will also be able to purchase shares of common stock of the acquiring or surviving entity if the stockholder rights plan continues to remain in place. Our stockholder rights plan could discourage a takeover attempt and make an unsolicited takeover of our company more difficult. As a result, without the approval of our Board, you may not have the opportunity to sell your shares to a potential acquirer of us at a premium over prevailing market prices. This could reduce the market price of our stock.
We may elect to not declare cash dividends on our stock, or may elect to only pay dividends on an infrequent or irregular basis, and any return on your investment may be limited to the value of our stock.
Our Board may from time to time declare, and we may pay, cash dividends on our outstanding shares of common stock in the manner and upon the terms and conditions provided by law. However, we may elect to retain all future earnings for the operation and expansion of our business, rather than paying cash dividends on our stock. Any payment of cash dividends on our stock will be at the discretion of our Board and will depend upon our results of operations, earnings, capital requirements, financial condition, business prospects, contractual restrictions, and other factors deemed relevant by our Board. In the event our Board declares any cash dividends, there is no assurance with respect to the amount, timing, or frequency of any such dividends.
We could be negatively affected as a result of a proxy fight and related litigation.
In March 2014, we received from Oracle Partners, L.P., Oracle Institutional Partners, L.P., Oracle Ten Fund Master, L.P., Oracle Associates, LLC, Oracle Investment, Inc., and Larry N. Feinberg (collectively “Oracle”), which reports that it owns 16% of our common stock, declared its intention to change the composition of our Board. Oracle nominated a majority opposition slate of individuals for election to replace our Board at the 2014 Annual Meeting of Stockholders and has stated its dissatisfaction with our performance and senior management. Oracle has filed a lawsuit against our Board with respect to the present composition of our Board and the operation of the Company until the Court determines the Board composition, see Item 3 - “Legal Proceedings.” A proxy contest and related litigation could negatively affect us because:
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Responding to proxy contests, litigation, and other actions by dissident shareholders can be costly and time-consuming, disrupting our operations and diverting the attention of management and our employees;
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Perceived uncertainties as to our future direction may divert the attention of, damage morale, and create instability among our business partners, management, and employees, and adversely impact our existing and potential strategic and operational relationships and opportunities;
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We may experience difficulties in hiring, retaining, and motivating personnel during the resulting uncertain and turbulent times;
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If individuals are elected to our Board with a specific agenda, it may adversely affect our ability to effectively and timely implement our current business plan which could have a material adverse effect on our results of operations and financial condition;
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Increases in legal fees, administrative, and associated costs incurred in connection with responding to a proxy contest and related litigation could be substantial; and
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A proxy contest, or the threat of one, could cause our stock price to experience periods of volatility or stagnation.
Risks Related to Our Revolving Credit Facilities
The terms of our revolving credit facilities impose financial and operating restrictions on us and failure to comply may have an adverse effect on our business, liquidity, and financial position.
Our revolving credit facilities contain a number of negative covenants that limit our ability to engage in activities. These covenants limit or restrict, among other things, our ability to:
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incur additional indebtedness and grant liens on assets;
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make certain investments and restricted payments (including the ability to pay cash dividends and repurchase stock);
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undertake certain acquisitions or sell certain assets;
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enter into certain transactions with our affiliates; and
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replace our Chief Executive Officer or Chief Financial Officer, unless our Board determines, in good faith, exigent circumstances require their prompt replacement.
These limitations and restrictions may adversely affect our ability to finance our future operations or capital needs or engage in other business activities that may be in our best interests. Further, the revolving credit facilities subject us to various reporting covenants and financial covenants, including requirements to maintain certain levels of debt ratios and minimum earnings before income taxes, depreciation, and amortization (“EBITDA”).
The lockbox arrangements under the revolving bank facilities provide that substantially all of the income generated is deposited directly into lockbox accounts and then swept into cash management accounts for the benefit of the bank. Cash is disbursed to us only after payment of the applicable debt service and principal.
Our ability to borrow under the revolving bank facilities is subject to compliance with the negative and financial covenants. If we breach any of the covenants in our revolving credit facilities, we may be in default under our revolving credit facilities. If we default, our borrowings under the revolving credit facilities, plus accrued interest and other fees, could be declared due and payable.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
As of December 31, 2013, we owned or leased a total of approximately 73,000 square feet of space worldwide. We lease our corporate headquarters and manufacturing facility which consists of approximately 57,000 square feet in Irvine, California. Our lease expires on April 20, 2015. We also own a 12,000 square foot manufacturing and administrative facility in Floss, Germany. See Note 3 to the Notes to the Consolidated Financial Statements - Property, Plant, and Equipment, Net.
We believe that our current facilities are sufficient for the current operations of our business and we believe that suitable additional space in various applicable local markets is available to accommodate any needs that may arise.
Item 3.
Item 3. Legal Proceedings
We disclose material loss contingencies deemed to be reasonably possible and accrue for loss contingencies when, in consultation with our legal advisors, we conclude that a loss is probable and reasonably estimable. The ability to predict the ultimate outcome of such matters involves judgments, estimates, and inherent uncertainties. The actual outcome of such matters could differ materially from management’s estimates.
Class Action Lawsuits
On August 23, 2013, a purported class action lawsuit entitled Brady Adams v. Biolase, Inc., et al., Case No. 13-CV-1300 JST (FFMx) was filed in the United States District Court for the Central District of California against BIOLASE and its current executive officers Federico Pignatelli and Frederick D. Furry. On August 26, 2013, a purported class action lawsuit entitled Ralph Divizio v. Biolase, Inc., et al., Case No. 13-CV-1317 DMG (MRWx) was filed in the same court against BIOLASE, Messrs. Pignatelli and Furry, and current executive officer Alexander K. Arrow. Each of the lawsuits alleges violations of the federal securities laws and asserts causes of action against the defendants under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. In accordance with the Private Securities Litigation Reform Act of 1995, on December 10, 2013, the court entered an order consolidating the lawsuits, appointing a lead plaintiff and approving lead plaintiff's selection of lead counsel. On February 24, 2014, lead plaintiff filed a consolidated complaint against BIOLASE and Messrs. Pignatelli, Furry, and Arrow, alleging violations of the federal securities laws and asserting causes of action against the defendants under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934.
On November 19, 2013, our Board received a letter from attorneys for purported shareholder David T. Long, demanding that the Board investigate, institute litigation, and take measures to redress and prevent alleged wrongdoing concerning the dissemination of certain allegedly false and misleading public disclosures we made between January 2013 and August 2013.
As of December 31, 2013, we paid $250,000 for legal costs expected to be incurred in connection with these matters. We believe that the claims contained in the lawsuits are without merit and intend to vigorously defend against the claims.
Director Dispute and Shareholder Litigation
On March 3 and 6, 2014, we disclosed that the Board had appointed Paul N. Clark and Jeffrey M. Nugent to the Board and Dr. Alexander K. Arrow and Dr. Sam Low had tendered their resignations. Subsequent to this disclosure, questions were raised as to whether these changes were effected.
On March 7, 2014, we received from Oracle, which reports that it is a 16% shareholder, a notice pursuant to our Bylaws, stating that Oracle intended to nominate four independent directors for election to the Board at our 2014 Annual Meeting of Stockholders. Oracle’s nominees are Messrs. Clark and Nugent, Frederic H. Moll, and Eric Varma, M.D.
On March 11, 2014, Oracle filed a lawsuit in the Delaware Court of Chancery seeking a determination of the composition of our Board and a temporary restraining order that would preclude our Board from taking any action without the approval of four purported directors whose directorships Oracle claims to be undisputed.
We have reason to believe that Oracle and individuals who may be, depending on the outcome of the foregoing dispute, members of our Board will seek to make changes in our senior management and the composition of our Board and its committees.
Intellectual Property Litigation
On April 24, 2012, CAO Group, Inc. (“CAO”) filed a lawsuit against us in the District of Utah for patent infringement of U.S. Patent No. 7,485,116 regarding our EZlase dental laser. On September 9, 2012, CAO filed its First Amended Complaint, which added claims for (1) business disparagement/injurious falsehood under common law and (2) unfair competition under 15 U.S.C. Section 1125(a). The additional claims stem from a press release that we issued on April 30, 2012, which CAO claims contained false statements that are disparaging to CAO and its diode product. The First Amended Complaint seeks injunctive relief, treble damages, attorneys’ fees, punitive damages, and interest. On November 13, 2012, the Court stayed the lawsuit for 120 days to allow the United States Patent and Trademark Office (“USPTO”) to consider our request for reexamination of the patent-in-suit. The USPTO granted the request to reexamine the asserted claims of the patent-in-suit and, on February 28, 2013, the Court stayed the lawsuit until the termination of the reexamination proceedings. On April 23, 2013, the USPTO issued an office action rejecting all of the asserted claims over the prior art, and CAO responded to the office action. On August 28, 2013, the USPTO issued an Action Closing Procedure, rejecting all of CAO’s patent claims. CAO responded to the USPTO’s ruling and on December 10, 2013, the USPTO issued a Right of Appeal Notice, finally rejecting some claims of the patent while finding that other claims appeared to be patentable. Both parties are permitted to appeal the USPTO’s findings to the Patent Trial and Appeal Board. We appealed the USPTO’s findings on January 9, 2014. On January 27, 2014, the USPTO declined to reconsider the finding of certain claims as patentable and instructed the parties to proceed to appeal to the Patent Trial and Appeal Board.
We filed a patent infringement lawsuit against Fotona dd. (“Fotona”) in Düsseldorf District Court alleging infringement with respect to the Fotona Fidelis dental laser system. Oral proceedings are currently scheduled for March 2014. Fotona denies liability and seeks the reimbursement of statutory fees from us. Together with its response brief, Fotona also filed a nullity action against the patent in dispute, patent number EP 1 560 470. The nullity action is pending at the German Federal Patent Court (the “Patent Court”), Docket No. 1 Ni 58/13 (EP). On September 2, 2013, we filed our counterplea in the infringement proceedings and phrased our arguments defending the validity of the patent. These arguments were also the subject of the defense brief to the Patent Court in the parallel nullity action proceedings. On September 9, 2013, we filed our response to the Patent Court. Fotona filed a rejoinder on February 3, 2014, including our counterplea on nullity.
False Advertising Lawsuit
We filed a false advertising lawsuit against Fotona and Technology4Medicine L.L.C., two of our competitors (together "the Defendants") in United States District Court for the Central District of California. The lawsuit alleges six causes of action, and claims that the Defendants have made false and misleading statements regarding the Company's products, technology, and management. The lawsuit, filed on February 20, 2014, seeks both cash damages and injunctive relief.
Other Matters
In the normal course of business, we are subject to legal proceedings, lawsuits, and other claims. Although the ultimate aggregate amount of probable monetary liability or financial impact with respect to these matters is subject to many uncertainties and is therefore not predictable with assurance, management believes that any monetary liability or financial impact to us from these matters, individually and in the aggregate, would not be material to our financial condition, results of operations, or cash flows. However, there can be no assurance with respect to such results, and monetary liability or financial impact to us from these other matters could differ materially from those projected.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Market Information
Our common stock is traded on the NASDAQ Capital Market under the symbol “BIOL.”
The following table sets forth the high and low closing prices for our common stock for the periods indicated:
The above quotations reflect inter-dealer prices, without retail markup, markdown, or commission and may not necessarily represent actual transactions.
As of February 28, 2014, the closing price of our common stock on the NASDAQ Capital Market was $3.09 per share, and the number of stockholders of record was 169. We believe that the number of beneficial owners is substantially greater than the number of record holders because a large portion of our stock is held of record through brokerage firms in “street name.”
Dividend Policy
We currently intend to retain our available funds from earnings and other sources for future growth and, therefore, do not anticipate paying any cash dividends in the foreseeable future. Stock dividends are discussed quarterly by our Board and management. The actual declaration of future stock dividends, and the establishment of record and payment dates, is subject to final determination by our Board after its review of our financial performance, expected future operations and earnings, and any other factors as our Board may deem relevant. Our dividend policy may be changed at any time, and from time to time, by our Board.
Sale of Unregistered Common Stock
On December 19, 2013, we entered into a subscription agreement (the “December 2013 Subscription Agreement”) with Oracle Ten Fund Master, L.P. under which we sold an aggregate of 340,000 unregistered shares of common stock in a private placement at a price of $1.80 per share. Gross proceeds from the sale totaled $612,000. The common stock has not been registered under the Securities Act of 1933 (the "Act") and was offered pursuant to the exemptions from registration promulgated under the Act. No registration rights were provided and none of the common stock sold may be re-offered or resold absent either registration under the Act or the availability of an exemption from the registration requirements.
The following table sets forth certain information relating to our stock dividends declared during 2013, 2012, and 2011:
In February 2014, the Board announced a 2% annual stock dividend policy for 2014 and declared a one-half percent stock dividend (the “March Stock Dividend”) payable March 28, 2014 to stockholders of record on March 14, 2014. Although the Board expressed its desire to continue to declare stock dividends in each quarter, the March Stock Dividend was deemed to be a special dividend and there is no assurance, with respect to the amount or frequency, that any stock dividend will be declared in the future.
Stock Repurchase Program
On August 10, 2011, we announced that our Board authorized a stock repurchase program, pursuant to which we were authorized to repurchase up to an aggregate of 2,000,000 shares of our outstanding common stock. The stock repurchase program became effective on August 12, 2011 and expired on August 12, 2013. Pursuant to the stock repurchase program, we repurchased 133,365 shares and 100,500 shares of our common stock at a weighted average price of $1.73 and $2.68 during the years ended December 31, 2012 and 2011, respectively.
Stock Performance Graph
The following stock performance graph and related information shall not be deemed “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act or the Exchange Act, except to the extent that we specifically incorporate it by reference into such filings.
The following stock performance graph below compares the cumulative total stockholder return for Biolase, Inc. on $100 invested, assuming the reinvestment of all dividends, on December 31, 2008, the last trading day before our 2009 fiscal year, through the end of fiscal 2013 with the cumulative total return on $100 invested for the same period in the NASDAQ Composite Index and the NASDAQ Medical Equipment Index. The historical stock performance shown on the graph below is not necessarily indicative of future price performance.
Item 6.
Item 6. Selected Financial Data
The information set forth below is not necessarily indicative of future operations and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the Consolidated Financial Statements and notes thereto included in Item 8, “Financial Statements and Supplementary Data,” of this Form 10-K, which are incorporated herein by reference, in order to understand further the factors that may affect the comparability of the financial data presented below.
(1)
2013, 2012, 2011, 2010, and 2009 include $1.6 million, $1.6 million, $1.5 million, $727,000, and $1.4 million, respectively, in total compensation cost related to stock options classified in cost of revenue, sales and marketing, general and administrative, and engineering and development expenses.
(2)
In 2010, we wrote down the value of our land and building in Germany by $35,000 to reflect the market value of the asset.
(3)
Shares used in computing net loss from operations per share and net loss per share have been adjusted to reflect the effects of stock dividends.
Item 7.
