UNITED STATES

SECURITIES AND EXCHANGE COMMISSION WASHINGTON,

Washington, D.C. 20549


FORM 10-K/A

(Amendment No. 1 (Mark2)

(Mark One) [X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 1998

[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2002

OR [_] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _______________ to _______________

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period fromto

Commission File Number 0-19627 file number 000-19627


BIOLASE TECHNOLOGY, INC. (Exact

(Exact Name of Registrant as Specified in Its Charter) Delaware 87-0442441 (State or Other Jurisdiction of (IRS Employer Identification No.) Incorporation or Organization)

Delaware87-0442441

(State or Other Jurisdiction

of Incorporation or Organization)

(I.R.S. Employer

Identification No.)

981 Calle Amanecer

San Clemente, California 92673 (Address

(Address of Principal Executive Offices) (Zip Code) Registrant's telephone number,Offices, including area code: zip code)

(949) 361-1200 ________________________________

(Registrant’s Telephone Number, Including Area Code)


Securities registered pursuant to Section 12(b) of the Act: None

None.

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, Par Valuepar value $.001 Per Share (Titleper share

(Title of class) ________________________________


Indicate by check mark whether the registrant:Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  X¨    No  ------- ------- x

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant'sRegistrant’s knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [_] Asx

[Cover page 1 of March 31, 1999,2 pages]


Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes  x    No¨

State the aggregate market value of the voting stockand non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the Registrantlast business day of the Registrant’s most recently completed second fiscal quarter:

As of June 30, 2002, the aggregate market value of the voting and non-voting common equity held by non-affiliates was $46,909,283 computed using$102,142,534, based on the closing price of $2.675 per share of $5.79 for the Registrant’s common stock on March 31, 1999 as reported by Nasdaq based on the assumption that directors and officers and more than 10% stockholders are affiliates. On March 31, 1999, there were 17,657,387Nasdaq National Market on such date multiplied by 20,027,948 shares of the Registrant'sRegistrant’s common stock which were outstanding and held by non-affiliates on such date.

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of the latest practicable date: As of August 31, 2003, there were 21,539,571 shares of the Registrant’s common stock, par value $0.001 per share, outstanding. Information

DOCUMENTS INCORPORATED BY REFERENCE

Certain information required byin Part III isof the Registrant’s Annual Report on Form 10-K for December 31, 2002, was incorporated therein by reference to portions of the Registrant's Proxy StatementRegistrant’s definitive proxy statement for the 1999Registrant’s 2003 Annual Meeting of Stockholders, to be held May 25, 1999, which will bewas filed with the Securities and Exchange Commission within 120 dayson March 27, 2003.

[Cover page 2 of 2 pages]



BIOLASE TECHNOLOGY, INC. AND SUBSIDIARIES

AMENDMENT NO. 2 TO ANNUAL REPORT ON FORM 10-K/A

FOR THE YEAR ENDED DECEMBER 31, 2002

EXPLANATORY NOTE

The purpose of this Amendment No. 2 on Form 10-K/A is to re-file new certifications required under the Sarbanes-Oxley Act of 2002. The attached certifications in Exhibits 31.1, 31.2, 32.1 and 32.2 replace those filed on September 17, 2003 in Amendment No. 1 on Form 10-K/A for the year ended December 31, 2002. The contents of Amendment No. 1 are repeated in this filing because that is required when filing the new certifications. Except as noted below, the contents of Amendment No. 1, including the Introductory Note, numbers, text and all other information are repeated verbatim in this filing and have not changed from Amendment No. 1 filed on September 17, 2003. The only changes are the new certifications required under Section 302 of the Sarbanes-Oxley Act of 2002 (Exhibits 31.1 and 31.2) and corresponding changes to Item 9A of Part II, new certifications under Section 906 of that Act (Exhibits 32.1 and 32.2), an updated consent of independent accountants (Exhibit 23.1) and newly added Note 10 to the consolidated financial statements which was added to reflect a significant subsequent event that occurred after the closefiling date of Amendment No. 1.

TABLE OF CONTENTS*

PART I

Item 1.

Business5
Available Information14

Item 3.

Legal Proceedings15
PART II

Item 6.

Selected Consolidated Financial Data16

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations18

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk39

Item 8.

Financial Statements and Supplementary Data39

Item 9A

Controls and Procedures39
PART III

Item 11.

Executive Compensation41
PART IV

Item 15.

Exhibits, Financial Statement Schedules and Reports on Form 8-K.43

* This Form 10-K/A amends only items identified in the 1999 fiscal year. PART I ITEM 1. DESCRIPTION OF BUSINESS Qualifying Statement With Respect To Forward-Looking Information - ---------------------------------------------------------------- The United States Private Securities Litigation Reform ActTable of 1995 provides a "safe harbor" for certain forward-looking statements. Such forward-looking statements are based uponContents, and no other information included in the current expectations of the Company and speak only as of the date made. These forward-looking statements involve risks, uncertainties and other factors. The factors discussed below under "Forward- Looking Statements" and elsewhere in thisCompany’s Annual Report on Form 10-K are among those factors that in some cases have affectedis amended hereby. Information previously required under Item 14 of the Company's historic results and could cause actual results in the future to differ significantly from the results anticipated in forward-looking statements made in thisCompany’s Annual Report on Form 10-K future filings byis set forth under Item 9A of this Form 10-K/A, pursuant to new rules adopted after the original filing of the Form 10-K.

INTRODUCTORY NOTE

As reported in the press release in the report of BioLase Technology, Inc. (the “Company”) on Form 8-K filed August 14, 2003, the Company decided to seek guidance from the Securities and Exchange Commission (“SEC”) regarding the accounting effect of certain language in the Company’s purchase order forms. To protect the Company’s right to payment, the forms stated that title to goods transferred to the customer upon receipt of full payment. Legally, this language only provided the Company a lien to secure payment.

One of the revenue recognition criteria of Staff Accounting Bulletin No. 101 (“SAB 101”), Revenue Recognition in Financial Statements, requires the transfer of title and the risks and rewards of ownership to the customer. Historically, the Company recognized revenue when it received a purchase order, goods were shipped and the other criteria for revenue recognition were met. As reported in the press release in the Company’s report on Form 8-K filed August 29, 2003, the Company is amending previously filed financial statements for all periods subsequent to the effective date of SAB 101 to recognize revenue with respect to domestic customers upon receipt of full payment. It was determined that under an interpretation of SAB 101 the language in the Company’s purchase order regarding title prevents revenue from being recognized until full payment is received. In addition, the Company is amending its previously filed financial statements to recognize revenue with respect to direct European customers upon installation of the equipment, which is when the customer is obligated to pay, and not upon shipment.

The purpose of this Amendment No. 1 on Form 10-K/A to the Company’s Annual Report is to:

(i)restate the Company’s consolidated financial statements as of December 31, 2002 and 2001, and for each of the three years ended December 31, 2002; and

(ii)modify certain disclosures in response to comments from the SEC in connection with the Company’s registration statement on Form S-3 filed on June 19, 2003 for the Company’s proposed stock offering.

In addition to this report on Form 10-K/A, the Company is filing amended Quarterly Reports on Form 10-Q/A to restate the Company’s financial statements for the periods ended March 31, 2002 through March 31, 2003. The Company is also filing its Quarterly Report on Form 10-Q for the period ended June 30, 2003, which was delayed while the Company sought SEC guidance on the revenue recognition issue. The Company will also file an amendment to its Current Report on Form 8-K/A relating to its acquisition of the American Dental Laser product line of American Medical Technologies, which was initially filed on June 4, 2003, and subsequently amended on June 23, 2003 and August 1, 2003.

The Company did not amend its annual reports on Form 10-K for years prior to 2002 because financial statements for 2001 and 2000 are contained in this Form 10-K/A. Similarly, the Company did not amend its Quarterly Reports on Form 10-Q for the quarterly periods in 2001 because financial statements for those periods are contained in the Forms 10-Q/A the Company is filing for 2002. You should not rely on the financial statements and other financial information contained in the Company’s Forms 10-K and 10-Q for periods prior to 2002. You should also not rely on any financial statements or financial information contained in the Company’s Forms 8-K that were filed before this Form 10-K/A.

Except where this report indicates that information is as of December 31, 2002 or another specific date, the information in this Form 10-K/A speaks as of the filing date of this Form 10-K/A. This report should be read in conjunction with Amendment No. 1 to the Company’s Quarterly Report on Form 10-Q/A for the quarter ended March 31, 2003 and the Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, as well as the Company’s subsequent filings.