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 biomedical company that develops, manufactures, and markets lasers in dentistry and medicine and also markets and distributes dental imaging equipment, including cone beam digital x-rays and CAD/CAM intra-oral scanners, and in-office, chair-side milling machines and three-dimensional (“3-D”) printers; products that are focused on technologies that advance the practice of dentistry and medicine. Our proprietary dental laser systems 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 instruments. We have clearance from the FDA to sell 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. Our licensed dental imaging equipment and other related products are designed to improve diagnoses, applications, and procedures in dentistry and medicine.
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, pain therapy, and cosmetic procedures, including teeth whitening. We currently have approximately 180 issued and 120 pending U.S. and international patents, the majority of which are related to our core WaterLase technology and dental and medical lasers. From 1998 through December 31, 2013, we have sold over 10,200 WaterLase systems, including more than 6,200 WaterLase MD and iPlus systems, and more than 24,800 laser systems in over 70 countries around the world.
We have suffered recurring losses from operations and have not generated cash from operations for the three years ended December 31, 2013. 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.
The available borrowing capacity on our lines of credit with Comerica Bank and the net proceeds from the below mentioned equity transactions have been principal sources of liquidity during the year ended December 31, 2013. On September 6, 2013 and November 8, 2013, we amended our lines of credit with Comerica Bank. These amendments waived noncompliance with certain financial covenants and established future covenants, restrictions, and potential penalties for noncompliance. The amendment on November 8, 2013, included liquidity ratio and liquid asset covenants, and an equity raise requirement. We met the equity raise requirement on February 10, 2014. We received waivers for noncompliance with financial covenants as of January 31, 2014, December 31, 2013, and November 30, 2013. In connection with the waiver for January 2014 and December 2013 Comerica Bank reduced the total aggregate available borrowings on the lines of credit to $5 million. The waiver for November 2013 reset covenants for the remaining term of the agreements. These credit facilities expire May 1, 2014, and we are considering alternative solutions, including potentially issuing alternative debt securities, to mitigate any future liquidity constraints these covenants, restrictions, and maturities may impose on us. Further discussion of the amendments is included in Note 5 to the Consolidated Financial Statements in Part IV, Item 15 of this Annual Report on Form 10-K, which is incorporated herein by reference.
On February 10, 2014, we entered into a subscription agreement (the “February 2014 Subscription Agreement”) with Oracle Partners L.P., Oracle Institutional Partners, L.P., and Oracle Ten Fund Master L.P. under which we offered an aggregate of 1,945,525 unregistered shares of common stock in a private placement at a price of $2.57 per share. Gross proceeds from the sale totaled $5 million, and net proceeds, after offering expenses of approximately $208,000, totaled approximately $4.8 million.
On January 17, 2014, we filed a registration statement on Form S-3, File No. 333-193426 (“January 2014 Registration Statement”) with the Securities and Exchange Commission (“SEC”) to register an indeterminate number of shares of common stock, preferred stock, and warrants with a total offering price not to exceed $12.5 million. The January 2014 Registration Statement was declared effective by the SEC on January 29, 2014.
On December 19, 2013, we entered into a subscription agreement (the “December 2013 Subscription Agreement”) with Oracle Ten Fund Master, L.P. under which we offered an aggregate of 340,000 unregistered shares of common stock in a private placement at a price of $1.80 per share. Gross proceeds from the sale totaled $612,000, and net proceeds, after offering expenses of approximately $34,000, totaled approximately $578,000. We used the proceeds for working capital and general corporate purposes.
On July 26, 2013, we filed a registration statement on Form S-3, File No. 333-190158 (the “2013 Registration Statement”) with the SEC to register an indeterminate number of shares of common stock, preferred stock, and warrants with a total offering price not to exceed $5 million. The 2013 Registration Statement was declared effective by the SEC on September 19, 2013. On September 23, 2013, we entered into an agreement with Northland Securities, Inc. (“Northland”), pursuant to which Northland acted as placement agent in connection with the sale of 2,688,172 shares of our common stock to Camber Capital Management, LLC, at a price of $1.86 per share. Gross proceeds from the sale totaled $5 million, and net proceeds, after offering expenses of $408,000 which included Northland’s fee, totaled approximately $4.6 million.
In order for us to continue operations 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 distributors, establish profitable operations through increased sales, decrease expenses, and generate cash from operations or obtain additional funds when needed. We intend to improve our financial condition and ultimately improve our financial results by increasing revenues through expansion of our product offerings, continuing to develop our direct sales force and distributor relationships both domestically and internationally, forming strategic arrangements within the dental and medical industries, educating dental and medical patients as to the benefits of our advanced medical technologies, and continuing cost reduction initiatives.
In February 2014, we completed the first phase of our planned cost saving measures by streamlining operations and reducing payroll and payroll related expenses by approximately $1.3 million, net (unaudited), on an annualized basis. For the second phase, we have begun to reallocate and rationalize certain marketing and advertising activities. We expect that we will begin to realize the impact of these cost saving measures in the quarter ending June 30, 2014.
Additional capital requirements may depend on many factors, including, among other things, the rate at which our business grows, demands for working capital, manufacturing capacity, and any acquisitions that we may pursue. From time to time, we could be required, or may otherwise attempt, to raise capital through either equity or debt offerings. We cannot provide assurance that we will enter into any such equity or debt financings in the future or that the required capital would be available on acceptable terms, if at all, or that any such financing activity would not be dilutive to our stockholders.
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. As a result, the opinion we have received from our independent registered public accounting firm on our consolidated financial statements contains an explanatory paragraph stating that there is a substantial doubt regarding our ability to continue as a going concern.
The accompanying financial statements have been prepared on a going concern basis that contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The 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.
During the year ended December 31, 2013 (“Fiscal 2013”), we received FDA clearance for both the Diolase 10S and Epic 10S for over 80 different procedures in 19 additional medical markets, including general surgery, ophthalmology, dermatology, plastic surgery, ENT, oral surgery, arthroscopy, gastroenterology, podiatry, GI/GU, gynecology, neurosurgery, pulmonary surgery, cardiac surgery, thoracic surgery, urology, aesthetics, and vascular surgery. We continue to invest in our intellectual property and were granted several new patents covering the use of laser technologies for treating various conditions of the eye, including presbyopia, glaucoma, retinal disorders, and cataracts, several new patents for our laser delivery system configurations, and a new patent for our non-contact hand piece for cutting both hard and soft tissue with our WaterLase all-tissue lasers. The FDA also cleared the WaterLase iPlus all-tissue laser for use as a surgical instrument for soft-tissue procedures in orthopedic and podiatric surgery.
We have taken steps during Fiscal 2013, which we believe will improve our financial condition and ultimately improve our financial results, including increasing our product offerings with the launch of the new Epic 10S and Epic V-Series diode laser systems. The Epic 10S platform has launched us into the medical field serving otolaryngologists (also known as "Ear, Nose, and Throat" or "ENT" doctors). We also have a strategic agreement with Valam, Inc. (“Valam”) to develop, market, and sell office-based laser systems to otolaryngologists (the “Valam Agreement”). The Valam Agreement provides us with an exclusive worldwide license to Valam’s ENT related patents and patent applications which complement our patent portfolio. We believe our Epic V-Series platform will be a leading technology in the evolution of dental and medical treatments available in the veterinary market. We expanded our line of digital imaging equipment with the NewTom Biolase VG3.
Our recently launched OCCULASE website is also a marketing platform for our ophthalmology technologies for which we continue to seek strategic partnerships to assist in our entry into the ophthalmology laser market. We continue to reshape and expand our direct sales force and certain distributor relationships. During this period we also restructured our sales and marketing department and its priorities, which we expect will lead to improved resource allocation within the largest share of our operating expenses.
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. We sell our products in North America directly to customers through our direct sales force and through non-exclusive distributors. 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 primarily sell products through independent distributors. 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. 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 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 laser and certain imaging 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 record the purchased trade-ins as inventory at the fair value of the asset surrendered with the offset to accounts receivable. In determining the estimated fair value of used laser trade-ins, we make an assessment of usable parts, key components, and consider the ultimate resale value of the certified pre-owned (or “CPO”) laser with applicable margins. We sell these CPO laser trade-ins as refurbished lasers following our laser system revenue recognition policy. Trade-in rights are not established nor negotiated with customers during the initial sales transaction of the original lasers. Trade-in rights are promotional events used at our discretion to encourage existing laser customers to purchase new lasers by offering perceived discounts in exchange for customers trading in original lasers. A customer is not required to trade-in a laser nor are we required to accept a trade-in, however, the promotional value offered in exchange for the trade-in laser is not offered without a laser trade-in. The transaction is treated as a monetary transaction as each sale transaction involving a customer trade-in includes significant boot of greater than 25% of the fair value of the exchange. As a monetary transaction, the sale is recognized following our laser system revenue recognition policy. There have been no sales transactions in which the cash consideration was less than 25% of the total transaction value.
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 using the Black-Scholes option valuation model, taking into consideration the probability of vesting and estimated forfeitures.
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 from due date 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.
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, 2013 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. We provide warranties against defects in materials and workmanship of our laser systems for specified periods of time. WaterLase systems sold domestically are covered by our warranty 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. WaterLase systems sold internationally are generally covered by our warranty 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. 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. Our overall accrual is based on our historical experience and our expectation of future conditions, taking into consideration the location and type of customer and the type of laser, which directly correlate to the materials and components under warranty, the duration of the warranty period, and the logistical costs to service the warranty. Additional factors that may impact our warranty accrual include changes in the quality of materials, leadership and training of the production and services departments, knowledge of the lasers and workmanship, training of customers, and adherence to the warranty policies. Additionally, an increase in warranty claims or in the costs associated with servicing those claims would likely result in an increase in the accrual and a decrease in gross profit. We offer extended warranties on certain imaging products; however all imaging products are initially covered by the manufacturer’s warranties.
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 2013, 2012, and 2011 and the available evidence, management has determined that it is more likely than not that the deferred tax assets as of December 31, 2013 will not be realized in the near term. Consequently, we have established a valuation allowance against our net deferred tax asset totaling approximately $35.6 million and $33.3 million as of December 31, 2013 and 2012, 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 and cash equivalents, accounts receivable, accounts payable, and accrued liabilities, approximate fair value because of the short maturity of these items. Financial instruments consisting of lines of credit approximate fair value, as the interest rates associated with the lines of credit approximates the market rates 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.
Results of Operations
The following table sets forth certain data from our operating results for each of the years ended December 31, 2013, 2012, and 2011, expressed as percentages of revenue:
The following table summarizes our net revenues by category for the years ended December 31, 2013, 2012, and 2011 (dollars in thousands):
Non-GAAP Disclosure
In addition to the financial information prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”), we provide certain historical non-GAAP financial information. Management believes that adjustments for these items assist investors in making comparisons of period-to-period operating results and that these items are not indicative of the Company's on-going core operating performance.
Management believes that the presentation of this non-GAAP financial information provides investors with greater transparency and facilitates comparison of operating results across a broad spectrum of companies with varying capital structures, compensation strategies, derivative instruments, and amortization methods, which provide a more complete understanding of our financial performance, competitive position, and prospects for the future. However, the non-GAAP financial measures presented herein have certain limitations in that they do not reflect all of the costs associated with the operations of our business as determined in accordance with GAAP. Therefore, investors should consider non-GAAP financial measures in addition to, and not as a substitute for, or as superior to, measures of financial performance prepared in accordance with GAAP. Further, the non-GAAP financial measures presented by the Company may be different from the non-GAAP financial measures used by other companies.
Non-GAAP Net Loss. Management uses non-GAAP net loss (defined as net loss before interest, taxes, depreciation and amortization, and stock-based other equity instruments, and other non-cash compensation) in its evaluation of the Company's core after-tax results of operations and trends between fiscal periods and believes that these measures are important components of its internal performance measurement process. Management believes that this non-GAAP financial information reflects an additional way of viewing aspects of our business that, when viewed with our GAAP results, provide a more complete understanding of factors and trends affecting our business.
Non-GAAP net loss for the periods presented is as follows (in thousands):
Comparison of Results of Operations
Year Ended December 31, 2013 Compared With Year Ended December 31, 2012
Net Revenue. Net revenue for Fiscal 2013 was $56.4 million, a decrease of $926,000, or 2%, as compared with net revenue of $57.4 million for the year ended December 31, 2012 (“Fiscal 2012”). Domestic revenues were $35.6 million, or 63% of net revenue, for Fiscal 2013 compared to $40.6 million, or 71% of net revenue, for Fiscal 2012. International revenues for Fiscal 2013 were $20.8 million, or 37% of net revenue compared to $16.8 million, or 29% of net revenue for Fiscal 2012. The decrease in period-over-period net revenue resulted from decreases in domestic laser system revenue, offset by increases in imaging systems, consumables and other, services, and license fees and royalty revenue. We believe that these results were primarily due to our transition from primarily selling WaterLase dental lasers to selling a wide range of hard- and soft-tissue dental and medical lasers and other high-tech solutions for dentists, including digital radiography and CAD/CAM intra-oral scanners. In order to more effectively deploy our resources and improve overall revenue as well as our margins we recently changed our sales and marketing leadership. Subsequent to our leadership change we have hired 15 additional sales personnel of which 12 will be primarily focused on selling our core laser products.
Laser system net revenues, as a result of the aforementioned reasons, decreased by approximately $3.6 million, or 9%, in Fiscal 2013 compared to Fiscal 2012. As expected, we experienced an improvement in sales of our core laser systems during the quarter ending December 31, 2013 as compared with the quarter ending September 30, 2013. Historically, revenue in the fourth quarter has typically been stronger than average due to the buying patterns of dental professionals. We believe that a significant number of dentists purchase capital equipment during the fourth quarter in order to maximize their practice earnings and minimize their taxes through the utilization of certain tax incentives, such as accelerated depreciation methods for purchased capital equipment, as part of their year-end tax planning.
Imaging system net revenue increased by approximately $1.3 million, or 38%, in Fiscal 2013 compared to Fiscal 2012. The increase was driven by increased offerings at various value propositions, including the recently introduced NewTom VG3. We expect continued improvement in sales of our imaging systems during the year ended December 31, 2014 as we gain more experience with these products, as a result of the recent changes we have made to our sales and marketing leadership, and as we continue to increase in the number of sales professionals that will be primarily focused on selling our imaging products.
Consumables and other net revenue, which includes consumable products such as disposable tips and shipping revenue, increased approximately $504,000, or 8%, for Fiscal 2013, as compared to Fiscal 2012. This increase in consumables and other net revenue was primarily a result of auxiliary sales to our growing laser customer base.
Services net revenue, which consists of extended warranty service contracts, advanced training programs, and other services, increased by approximately $836,000, or 15%, for Fiscal 2013, as compared to Fiscal 2012. The increased revenue was due largely to increased follow-on sales related to our growing laser customer base and increased sales and marketing efforts in this part of our business.
License fees and royalty revenue increased approximately $79,000 to approximately $244,000 in Fiscal 2013 compared to $165,000 in Fiscal 2012. These license fees and royalty revenue were attributable to intellectual property related to our laser technologies. We also have a non-exclusive license agreement with P&G, granting them non-exclusive license rights to certain of our patents. Although the term of the arrangement continues until the underlying patents expire unless terminated earlier by either party, we have not generated revenue under the arrangement since 2011 and we are exploring alternative product development opportunities.
Cost of Revenue. Cost of revenue in Fiscal 2013 increased by $4.0 million, or 13%, to $34.9 million, or 62% of net revenue, compared with cost of revenue of $30.9 million, or 54% of net revenue, in Fiscal 2012. The increased cost as a percentage of revenue is a result of lower laser system sales and increased imaging and international sales. Our laser systems generally have significantly higher margins than our licensed imaging systems and our domestic sales generally have higher margins than our international sales. We also recorded a provision of $1.0 million for excess and obsolete inventory during the quarter ended September 30, 2013, related to negative market trends for certain products and the decreased velocity of certain elements of our inventory at that time.
Gross Profit. Gross profit for Fiscal 2013 was $21.5 million, or 38% of net revenue, a decrease of approximately $5.0 million, as compared with gross profit of $26.5 million, or 46% of net revenue, for Fiscal 2012. The decrease was primarily due to higher sales of licensed imaging systems, which generally carry lower margins than our laser products, increased international laser sales, which generally carry a lower margin than our domestic laser sales, and the increased provision for excess and obsolete inventory.
Operating Expenses. Operating expenses for Fiscal 2013 were $32.5 million, or 58% of net revenue, an increase of approximately $3.5 million as compared with $29.0 million, or 51% of net revenue, for Fiscal 2012. We expect that operating expenses as a percentage of net revenue will decrease for the year ending December 31, 2014 as a result of cost saving measures we began implementing in February 2014, including streamlining operations and reducing payroll and payroll related expenses by approximately $1.3 million, net (unaudited), on an annualized basis, and reducing and rationalizing certain marketing and advertising activities. We expect that we will begin to realize the impact of these cost saving measures in the quarter ending June 30, 2014. The year-over-year increase in expense is explained in the following expense categories:
Sales and Marketing Expense. Sales and marketing expenses for Fiscal 2013 increased by $2.4 million, or 15%, to $18.7 million, or 33% of net revenue, as compared with $16.3 million, or 28% of net revenue, for Fiscal 2012. The increase was primarily a result of increased payroll and consulting related expenses of $1.4 million, increased convention costs of $579,000, and increased media and advertising expenses of $471,000, offset by decreased commission expenses of $482,000 related to lower sales. The increased costs were related to the launch and integration of our Cefla NewTom and Biolase DaVinci 3-D Imaging product lines and our 3Shape Trios intra-oral scanners, the launch of our Epic V-Series and Epic 10S diode lasers in veterinary and otolaryngology, respectively, and the introduction of our Galaxy BioMill CAD/CAM chair-side milling system. We expect our effeciencies with these new products to improve as we continue their integration and from the recent changes we have made to our sales and marketing leadership.
General and Administrative Expense. General and administrative expenses for Fiscal 2013 increased by $1.3 million, or 16%, to $9.4 million, or 17% of net revenue, as compared with $8.1 million, or 14% of net revenue, for Fiscal 2012. We experienced increased legal expenses of $615,000, of which $250,000 related to the defense of class action lawsuits (refer to “Part I, Item 3. Legal Proceedings”), increased payroll and consulting related expenses of $536,000, and increased investor relations expenses of $220,000.
Engineering and Development Expense. Engineering and development expenses for Fiscal 2013 decreased by $655,000, or 14%, to $4.0 million, or 7% of net revenue, as compared with $4.7 million, or 8% of net revenue, for Fiscal 2012. The decrease was primarily related to decreased payroll and consulting related expenses of $295,000 and decreased supplies expenses of $463,000. We expect to increase our investment in engineering and development as we continue our efforts in new product development in the future.
Excise Tax Expense. Beginning January 1, 2013, the Patient Protection and Affordable Care Act imposed a 2.3% medical device excise tax on certain product sales to customers located in the U.S. We incurred excise tax expenses of $438,000, or 1% of net revenue, for Fiscal 2013.
Non-Operating Income (Loss)
(Loss) Gain on Foreign Currency Transactions. We recognized a $50,000 loss on foreign currency transactions for Fiscal 2013 compared to an $175,000 loss for Fiscal 2012 due to exchange rate fluctuations between the U.S. dollar and other currencies.
Interest Expense, Net. Interest expense consists primarily of interest on our revolving credit facilities, amortization of debt issuance costs and debt discount, and the financing of our business insurance premiums. Interest expense totaled approximately $600,000 and $239,000 for Fiscal 2013 and 2012, respectively.
Provision (benefit) for Income Taxes. Our provision for income taxes was a benefit of $164,000 for Fiscal 2013, compared to provision of $111,000 in Fiscal 2012. During Fiscal 2013, we reversed certain tax liabilities associated with unrecognized tax benefits related to international operations due to expiring statutes and recognized tax benefits of $138,000. In addition, we recognized deferred tax assets related to certain indefinite lived assets (federal alternative minimum tax credits and California R&D credits) that were used to offset deferred tax liabilities related to indefinite-lived intangible assets. This resulted in additional tax benefits of $107,000. We also recorded an income tax expense of $81,000 for the current year tax provision.
Net Loss. For the reasons stated above, our net loss was $11.5 million for Fiscal 2013 compared to a net loss of $3.1 million for Fiscal 2012.
Year Ended December 31, 2012 Compared With Year Ended December 31, 2011
Net Revenue. Net revenue for Fiscal 2012 was $57.4 million, an increase of $8.5 million, or 17%, as compared with net revenue of $48.9 million for the year ended December 31, 2011 (“Fiscal 2011”). The increase was primarily attributed to continued demand for our all-tissue WaterLase systems and increased sales of imaging systems. These increases, fueled by increased sales and marketing efforts, were offset by decreased sales of diode laser systems and lower royalty revenues. Domestic revenues were $40.6 million, or 71% of net revenue, for Fiscal 2012 compared to $32.8 million, or 67% of net revenue, for Fiscal 2011. International revenues for Fiscal 2012 were $16.8 million, or 29% of net revenue compared to $16.1 million, or 33% of net revenue for Fiscal 2011.
Laser system net revenues increased by approximately $3.9 million, or 10%, in Fiscal 2012 compared to Fiscal 2011. Net revenues increased primarily due to increased sales and marketing efforts, offset by a $1.1 million reduction in revenue resulting from our Fiscal 2012 purchase of WaterLase MD Turbo laser systems originally sold by us to our former exclusive distributor.
Imaging system net revenue was $3.4 million in Fiscal 2012 compared to $238,000 in Fiscal 2011. Imaging systems were included in our product offerings beginning in late 2011.
Consumables and other net revenue, which includes consumable products, such as disposable tips, and shipping revenue increased approximately $718,000, or 14%, for Fiscal 2012, as compared to Fiscal 2011. This increase in consumables and other net revenue is primarily a result of a larger customer base using our lasers.
Services net revenue, which consists of extended warranty service contracts, advanced training programs, and other services, increased by approximately $1.0 million, or 23%, for Fiscal 2012, as compared to Fiscal 2011. The increased revenues were due to increased follow on sales related to a larger customer base using our lasers and increased sales and marketing efforts in this part of our business.
License fees and royalty revenue decreased approximately $274,000 to approximately $165,000 in Fiscal 2012 compared to $439,000 in Fiscal 2011. The decrease resulted primarily as a result of recognition of deferred royalty revenue from P&G of $375,000 during Fiscal 2011.
Net Cost of Revenue. Net cost of revenue in Fiscal 2012 increased by $3.4 million, or 12%, to $30.9 million, compared with net cost of revenue of $27.5 million in Fiscal 2011. This increase was primarily attributed to increased sales, offset by a $1.1 million reduction in costs resulting from our Fiscal 2011purchase of WaterLase MD Turbo laser systems originally sold by us to our former exclusive distributor.
Gross Profit. Gross profit for Fiscal 2012 was $26.5 million, or 46% of net revenue, an increase of $5.2 million, as compared with gross profit of $21.3 million, or 44% of net revenue, for Fiscal 2011. The increase was primarily due to increased sales, continued quality improvements, and efficiencies gained through improvements in the manufacturing process.
Operating Expenses. Operating expenses for Fiscal 2012 were $29.0 million, or 51% of net revenue, a $3.7 million increase as compared with $25.3 million, or 52% of net revenue, for Fiscal 2011. The year-over-year increase in expense is explained in the following expense categories:
Sales and Marketing Expense. Sales and marketing expenses for Fiscal 2012 increased by $3.2 million, or 24%, to $16.3 million, or 28% of net revenue, as compared with $13.1 million, or 27% of net revenue, for Fiscal 2011. The increase was primarily a result of increased commission expenses of $1.0 million related to higher sales, increased convention costs of $988,000 related to the launch and integration of the Cefla NewTom and Biolase DaVinci 3-D Imaging product lines, higher payroll and consulting related expenses of $645,000, and increased media and advertising expenses of $533,000, offset by a net reduction in support services of $252,000 related to the 2011purchase of WaterLase MD Turbo laser systems originally sold by us to our former exclusive distributor.
General and Administrative Expense. General and administrative expenses for Fiscal 2012 increased by $139,000, or 2%, to $8.1 million, or 14% of net revenue, as compared with $7.9 million, or 16% of net revenue, for Fiscal 2011. The increase in general and administrative expenses resulted primarily from increased bank fees of $206,000 and increased allowance for doubtful accounts of $143,000, offset by decreased patent and legal costs of $135,000 and decreased payroll and consulting related expenses of $103,000.
Engineering and Development Expense. Engineering and development expenses for Fiscal 2012 increased by $373,000, or 9%, to $4.7 million, or 8% of net revenue, as compared with $4.3 million, or 9% of net revenue, for Fiscal 2011. The increase was primarily related to increased payroll and consulting related expenses of $266,000 and increased supplies expenses of $196,000, offset by lower depreciation expenses of $87,000.
Non-Operating Income (Loss)
(Loss) Gain on Foreign Currency Transactions. We recognized a $175,000 loss on foreign currency transactions for Fiscal 2012 compared to an $88,000 loss for Fiscal 2011 due to exchange rate fluctuations between the U.S. dollar and other currencies.
Interest Expense. Interest expense consists primarily of interest on our revolving credit facilities, amortization of debt issuance costs and debt discount, the financing of our business insurance premiums, and interest on our term loan payable which was repaid in full in February 2011. Interest expense totaled approximately $239,000 and $305,000 for Fiscal 2012 and 2011, respectively. Interest expense for Fiscal 2011 included $225,000 of unamortized debt-related costs that were expensed in conjunction with the repayment of our outstanding balances under the Loan and Security Agreement during February 2011.
Provision for Income Taxes. Our provision for income taxes was $111,000 for Fiscal 2012, compared to $89,000 in Fiscal 2011.
Net Loss. For the reasons stated above, our net loss was $3.1 million for Fiscal 2012 compared to a net loss of $4.5 million for Fiscal 2011.
Selected Quarterly Financial Data
The following table presents our operating results for each quarter in our last two fiscal years. This data has been derived from unaudited financial statements that, in the opinion of management, include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of such information when read in conjunction with our annual audited financial statements and notes thereto. These operating results are not necessarily indicative of results for any future operating period.
(1)
Loss from operations and net loss includes $368,000, $380,000, $491,000, and $370,000 in compensation cost related to stock options for the quarters ended March 31, June 30, September 30, and December 31, 2013, respectively.
(2)
Loss from operations and net loss includes $583,000, $340,000, $357,000, and $320,000 in compensation cost related to stock options for the quarters ended March 31, June 30, September 30, and December 31, 2012, respectively.
(3)
Net (loss) income per share calculations for each of the quarters were based upon the weighted average number of shares outstanding for each period, adjusted to reflect the effects of stock dividends, and the sum of the quarters may not necessarily be equal to the full year net (loss) income per common share amount.
Liquidity and Capital Resources
At December 31, 2013, we had approximately $1.4 million in cash and cash equivalents. Management defines cash and cash equivalents as highly liquid deposits with original maturities of 90 days or less when purchased. The decrease in our cash and cash equivalents by $1.1 million was primarily due to net cash used in operating and investing activities of $9.3 million and $685,000, respectively, offset by cash provided by financing activities of $8.8 million.
At December 31, 2013, we had approximately $3.9 million in working capital. Our principal sources of liquidity at December 31, 2013, consisted of approximately $1.4 million in cash and cash equivalents, $11.1 million of net accounts receivable, and available borrowings under two revolving credit facility agreements totaling approximately $3.4 million at December 31, 2013.
We have suffered recurring losses from operations and have not generated cash from operations for the three years ended December 31, 2013. Our level of 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.
The available borrowing capacity on our lines of credit with Comerica Bank, as amended, and the net proceeds from the aforementioned equity transactions have been principal sources of liquidity during the year ended December 31, 2013. These credit facilities expire May 1, 2014, and we are considering alternative solutions, including potentially issuing alternative debt securities, to mitigate any future liquidity constraints these covenants, restrictions, and maturities may impose on us. Further discussion of our lines of credit is included in Note 5 to the Consolidated Financial Statements in Part IV, Item 15 of this Annual Report on Form 10-K, which is incorporated herein by reference.
On February 10, 2014, we entered into the February 2014 Subscription Agreement with Oracle Partners L.P., Oracle Institutional Partners, L.P., and Oracle Ten Fund Master L.P. under which we offered an aggregate of 1,945,525 unregistered shares of common stock in a private placement at a price of $2.57 per share. Gross proceeds from the sale totaled $5 million, and net proceeds, after offering expenses of approximately $208,000, totaled approximately $4.8 million.
On January 17, 2014, we filed the January 2014 Registration Statement with the SEC to register an indeterminate number of shares of common stock, preferred stock, and warrants with a total offering price not to exceed $12.5 million. The January 2014 Registration Statement was declared effective by the SEC on January 29, 2014.
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 distributors, establish profitable operations through increased sales, decrease expenses, and generate cash from operations or obtain additional funds when needed. We intend to improve our financial condition and ultimately improve our financial results by increasing revenues through expansion of our product offerings, continuing to expand and develop our direct sales force and distributor relationships both domestically and internationally, forming strategic arrangements within the dental and medical industries, educating dental and medical patients as to the benefits of our advanced medical technologies, and reducing expenses.
In February 2014, we completed the first phase of our planned cost saving measures by streamlining operations and reducing payroll and payroll related expenses by approximately $1.3 million, net (unaudited), on an annualized basis. For the second phase, we have begun to reallocate and rationalize certain marketing and advertising activities. We expect that we will begin to realize the impact of these cost saving measures in the quarter ending June 30, 2014.
Additional capital requirements may depend on many factors, including, among other things, the rate at which our business grows, demands for working capital, manufacturing capacity, and any acquisitions that we may pursue. From time to time, we could be required, or may otherwise attempt, to raise capital through either equity or debt offerings. We cannot provide assurance that we will enter into any such equity or debt financings in the future or that the required capital would be available on acceptable terms, if at all, or that any such financing activity would not be dilutive to our stockholders.