CAUTIONARY STATEMENT

This report contains forward-looking statements, which include, but are not limited to, statements concerning projected operational plans, results of operations and financial condition, potential market applications and the market acceptance of our products, the competitive nature of and anticipated growth in our markets and the need for additional capital. These forward-looking statements are based on our current expectations, estimates, assumptions and projections about our industry and reflect management’s beliefs based on information available to us at the time of this report. Words such as “anticipates,” “expects,” “plans,” “believes,” “seeks,” “estimates,” “may,” “will,” and variations of these words or similar expressions are intended to identify forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict, including those set forth under “Risk Factors” in Item 7. These risks and uncertainties, some of which are more fully discussed below and in our other filings with the Securities and Exchange Commission in the Company's press releases and in oral statements made by authorized officers of the Company. When used in this Annual Report on Form 10- K, the words "estimate," "project," "anticipate," "expect," "intend," "believe," "hope," "may" and similar expressions, as well as "will," "shall" and other indications of future tense, are intended to identify forward-looking statements. Introduction - ------------ BioLase Technology, Inc., a Delaware corporation ("BioLase" and together with its consolidated subsidiary, the "Company") designs, develops, manufactures and markets laser-based systems for use in dental and medical applications. The current generation of the Company's laser-based systems incorporates its proprietary HydroKinetic(TM) technology into its surgical tissue cutting system, Millennium(TM), which utilizes electromagnetic energy laser pulses from an erbium, chromium: yttrium scandium gallium garnet ("Er,Cr:YSGG") laser and a proprietary air-water spray. In a configuration utilizing higher power settings, the laser pulses act to rapidly energize and transform atomized water droplets from the air-water spray into smaller, energized water molecules that can precisely remove both dental hard and soft tissues, and the Millennium(TM) system, when operating in this manner, is intended for use primarily in hard tissue applications. In a configuration utilizing lower power settings, the Er,Cr:YSGG laser incorporated into the Millennium(TM) system acts as a conventional laser, with the air-water spray serving as a cooling agent. When operating in this manner, the Millennium(TM) system is intended for use in soft tissue applications. The Millennium(TM) system is currently marketed both in the United States and internationally for dental hard and soft tissue applications. The Company also has clearance from the United States Food and Drug Administration ("FDA") to market a laser-based surgical tissue cutting system in the United States for a broad range of dermatological and general surgical soft tissue applications. In response to this clearance, the Company intends to introduce a laser-based system in a configuration designed for aesthetic and dermatologic applications in late 1999 or early 2000. The Company has (i) an automated system used in endodontic procedures for locating and shaping root canals, known as the Canal Finder System(TM), along with a full range of other proprietary and non-proprietary endodontic products, and (ii) an air-water spray laser accessory, LaserSpray(TM), designed to cool the tissue receiving laser energy and the surrounding tissue, 1 that is incorporated into the Company's laser-based systems and has the potential to be employed with fiber-coupled laser systems manufactured by others. The Company has developed a home consumer product called LazerSmile(TM), a toothbrush that utilizes a light source and a proprietary gel for whitening teeth. The Company has under development a fluid conditioning system known as FlavorFlow(TM), for which it has been granted a patent, that sanitizes, flavors and administers fluids and enhances the scent of air present during dental and medical procedures; and a line of biomaterials for dental and medical applications. General - ------- Prior to 1995, the Company's principal products were Nd:YAG (neodymium: yttrium aluminum garnet) laser systems that were marketed domestically for dental soft tissue applications and internationally for certain dental hard and soft tissue applications, and an automated endodontic (root canal) handpiece. In 1994, the Company commenced its research and development efforts related to what is now its patented and proprietary Er,Cr:YSGG HydroKinetic technology. This technology employs electromagnetic energy laser pulses which, at higher power settings, rapidly energize and transform small atomized water droplets from an air-water spray into smaller, energized water molecules that can precisely remove both dental hard and soft tissues. This technology has proved to be effective and efficient in removing enamel and dentin tooth structure in a precise, non-thermal manner. In 1995, the Company started developing this technology into a product that has evolved into the Millennium(TM). The initial design of a system for dental and oral surgical applications was completed in late 1996, while refinement and enhancements to its design has continued through the present time. In a configuration utilizing lower power settings, the Er,Cr:YSGG laser incorporated into the Millennium(TM) system acts as a conventional laser, with the air-water spray serving as a cooling agent. When operating in this manner, the Millennium(TM) system is intended for use in soft tissue applications. In 1995, the Company developed LaserSpray(TM), an air-water spray accessory using its proprietary Target Tissue Cooling System(TM) ("TTCS(TM)") technology which is designed to cool the tissue receiving laser energy and adjacent tissue. LaserSpray(TM) is incorporated into the Company's laser-based systems and has the potential to be employed in conjunction with fiber-coupled laser systems manufactured by other companies. In 1996, the Company commenced the development of a toothbrush for the consumer market, originally called the LaserBrush(TM), that utilizes a monochromatic optical energy light source embedded within a toothbrush in conjunction with a clear, non-abrasive tooth whitening gel developed by the Company. In August 1998, the Company changed the name of the LaserBrush(TM) to LazerSmile(TM). The Company is in the process of introducing the LazerSmile(TM) nationwide through a variety of channels attuned to the distribution of home consumer products. More recently, the Company commenced development of FlavorFlow(TM), a patented product that sanitizes and alters the flavor and scent of fluids administered during medical, dental and oral surgical treatments. The Company also possesses patents and proprietary technology for a group of biomaterials under the trade names PerioFil(TM), PerioSeal(TM), LaserBond(TM) and EndoPlas(TM) for use in periodontics, endodontics, general dentistry, orthopedics and other medical applications. 2 Commercialization of these biomaterials will depend on, among other things, resource availability and completion of development and regulatory approval. Laser Background - ---------------- The term "laser" is an acronym for Light Amplification by Stimulated Emission of Radiation. A laser is an apparatus that stimulates the atoms in a core material (such as a gas or crystal) to emit packets of light and then amplifies and focuses the light in a single beam. Laser light, which consists of a single wavelength of light, differs from light emitted from an ordinary light bulb primarily through greater concentration and intensity. Lasers are typically classified by the element or compound that emits light when energized, such as carbon dioxide (CO2), Nd:YAG, argon, ruby and erbium. Lasers were first developed for research, industrial and military uses and, more recently, have been adapted for many medical and dental applications. The benefits of lasers in medical and dental applications are generally believed to include reduced pain, minimized infection, promotion of rapid healing, reduced bleeding, reduced scarring, increased precision and time-effective procedures. In many cases, lasers perform procedures which otherwise could not be achieved through traditional surgical means. Lasers are currently used in a wide variety of medical fields including dentistry, dermatology, plastic surgery, ophthalmology, otolaryngology (ear, nose and throat ("ENT")), gynecology, urology, cardiology, gastroenterology and general surgery. Medical and dental laser-based systems, including the Company's Millennium(TM) system, are highly specialized tools specifically designed for a particular application or set of applications. The most important factors in developing a laser-based system for a specific application are the wavelength of the laser, its pulse length, energy per pulse, the method of delivery of the laser energy to the tissue, and the method, if any, of cooling the tissue. A matter that has required attention in the development of lasers for medical and dental applications is the temperature sensitivity of soft and hard tissue, including skin, bone, tooth enamel and dentin. Elevated temperatures can cause irreversible deterioration in vital tissue. The Company's patented TTCS(TM), incorporated into its laser-based systems, is intended to enable the user to apply focused energy levels on hard tissue, such as bone, enamel and dentin, and avoid damage to the tissue being lased and the surrounding tissue by cooling with an air-water spray the tissue receiving the energy and the contiguous region. TTCS(TM) is incorporated into the Company's laser-based systems and has the potential to be installed as an accessory on most fiber-coupled lasers manufactured by other companies. The Millennium(TM) System - ------------------------- The Company has recently developed its Millennium(TM) system, an Er,Cr:YSGG laser incorporating the Company's patented HydroKinetic technology which involves the use of this proprietary laser-based technology for a variety of dental and medical applications. HydroKinetic(TM) technology permits the Millennium(TM) at higher power settings to combine the Company's TTCS(TM) with its Er,Cr:YSGG laser-based system to generate electromagnetic energy pulses that rapidly energize and transform water spray into an energized state capable of precisely removing hard tissue, such as tooth, bone and cartilage. In a modified configuration, the Er,Cr:YSGG laser incorporated into the Millennium(TM) system acts as a 3 conventional laser, with the air-water spray serving as a cooling agent. When operating in this manner, the Millennium(TM) system is intended for use in soft tissue applications. The current Millennium(TM) system configured for dental and oral surgical applications consists of a flexible fiber-optic delivery system and mobile floor system containing an Er,Cr:YSGG laser, power supply, internal cooling system and control panel. The Millennium(TM) system uses electromagnetic energy pulses from the Er,Cr:YSGG laser to rapidly energize and transform water spray into a safe, cool and precise biocompatible tissue removing device. The Millennium(TM) system is capable of cutting both hard and soft human tissue. To give medical practitioners more flexibility, Millennium(TM) systems may also be used without water or with water as a cooling medium for standard laser-based soft tissue applications, in fields such as dermatology, orthopedics and otolaryngology (ENT), although specific applications within these fields would require additional regulatory clearances by the FDA. See " - Government Regulation". The Company believes that its Millennium(TM) system has a broader range of applications than conventional laser systems. The Company currently is marketing the Millennium(TM) system only for dental and oral surgical applications in the U.S. and internationally. The Company has FDA clearance to market its Millennium(TM) for certain dental hard and soft tissue applications and has also received clearance by the FDA to market a laser system that utilizes a variation of the Er,Cr:YSGG HydroKinetic(TM) technology for a broad range of dermatological, aesthetic and general surgical soft tissue applications. The Company intends to continue the development of these applications during 1999. Marketing for certain expanded applications of the Er,Cr:YSGG HydroKinetic(TM) system in the United States would require additional regulatory clearance. The Company may be required to engage in further development of the Er,Cr:YSGG HydroKinetic(TM) technology or to complete clinical studies successfully in order to pursue certain expanded applications. No assurances can be given that any such clinical studies will be successfully completed or such regulatory clearances will be granted. See " - Government Regulation". Use of the Company's proprietary technology for various non-dental applications will require certain modifications to the hardware and software configurations of the technology. The Company has received certification for its Millennium(TM) system signifying its compliance with the Medical Device Directive, evidenced by the "CE" mark, established within the European Community. The Millennium(TM) system has also been granted the Canadian Standards Association ("CSA") mark symbolizing compliance with certain safety and performance standards. The CE and CSA marks allow the Company to import and market its Millennium(TM) system in the European Community and Canada, respectively. See " - Government Regulation". While the Company believes that its Er,Cr:YSGG HydroKinetic(TM) surgical system should be effective in a broad range of medical and dental applications, this belief, except with respect to certain dental and dermatological applications, for which clinical research has been and is being conducted, is based largely on preliminary in vitro and in vivo research and extrapolation of observations in such clinical research. No assurances can be given that the Company's proprietary technology will prove to be applicable to, or will find market acceptance in, any medical or dental fields or that the Company will receive clearance from the FDA or other regulatory agencies to market the Millennium(TM) system or other products embodying its HydroKinetic(TM) technology for additional applications in any such fields. 4 Applications and Potential Applications of the Millennium(TM) System. -------------------------------------------------------------------- Dentistry. The Millennium(TM) system, currently marketed by the Company in --------- the United States and internationally (principally in Canada, Western Europe and, for clinical evaluations, Japan), is configured for dental and oral surgical applications. The Company intends to expand its marketing emphasis to other significant markets that appear to present potential interest in its Er,Cr:YSGG HydroKinetic(TM) products. These markets may include but are not limited to Mexicothe following:

Uncertainties relating to worldwide political stability, general economic conditions and trade policies;

Uncertainties relating to government and regulatory policies;

Unforeseen technological developments by competitors;

The entry of new, well-capitalized competitors;

The availability and pricing of materials used in the manufacture of our products;

Uncertainties relating to the development, ownership and enforcement of intellectual property rights;

Adverse changes in the financing and coverage of commercial health and dental plans;

Adverse changes in the financial markets affecting the availability and cost of capital;

The impact of natural disasters, including a major earthquake, on our operations; or

The ability to attract and retain qualified personnel to grow and compete effectively.

Due to the foregoing risks and uncertainties, among others, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various Southfactors. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

The information contained in this report is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in the report and in our other reports filed with the Securities and Exchange Commission.

PART 1

Item 1.Business

We design, manufacture and market proprietary dental laser systems that allow dentists, oral surgeons and other specialists to perform a broad range of common dental procedures, including cosmetic applications. Our systems provide clinically superior performance for many types of dental procedures, with less pain and faster recovery times than are generally achieved with drills and other dental instruments. We have clearance from the U.S. Food and Drug Administration to market our laser systems in the United States. We also have the approvals necessary to sell our laser systems in Canada, the European Union and other international markets.

Our primary product, the Waterlase system, uses a patented combination of water and laser to perform most procedures currently performed using dental drills, scalpels and other traditional dental instruments. We refer to our patented interaction of water with laser as YSGG Laser Hydrokinetics. YSGG is a shortened abbreviation referring to the unique crystal (Er, Cr: YSGG) laser used in the Waterlase, which contains the elements erbium, chromium, yttrium, scandium, gallium and garnet. This unique crystal laser produces energy with specific absorption and tissue interaction characteristics optimized for dental applications. Hydrokinetics refers to the interaction of laser with water to produce energy to cut tissue. Through YSGG Laser Hydrokinetics, the Waterlase system can precisely cut hard tissue, such as bone and teeth, and soft tissue, such as gums, with minimal or no damage to surrounding tissue. The Waterlase is the best selling dental laser system and we estimate it currently accounts for a majority of all dental lasers sold worldwide.

We also offer the LaserSmile system, which uses a laser to perform soft tissue and cosmetic procedures, including tooth whitening. The LaserSmile serves the growing markets for cosmetic and hygiene procedures. In May 2003, we acquired the American countries,Dental Laser product line of American Medical Technologies, Inc., including the Pacific Rim countries, AustraliaDiolase and New Zealand. Depending on the local regulatory requirements within these respective countries, further regulatory clearances mayPulsemaster systems, which can be necessary prior to entry into these markets. See " - Government Regulation". There are approximately 140,000 dentists in active practiceused for common soft tissue procedures. The Diolase and Pulsemaster, together with our Waterlase and LaserSmile systems, offer practitioners a broad product line with a range of features and price points. We also manufacture and sell accessories and disposables for our laser systems, such as handpieces, laser tips and tooth whitening gel.

We believe there is a large market for our products in the United States and abroad. According to the American Dental Association, there are over 160,000 practicing dentists in the United States. According to the World Federation of Dentistry, an even greaterinternational dental organization, there are at least 700,000 dentists worldwide, and we believe that a substantial percentage of them practice in major international markets outside the United States. The use of lasers in dentistry is growing. However, we believe only a small percentage of dentists currently use laser systems, and that there is a significant opportunity to increase sales of our products worldwide.

Our goal is to establish our laser systems as essential tools in dentistry and to continue our leading position in the dental laser market. Our sales and marketing efforts focus on educating dental professionals and patients on the benefits of our laser systems, particularly our Waterlase system. In 2002, we founded the World Clinical Laser Institute, an association that includes prominent dental industry leaders, to formalize our efforts to educate and train dentists and oral surgeons in laser dentistry. We participate in numerous other symposia and dental industry events to stimulate demand for our products. We have also developed numerous relationships with dental schools, research facilities and dental institutions, in the United States and abroad, which use our products for education and training. More than 20 institutions use our products, including St. Barnabas Hospital and the dental schools of Columbia University, Loma Linda University, Tufts University, University of Barcelona and University of Vienna. We believe this will expand awareness of our products among new generations of dental professionals.

Company Background and Recent Events

From inception in 1987 until 1998, we were engaged primarily in the research and development of the use of water and laser technology. Our company was originally formed as Societe Endo Technic, SA, or SET, in 1984 in Marseilles, France, to develop and market various endodontic and laser products developed by Dr. Guy Levy, then chairman of the Endodontics Department at the University of Marseilles. In 1987, SET was moved to the United States and was merged with a public holding company, Pamplona Capital Corp. In 1994, we changed our name to BioLase Technology, Inc. Through the end of fiscal 2000, we were financed by approximately $42 million in stockholder investments through a series of private placements of stock and the exercise of warrants and stock options.

Since 1998, our objective has been to become the leading designer, manufacturer and marketer of laser systems for the dental industry. We have focused our efforts on receiving governmental clearances with the U.S. Food and Drug Administration as well as furthering the commercial success and viability of our water and laser technology via our direct sales campaign initiatives and intellectual property advancements. In 1998, we began the commercialization of our systems based on water and laser technology.

The selective pursuit of acquisitions represents an important component of our business strategy. We focus primarily on those candidates that will enable us to consolidate positions of leadership in our existing markets, further develop our portfolio of intellectual property, expand our strategic partnerships with leading companies and increase our capability and capacity to derive value for our customers and stockholders.

In December 2001, we formed BIOLASE Europe, GmbH, a wholly owned subsidiary based in Germany. In February 2002, BIOLASE Europe acquired a laser manufacturing facility in Germany and commenced manufacturing operations at that location. This acquisition has enabled us to initiate an expansion of our sales in Europe and neighboring regions. We purchased the facility for cash consideration of approximately Euros 1.2 million payable in installments through 2003, subject to reduction if we were unable to conclude a patent license arrangement with the seller and another company. We did not conclude that arrangement and the consideration was reduced in September 2003 to Euros 989,000 per the agreement. We are in discussions with the seller regarding a further reduction based on our belief that the seller failed to fulfill its responsibilities under the purchase agreement.