Our Board has authorized us to seek the services of an investment bank to explore possible merger and acquisition transactions with the goal of maximizing shareholder value. We have engaged the services of Piper Jaffray & Co. (“Piper Jaffray”) and continue to explore opportunities, through either acquisitions or strategic alliances.
We may not be able to increase sales, reduce expenses, or obtain additional funds when needed or guarantee 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. As a result, the opinion we have received from our independent registered public accounting firm on our consolidated financial statements contains an explanatory paragraph stating that there is a substantial doubt regarding our ability to continue as a going concern.
The accompanying financial statements have been prepared on a going concern basis that contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The 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.
Concentration of Credit Risk
Financial instruments which potentially expose us to a concentration of credit risk consist principally of cash and cash equivalents, restricted cash, and trade accounts receivable. We maintain our cash and cash equivalents and restricted cash with established commercial banks. At times, balances may exceed federally insured limits. To minimize the risk associated with trade accounts receivable, we perform ongoing credit evaluations of customers’ financial condition and maintain relationships with their customers which allow us to monitor current changes in business operations so we can respond as needed. We do not, generally, require customers to provide collateral before we sell them our products; however we have required certain distributors to make prepayments for significant purchases of our products. For the years ended December 31, 2013, 2012, and 2011, sales to HSIC worldwide accounted for approximately 5%, 3%, and 19%, respectively, of our net sales.
Receivables and Allowance for Doubtful Accounts
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in the existing accounts receivable. We determine the allowance based on a quarterly specific account review of past due balances over 90 days. All other balances are reviewed on a pooled basis by age of receivable. Account balances are charged off against the allowance when it is probable the receivable will not be recovered. We do not have any off-balance-sheet credit exposure related to our customers.
See “Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Substantially all of our revenue is denominated in U.S. dollars, including sales to our international distributors. Only a small portion of our revenue and expenses is denominated in foreign currencies, principally the Euro and Indian Rupee. Our foreign currency expenditures primarily consist of the cost of maintaining our offices, including the facilities, consulting services and employee-related costs. To date, we have not entered into any hedging contracts. Future fluctuations in the value of the U.S. dollar may, however, affect the price competitiveness of our products outside the United States.
Outstanding balances on our lines of credit expose us to variable interest rate risks associated with fluctuations in the daily prime rate and LIBOR rate. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. An increase in the daily prime rate or LIBOR rate would increase the interest expense we must pay.
Inflation has not had a significant effect on our results of operations during the three years ending December 31, 2013 as we do not have significant operations in countries which have experienced high rates of inflation.
Item 8.
Item 8. Financial Statements and Supplementary Data
All financial statements and supplementary data required by this Item 8, including the report of the independent registered public accounting firm, are listed in Part IV, Item 15 of this Form 10-K, are set forth beginning on Page of this Form 10-K, and are hereby incorporated into this Item 8 by this reference. The Selected Quarterly Financial Data required by this Item 8 is set forth in Item 7 (Management’s Discussion and Analysis of Financial Condition and Results of Operations) of this Form 10-K and is hereby incorporated into this Item 8 by this reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
Our management, with the participation of our CEO and CFO, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2013. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of December 31, 2013.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. A company’s internal control over financial reporting is a process designed by, or under the supervision of, our principal executive and financial officers, and effected by our board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on our financial statements.
Under the supervision and with the participation of management, including our CEO and CFO, management conducted an assessment of the effectiveness of our internal control over financial reporting based on the framework established by the Committee of Sponsoring Organizations of the Treadway Commission entitled “Internal Control - Integrated Framework (1992)” (the “COSO Framework”). Based on our evaluation under the COSO Framework, management has concluded that our internal control over financial reporting was effective at a reasonable assurance level as of December 31, 2013.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
BDO USA, LLP, our independent registered public accounting firm that audited the consolidated financial statements included in this Annual Report on Form 10-K, issued an attestation report on our internal control over financial reporting as of December 31, 2013; their report is included herein.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) that occurred during the fourth quarter of 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
BIOLASE, Inc.
Irvine, California
We have audited BIOLASE, Inc.’s (the “Company’s”) internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Item 9A, Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, BIOLASE, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of BIOLASE, Inc. as of December 31, 2013 and 2012, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2013 and our report dated March 17, 2014 expressed an unqualified opinion thereon and included an explanatory paragraph regarding the Company’s ability to continue as a going concern.
/s/ BDO USA, LLP
Costa Mesa, California
March 17, 2014
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Information regarding our executive officers is included in Part I of this Form 10-K under “Item 1. Business - Executive Officers of the Registrant.” In addition, the information set forth under the caption “Election of Directors” and “Security Ownership of Certain Beneficial Owners and Management - Section 16(a) Beneficial Ownership Reporting Compliance” in the definitive proxy statement (the “Proxy Statement”) to be filed in connection with our 2014 Annual Meeting of Stockholders, which Proxy Statement will be filed with the SEC within 120 days of December 31, 2013, is incorporated by reference herein.
We have adopted the Biolase, Inc. Code of Business Conduct and Ethics which applies to all our employees, officers and directors, including our Chief Executive Officer and Chief Financial Officer, and is filed as an exhibit to this Annual Report on Form 10-K.
Item 11.
Item 11. Executive Compensation
The information set forth under the captions “Executive Compensation” and “Election of Directors - Director Compensation” in the Proxy Statement is incorporated by reference herein.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information set forth under the captions “Security Ownership of Certain Beneficial Owners and Management” and “Executive Compensation - Equity Compensation Plan Information” in the Proxy Statement is incorporated by reference herein.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information set forth under the captions “Election of Directors” and “Certain Relationships and Related Transactions” in the Proxy Statement is incorporated by reference herein.
Item 14.
Item 14. Principal Accountant Fees and Services
The information set forth under the caption “Principal Accountant Fees and Services” in the Proxy Statement is incorporated by reference herein.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) The following documents are filed as part of this Annual Report on Form 10-K beginning on the pages referenced below:
(1)
Financial Statements:
Page
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2013 and 2012
Consolidated Statements of Operations and Comprehensive Loss for the years ended December 31, 2013, 2012, and 2011
Consolidated Statements of Stockholders’ Equity (Deficit) for the years ended December 31, 2013, 2012, and 2011
Consolidated Statements of Cash Flows for the years ended December 31, 2013, 2012, and 2011
Notes to Consolidated Financial Statements
(2)
Financial Statement Schedule:
Schedule II - Consolidated Valuation and Qualifying Accounts and Reserves for the years ended December 31, 2013, 2012, and 2011
S-1
All other schedules have been omitted as they are not applicable, not required or the information is included in the consolidated financial statements or the notes thereto.
(3)
Exhibits:
The following exhibits are filed with this Annual Report on Form 10-K or are incorporated by reference herein in accordance with the designated footnote references.
†
Confidential treatment was granted for certain confidential portions of this exhibit pursuant to Rule 24b-2 under the Securities Exchange Act of 1934. In accordance with Rule 24b-2, these confidential portions were omitted from this exhibit and filed separately with the Securities and Exchange Commission.
††
Confidential treatment was requested for certain confidential portions of this exhibit pursuant to Rule 24b-2 under the Securities Exchange Act of 1934. In accordance with Rule 24b-2, these confidential portions were omitted from this exhibit and filed separately with the Securities and Exchange Commission.
*
Management contract or compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
Signature
Title
Date
/S/ FEDERICO PIGNATELLI
Chairman of the Board and
Chief Executive Officer,
(Principal Executive Officer)
March 17, 2014
Federico Pignatelli
/s/ FREDERICK D. FURRY
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
March 17, 2014
Frederick D. Furry
/s/ DR. NORMAN J. NEMOY
Director
March 17, 2014
Dr. Norman J. Nemoy
/s/ DR. FREDERIC H. MOLL
Director
March 17, 2014
Dr. Frederic H. Moll
/s/ JAMES R. TALEVICH
Director
March 17, 2014
James R. Talevich
BIOLASE, INC.
Index to Consolidated Financial Statements and Schedule
Page
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2013, and 2012
Consolidated Statements of Operations and Comprehensive Loss for the years ended December 31, 2013, 2012, and 2011
Consolidated Statements of Stockholders’ Equity (Deficit) for the years ended December 31, 2013, 2012, and 2011
Consolidated Statements of Cash Flows for the years ended December 31, 2013, 2012, and 2011
Notes to Consolidated Financial Statements
SCHEDULE
Schedule numbered in accordance with Rule 5.04 of Regulation S-X:
II. Consolidated Valuation and Qualifying Accounts and Reserves
S-1
All Schedules, except Schedule II, have been omitted as the required information is shown in the consolidated financial statements, or notes thereto, or the amounts involved are not significant or the schedules are not applicable.
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
BIOLASE, Inc.
Irvine, California
We have audited the accompanying consolidated balance sheets of BIOLASE, Inc. (the “Company”) as of December 31, 2013 and 2012 and the related consolidated statements of operations and comprehensive loss, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2013. In connection with our audits of the consolidated financial statements, we have also audited the consolidated financial statement schedule listed in the accompanying index as of and for the years ended December 31, 2013, 2012, and 2011. These consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements and schedule. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of BIOLASE, Inc. at December 31, 2013 and 2012, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America.
Also, in our opinion, the consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring losses from operations and has not generated cash from operations for each of the three years in the period ended December 31, 2013. These factors, among others, raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United Sates), the Company’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 17, 2014 expressed an unqualified opinion thereon.
/s/ BDO USA, LLP
Costa Mesa, California
March 17, 2014
BIOLASE, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
See accompanying notes to consolidated financial statements.
BIOLASE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in thousands, except per share data)
See accompanying notes to consolidated financial statements.
BIOLASE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
(in thousands)
See accompanying notes to consolidated financial statements.
BIOLASE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying notes to consolidated financial statements.
BIOLASE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENT
NOTE 1 - BASIS OF PRESENTATION
The Company
BIOLASE, Inc., (the “Company”) incorporated in Delaware in 1987, is a biomedical company that develops, manufactures, and markets lasers in dentistry and medicine and also markets and distributes dental imaging equipment, including cone beam digital x-rays and CAD/CAM intra-oral scanners, and in-office, chair-side milling machines and three dimensional (“3-D”) printers; products that are focused on technologies that advance the practice of dentistry and medicine.
Basis of Presentation
The consolidated financial statements include the accounts of BIOLASE, Inc. and its wholly-owned subsidiaries. The Company has eliminated all material intercompany transactions and balances in the accompanying consolidated financial statements. Certain amounts for prior years have been reclassified to conform to the current year presentation.
Use of Estimates
The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires the Company to make estimates and assumptions that affect amounts reported in the consolidated financial statements and the accompanying notes. Significant estimates in these consolidated financial statements include allowances on accounts receivable, inventory and deferred taxes, as well as estimates for accrued warranty expenses, indefinite-lived intangible assets and the ability of goodwill to be realized, revenue deferrals for multiple element arrangements, effects of stock-based compensation and warrants, contingent liabilities and the provision or benefit for income taxes. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may differ materially from those estimates.
Fair Value of Financial Instruments
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal market (or, if none exists, the most advantageous market) for the specific asset or liability at the measurement date (referred to as the “exit price”). The fair value is based on assumptions that market participants would use, including a consideration of nonperformance risk. Under the accounting guidance for fair value hierarchy there are three levels of measurement inputs. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. Level 2 inputs are observable, either directly or indirectly, other than Level 1. Level 3 inputs are unobservable due to little or no corroborating market data.
The Company’s financial instruments, consisting of cash and cash equivalents (Level 1), and accounts receivable, accounts payable, and accrued liabilities (Level 3), approximate fair value because of the short maturity of these items. Financial instruments consisting of lines of credit (Level 3) approximate fair value, as the interest rates associated with the lines of credit approximates the market rates for debt securities with similar terms and risk characteristics.
Concentration of credit risk, interest rate risk and foreign currency exchange rate risk
Financial instruments which potentially expose the Company to a concentration of credit risk consist principally of cash and cash equivalents, restricted cash, and trade accounts receivable. The Company maintains its cash and cash equivalents and restricted cash with established commercial banks. At times, balances may exceed federally insured limits. To minimize the risk associated with trade accounts receivable, management performs ongoing credit evaluations of customers’ financial condition and maintains relationships with the Company’s customers which allow management to monitor current changes in business operations respond as needed. The Company does not, generally, require customers to provide collateral before it sells them products; however it has required certain distributors to make prepayments for significant purchases of products. For the years ended December 31, 2013, 2012, and 2011, worldwide sales to the Company’s largest distributor, Henry Schein, Inc. (“HSIC”), accounted for approximately 5%, 3%, and 19%, respectively, of our net sales.
Substantially all of the Company’s revenue is denominated in U.S. dollars, including sales to international distributors. Only a small portion of its revenue and expenses is denominated in foreign currencies, principally the Euro and Indian Rupee. The Company’s foreign currency expenditures primarily consist of the cost of maintaining offices, including the facilities, consulting services and employee-related costs. To date, the Company has not entered into any hedging contracts. Future fluctuations in the value of the U.S. dollar may, however, affect the price competitiveness of the Company’s products outside the United States.
Outstanding balances on the Company’s lines of credit expose it to variable interest rate risks associated with fluctuations in the daily prime rate and LIBOR rate. Under the Company’s current policies, it does not use interest rate derivative instruments to manage exposure to interest rate changes. An increase in the daily prime rate or LIBOR rate would increase the interest expense the Company must pay.
Liquidity and Management’s Plans
The Company has suffered recurring losses from operations and has not generated cash from operations for the three years ended December 31, 2013. The Company’s level of cash from operations, the potential need for additional capital, and the uncertainties surrounding its ability to raise additional capital, raises substantial doubt about its ability to continue as a going concern. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates that the Company will continue in operation for the next twelve months and will be able to realize its assets and discharge its 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 the Company’s inability to continue as a going concern.
At December 31, 2013, the Company had approximately $3.9 million in working capital. The Company’s principal sources of liquidity at December 31, 2013 consisted of approximately $1.4 million in cash and cash equivalents, $11.1 million of net accounts receivable, and available borrowings under two revolving credit facility agreements totaling approximately $3.4 million at December 31, 2013.
The available borrowing capacity on the Company’s lines of credit with Comerica Bank, discussed further in Note 5 - Lines of Credit and Other Borrowings, and the net proceeds from equity transactions, discussed further in Note 8 - Stockholders’ Equity, have been principal sources of liquidity during the year ended December 31, 2013. On September 6, 2013 and November 8, 2013, the Company amended its lines of credit with Comerica Bank. These amendments waived noncompliance with certain financial covenants and established future covenants, restrictions, and potential penalties for noncompliance. The amendment on November 8, 2013, includes liquidity ratio and liquid asset covenants, and an equity raise requirement. The Company met the equity raise requirement on February 10, 2014. On March 4, 2014, the Company received a waiver from Comerica Bank to waive noncompliance with certain financial and nonfinancial covenants as of January 31, 2014 and December 31, 2013. In connection with the waiver, Comerica Bank reduced the total aggregate available borrowings on the lines of credit to $5.0 million. These credit facilities expire May 1, 2014, and the Company is considering alternative solutions, including potentially issuing alternative debt securities, to mitigate any future liquidity constraints these covenants, restrictions, and maturities may impose on it.
On January 17, 2014, the Company filed a registration statement to register an indeterminate number of shares of common stock, preferred stock, and warrants with a total offering price not to exceed $12.5 million.
In order for the Company to continue operations and be able to discharge its liabilities and commitments in the normal course of business, the Company must sell its products directly to end-users and through distributors, establish profitable operations through increased sales, decrease expenses, and generate cash from operations or obtain additional funds when needed. The Company intends to improve its financial condition and ultimately improve its financial results by increasing revenues through expansion of its product offerings, continuing to expand and develop its direct sales force and distributor relationships both domestically and internationally, forming strategic arrangements within the dental and medical industries, educating dental and medical patients as to the benefits of its advanced medical technologies, and reducing expenses.
In February 2014, the Company completed the first phase of its planned cost saving measures by streamlining operations and reducing payroll and payroll related expenses by approximately $1.3 million, net (unaudited), on an annualized basis. For the second phase, the Company has begun to reallocate and rationalize certain marketing and advertising activities. We expect that we will begin to realize the impact of these cost saving measures in the quarter ending June 30, 2014.
Additional capital requirements may depend on many factors, including, among other things, the rate at which the Company’s business grows, demands for working capital, manufacturing capacity, and any acquisitions that the Company may pursue. From time to time, the Company could be required, or may otherwise attempt, to raise capital through either equity or debt offerings. The Company cannot provide assurance that it will enter into any such equity or debt financings in the future or that the required capital would be available on acceptable terms, if at all, or that any such financing activity would not be dilutive to its stockholders.
As disclosed in a press release on November 11, 2013, the Company’s Board of Directors (“Board”) has authorized the Company to seek the services of an investment bank to explore possible merger and acquisition transactions with the goal of maximizing shareholder value. The Company has engaged the services of Piper Jaffray & Co. (“Piper Jaffray”) and continues to explore opportunities, through either acquisitions or strategic alliances.
The Company cannot guarantee that it 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 the Company. If the Company is unable to increase sales, reduce expenses, or raise sufficient additional capital, it may be unable to continue to fund its operations, develop its products, or realize value from its assets and discharge its liabilities in the normal course of business. These uncertainties raise substantial doubt about the Company’s ability to continue as a going concern.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents
The Company considers all highly liquid investments with maturities of three months or less when purchased, as cash equivalents. Cash equivalents are carried at cost, which approximates fair market value. Investments in money market funds are carried at fair value.
Restricted Cash
The Company maintains bank accounts under deposit account control agreements with Comerica Bank, to be held for repayment of lines of credit and accrued interest expense or disbursement to its operating bank account, pursuant to the terms of two revolving credit facility agreements with Comerica Bank. At December 31, 2013, there were no restricted cash amounts.
Accounts Receivable
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in its existing accounts receivable. The Company evaluates its allowance for doubtful accounts based upon its 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 more than 90 days from due date 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 it is probable the receivable will not be recovered. The Company does not have any off-balance-sheet credit exposure related to its customers.
Inventory
The Company values inventory at the lower of cost, determined using the first-in, first-out method, or market. The carrying value of inventory is evaluated periodically for excess quantities and obsolescence. Management evaluates 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. The allowance is adjusted based on such evaluation, with a corresponding provision included in cost of revenue. Abnormal amounts of idle facility expenses, freight, handling costs and wasted material are recognized as current period charges and our allocation of fixed production overhead is based on the normal capacity of our production facilities.
Property, Plant, and Equipment
Property, plant, and equipment is stated at acquisition cost less accumulated depreciation. Maintenance and repairs are expensed as incurred. Upon sale or disposition of assets, any gain or loss is included in the consolidated statements of operations.
The cost of property, plant, and equipment is depreciated using the straight-line method over the following estimated useful lives of the respective assets, except for leasehold improvements, which are depreciated over the lesser of the estimated useful lives of the respective assets or the related lease terms.
Building
30 years
Leasehold improvements
3 to 5 years
Equipment and computers
3 to 5 years
Furniture and fixtures
5 years
Depreciation expense for the years ended December 31, 2013, 2012, and 2011 totaled approximately $484,000, $377,000, and $565,000, respectively.
Goodwill and Other Intangible Assets
Goodwill and other intangible assets with indefinite lives are not subject to amortization but are evaluated for impairment annually or whenever events or changes in circumstances indicate that the asset might be impaired. The Company operates in one operating segment and has one operating unit; therefore goodwill is tested for impairment at the consolidated level against the fair value of the Company. The fair value of a reporting unit refers to the amount at which the unit as a whole could be bought or sold in a current transaction between willing parties. Quoted market prices in active markets are the best evidence of fair value and are used as the basis for measurement, if available. Management assesses potential impairment on an annual basis on June 30th and compares the Company’s market capitalization to its carrying amount, including goodwill. A significant decrease in the Company’s stock price could indicate a material impairment of goodwill which, after further analysis, could result in a material charge to operations. If goodwill is considered impaired, the impairment loss to be recognized is measured by the amount by which the carrying amount of the goodwill exceeds the implied fair value of that goodwill. Inherent in the Company’s fair value determinations are certain judgments and estimates, including projections of future cash flows, the discount rate reflecting the inherent risk in future cash flows, the interpretation of current economic indicators and market valuations, and strategic plans with regards to operations. A change in these underlying assumptions could cause a change in the results of the tests, which could cause the fair value of the reporting unit to be less than its respective carrying amount.
Costs incurred to acquire and successfully defend patents, and costs incurred to acquire trademarks and trade names are capitalized. Costs related to the internal development of technologies that are ultimately patented are expensed as incurred. Intangible assets, except those determined to have an indefinite life, are amortized using the straight-line method over management’s best estimate of the pattern of economic benefit over the estimated useful life of the assets. Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable.
Long-Lived Assets
The carrying values of long-lived assets, including intangible assets subject to amortization, are reviewed when indicators of impairment, such as reductions in demand or significant economic slowdowns, are present. Reviews are performed to determine whether carrying value of an asset is impaired based on comparisons to undiscounted expected future cash flows. If this comparison indicates that there is impairment, the impaired asset is written down to fair value, which is typically calculated using discounted expected future cash flows. Impairment is based on the excess of the carrying amount over the fair value of those assets.
Other Comprehensive (Loss) Income
Other comprehensive (loss) income encompasses the change in equity from transactions and other events and circumstances from non-owner sources and is included as a component of stockholders’ equity (deficit) but is excluded from net (loss) income. Accumulated other comprehensive gain (loss) consists of the effects of foreign currency translation adjustments.
Foreign Currency Translation and Transactions
Transactions of the Company’s German, Spanish, Australian, and Indian subsidiaries are denominated in their local currencies. The results of operations and cash flows are translated at average exchange rates during the period, and assets and liabilities are translated at end-of-period exchange rates. Translation gains or losses are shown as a component of accumulated other comprehensive gain (loss) in stockholders’ equity (deficit). Gains and losses resulting from foreign currency transactions, which are denominated in a currency other than the entity’s functional currency, are included in the consolidated statements of operations.
Revenue Recognition
The Company’s products are sold domestically both directly to customers through its direct sales force and through non-exclusive distributors. Sales are recorded upon shipment and payment is generally due within 90 days or less. Internationally, the Company sells products through independent distributors. Revenue is recorded based on four basic criteria that must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred and title and the risks and rewards of ownership have been transferred to the customer or services have been rendered; (3) the price is fixed or determinable; and (4) collectability is reasonably assured. Revenue is recorded for all sales upon shipment assuming all other revenue recognition criteria are met.
Sales of the Company’s laser systems include separate deliverables consisting of the product, disposables used with the laser systems, installation, and training. The Company applies 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 the Company 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 the Company sells 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. Deferred revenue attributable to undelivered elements, which primarily consists of training, totaled approximately $1.8 million and $1.7 million as of December 31, 2013 and 2012, respectively.
Key judgments of the Company’s 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. The Company evaluates the customer’s credit worthiness prior to the shipment of the product. Based on the assessment of the credit information available, the Company may determine the credit risk is higher than normally acceptable, and 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 the Company to defer the revenue until the obligation is satisfied.
Although all sales are final, the Company accepts returns of products in certain, limited circumstances and records 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. As of December 31, 2013 and 2012, $110,000 and $110,000, respectively, was recorded as a reduction of accounts receivable for sales returns.
Extended warranty contracts, which are sold to laser and certain imaging customers, are recorded as revenue on a straight-line basis over the period of the contracts, which is typically one year. Included in deferred revenue for each of the years ended December 31, 2013 and 2012, was approximately $1.6 million and $1.5 million, respectively, for extended warranty contracts.
For sales transactions involving used laser trade-ins, the Company records the purchased trade-ins as inventory at the fair value of the asset surrendered with the offset to accounts receivable. In determining the estimated fair value of used laser trade-ins, Management makes an assessment of usable parts, key components, and consider the ultimate resale value of the certified pre-owned (or “CPO”) laser with applicable margins. The Company sells these CPO laser trade-ins as refurbished lasers following its laser system revenue recognition policy. Trade-in rights are not established nor negotiated with customers during the initial sales transaction of the original lasers. Trade-in rights are promotional events used at Management’s discretion to encourage existing laser customers to purchase new lasers by offering perceived discounts in exchange for customers trading in original lasers. A customer is not required to trade-in a laser nor is the Company required to accept a trade-in, however, the promotional value offered in exchange for the trade-in laser is not offered without a laser trade-in. The transaction is treated as a monetary transaction as each sale transaction involving a customer trade-in includes significant boot of greater than 25% of the fair value of the exchange. As a monetary transaction, the sale is recognized following the Company’s laser system revenue recognition policy. There have been no sales transactions in which the cash consideration was less than 25% of the total transaction value.
The Company recognizes revenue for royalties under licensing agreements for our patented technology when the product using our technology is sold. The Company estimates and recognizes the amount earned based on historical performance and current knowledge about the business operations of our licensees. Historically, the Company’s estimates have generally been consistent with amounts reported by the licensees. Licensing revenue related to exclusive licensing arrangements is recognized concurrent with the related exclusivity period and totaled $0, $0, and $64,000 for the years ended December 31, 2013, 2012, and 2011, respectively.
From time to time, the Company may offer sales incentives and promotions on its products. The cost of sales incentives are recorded at the date at which the related revenue is recognized as a reduction in revenue, increase in cost of goods sold or as a selling expense, as applicable, or later, in the case of incentives offered after the initial sale has occurred.
Provision for Warranty Expense
The Company provides warranties against defects in materials and workmanship of its laser systems for specified periods of time. WaterLase systems sold domestically are covered by the Company’s warranty for a period of one year while the Company’s Diode systems warranty period is for two years from date of sale by the Company or the distributor to the end-user. WaterLase systems sold internationally are generally covered by the Company’s warranty for a period of sixteen months while its Diode systems warranty period is up to twenty eight months from date of sale to the international distributor. 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. The Company’s overall accrual is based on its historical experience and Management’s expectation of future conditions, taking into consideration the location and type of customer and the type of laser, which directly correlate to the materials and components under warranty, the duration of the warranty period, and the logistical costs to service the warranty. Additional factors that may impact the Company’s warranty accrual include changes in the quality of materials, leadership and training of the production and services departments, knowledge of the lasers and workmanship, training of customers, and adherence to the warranty policies. Additionally, an increase in warranty claims or in the costs associated with servicing those claims would likely result in an increase in the accrual and a decrease in gross profit. The Company offers extended warranties on certain imaging products; however, all imaging products are initially covered by the manufacturer’s warranties.
Changes in the initial product warranty accrual and the expenses incurred under our initial and extended warranties for the years ended December 31 were as follows (in thousands):
Shipping and Handling Costs and Revenues
Shipping and handling costs are expensed as incurred and are recorded as a component of cost of revenue. Charges to customers for shipping and handling are included as a component of revenue.
Advertising Costs
Advertising costs are expensed as incurred and totaled approximately $1.5 million, $907,000, and $444,000 for the years ended December 31, 2013, 2012, and 2011, respectively.
Engineering and Development
Engineering and development expenses are generally expensed as incurred and consist of engineering personnel salaries and benefits, prototype supplies, contract services and consulting fees related to product development.
Stock-Based Compensation
During the years ended December 31, 2013, 2012, and 2011, the Company recognized compensation cost related to stock options of $1.6 million, $1.6 million, and $1.5 million, respectively, based on the grant date fair value. The net impact to earnings for the years ended December 31, 2013, 2012, and 2011, was $(0.05), $(0.05), and $(0.05) per diluted share, respectively. The following table summarizes the income statement classification of compensation expense associated with share-based payments (in thousands):
As of December 31, 2013 and 2012, the Company had $2.7 million and $1.9 million, respectively, of total unrecognized compensation cost, net of estimated forfeitures, related to unvested share-based compensation arrangements granted under our existing plans. The cost is expected to be recognized over a weighted average period of 1.5 years.
The Black-Scholes option valuation model is used in estimating the fair value of traded options. This option pricing model requires the Company to make several assumptions regarding the key variables used to calculate the fair value of its stock options. The risk-free interest rate used is based on the U.S. Treasury yield curve in effect for the expected lives of the options at their dates of grant. Since July 1, 2005, the Company has used a dividend yield of zero as it does not intend to pay cash dividends on its common stock in the foreseeable future. The most critical assumption used in calculating the fair value of stock options is the expected volatility of the Company’s common stock. Management believes that the historic volatility of the Company’s common stock is a reliable indicator of future volatility, and accordingly, a stock volatility factor based on the historical volatility of the Company’s common stock over a period of time is used in approximating the estimated volatility of new stock options. The expected term is estimated by analyzing the Company’s historical share option exercise experience over a five year period. Compensation expense is recognized using the straight-line method for all stock-based awards. Compensation expense is recognized only for those options expected to vest, with forfeitures estimated at the date of grant based on historical experience and future expectations. Forfeitures are estimated at the time of the grant and revised as necessary in subsequent periods if actual forfeitures differ from those estimates.
The stock option fair values were estimated using the Black-Scholes option-pricing model with the following assumptions:
Excise Tax
Commencing January 1, 2013, certain of the Company’s product sales are subject to the newly enacted medical device excise tax. The Company has included such taxes separately as a component of operating expense.
Income Taxes
Differences between accounting for income taxes for financial statement purposes and accounting for tax return purposes are stated as deferred tax assets or deferred tax liabilities in the accompanying consolidated financial statements. The provision for income taxes represents the tax payable for the period and the change during the period in deferred tax assets and liabilities. The Company establishes a valuation allowance when it is more likely than not that the deferred tax assets will not be realized.