On May 21, 2003, we acquired the American Dental Laser product line and other dental laser assets of American Medical Technologies, Inc., or AMT, for approximately $5.8 million, consisting of $1.8 million in cash, 307,500 shares of our common stock and $134,000 in costs directly attributable to the acquisition. As a part of the purchase transaction, we and AMT agreed to dismiss with prejudice the lawsuit we had filed in October 2002 against AMT which alleged infringement of certain of our patents. In the dismissal, AMT acknowledged that it had infringed our intellectual property rights as identified in our complaint and recognized that the patents we had asserted in the legal action are valid and enforceable. The acquired assets included dental laser patents, customer lists, brand names and other intellectual property as well as laser systems, including the Diolase and Pulsemaster systems. The purchase price will be allocated to the assets based on their fair value. We intend to sell the Diolase and Pulsemaster systems both domestically and internationally under the American Dental Laser brand name, commencing in the second half of 2003. We expect sales of the new systems to begin in the second half of 2003.

Products

We have two principal product lines. Our BioLase product line includes the Waterlase and LaserSmile systems, which we developed through our own research and development. In May 2003, we acquired the American Dental Laser product line, which includes the Diolase and Pulsemaster systems.

We currently sell our products in over 20 countries. All of our laser systems have been cleared by the U.S. Food and Drug Administration for the applications listed below, which enables us to market the systems in the United States. Our systems have the CE Mark and may be sold in the European Union. Additionally, we have approval to sell our Waterlase system in Canada, Australia, New Zealand and other Pacific Rim countries.


PRODUCTSELECTED APPLICATIONSTECHNOLOGY

BioLase Product Line

Waterlase System

Hard Tissue: Cavity preparation, caries removal, roughening or etching, root canal and other hard tissue surgical applications.

Bone: Cutting, shaping, contouring, resection, crown lengthening (restorative), apicoectomy or amputation of root end, and other oral osseous or bone procedures.

Soft Tissue: Incision, excision and biopsy of soft tissue, frenectomy, troughing, fibroma removal, hemostasis, aphthous oral ulcers, operculectomy and other soft tissue surgical applications.

Cosmetic: Gingivectomy, gingivoplasty and crown lengthening.

Solid State Crystal, Erbium, Chromium: Yttrium, Scandium, Gallium, Garnet (Er, Cr: YSGG), Laser with Air-Water Spray

LaserSmile System

Soft Tissue: Incision, excision and biopsy of soft tissue, frenectomy, troughing, gingivoplasty and other soft tissue surgical applications.

Cosmetic: Gingivectomy, gingivoplasty and tooth whitening.

Semiconductor Diode Laser

American Dental Laser Product Line


Diolase System

Soft Tissue: Incision, excision and biopsy of soft tissue, frenectomy, troughing and other soft tissue surgical applications.

Cosmetic: Gingivectomy and gingivoplasty.

Semiconductor Diode Laser

Pulsemaster System

Soft Tissue: Incision, excision and biopsy of soft tissue, frenectomy, troughing, gingivectomy, gingivoplasty and other soft tissue surgical applications.

Cosmetic: Gingivectomy and gingivoplasty.

Neodymium: Yttrium, Aluminum, Garnet (Nd:YAG), Crystal Laser

BioLase Product Line

The following are the two laser systems developed by our in-house team of engineers.

Waterlase System. The Waterlase laser uses an Er, Cr: YSGG crystal, which produces a unique wavelength optimized for dental applications. Using YSGG Laser Hydrokinetics, the Waterlase enables highly

controlled cutting of bone and tooth with minimal to no damage to surrounding tissue, resulting in less trauma and pain than is achieved with dental drills or other dental instruments. The Waterlase can cut teeth or bone in narrow spaces with limited access for conventional instruments. By reducing or eliminating the water spray level, the Waterlase can also be used to perform a number of dentistssoft tissue procedures. Our Waterlase cuts soft tissue efficiently and provides effective coagulation in other countriesmany types of soft tissue procedures. The approximate list price of the Waterlase system is $50,000.

LaserSmile System. The LaserSmile system uses a semiconductor diode laser primarily for use in soft tissue and cosmetic procedures, particularly tooth whitening. For tooth whitening, the LaserSmile is used with our proprietary gel to whiten teeth faster than competitive non-laser whitening systems. In addition, the high power of the LaserSmile makes it particularly effective in soft tissue procedures where deeper penetration and faster coagulation is desired. The approximate list price of the Company intends to market its products. Industry analystsLaserSmile system is $23,000.

American Dental Laser Product Line

In May 2003, we acquired the American Dental Laser product line, including the Diolase and Pulsemaster systems. We believe that the Diolase system complements our Waterlase and LaserSmile systems and will enable us to increase market penetration by offering a broad line of laser systems with a range of features and price points.

Diolase System. Our recently acquired Diolase system uses a semiconductor diode laser for a range of dental soft tissue, cosmetic and hygiene procedures. The Diolase has simpler features than our other systems, and is positioned as an entry level laser system. The approximate list price of the U.S. population grows and ages and more natural teeth are retained, the demand for dental services will increase along with the demand for newer and improved technology. The Company believes that the Millennium(TM)Diolase system is well suited$14,000.

Pulsemaster System. Our recently acquired Pulsemaster system uses the popular Nd:YAG crystal that is broadly accepted for a variety of soft tissue procedures. The Pulsemaster system is well established and has been adopted by many dental practitioners, especially for periodontal procedures. The Pulsemaster system performs many of the same functions as our existing LaserSmile system. As a result, we plan to make the Pulsemaster available only in limited quantities, on a made-for-order basis, to dental practitioners who express a strong preference for that system. The approximate list price of the Pulsemaster system is $27,500.

Related Accessories and oral surgical applications such as cavity preparationDisposable Products

We also manufacture and restoration, implant preparation, aesthetic dentistry, periodontics (treatmentsell disposable products and accessories for our laser systems. Our Waterlase system uses disposable laser tips of gum disease)differing sizes and prosthodontics (replacementshapes depending on the procedures being performed. We also market flexible fibers, handpieces, tooth whitening gel and aftercare products for our LaserSmile system. In connection with our acquisition of teeth). Plaque and Periodontal Disease. Plaque is a sticky, colorless film of bacteria that forms on teeth. If not removed regularly, it can cause cavities or gum (periodontal) disease. Most adults have periodontal disease, which can exist without symptoms for years. When plaque is allowed to build up in the crevice between tooth and gum, it eventually separates the gum from the tooth root. As the gum pulls away, the bone underneath deteriorates. The resulting periodontitis causes tooth loss in 70% of all adults, according to the American AcademyDental Laser product line, we acquired a complete line of Periodontology. When plaque hardens, it becomes tartar, a rough, porous material that can be removed only by professional cleaning. Although tartar itself is not believed to cause periodontal disease, the presence of tartar makes plaque harder to remove. The Millennium(TM) system can be utilizedaccessories for the removal of plaqueDiolase and tartarPulsemaster systems, as well as other accessories marketed under the treatmentAmerican Dental Laser brand name.

Warranties and Insurance

Our laser systems sold to end-users and distributors are covered by a one-year and fourteen-month warranty, respectively, against defects in material and workmanship. Our warranty covers parts and service for direct sales and parts only for distributor sales with additional coverage on certain components for up to two years. We sell service contracts that cover the period after the expiration of infected tissue associatedour 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. In addition, we maintain product liability insurance with periodontal disease. Cavity Preparation/Aesthetic Dentistry. Aesthetic considerations are gaining increased importance in dentistry, as patients seek natural looking dental restorations. Duerespect to these aesthetic and health concerns, natural colored composites are replacing amalgam (gold and silver) fillingsour products with a general coverage limit of $12 million in the restorationaggregate. Since commencing the sale of cavities. When working with compositesour systems, no product liability claims have been initiated against us.

Manufacturing

We manufacture, assemble and test our products at manufacturing facilities located in cavity restorations, dentists must preserveSan Clemente, California, and Floss, Germany. We acquired our German manufacturing facility in 2002. We manufacture and install our systems and provide maintenance services for products sold in Europe and other international markets

through our German operations. Sales of products manufactured at our German facility accounted for 9% of our revenue in 2002.

We use an integrated approach to manufacturing, including the tooth structureassembly of laser heads, electronics and veneer (the thin ceramic covering the front surface)cabinetry, which allows us to enhance bondingmaintain high quality and control cost. We obtain components and subassemblies for our products from third party suppliers, most of the composite and minimize stress upon the reconstructed tooth. Penetration of the bonding materials into the tooth structure and thus the strength of the adhesive bond between the tooth and the composite material depend upon cavity preparation procedures that minimize cracks, fuses and fractures of the enamel rods and dentin tubules. In addition, decay must be removed, and the interior of the cavity preparation must be clean and free of debris such as that left by conventional dental drills. The Company believes that its Millennium(TM) system can cut precisely and cleanly with minimal disruption to tooth structure, thus providing improved preparation for restorations with enhanced adhesive and aesthetic qualities. 5 Prosthodontics. The replacement of missing teeth and the significant -------------- restoration of decayed or damaged teeth have evolved as dental specialties as a result of the development of stronger ceramic, porcelain and composite materials. The onlay and inlay require not only precise cavity preparation, but also strong adhesion of the bonding which is necessary for enhancement of retention. The Company believes that the Millennium(TM) system can effectively minimize cracking, and avoid the heating and fracturing of the enamel or dentin structure during cavity preparation and promote a stronger bond or adhesion, thereby facilitating a more durable and aesthetic restoration. The Company also believes the Millennium(TM) system has the potential to precisely cut the appropriate shoulder preparation to be used to retain removable or partial dentures and distribute stress force along the anchor tooth. The Company believes that because the Millennium(TM) system minimizes vibration, use of the system can provide increased patient comfort and conserve tooth structure. The Millennium(TM) system can also be utilized to shape shoulders and margins, facilitate improved impressions and promote secure and closed margins. The Company believes that benefits associated with this potential use of the Millennium(TM) system include reduction of the vibration, high-pitched noise and microfracturing of teeth associated with the conventional dental drill. The soft tissue that surrounds the crown preparation area usually requires shaping prior to taking an impression. The Company believes that use of the Millennium(TM) system to remove or reshape the tissue will result in reduced bleeding and increased patient comfort. Osseous (Bone) Implant Surgery. Bone implants are used for bone ------------------------------ stabilization, to add strength to existing bone and to serve as the infrastructure for reconstructive dental procedures. For such procedures, it is important that the bone cutting for the implant placement be clean and that the practitioner not damage the bone itself during cutting by the generation of excessive heat. Thermal damage, such as that caused by conventional dental drills, can impede or destroy the fusion of the bone to the implant. The Company believes that the Millennium(TM) system, through its HydroKinetic(TM) technology, can effectively cut bone cleanly and without thermal damage; however, the device is presently not cleared by the FDA for marketing for cutting bonelocated in the United States. See " - Government Regulation".We generally purchase components and subassemblies from a limited group of suppliers through purchase orders. We have no written supply contracts with our key suppliers. Three key components used in our Waterlase system, which accounted for approximately 77% of our revenue in 2002, are each supplied by a separate single-source supplier. The osseous (bone) implant placement process usually requires procedures uncoveringWaterlase hand pieces are made by a leading European supplier of precision hand tools, and the soft tissuelaser crystal and shaping aroundfiber components are each made by a separate supplier. We have not experienced material delays from the neck of the tooth. The Company believes that the Millennium(TM) system can be used effectively for these procedures, as a result of its ability to cut oral soft tissue cleanly, precisely and without induced bleeding. Dermatology and Plastic/Cosmetic Surgery. An estimated 400,000 worldwide ---------------------------------------- laser-based skin resurfacing procedures will be performed this year. Laser skin resurfacing, which has been evolving as a surgical technique since it was introduced in 1993, involves using a high-energy laser beam to remove epidermal layers. This surgical process normally leaves a swollen, red wound which must heal over a period of weeks or months. If successful, this procedure reduces wrinkles and produces some tightening of the skin. Mostsuppliers of these surgeriesthree key components, and we have identified and tested alternative suppliers for each of these components. However, an unexpected interruption in a single source supplier could create manufacturing delays, and disrupt sales as we sought to replace the supplier, which we estimate could take up to three months.

Our manufacturing facilities are performed by dermatologists, plastic surgeons, oculoplastic surgeons,ISO 9001 certified. ISO 9001 certification provides guidelines for quality of company systems associated with the design, manufacturing, installation and various other sub-specialists using short-pulsed carbon-dioxide lasers. Currently, there is a worldwide installed baseservicing of approximately 4,000 lasers for this application. This installed base is expected to grow to 10,000 units by the year 2000. 6 The Company believes that its Er,Cr:YSGG HydroKinetic(TM) technology may provide a significant technological breakthrough for the treatment of wrinkles, scars and warts and for skin resurfacing. The Company believes the Er,Cr:YSGG HydroKinetic(TM) system may also offer some clinical advantages in terms of non- thermal, controlled removal of dermal soft tissue.company products. In particular, a practitioner would have the ability to use the Er,Cr:YSGG HydroKinetic(TM) technology for certain cosmetic surgery procedures (e.g., bone, cartilage, and skin reshaping) or to reduce the power, adjust the energy characteristics and alter the amount of air and water used during an application, thereby allowing the use of the laser medium to remove the skin surface with less depth of radiation than that typically experienced when using laser systems with wavelengths that differ from that of the Er,Cr:YSGG HydroKinetic(TM) system. The Company has FDA clearance to market a laser system for a broad range of dermatological and general surgical soft tissue applications, including scar revision, removal of tumors and cysts, skin resurfacing and diagnostic biopsies. See " - Government Regulation". This system, formally under the name "DermaLase(TM)", which the Company continues to develop, utilizes the Er,Cr:YSGG laser employed in Millennium(TM), but configured with laser energy, water and air characteristics optimized for its specific application. In this configuration, the system utilizes the air-water spray as a cooling agent. In the Company's opinion, the combination of the air-water spray and the specific wavelength employed provides improved histological effects on tissue, such as reduced tissue trauma and faster healing. Oral/Maxillofacial Surgery. Over 7,000 specialists practice -------------------------- oral/maxillofacial surgery inaddition, both the U.S. These specialists have also become involvedand German facilities are registered with cosmetic surgery, including facial skin resurfacingthe U.S. Food and Drug Administration and are compliant with lasers. The Company believes that its Er,Cr:YSGG HydroKinetic(TM) system can provide significant advantages in oral/maxillofacial surgery, as a single surgical instrument that efficiently cuts bone, cartilage,the FDA’s Good Manufacturing Practice guidelines.