On January 1, 2007, the Company adopted the interpretations issued by the Financial Accounting Standards Board (“FASB”) which establishes a single model to address accounting for uncertain tax positions. The interpretations clarify the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements and also provides guidance on de-recognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.
The income tax provision for the year ended December 31, 2013 was calculated using the discrete year-to-date method, which management determined to be more appropriate than the annual effective rate method which was used to calculate the income tax provision for the quarter ended March 31, 2013. See Note 6 - Income Taxes for additional disclosures related to the Company’s income tax.
Net Loss Per Share - Basic and Diluted
Basic net income (loss) per share is computed by dividing income (loss) available to common stockholders by the weighted-average number of common shares outstanding for the period. In computing diluted net income (loss) per share, the weighted average number of shares outstanding is adjusted to reflect the effect of potentially dilutive securities. Common shares outstanding, as included in the calculation of basic and diluted loss per share, includes retroactive adjustments to reflect increases resulting from stock dividends that have been paid through the date that these financial statements are issued.
Outstanding stock options and warrants to purchase approximately 6,039,000, 4,713,000, and 4,626,000 shares were not included in the calculation of diluted loss per share amounts for the years ended December 31, 2013, 2012, and 2011, respectively, as their effect would have been anti-dilutive.
Recent Accounting Pronouncements
Changes to U.S. GAAP are established by the FASB in the form of accounting standards updates (“ASU’s”) to the FASB’s Accounting Standards Codification (“ASC”).
The Company considers the applicability and impact of all ASU’s. ASU’s not listed below were assessed and determined to not be applicable or are expected to have minimal impact on our consolidated financial position and results of operations.
Newly Adopted Accounting Standards
In July 2012, the FASB simplified guidance for testing for impairment of indefinite-lived intangible assets other than goodwill. The changes are intended to reduce compliance costs. The revised guidance allows a qualitative approach for testing indefinite-lived intangible assets for impairment, similar to the recently issued impairment testing guidance for goodwill and allows the option to first assess qualitative factors (events and circumstances) that could have affected the significant inputs used in determining the fair value of the indefinite-lived intangible asset to determine whether it is more likely than not (meaning a likelihood of more than 50 percent) that the indefinite-lived intangible asset is impaired. An organization may choose to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to calculating its fair value. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The adoption did not have a material impact on the Company’s consolidated financial statements.
In February 2013, the FASB issued guidance for reporting of amounts reclassified out of accumulated other comprehensive income. The revised guidance requires reporting the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required to be reclassified in its entirety to net income. For other amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures that provide additional detail about these amounts. The amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. The guidance is effective prospectively for reporting periods beginning after December 15, 2012. The adoption did not have a material impact on the Company’s consolidated financial statements.
Accounting Standards not yet Adopted
In March 2013, the FASB issued guidance on a parent’s accounting for the cumulative translation adjustment upon de-recognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity. The revised guidance requires that the parent release any related cumulative translation adjustment into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. The guidance is effective prospectively for reporting periods beginning after December 15, 2013. Early adoption is permitted. Management believes that the adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.
In July 2013, the FASB issued guidance to address the diversity in practice related to the financial statement presentation of unrecognized tax benefits as either a reduction of a deferred tax asset or liability when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. This guidance is effective prospectively for reporting periods beginning after December 15, 2013. Early adoption is permitted. Management believes that the adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.
NOTE 3 - SUPPLEMENTARY BALANCE SHEET INFORMATION
Accounts receivable is net of allowances for doubtful accounts of approximately $573,000 and $304,000 and sales returns of approximately $110,000 and $110,000 at December 31, 2013 and 2012, respectively.
Inventory is net of a provision for excess and obsolete inventory totaling approximately $2.8 million and $1.9 million at December 31, 2013 and 2012, respectively.
On August 21, 2012, pursuant to a Sale and Purchase Agreement entered on June 12, 2012, the Company sold the smaller of two buildings and a portion of the land parcel of its two-building property in Floss, Germany. The purchase price of approximately $136,000 was reduced by transaction costs, resulting in net proceeds of approximately $124,000. The Company recorded a realized gain on the sale of these assets of approximately $3,000 during the year ended December 31, 2012. The Company also undertook an appraisal of the remaining land and building at the Floss property and determined that no impairment charge was necessary.
NOTE 4 - INTANGIBLE ASSETS AND GOODWILL
The Company conducted its annual two-step impairment test of intangible assets and goodwill as of June 30, 2013 and determined that there was no impairment. The Company also tests its intangible assets and goodwill between the annual impairment test if events occur or circumstances change that would more likely than not reduce the fair value of the Company or its assets below their carrying amounts. No events have occurred that triggered further impairment testing of the Company’s intangible assets and goodwill during the years ended December 31, 2013 and 2012.
Amortization expense for the years ended December 31, 2013, 2012, and 2011, totaled $117,000, $136,000, and $130,000, respectively. Estimated intangible asset amortization expense, based on existing intangible assets, for the years ending December 31, 2014, 2015, and 2016, is $69,000, $62,000, and $52,000, respectively.
The following table presents the details of the Company’s intangible assets, related accumulated amortization and goodwill (in thousands):
In December 2012, the Company capitalized approximately $224,000 related to intangible assets acquired from its former distributor in India. These assets primarily include a non-compete agreement and customer and luminary lists. Of the total capitalized balance, $200,000 was a noncash investment whereby the Company reduced the accounts receivable from its former distributor in exchange for these assets. The Company is amortizing these assets on a straight-line basis over the expected useful life of four years and has recognized amortization expense of approximately $55,000 and $5,000 related to these intangible assets during the years ended December 31, 2013 and 2012, respectively.
NOTE 5 - LINES OF CREDIT AND OTHER BORROWINGS
Lines of Credit
On May 24, 2012, the Company entered into two revolving credit facility agreements with Comerica Bank (the “Credit Agreements”), as amended. As of December 31, 2013, the Credit Agreements provided for borrowings against certain domestic accounts receivable and inventory, as set forth in the $4.0 million revolving credit facility agreement (the “Domestic Revolver”), and borrowings against certain export related accounts receivable and inventory, as set forth in the $4.0 million revolving credit facility agreement (the “Ex-Im Revolver”), for a combined aggregate commitment of borrowings up to $8.0 million. The lines of credit mature on May 1, 2014, at which date any remaining borrowings and accrued interest under the lines of credit become due and payable. As of December 31, 2013, the Company had outstanding borrowings totaling approximately $4.6 million, which included $1.8 million under the Domestic Revolver and $2.8 million under the Ex-Im Revolver.
As of December 31, 2013, the outstanding principal balances of the Credit Agreements bear interest at annual percentage rates equal to the daily prime rate, plus 2.00% for the Domestic Revolver and 1.50% for the Ex-Im Revolver. The daily prime rate is subject to a floor of the daily adjusting LIBOR rate plus 2.50% per annum, or if LIBOR is undeterminable, 2.50% per annum. The Company is also required to pay an unused commitment fee of 0.25% based on a portion of the undrawn lines of credit, payable quarterly in arrears. During the years ended December 31, 2013 and 2012, the Company incurred $599,000 and $232,000, respectively, of interest expense associated with the credit facilities, including $197,000 and $91,000, respectively, of amortization of deferred debt issuance costs and $179,000 and $43,000, respectively, of amortization of the discount on lines of credit. Interest expense payable was approximately $20,000 and $19,000 at December 31, 2013 and 2012, respectively, and was included in accrued liabilities in the accompanying consolidated financial statements.
Lockbox arrangements under the revolving bank facilities provide that substantially all of the income generated is deposited directly into lockbox accounts and then swept into cash management accounts for the benefit of Comerica Bank. Cash is disbursed from Comerica Bank to the Company only after payment of the applicable debt service and principal. At December 31, 2013 and 2012, there were no restricted cash amounts. The Company’s obligations are generally secured by substantially all of the Company’s assets now owned or hereinafter acquired.
The Credit Agreements require the Company to maintain compliance with certain monthly financial and non-financial covenants, as defined therein. Any noncompliance with these covenants may result in default interest rates and penalties, and Comerica Bank could declare the amounts outstanding immediately due and payable. The Company was either in compliance with these covenants at December 31, 2013, or had received a waiver in the event of non-compliance. On March 4, 2014, the Company received a waiver from Comerica Bank to waive noncompliance with certain financial and nonfinancial covenants as of January 31, 2014 and December 31, 2013. In connection with the waiver, the Company incurred a fee of $10,000 and Comerica Bank reduced the total aggregate available borrowings on the lines of credit to $5.0 million.
Pursuant to the Credit Agreements, the Company paid both the first and second annual $120,000 commitment fees, each being one and one-half percent of the aggregate $8.0 million commitment, totaling $240,000 during the year ended December 31, 2012. During the year ended December 31, 2013, the Company incurred an additional $67,000 of commitment fees and legal costs associated with the various waivers and amendments. Commitment fees and legal costs associated with acquiring and maintaining the credit facilities are capitalized and are being amortized on a straight-line basis as interest expense over the term of the Credit Agreements.
On November 8, 2013, the Company issued a warrant to Comerica Bank (the “November 2013 Comerica Warrant”) in connection with Amendment No. 4 to the Credit Agreements to purchase up to 100,000 shares of the Company’s common stock at an exercise price per share of $2.00. The November 2013 Comerica Warrant includes an accelerated vesting clause that may be triggered by certain events described therein, but otherwise vests in four equal quarterly tranches commencing on December 31, 2013, and shares are exercisable once vested. The November 2013 Comerica Warrant may be exercised with a cash payment from Comerica Bank, or, in lieu of a cash payment, Comerica Bank may convert the warrant shares into a number of shares, in whole or in part. These warrant shares will expire if unexercised on November 8, 2018. The fair value of the November 2013 Comerica Warrant was estimated using the Black-Scholes option-pricing model with the following assumptions: expected term of 5.00 years; volatility of 102.65%; annual dividend per share of $0.00; and risk-free interest rate of 1.42%; and resulted in an estimated fair value of $137,000 which was recorded as equity and resulted in a discount to the Credit Agreements that is being amortized on a straight-line basis to interest expense over the remaining term.
On September 6, 2013, the Company issued an additional warrant to Comerica Bank (the “September 2013 Comerica Warrant”) in connection with Amendment No. 3 to the Credit Agreements to purchase up to 100,000 shares of the Company’s common stock at an exercise price per share of $2.00. The September 2013 Comerica Warrant vests in four equal quarterly tranches commencing on December 31, 2013 and shares are exercisable once vested. The 2013 Comerica Warrant may be exercised with a cash payment from Comerica Bank, or, in lieu of a cash payment, Comerica Bank may convert the warrant shares into a number of shares, in whole or in part. These warrant shares will expire if unexercised on September 6, 2018. The fair value of the September 2013 Comerica Warrant was estimated using the Black-Scholes option-pricing model with the following assumptions: expected term of 5.00 years; volatility of 105.32%; annual dividend per share of $0.00; and risk-free interest rate of 1.77%; and resulted in an estimated fair value of $143,000 which was recorded as equity and resulted in a discount to the Credit Agreements that is being amortized on a straight-line basis to interest expense over the remaining term.
During the year ended December 31, 2012, the Company issued a warrant to Comerica Bank (the “2012 Comerica Warrant”) to purchase up to 80,000 shares of the Company’s common stock at an exercise price of $2.83 per share, which was reduced to $2.00 per share in connection with Amendment No. 1 to the Credit Agreements, with an expiration date of May 24, 2017. During the three months ended March 31, 2013, Comerica Bank exercised all 80,000 of the 2012 Comerica Warrant shares on a cashless basis pursuant to the Notice of Exercise resulting in a net issuance of 40,465 shares of common stock. The amended warrant issuance has an estimated fair value of $142,000 which was recorded as equity and resulted in a discount to the Credit Agreements that is being amortized on a straight-line basis to interest expense over the remaining term.
Loan and Security Agreement
In May 2010, the Company entered into the Loan and Security Agreement with MidCap Financial, LLC (subsequently assigned to MidCap Funding III, LLC) and Silicon Valley Bank. In connection with the Loan and Security Agreement, the Company issued two secured promissory notes in an aggregate principal amount of $3 million, at 14.25%, secured by the Company’s assets, and warrants to purchase up to an aggregate of 101,694 shares of Common Stock at an exercise price of $1.77 per share, which was subsequently reduced to $0.84 per share, with an expiration date of May 26, 2015.
During February 2011, the Company repaid approximately $2.6 million in principal and MidCap Funding III, LLC and Silicon Valley Bank performed a cashless exercise of all of their warrants, which resulted in the combined issuance of 78,172 shares of unregistered stock.
During the year ended December 31, 2011, the Company incurred $293,000 of interest expense, including amortization of debt issuance costs and discounts, associated with the Loan and Security Agreement.
Other Borrowings
The Company finances a portion of its annual insurance premiums which it pays in installments over nine months. As of December 31, 2013 and 2012, $197,000 at an annual interest rate of 2.9% and $379,000 at an annual interest rate of 3.0%, respectively, were outstanding under this arrangement. The Company incurred interest expense associated with the financed insurance premiums of approximately $5,000 during each of the years ended December 31, 2013, 2012, and 2011.
NOTE 6 - INCOME TAXES
The Company accounts for income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Management evaluates the need to establish a valuation allowance for deferred tax assets based upon the amount of existing temporary differences, the period in which they are expected to be recovered, and expected levels of taxable income. A valuation allowance to reduce deferred tax assets is established when it is “more likely than not” that some or all of the deferred tax assets will not be realized. Management has determined that a full valuation allowance against the Company’s net deferred tax assets is appropriate.
The following table presents the current and deferred provision (benefit) for income taxes for the years ended December 31 (in thousands):
During the year ended December 31, 2013, the Company reversed certain tax liabilities associated with unrecognized tax benefits related to international operations due to expiring statutes and recognized tax benefits of $138,000 and recognized deferred tax assets related to certain indefinite lived assets (federal alternative minimum tax credits and California R&D credits) that were used to offset deferred tax liabilities related to indefinite-lived intangible assets of $107,000 resulting in an overall tax benefit of $245,000. Management does not expect to record additional significant tax benefits in the foreseeable future.
The provision for income taxes differs from the amount that would result from applying the federal statutory rate as follows for the years ended December 31:
The components of the deferred income tax assets and liabilities as of December 31 (in thousands):
Based upon the Company’s operating losses incurred for the three years ended December 31, 2013, and the available evidence, the Company has established a valuation allowance against its net deferred tax assets in the amount of $35.6 million as of December 31, 2013. Management considered factors such as the Company’s earnings history, future projected earnings and tax planning strategies. If sufficient evidence of the Company’s ability to generate sufficient future taxable income tax benefits becomes apparent, the valuation allowance may be reduced, thereby resulting in tax benefits in the statement of operations and additional paid-in-capital. Management evaluates the potential realization of the Company’s deferred tax assets and assesses the need for reducing the valuation allowance periodically.