Marketing and soft tissue. While the Company presently has clearance toSales

Marketing

We currently market its Er,CR:YSGG Hydrokinetic(TM) system for various dermatological and other various soft tissue procedures, the device is presently not cleared for marketingour laser systems in the United States, by the FDA for the cutting of bone. See " - Government Regulation". Orthopedic Surgery. According to the American College of Surgeons, nearly ------------------ 21,000 orthopedic surgeons in the U.S. perform in excess of 3,000,000 annual surgeries, including joint arthroscopy, spinal disc alterationsCanada, Australia and arthroplasties of knee, shoulder and hip. Statistics on international procedures are not compiled, but industry experts estimate at least 1,000,000 annual procedures outside of the United States. Laser use in orthopedic surgery has been limited to a very small percentage of surgeons using long-pulse holmium lasers in arthroscopic procedures. The main advantage of a holmium laser is finesse for tissue sculpting. However, the medical community has criticized the holmium laser as being too slow compared to the traditional mechanical endoscopic cutting devices. Thermal damage caused by the pulsed holmium laser has also been an issue. By contrast, the Company believes that the Er,Cr:YSGG HydroKinetic(TM) system can offer significant advantages in terms of improved speed, non-thermal effect, and providing one surgical device that can perform all the functions that a surgeon needs for bone and cartilage cutting, along with the ability to perform bone shaping and sculpting. The device, however, is presently not cleared for marketing in the United States by the FDA for the cutting of bone. See " - Government Regulation". Otolaryngology. The Company believes that the unique bone-cutting capability -------------- of the Er,Cr:YSGG HydroKinetic(TM) system lends itself to surgical procedures in the ear and nasal passages, where hard tissue (primarily cartilage) must be precisely removed under endoscopic control. Approximately 400,000 ear, nose, and throat (ENT) surgical procedures 7 are performed in the United States each year by some 10,000 specialists with an estimated 650,000 additional annual procedures internationally. Currently, lasers are utilized in less than 5% of these surgeries. Primary applications for lasers in ENT now include: laser assisted palatoplasty (partial removal of the palate); uvulopalatoplasty (partial removal of the uvula and the palate to reduce sleep apnea and snoring); tonsillectomy (surgical removal of tonsils); and myringotomy (surgical creation of a small hole in the tympanic membrane of a child's ear for drainage of fluid caused by chronic ear infection). The Company believes, based on in-vitro tests, that the Millennium(TM) system may provide an improved surgical tool for performing some types of ENT procedures. While the Company's Er,Cr:YSGG HydroKinetic(TM) system is cleared for marketing in the United States for a variety of general surgical applications, including resection of internal organs, tumors and lesions, further clearances may be required for specific applications when and if the Company decides to enter this market arena. See " - Government Regulation". Other Dental and Medical Products - --------------------------------- LazerSmile(TM). In 1996, BioLase commenced the development of a toothbrush -------------- for the consumer market, originally called the LaserBrush(TM), that utilizes a monochromatic optical energy source embedded within a toothbrush in conjunction with a clear, non-abrasive, proprietary, tooth-whitening gel. The Company completed its design in 1998 and renamed the product LazerSmile(TM). The LazerSmile(TM), which utilizes the Company's patented and patent-pending technologies, is designed to bring into the consumer's home technology that utilizes optical energy to activate ingredients in its proprietary tooth- whitening gel, formulated by the Company, to clean and whiten teeth. The LazerSmile(TM), which is configured much like a conventional toothbrush, is smaller than conventional motorized tooth brushing instruments. During 1999, the Company intends to focus its marketing strategy for LazerSmile(TM) on utilization of experienced consumer marketing groups that specialize in the distribution of home consumer health products through such channels as television shopping networks, specialty catalogs and traditional consumer distribution channels. LaserSpray(TM). LaserSpray(TM) is a stand-alone product that incorporates a -------------- patented technology to allow a dental or medical practitioner to deliver a coolant spray of air and water to tissue sites during surgical laser interventions. LaserSpray(TM) has the potential to be installed with most fiber-coupled lasers manufactured by other companies. The LaserSpray(TM) uses BioLase's proprietary TTCS(TM) which has applications for various medical and dental lasers. The Company believes that thermal effects resulting from high temperatures can be significantly reduced when the LaserSpray(TM) cooling system is used during application of laser-based energy. To date, the Company has not pursued marketing of the LaserSpray(TM) as available resources have been dedicated to the completion and marketing of its Millennium(TM) and LazerSmile(TM) products. FlavorFlow(TM) Fluid Conditioning System. In response to recently proposed ---------------------------------------- standards for use of sanitized fluids in dental and medical procedures, BioLase has been developing the FlavorFlow(TM) fluid conditioning system, a system utilizing patent-pending technology to sanitize, flavor and administer fluids and enhance the scent of air present during medical and dental treatments. FlavorFlow(TM) is designed to overcome the unpleasant tastes and odors which patients typically associate with pain and discomfort and which contribute to negative clinical experiences. The Company believes that when the FlavorFlow(TM) system is utilized to deliver sanitized fluids, the possibility of parasitic (such as potentially lethal cryptosporidium) and 8 bacterial infection being introduced through the fluids used during medical and dental interventions would be significantly reduced. The Company expects that a market for the FlavorFlow(TM) fluid conditioning system will exist only after new standards regarding sanitized fluids are imposed. Canal Finder System(TM). Endodontic procedures (root canals) involve removing ----------------------- pulp and dentin material from the root of the tooth, typically by drilling through the crown of the tooth and inserting flexible micro-files in the tooth canal. The practitioner must file the inside cavity, with ever-increasing size instrumentation, to enlarge the canal and remove debris. Since most human tooth canals are highly curved and conventional files are flat and inflexible, they tend to remove excess dentin material from the inside of curves, while leaving the outside of curves unworked. In addition, conventional files tend to push debris deeper into the canal, rather than pulling out debris, which can lead to the growth of a cyst or granuloma. The Company has developed its patented Canal Finder System(TM) ("CFS") designed to be used in endodontic root canal procedures for locating and shaping root canals. The CFS handpiece embodies a patented automated method that is geared to impart lengthwise vibratory motion to the file, with no rotation. There is a clutch action that allows the file to stop working when too great a resistance is met, so that if a curve is not being negotiated the file will not create its own canal. The clutch action and the non-rotational movement of the file are also designed to minimize the damage resulting from files breaking in the root canal, which often requires extraction of the tooth. The proprietary CFS files are engineered to have a maximized cutting angle on the outside of a curve, and a minimized cutting angle on the inside of a curve, to compensate for a file's natural tendency to straighten canals. The cutting angles of the files are also engineered to cut only on withdrawal, and to migrate debris up and out of the tooth, rather than to compact debris at the base of the canal. CFS files are rounded at the tip to enhance the file's ability to follow a tightly curved canal without forming a ledge or groove. Management believes that the principal advantages of the CFS are, first, that the system is designed to adapt automatically to the resistance placed on the file and, second, the CFS allows root canals to be done substantially faster than other traditional techniques. The CFS allows the dentist to stock fewer instruments, since the CFS can complete a given procedure using fewer files and can facilitate the filing of canals. The Company believes that CFS shapes and cleans root canals better than conventional techniques, thus reducing tooth trauma and providing a more successful root canal procedure with less risk of infection. The CFS, however, is not one of the primary pursuits of the Company. Other Endodontic Products. The Company offers a variety of proprietary and ------------------------- non-proprietary endodontic products used by dentists and endodontic specialists. Proprietary products include an irrigation/washing device, reamers, filling compounds, an endodontic storage and sterilization system, and patented hand- held filing instruments. The Company also distributes a variety of non- proprietary products such as gutta percha and paper points to provide a full endodontic product line for its dental and endodontic customers. The Company has an ongoing development effort, and may develop additional products for which patents may be applied. Acquisition of Laser Skin Toner, Inc. - ------------------------------------- On July 2, 1998, the Company acquired substantially all of the assets of Laser Skin Toner, Inc., a development stage company ("LSTI"). The assets acquired relate primarily to the proprietary laser-based technology being developed by LSTI for non-invasive laser treatment in the field of aesthetic skin rejuvenation, including all intellectual property rights consisting of patents, patent applications, a trademark application and certain know-how. At the time of the acquisition, the intellectual property embodying this developmental effort represented substantially all of LSTI's assets, and the developmental efforts did not appear applicable to any alternative use. As consideration for the assets acquired, the Company issued to LSTI an aggregate 1,600,000 shares of the Company's common stock, including 182,880 shares of common stock retained by the Company pending the achievement by the business of specified performance objectives. Pursuant to a separate agreement, the Company also issued 50,000 shares of its common stock to O'Donnell Eye Centers, Incorporated, a Missouri corporation ("OECI") in consideration for the license of certain technology, the subject of a pending patent application, and a continuation of the basic technology acquired from LSTI. Because the technology licensed from OECI does not appear to have any use apart from the technology acquired from LSTI, the Company did not capitalize the value of its Common Stock issued to OECI in consideration of the license agreement. A valuation of LSTI's in-process research and development effort as of the date of acquisition assigned a value of $5,134,920, the full amount of the consideration paid by the Company in its acquisition of LSTI's assets and the license of the OECI technology, to the in-process research and development. In accordance with Financial Accounting Standards Boards ("FASB") Interpretation No. 4, "Application of FASB No. 2 to Business Combinations Accounted for by the Purchase Method", the $5,134,920 assigned to the in-process research and development effort, for which only the single use existed, was charged to expense on the date of the acquisition. The valuation process included, but was not limited to, an analysis of (i) the estimated costs associated with completing the development of the LSTI technology; (ii) the markets for products based on LSTI's technology; (iii) the anticipated cash flows attributable to the development of the LSTI technology and the products to be based on that technology; and (iv) the risks associated with realizing such cash flows. The forecasts used in valuing the in-process research and development were based on assumptions the Company believed at the time of the LSTI acquisition to be reasonable but which are inherently uncertain. For example, material cash flows were assumed to commence in 1999 and to be realized over a five-year period, based upon the assumed successful development of the LSTI technology and market acceptance of the products to be based on such technology. At the time of acquisition, the Company intended to proceed with those additional research and development efforts necessary to complete development of the LSTI technology and to fund the costs from working capital. In anticipation of and then in response to the clearance it received in October 1998 from the FDA to market its Millennium (TM) tissue cutting system for dental hard tissue applications, the Company shortly after acquiring the LSTI technology decided to focus its limited resources on the marketing of its Millennium (TM) system, including a build-up of inventory and expansion of sales staff. The Company has since determined that it is in the best interests of its stockholders to continue its focus on the marketing and further enhancement of products embodying its HydroKinetic (TM) technology, including its Millennium (TM) system, and not to further develop the LSTI technology. The Company's efforts devoted to the LSTI technology since the date of acquisition have not provided a basis for the Company either to revise or to validate its estimates made at the time of acquisition regarding the time and resources required to complete the development of the LSTI technology. Manufacturing - ------------- The Company, as a medical device manufacturer, is required by the FDA to comply with Good Manufacturing Practice ("GMP") regulations. As a result, the Company's manufacturing 9 processes must meet certain standards regarding quality assurance and documentation. See " - Government Regulation". The Company fabricates certain proprietary components of its products and inspects, tests and packages all components prior to inclusion within a finished product or shipment as a replacement part. By designing and manufacturing key proprietary products, the Company believes it can better control quality, limit outside access to its proprietary technology, control costs and manage manufacturing process changes more efficiently and effectively. During assembly, appropriate steps are taken to maintain quality standardization. Prior to release, the Company's products are submitted to a formal factory acceptance test which must be passed prior to transfer as a finished product. The Company contracts with various non-affiliated companies to manufacture certain components according to the Company's specifications. Substantially all of the Company's products are manufactured in the United States. At present, all products manufactured by third parties are sent to the Company's headquarters in San Clemente, California for quality control, final assembly if necessary, and shipment to customers or distributors. The Company has identified alternate suppliers for most of its components. There are certain key components for which there is a single supplier. The Company is diligently searching for alternative sources for these components. A change in the suppliers of certain system components, however, would require new regulatory approvals and, in particular, could require an amendment to the "CE" mark granted to the Company pursuant to the European Community's Medical Device Directive, which would hamper the Company's ability to distribute its systems in the European countries requiring such an approval. Field service repairs in the United States are currently performed by the Company's direct employee technicians. International field repairs are performed by the corresponding distributor's service technicians who are technically trained by the Company in the servicing of its products. The Company also provides technical assistance and training seminars to its international distributor technicians on an as-needed basis. Engineering and Development - --------------------------- During the years ended December 31, 1998, 1997 and 1996, the Company expended approximately $1,825,000, $1,023,000 and $984,000, respectively, on engineering and development. Such expenditures were directed primarily to development of the Company's HydroKinetic(TM) technology and the design and development of the LazerSmile(TM) tooth whitening system. Competition - ----------- The medical and dental laser marketplaces are extremely competitive, with several wavelengths competing for acceptance and a number of manufacturers competing for sales to that segment of the healthcare community, which is positioned to purchase laser-based products. 10 The Company's principal competitors within the dental field have included American Dental Technology, Inc., a manufacturer of an Nd:YAG laser system, Sunrise Technologies, Inc., a manufacturer of a series of Nd:YAG lasers and a holmium laser, and Luxar Corporation, the manufacturer of a line of CO2 lasers. Presently, the Company's primary competitors in the dental marketplace include Premier Laser Systems, Inc. ("Premier"), the only other company to date that has obtained FDA clearance to market a laser system for dental hard-tissue applications. Premier manufactures Er:YAG, Nd:YAG and distributes argon laser systems. Certain foreign competitors, including Continuum Biomedical (ConBio), a wholly owned subsidiary of Continuum Electro-Optics, Inc., KaVo, Inc. and Fotona, Inc., have developed Er:YAG laser systems and are marketing them inthroughout Europe and the Pacific Rim. ConBio has applied for FDA clearancesOur marketing efforts are focused on increasing brand and specific product awareness among dental practitioners. We recently began efforts to increase awareness of the benefits of our products by marketing directly to patients.

Dental Practitioners. We currently market its Er:YAG laser in the U.S. There may be additional companies seeking FDA clearance for dental hard tissue applications. Several companies, such as HGM, Inc. and LaserMed, Inc. manufacture argonour laser systems typically used for specialized teeth-whitening applications and the curing of various bonding acrylics. The Company believes that its Er,Cr:YSGG HydroKinetic(TM) technology incorporated in its Millennium(TM) system has important advantages in comparisondirectly to the traditional laser technology employed by its competitors for hard-tissue applications, as evidenced by clinical studies indicating that there is no adverse thermal effect associated with the use of the HydroKinetic(TM) technology. The Company is not aware of any other medical or dental laser-based system that can both cutpractitioners through bone, enamel and dentin as effectively as its Millennium(TM) system, and be used efficiently on as wide a range of applications. The Company believes that a wide range of applications is important to provide a sufficient cost justification to the practitioner to support the expenditure related to a purchase of capital equipment. Competition within the aesthetic surgery and oral/maxillofacial fields is intense and technological developments are expected to continue at a rapid pace. Several companies have received clearance from the FDA for various related cosmetic surgical applications for which BioLase intends to compete. The Company has FDA clearance to market its Er,Cr:YSGG system for a broad range of dermatological and general surgical soft tissue applications. The Company's primary competitors in this field include Coherent, Inc., ESC Medical Systems Ltd., ConBio and Aesculap-Meditec which manufacture a variety of CO2 and Er:YAG laser systems. The Company believes that its unique Er,Cr:YSGG system together with the air-water spray will provide an improved histological effect on tissue, such as reduced tissue trauma and faster healing. In addition, the Company believes that the variability offered by its Millennium(TM) system, by adjusting the amount of power and air and water used, provides a more versatile instrument to the practitioner for both hard and soft tissue applications. For example, a practitioner will have the ability to use HydroKinetic(TM) technology for certain cosmetic surgery procedures (e.g., bone, cartilage, and skin reshaping) or change the laser settings and the amount of air and water used during an application, thereby allowing the use of the conventional laser medium to remove the skin surface with less depth of radiation than that typically experienced when using laser systems with wavelengths that differ from that of the BioLase Er,CR:YSGG laser system. A number of the Company's competitors have substantially greater financial resources and engineering, development, manufacturing and marketing capabilities. The Company believes that its patent protection, and pending patent protection, should provide a competitive advantage to the Company over the next several years. However, there can be no assurance that technology superior to that of the Company will not be developed or that the Company's patent and patent-pending protection will be upheld or will prove to have commercial value. See " - Patents and Proprietary Technology". 11 BioLase faces substantial competition in all markets which it seeks to distribute the Millennium(TM) system. Competition in these markets consists of numerous medical laser manufacturers promoting their respective lasers to users via trade show exhibitions, advertisements, product demonstrations, educational workshops, and sales representatives. In addition, the Company will compete against conventional non-laser surgical methodologies and devices such as high and low-speed drills, and air abrasion systems in the dental field and air abrasion, electrosurgery, scalpels, saws, drills and punches in the medical field. Some of these alternative and traditional methods have been proven and tested, require minimal special training for established practitioners, and generally require less capital investment than the Millennium(TM) system. However, the Company believes that users of conventional methods and traditional laser-based methods are continually evaluating new technologies that may provide improved and effective techniques to replace existing technologies. BioLase believes that the Er,Cr:YSGG HydroKinetic system represents a strong candidate to replace existing technologies in various markets. Patents and Proprietary Technology - ---------------------------------- The Company has patented and patent-pending technology related to the Millennium(TM) system and its HydroKinetic(TM) technology. In April, 1998, the U.S. Patent and Trademark Office granted BioLase a patent (U.S. Patent No. 5,741,247) entitled "Atomized Fluid Particles for Electromagnetically Induced Cutting" with broad applicability in dentistry, medicine and various industrial applications. The proprietary technology encompassed within this patent serves as the foundation for BioLase's Er,Cr:YSGG Hydrokinetic(TM) platform. In June 1998, the U.S. Patent and Trademark Office granted BioLase a patent (U.S. Patent No. 5,762,501) entitled "Surgical and Dental Procedures using Laser Radiation" that provides the Company with broader claims related to its proprietary air and water cooling technology (TTCS(TM)), designed to cool the tissue receiving laser energy and adjacent tissue. This patent serves as a continuation of U.S. Patent No. 5,020,995 awarded the Company in June 1991. In July 1998, the Company was awarded a patent (U.S. Patent No. 5,785,521) entitled "Fluid Conditioning System". This proprietary fluid conditioning technology allows the practitioner to simultaneously apply medications, anesthesia, vitamins and flavored fluids during certain dental and medical procedures, thereby eliminating the need for separate, more cumbersome tools while reducing operating time and the risk of infection. The Company intends to incorporate this technology into its FlavorFlow(TM) product that is under development. In 1994, the United States Patent Office granted the Company a patent covering a portable, hand-held laser tooth brushing instrument which was the predecessor to the LazerSmile tooth whitening system. Other patents included within the Company's domestic and foreign patent portfolios consist of awards issued and pending related to the Company's Er,Cr:YSGG HydroKinetic(TM) technology, its LaserSpray(TM), LazerSmile(TM) and FlavorFlow(TM) products, and other proprietary laser technology. The Company also holds a patent on its Canal Finder System(TM) and on certain of its filing instruments. There can be no assurance that the issued patents or subsequent patents, if issued, will adequately protect the Company's technology or that such patents will provide protection against infringement claims by competitors. 12 BioLase also relies upon trade secrets, unpatented proprietary know-how and continuing technological innovation to develop its competitive position. The Company enters into confidentiality and technology agreements with its employees pursuant to which such employees agree to maintain the confidentiality of the Company's proprietary information and to assign to the Company any inventions relating to the Company's business made by them while in the Company's employ. There can be no assurance, however, that others may not acquire or independently develop similar technology or, if patents are not issued with respect to products arising from the Company's engineering and development activities, that the Company will be able to maintain information pertinent to such research as proprietary technology or trade secrets. Marketing - --------- The Company markets its Millennium(TM) system in the U.S. through a direct sales force and Sullivan-Schein, the largest domestic dental distributor. As of year-end 1998, the Company was in the process of significantly expanding its domestic sales force. Internationally, the Company sells its Millennium(TM) through distributors that are trained by the Company in the clinical and service aspects of the related technology. The Company currently distributes its laser-based products in the United States, Western Europe, Middle East and Far East and is actively working to expand its worldwide network through pursuance of qualified and proven distributors. The Company is presently developing aesthetic and dermatologic applications for its Er,Cr:YSGG HydroKinetic(TM) technology. The Company seeks third-party endorsements from respected practitioners, professional associations and universities. By working with selected entities to conduct testing and evaluation, the Company hopes to induce those entities to become influential independent supporters of the Company's products. Management believes that the perceived benefits of the Company's products to practitioners and patients will result in positive word-of-mouth publicity for the Company. The Company attends regional, national and international trade shows 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 2002, we founded the World Clinical Laser Institute to formalize our efforts to educate and train dental practitioners in laser dentistry. The Institute conducts and sponsors educational programs domestically and internationally for dental practitioners, researchers and academicians, including two or three day seminars and training sessions involving in-depth discussions on the use of lasers in dentistry. In addition, we have developed relationships with research institutions, dental schools and clinical laboratories, which use our products in training and demonstrations. We believe these relationships will increase awareness of our products.