As of December 31, 2013, the Company had net operating loss (“NOL”) carryforwards for federal and state purposes of approximately $77.9 million and $55.2 million, respectively, which will begin to expire in 2014 through 2033. The utilization of NOL and credit carryforwards may be limited under the provisions of the Internal Revenue Code (“IRC”) Section 382 and similar state provisions. IRC Section 382 generally imposes an annual limitation on the amount of NOL carryforwards that may be used to offset taxable income where a corporation has undergone significant changes in stock ownership. During the year ended December 31, 2006, the Company completed an analysis to determine the potential applicability of any annual limitations imposed by IRC Section 382. Based on the analysis, management determined that there was no significant IRC Section 382 limitation. As of December 31, 2013, the Company had research and development tax credit carryforwards for federal and state purposes of approximately $1.1 million and $689,000, respectively, which will begin to expire in 2018 through 2033 for federal purposes and will carryforward indefinitely for state purposes. An updated analysis may be required at the time the Company begins utilizing any of its net operating losses to determine if there is an IRC Section 382 limitation.
In addition to the NOL carryforwards included in the deferred tax asset and liability schedule are excess tax deductions relating to stock options that have not been realized. When the benefit of the NOLs containing these excess tax deductions are realized, the benefit will not affect earnings, but rather additional paid-in-capital. As of December 31, 2013, the cumulative unrealized excess tax deductions amounted to approximately $7.0 million. These amounts have been excluded from the Company’s NOL carryforwards. To the extent that such excess tax deductions are realized in the future by virtue of reducing income taxes payable, the Company would expect additional paid-in-capital to increase by approximately $2.7 million. The Company follows the appropriate ordering rules to determine when such NOLs have been realized.
Recently enacted tax laws may also affect the tax provision on the Company’s financial statements. The state of California requires the use of a single sales factor apportionment formula for tax years beginning on or after January 1, 2013. During the year ended December 31, 2013, the Company’s state deferred tax assets were revalued to account for the change in the tax law; however, the Company records a full valuation allowance against the state deferred tax assets therefore the California apportionment mandate did not have a material impact on the Company’s consolidated financial statements.
The following table summarizes the activity related to the Company’s unrecognized tax benefits during the year ended December 31, 2013 (in thousands):
The Company expects resolution of unrecognized tax benefits, if created, would occur while the full valuation allowance of deferred tax assets is maintained; therefore, the Company does not expect to have any unrecognized tax benefits that, if recognized, would affect the effective tax rate. As of December 31, 2013, the Company does not have liability for potential penalties or interest. The Company does not expect its unrecognized tax benefits to change significantly over the next 12 months.
The Company files U.S., state and foreign income tax returns in jurisdictions with varying statutes of limitations. The 2009 through 2013 tax years generally remain subject to examination by federal and most state tax authorities. In foreign jurisdictions, the 2007 through 2013 tax years remain subject to examination by their respective tax authorities.
U.S. income taxes or withholding taxes were provided for all the distributed earnings for the Company’s foreign subsidiaries as of December 31, 2013. There were no undistributed earnings from foreign subsidiaries as of December 31, 2013. The Company intends to reinvest any earnings until such time a decision is made to liquidate the foreign operations.
NOTE 7 - COMMITMENTS AND CONTINGENCIES
Leases
In January 2006, the Company entered into a five-year lease for its 57,000 square foot corporate headquarters and manufacturing facility located at 4 Cromwell, Irvine, California, with initial monthly installments of $38,692 and annual adjustments over the lease term. On September 24, 2009, the lease was amended to extend the term through April 20, 2015, adjust the basic rent, and modify provisions to the security deposit. On January 4, 2011, the lease was further amended to defer a portion of the basic rent to future periods. The Company is recognizing rent expense on a straight line basis with the difference between rent expense and the cash paid recorded to deferred rent. These amounts are reflected in the commitments as of December 31, 2013, listed below. The Company also leases certain office equipment and automobiles under various operating lease arrangements.
Future minimum rental commitments under operating lease agreements with non-cancelable terms greater than one year for each of the years ending December 31 are as follows (in thousands):
Rent expense totaled approximately $1.1 million, $789,000, and $1.0 million for the years ended December 31, 2013, 2012, and 2011, respectively.
Employee arrangements and other compensation
Certain members of management are entitled to severance benefits payable upon termination following a change in control, which would approximate $717,000 at December 31, 2013. The Company also has agreements with certain employees to pay bonuses based on targeted performance criteria. No amount was required to be accrued at December 31, 2013 and 2012.
Purchase Commitments
The Company generally purchases components and subassemblies for its products from a limited group of third party suppliers through purchase orders. The Company had $11.4 million of purchase commitments as of December 31, 2013, for which the Company has not received the goods or services and which is expected to be purchased primarily within one year. These purchase commitments were made to secure better pricing and to ensure the Company will have the necessary parts to meet anticipated near term demand. Although open purchase orders are considered enforceable and legally binding, the Company may be able to cancel, reschedule, or adjust requirements prior to supplier fulfillment.
Litigation
The Company discloses material loss contingencies deemed to be reasonably possible and accrues for loss contingencies when, in consultation with its legal advisors, management concludes that a loss is probable and reasonably estimable. The ability to predict the ultimate outcome of such matters involves judgments, estimates, and inherent uncertainties. The actual outcome of such matters could differ materially from management’s estimates.
Class Action Lawsuits
On August 23, 2013, a purported class action lawsuit entitled Brady Adams v. Biolase, Inc., et al., Case No. 13-CV-1300 JST (FFMx) was filed in the United States District Court for the Central District of California against BIOLASE and its current executive officers Federico Pignatelli and Frederick D. Furry. On August 26, 2013, a purported class action lawsuit entitled Ralph Divizio v. Biolase, Inc., et al., Case No. 13-CV-1317 DMG (MRWx) was filed in the same court against BIOLASE, Messrs. Pignatelli and Furry, and current executive officer Alexander K. Arrow. Each of the lawsuits alleges violations of the federal securities laws and asserts causes of action against the defendants under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. In accordance with the Private Securities Litigation Reform Act of 1995, on December 10, 2013, the court entered an order consolidating the lawsuits, appointing a lead plaintiff and approving lead plaintiff's selection of lead counsel. On February 24, 2014, lead plaintiff filed a consolidated complaint against BIOLASE and Messrs. Pignatelli, Furry, and Arrow, alleging violations of the federal securities laws and asserting causes of action against the defendants under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934.
On November 19, 2013, BIOLASE’s Board received a letter from attorneys for purported shareholder David T. Long, demanding that the Board investigate, institute litigation, and take measures to redress and prevent alleged wrongdoing concerning the dissemination of certain allegedly false and misleading public disclosures made by the Company between January 2013 and August 2013.
As of December 31, 2013, the Company paid $250,000 for legal costs expected to be incurred in connection with these matters. The Company believes that the claims contained in the lawsuits are without merit and intends to vigorously defend against the claims.
Intellectual Property Litigation
On April 24, 2012, CAO Group, Inc. (“CAO”) filed a lawsuit against the Company in the District of Utah for patent infringement of U.S. Patent No. 7,485,116 regarding the Company’s EZlase dental laser. On September 9, 2012, CAO filed its First Amended Complaint, which added claims for (1) business disparagement/injurious falsehood under common law and (2) unfair competition under 15 U.S.C. Section 1125(a). The additional claims stem from a press release that the Company issued on April 30, 2012, which CAO claims contained false statements that are disparaging to CAO and its diode product. The First Amended Complaint seeks injunctive relief, treble damages, attorneys’ fees, punitive damages, and interest. On November 13, 2012, the Court stayed the lawsuit for 120 days to allow the United States Patent and Trademark Office (“USPTO”) to consider the Company’s request for reexamination of the patent-in-suit. The USPTO granted the request to reexamine the asserted claims of the patent-in-suit and, on February 28, 2013, the Court stayed the lawsuit until the termination of the reexamination proceedings. On April 23, 2013, the USPTO issued an office action rejecting all of the asserted claims over the prior art, and CAO responded to the office action. On August 28, 2013, the USPTO issued an Action Closing Procedure, rejecting all of CAO’s patent claims. CAO responded to the USPTO’s ruling and on December 10, 2013, the USPTO issued a Right of Appeal Notice, finally rejecting some claims of the patent while finding that other claims appeared to be patentable. Both parties are permitted to appeal the USPTO’s findings to the Patent Trial and Appeal Board. The Company appealed the USPTO’s findings on January 9, 2014. On January 27, 2014, the USPTO declined to reconsider the finding of certain claims as patentable and instructed the parties to proceed to appeal to the Patent Trial and Appeal Board.
The Company filed a patent infringement lawsuit against Fotona dd. (“Fotona”) in Düsseldorf District Court alleging infringement with respect to the Fotona Fidelis dental laser system. Oral proceedings are currently scheduled for March 2014. Fotona denies liability and seeks the reimbursement of statutory fees from the Company. Together with its response brief, Fotona also filed a nullity action against the patent in dispute, patent number EP 1 560 470. The nullity action is pending at the German Federal Patent Court (the “Patent Court”), Docket No. 1 Ni 58/13 (EP). On September 2, 2013, the Company filed its counterplea in the infringement proceedings and phrased its arguments defending the validity of the patent. These arguments were also the subject of the defense brief to the Patent Court in the parallel nullity action proceedings. On September 9, 2013, the Company filed its response to the Patent Court. Fotona filed a rejoinder on February 3, 2014, including its counterplea on nullity.
False Advertising Lawsuit
The Company filed a false advertising lawsuit against Fotona and Technology4Medicine L.L.C., two of its competitors (together "the Defendants") in United States District Court for the Central District of California. The lawsuit alleges six causes of action, and claims that the Defendants have made false and misleading statements regarding the Company's products, technology, and management. The lawsuit, filed on February 20, 2014, seeks both cash damages and injunctive relief.
Other Matters
In the normal course of business, the Company may be subject to other legal proceedings, lawsuits and other claims. Although the ultimate aggregate amount of probable monetary liability or financial impact with respect to these matters is subject to many uncertainties and is therefore not predictable with assurance, the Company’s management believes that any monetary liability or financial impact to the Company from these other matters, individually and in the aggregate, would not be material to the Company’s financial condition, results of operations or cash flows. However, there can be no assurance with respect to such result, and monetary liability or financial impact to the Company from these other matters could differ materially from those projected.
NOTE 8 - STOCKHOLDERS’ EQUITY
Preferred Stock
The Board, without further stockholder authorization, may issue from time to time up to 1,000,000 shares of the Company’s preferred stock. Of the 1,000,000 shares of preferred stock, 500,000 shares are designated as Series B Junior Participating Cumulative Preferred Stock. As of December 31, 2013 and 2012, none of the preferred stock was outstanding.
The Company has a stockholder rights plan under which one preferred stock purchase right was distributed on January 11, 1999 with respect to each share of common stock outstanding at the close of business on December 31, 1998. The rights have an amended expiration of December 31, 2018. While the rights are outstanding, they provide, among other things, that in the event any person becomes the beneficial owner of at least 20% of common stock outstanding, an increase from 15% pursuant to the second amendment effective February 4, 2014, each right will be exercisable to purchase shares of common stock having a market value equal to two times the then current exercise price of a right (initially $30.00). The rights also provide that, if on or after the occurrence of such event, the Company merges with any other corporation or 50% or more of its assets or earning power are sold, each right will be exercisable to purchase common stock of the acquiring corporation having a market value equal to two times the then current exercise price of such stock. The rights are subject to redemption at $0.001 per right at any time prior to the first date upon which they become exercisable to purchase common shares.
Common Stock
At December 31, 2013, the Company had 37,336,000 shares of common stock issued with 35,372,000 shares outstanding. The Company currently has 50,000,000 shares of common stock authorized for issuance and 1,964,000 shares of common stock in its treasury.
2014 common stock issuances
On February 10, 2014, the Company entered into a subscription agreement (“February 2014 Subscription Agreement”) with Oracle Partners L.P., Oracle Institutional Partners, L.P., and Oracle Ten Fund Master L.P., under which the Company offered an aggregate of 1,945,525 unregistered shares of common stock in a private placement at a price of $2.57 per share. Gross proceeds from the sale totaled $5 million and net proceeds, after offering expenses of approximately $208,000, totaled approximately $4.8 million. The Company used the proceeds for working capital and general corporate purposes.
On January 17, 2014, the Company filed a registration statement on Form S-3, File No. 333-193426 (“January 2014 Registration Statement”) with the Securities and Exchange Commission (“SEC”) to register an indeterminate number of shares of common stock, preferred stock, and warrants with a total offering price not to exceed $12.5 million. The January 2014 Registration Statement was declared effective by the SEC on January 29, 2014.
2013 common stock issuances
On December 19, 2013, the Company entered into a subscription agreement (the “December 2013 Subscription Agreement”) with Oracle Ten Fund Master, LP under which the Company offered an aggregate of 340,000 unregistered shares of common stock in a private placement at a price of $1.80 per share. Gross proceeds from the sale totaled $612,000, and net proceeds, after offering expenses of approximately $34,000, totaled approximately $578,000. The Company used the proceeds for working capital and general corporate purposes.
On July 26, 2013, the Company filed a registration statement on Form S-3, File No. 333-190158 (“2013 Registration Statement”) with the SEC to register an indeterminate number of shares of common stock, preferred stock, and warrants with a total offering price not to exceed $5 million. The 2013 Registration Statement was declared effective by the SEC on September 19, 2013. On September 23, 2013, the Company entered into an agreement with Northland Securities, Inc. (“Northland”), pursuant to which Northland acted as placement agent in connection with the sale of 2,688,172 shares of its common stock at a price of $1.86 per share. Gross proceeds from the sale totaled $5 million, and net proceeds after offering expenses of $408,000, which included Northland’s fee, totaled approximately $4.6 million.
2011 securities purchase agreement
In June 2011, the Company entered into a securities purchase agreement (the “June 2011 Securities Purchase Agreement”) with certain institutional investors (the “June 2011 Purchasers”) under which the Company sold an aggregate of 1,625,947 unregistered shares of the Company’s common stock at a price of $5.55 per share, together with five-year warrants to purchase 812,974 shares of its common stock having an exercise price of $6.50 per share (the “June 2011 Warrants”). Gross proceeds from the offering totaled approximately $9 million, and net proceeds to the Company, after commissions and other offering expenses of approximately $622,000, totaled approximately $8.4 million. Rodman & Renshaw, LLC (“Rodman & Renshaw”) served as the Company’s exclusive placement agent for the offering. The Company used the proceeds for working capital and general corporate purposes. The Company filed a registration statement on Form S-3 with the SEC to register the Registerable Securities (File No. 333-175664) on July 19, 2011 which was declared effective by the SEC on August 25, 2011, thereby satisfying the registration rights agreement. On August 2, 2011, the Company repurchased 90,000 of the June 2011 Warrants for $99,900, or $1.11 per underlying share, plus expenses of $30,000. The remaining June 2011 Warrants expire on June 29, 2016.
Stock dividends
The Board declared one-half percent stock dividends during each of the four quarters of 2013. The stock dividend declared during the quarter ended December 31, 2013 was payable December 30, 2013 to shareholders of record on December 16, 2013, the stock dividend declared during the quarter ended September 30, 2013 was payable September 13, 2013 to shareholders of record on August 30, 2013, the stock dividend declared during the quarter ended June 30, 2013 was payable June 28, 2013 to shareholders of record on June 14, 2013, and the stock dividend declared during the quarter ended March 31, 2013 was payable March 29, 2013 to shareholders of record on March 15, 2013. All stock information presented, other than that related to stock options and warrants, has been adjusted to reflect the effects of stock dividends.
In February 2014, the Board announced a 2% annual stock dividend policy for 2014, payable in quarterly installments, and declared a one-half percent stock dividend payable March 28, 2014, to stockholders of record on March 14, 2014. The Company expects to record the effects of the March Stock Dividend in the first quarter ending March 31, 2014. Stock dividends are discussed quarterly by the Board and management. The actual declaration of future stock dividends and the establishment of the record and payment dates are subject to final determination by the Board after its review of the Company’s financial performance, the expected results of future operations, availability of shares, and other factors that the Board may deem relevant. The Company’s dividend policy may be changed at any time by the Board, and there is no assurance, with respect to the amount or frequency, that any stock dividend will be declared in the future.
Stock repurchase program
On August 10, 2011, the Company announced that its Board authorized a stock repurchase program, pursuant to which the Company was authorized to repurchase up to an aggregate of 2,000,000 shares of the Company’s outstanding common stock. The stock repurchase program became effective on August 12, 2011 and expired on August 12, 2013. Pursuant to the stock repurchase program, the Company repurchased 133,365 shares and 100,500 shares of the Company’s common stock at a weighted average price of $1.73 and $2.68 during the years ended December 31, 2012 and 2011, respectively.
Warrants
The Company issues warrants for the sale of its common stock as approved by its Board. In addition to the aforementioned warrants issued in connection with common stock transactions, the Company has issued warrants in connection with strategic initiatives as follows:
On July 12, 2013, the Company entered into a strategic agreement with Valam, Inc. (“Valam”) to develop, market, and sell office-based laser systems to otolaryngologists (also known as “Ear, Nose, and Throat” or “ENT” doctors) (the “Valam Agreement”). The Valam Agreement provides the Company with an exclusive worldwide license to Valam’s ENT related patents and pending patents which complements the Company’s patent portfolio and supports the Company’s launch into the ENT laser market in late 2013. In connection with the Valam Agreement, the Company issued a warrant to Valam to purchase up to 165,000 shares of the Company’s common stock, at a modified price per share of $4.00 (the “Valam Warrant”), which is a decrease from the original agreed upon price per share of $6.00. The Valam Warrant is performance-based and will vest as follows: 30,000 warrant shares upon the launch of the Company’s first ENT laser; 55,000 warrant shares upon the receipt of certain specified clearances required from the U.S. Food and Drug Administration (the “FDA”); 40,000 warrant shares upon achieving $5 million in ENT laser revenues for a 12-month period; and 40,000 warrant shares upon achieving $10 million in ENT laser revenues for a 12-month period. Vested warrant shares may be exercised with a cash payment, or, in lieu of a cash payment, Valam may convert the vested warrant shares into a net number of whole common shares. The Valam Warrant expires on July 14, 2020. As of December 31, 2013, 30,000 warrant shares have been earned and stock-based compensation costs of approximately $41,000 have been recognized.
On April 26, 2013, the Company issued a warrant to Sun Dental Laboratories, LLC (“Sun Dental Labs”) to purchase up to 500,000 shares of the Company’s common stock, at a price per share of $5.90 (the “Sun Dental Warrant”). The Sun Dental Warrant is performance-based and will vest at a rate of 1,000 shares per each 3Shape A/S (“3Shape”) Trios intraoral scanner (“Trios IOS”) that Sun Dental Labs assists in selling in conjunction with the agreement. For the purposes of the Sun Dental Warrant, a sale is defined as a Trios IOS that has been installed at the customer's place of business and is fully operational, where the customer has been trained, and the Trios IOS has been paid for in full by the customer. Any unvested warrant shares will expire on April 24, 2014. Vested warrant shares may be exercised with a cash payment, or, in lieu of a cash payment, Sun Dental Labs may convert the vested warrant shares into a net number of whole common shares. The Company recorded stock-based compensation expense of less than $1,000 related to the Sun Dental Warrant during the year ended December 31, 2013.
On April 18, 2013, the Company issued a warrant (the “2013 IR Warrant”) to purchase up to 60,000 shares of the Company’s common stock to an investor relations firm, at a price per share of $5.10. The 2013 IR Warrant vests and becomes exercisable only if the Company’s common stock closing price on NASDAQ reaches or exceeds $7.50. The 2013 IR Warrant expires April 17, 2018. As of December 31, 2013, no stock-based compensation has been recognized for the 2013 IR Warrant. The Company will reassess whether achievement of the contingent exercise provisions are probable on a quarterly basis and recognize stock-based compensation when it is probable that the market performance requirements will be achieved.
On March 23, 2013, the Company issued two tranches of warrants to purchase up to 100,000 shares of the Company’s common stock to a consultant, at a price per share of $4.50 (the “CMR Warrant”). The first tranche of 50,000 warrant shares vests and becomes exercisable only if the Company’s common stock closing price on NASDAQ reaches or exceeds $6.00, as amended. The second tranche of 50,000 warrant shares was cancelled during the year ended December 31, 2013. The CMR Warrant expires March 22, 2018. As of December 31, 2013, no stock-based compensation has been recognized for the CMR Warrant. The Company will reassess whether achievement of the contingent exercise provision is probable on a quarterly basis and recognize stock-based compensation when it is probable that the market performance requirements will be achieved.
On November 8, 2012, the Company issued a warrant (the “2012 IR Warrant”) to purchase up to 50,000 shares of the Company’s common stock to an investor relations consultant, at a price per share of $2.50. The 2012 IR Warrant was subject to a vesting and exercisability condition which would have been met upon the Company’s common stock closing price on NASDAQ reaching or exceeding $7.00 by November 7, 2013. Furthermore, the 2012 IR Warrant called for immediate vesting of 25,000 shares upon early termination of the arrangement. The Company terminated the arrangement during the year ended December 31, 2013 and therefore recognized stock-based compensation of approximately $64,000 and issued 9,296 net shares of common stock during the same period.
During September 2010, the Company issued a warrant (the “2010 IR Warrant”) to purchase an aggregate of 50,000 shares of common stock at a price per share of $0.74 to three service providers who provide investor relations services. Pursuant to the agreement, the service providers were also entitled to a second tranche of 2010 IR Warrant to purchase an aggregate of 50,000 shares of common stock at a price per share of $0.74. The 2010 IR Warrant was fully exercised during the year ended December 31, 2012. In connection with the issuance of the 2010 IR Warrant, the Company recognized expenses of approximately $23,000 and $273,000 for the years ended December 31, 2012 and 2011, respectively.
The Company also issues warrants to its lenders. See Note 5 - Lines of Credit and Other Borrowings for further discussion.
Stock Options
As of December 31, 2013, a total of 7,750,000 shares have been authorized for issuance under the Company’s 2002 Stock Incentive Plan, of which 2,841,000 shares have been issued for options which have been exercised, 4,441,000 shares have been reserved for options that are outstanding, and 468,000 shares are available for the granting of additional options.
Stock options may be granted as incentive or nonqualified options; however, no incentive stock options have been granted to date. The exercise price of options is at least equal to the market price of the stock as of the date of grant. Options may vest over various periods but typically vest on a quarterly basis over three years. Options expire after five years, ten years or within a specified time from termination of employment, if earlier. The Company issues new shares of common stock upon the exercise of stock options. The following table summarizes option activity:
(1)
The intrinsic value calculation does not include negative values. This can occur when the fair market value on the reporting date is less than the exercise price of a grant.
The following table summarizes additional information for those options that are outstanding and exercisable as of December 31, 2013:
Cash proceeds, along with fair value disclosures related to grants, exercises, and vesting options, are as follows for the years ended December 31 (in thousands, except per share amounts):
(1)
Excess tax benefits received related to stock option exercises are presented as financing cash inflows. Currently the Company does not receive a tax benefit related to the exercise of stock options due to its net operating losses.
(2)
The intrinsic value of stock options exercised is the amount by which the market price of the stock on the date of exercise exceeded the market price of the stock on the date of grant.
On June 6, 2013, the Board granted stock options to purchase 350,000 shares of common stock to Alexander K. Arrow in connection with his appointment to President and Chief Operating Officer. These stock options were granted at an exercise price of $4.00 per share, vest and become exercisable in equal quarterly amounts over a four-year period beginning on June 6, 2014, and expire on June 6, 2020.
On May 7, 2012, the Board granted a non-qualified stock option to purchase 65,000 shares of the Company’s common stock to a consultant, at a price per share of $2.55, the closing market price of the Company’s common stock on the grant date. The option fully vests and becomes exercisable upon the achievement of certain specified performance conditions, as defined in the consulting agreement with this consultant, and the option expires five years from the grant date. As of December 31, 2013, no stock-based compensation has been recognized. The Company will reassess whether achievement of the performance conditions is probable on a quarterly basis and recognize stock-based compensation when it is probable that the performance conditions will be achieved.
NOTE 9 - SEGMENT INFORMATION
The Company currently operates in a single business segment. Management uses one measurement of profitability and does not segregate its business for internal reporting. Sales to customers located in the United States accounted for approximately 63%, 71%, and 67% of net revenue and international sales accounted for approximately 37%, 29%, and 33% of net revenue for the years ended December 31, 2013, 2012, and 2011, respectively.
Net revenue by geographic location based on the location of customers was as follows (in thousands):
No individual international country represented more than 10% of net revenue during the years ended December 31, 2013, 2012, and 2011.
Long-lived assets located outside of the United States at our foreign subsidiaries, totaled approximately $430,000 and $412,000 as of December 31, 2013 and 2012, respectively.
NOTE 10 - CONCENTRATIONS
Revenue from laser systems, the Company’s core product, which includes the iPlus, MDX, MD Turbo, and Epic, comprised 69%, 74%, and 79% of total net revenues for the years ended December 31, 2013, 2012, and 2011, respectively. Revenue from consumables and other, which are primarily related to laser systems, comprised 12%, 10%, and 11% of total revenue for the same periods. Revenue from imaging systems comprised 8%, 6%, and 0% of total net revenue for the same periods. Revenue from services, which are primarily related to laser systems, comprised 11%, 10%, and 9% of total net revenue for the same periods. Revenue from license fees and royalties comprised 0%, 0%, and 1% of total net revenue for the same periods.
Approximately 5%, 3%, and 19% of the Company’s revenue in 2013, 2012, and 2011, respectively, was generated through sales to HSIC worldwide.
The Company maintains its cash and cash equivalent accounts with established commercial banks. Such cash deposits periodically exceed the Federal Deposit Insurance Corporation insured limit.
No individual customer represented more than 10% of the Company’s accounts receivable at December 31, 2013 and 2012.
The Company currently purchases certain key components of its products from single suppliers. Although there are a limited number of manufacturers of these key components, management believes that other suppliers could provide similar key components on comparable terms. A change in suppliers, however, could cause delays in manufacturing and a possible loss of sales, which could adversely affect the Company’s results of operations.
NOTE 11 - SUBSEQUENT EVENTS
Stockholder Rights Plan
The Company entered into a Second Amendment to Rights Agreement on February 4, 2014, and a Restated Second Amendment to Rights Agreement on March 17, 2014, (together the “Amendment”), which amends the terms of the Rights Agreement, dated as of December 31, 1998 between the Company and Computershare Trust Company, N.A. (as successor right agent to U.S. Stock Transfer Company), as amended by that certain Amendment to Rights Agreement, dated as of December 19, 2008 (the "Rights Agreement"). The Amendment increases the threshold percentage of shares of the Company's common stock that must be acquired or proposed to be acquired to cause the distribution of rights certificates in accordance with the Rights Agreement, from 15% to 20%. Further discussion of the stockholder rights plan is disclosed in Note 8 - Stockholders’ Equity.
February 2014 Subscription Agreement
On February 10, 2014, the Company entered into the February 2014 Subscription Agreement with Oracle Partners L.P., Oracle Institutional Partners, L.P., and Oracle Ten Fund Master L.P. under which the Company offered an aggregate of 1,945,525 unregistered shares of common stock in a private placement at a price of $2.57 per share. Gross proceeds from the sale totaled $5 million, and net proceeds, after offering expenses of approximately $208,000, totaled approximately $4.8 million. Further discussion of the offering is disclosed in Note 8 - Stockholders’ Equity.
January 2014 Shelf Registration
On January 17, 2014, the Company filed a registration statement to register an indeterminate number of shares of common stock, preferred stock, and warrants with a total offering price not to exceed $12.5 million. Further discussion of the related registration is disclosed in Note 8 - Stockholders’ Equity.
Credit Agreements
On March 4, 2014, the Company received a waiver from Comerica Bank to waive noncompliance with certain financial and nonfinancial covenants as of January 31, 2014 and December 31, 2013. In connection with the waiver, the Company incurred a fee of $10,000 and Comerica Bank reduced the total aggregate available borrowings on the lines of credit to $5 million. See further discussion in Note 5 - Lines of Credit and Other Borrowings.
Stock Dividend
In February 2014, the Board announced a 2% annual stock dividend policy for 2014 and declared a one-half percent stock dividend (the “March Stock Dividend”) payable March 28, 2014 to stockholders of record on March 14, 2014. The Company expects to record the effects of the March Stock Dividend in the first quarter ending March 31, 2014.
Director Dispute and Shareholder Litigation
On March 3 and 6, 2014, the Company disclosed that the Board had appointed Paul N. Clark and Jeffrey M. Nugent to the Board and Dr. Alexander K. Arrow and Dr. Sam Low had tendered their resignations. Subsequent to this disclosure, questions were raised as to whether these changes were effected.
On March 7, 2014, the Company received from Oracle, which reports that it is a 16 % shareholder, a notice pursuant to the Company’s Bylaws, stating that Oracle intended to nominate four independent directors for election to the Board at the Company’s 2014 Annual Meeting of Stockholders. Oracle’s nominees are Messrs. Clark and Nugent, Frederic H. Moll, and Eric Varma, M.D.
On March 11, 2014, Oracle filed a lawsuit in the Delaware Court of Chancery seeking a determination of the composition of the Board and a temporary restraining order that would preclude the Board from taking any action without the approval of four purported directors whose directorships Oracle claims to be undisputed.
The Company has reason to believe that Oracle and individuals who may be, depending on the outcome of the foregoing dispute, members of the Company’s Board will seek to make changes in the Company’s senior management and the composition of the Company’s Board and its committees.
BIOLASE, INC.
Schedule II - Consolidated Valuation and Qualifying Accounts and Reserves
For the Years Ended December 31, 2013, 2012, and 2011
(in thousands)
S-1