Patients. We recently began to promote itsmarket the benefits of our laser systems directly to patients through marketing and advertising programs, including print media and radio spots, sponsored jointly by dental practitioners and us in selected markets that we feel have strong growth potential. We believe that making patients aware of our laser systems and their benefits will increase demand for our products. Health professionals often

Sales

We currently sell our products primarily to dentists in general practice. The majority of the dentists in the United States, as well as the majority of our customers, are sole practitioners. As awareness of our laser systems increases, we expect an increase in demand for our products among group practices. We also expect our laser systems to gain acceptance among oral surgeons and other dental specialists, as they become better aware of the clinical benefits and new treatment options available through use of our laser systems.

International sales account for a significant portion of our revenue. International sales accounted for approximately 23% of our revenue in 2002, 20% of our revenue in 2001 and 41% of our revenue in 2000. Sales in Asia, Pacific Rim countries and Australia accounted for approximately 12% of our revenue in 2002, while sales in

Europe and Canada accounted for 11% and 1% of our 2002 revenue, respectively. In 2001, sales in Europe accounted for approximately 9% of revenue for the year, whereas sales in Asia and Pacific Rim countries accounted for approximately 8% of the revenue. In 2000, sales in Europe accounted for approximately 24% of our revenue for the year, and sales in Asia and Pacific Rim countries accounted for approximately 11% of the revenue for the year.

Direct Sales. We sell products in the United States and Canada through our direct sales force, which is organized by region and consists of two regional managers and approximately 25 sales representatives. Each of our direct sales employees receives a base salary and commissions on sales. We plan to expand our direct sales force in territories that represent growing markets. We sell products in Germany through independent sales representatives who receive commissions on sales.

Distributors. Except for sales in Canada and Germany, we sell products outside the United States primarily through a network of independent distributors located in Europe, Asia and Australia. Generally, our distributors enter into exclusive agreements in which they purchase systems and disposables from us at a wholesale dealer price 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. We have exclusive arrangements with certain distributors for select territories, under which distributors are generally required to satisfy certain minimum purchase requirements to maintain exclusivity. Sales to distributors are generally paid in advance or secured with a letter of credit.

Seasonality. We have experienced a distinct seasonal pattern over the past several years. The fourth quarter, ending December 31, has generally been the strongest quarter, and in 2002 accounted for approximately 30% of our revenue. By contrast, the first quarter is generally the slowest sales quarter and in 2002 accounted for only 18% of 2002 revenue. The second quarter is generally stronger than the first quarter and in 2002 accounted for approximately 27% of our 2002 revenue. The third quarter has generally been flat compared to the second quarter and accounted for approximately 25% of our revenue in 2002. We believe the seasonality demonstrated in the fourth and first quarters is due to the buying patterns of many dentists, including the response to certain tax advantages offered in the United States for capital equipment purchases. We also believe the lack of growth in the third quarter compared to the second quarter is due to general practice patterns in which vacations occur in the third quarter of the year. As a result of this seasonality, our growth metrics compare growth in a quarter to the same quarter in the prior year and is not focused on growth in consecutive quarters which has been and we expect will continue to be skewed by this seasonality effect.

Customer Service. We provide maintenance and support services through our support hotline, service personnel and network of factory-trained service technicians. We provide maintenance and support services in the United States and Germany through our employee service technicians. We train and maintain a network of service technicians trained at our factory locations, who provide maintenance and support services in all other countries where we do business. Our 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 leasing companies or banks. In these transactions, we receive payment in full from the leasing company or bank, or occasionally, from the dentist, who receives funds from the leasing company or bank. We understand the dentist pays the leasing company or bank in installments and we do not bear the credit risk that the dentist might not make payments. The leasing companies and banks do not have recourse to us for a dentist’s failure to make payments. Approximately 36% of our revenue in 2002 was generated from dentists who financed their purchase through National Technology Leasing Corporation, an equipment-leasing broker. National Technology Leasing arranges financing through banks. We have an agreement with National Technology Leasing, which requires us to refer to National Technology Leasing dentists who request a referral to a leasing company. In exchange, National Technology Leasing agreed to publish specific lease rates to be used for lease contracts submitted to it on certain terms and conditions. Additionally, National Technology Leasing has agreed to be available at our trade shows, seminars, symposiums and other sales events, participate in seminarsproduct promotions and otherwise be available to our customers. Our customers are under no obligation to finance the purchase or lease of any equipment through National Technology Leasing and we refer only those customers that request a referral from us. If leasing arrangements were no longer available through National Technology Leasing or the banks with which it deals, we believe our customers would be able to obtain

financing through a variety of other leasing companies or banks that frequently approach us to provide financing for our products.

Research and Product Development

Research and development activities are essential to maintaining and enhancing our business. We believe our research and development team has demonstrated its ability to develop innovative products that meet evolving market needs. Our research and development group consists of 12 individuals with medical device and laser development experience and other relevant backgrounds, the majority of whom have degrees in physics or engineering, including three Ph.D.s. During the years ended December 31, 2002, 2001 and 2000, our research and development expenses were approximately $1.7 million, $1.5 million and $2.3 million, respectively. We intend to focus our research and development activities on improving our existing products and extending our product range in order to provide dental practitioners and patients with less painful and clinically superior laser systems.

Intellectual Property and Proprietary Rights

We rely, in part, on a combination of patents, trademarks, trade secrets, copyright and other intellectual property rights to protect our technology. We have over 60 issued patents and numerous pending patents. More than half of our existing patents were issued in the United States, and the rest were issued in Europe and in some regionsother countries. Our patents are requireddirected to engagethe use of laser and water in continuing certified education regarding advancements in thedentistry, laser energy exciting water, laser characteristics, fluid conditioning, laser accessories, laser technology development and other technologies for dental and medical fields. The Company's marketing strategy adopts the premise that establishing lasersapplications. We have patent applications pending and advanced technology as competitive marketing advantagesplan to apply for practitioners will be important in creating sales growth. It also adopts the premise that the consuming public will come to demand the use of laser-based and HydroKinetic(TM) technologies in medical and dental treatments. The Company accepts the evidence that the public is becoming increasingly aware of the benefits of lasers in dental, ENT, ophthalmological, dermatological, cosmetic and general surgical applications and that the consuming public will be a key factor in increasing demand for laser and HydroKinetic(TM) technologies within the medical and dental professions. The Company isother patents in the processfuture as we develop new technologies. While we hold a variety of marketingpatents covering a broad range of its LazerSmile(TM) tooth whitening system. Distributiontechnologies incorporated in our products, we rely on approximately one half of our patents in particular to protect the LazerSmile(TM) will include marketing through the use of established companies that are experiencedcore technology incorporated in mass market penetration using television and catalogs. 13 Customers - --------- The Company's customers include dentists, distributors, medical doctors and hospitals. With the introduction of the Company's LazerSmile(TM) tooth whiteningour systems, including our Waterlase system, the Company's customer base is expected to extend to consumers as well. During fiscal 1998, two distributors, Sweden & Martina, the Company's Italian distributor, and Ash Temple, the Company's Canadian distributor,which accounted for approximately 20%77% of our revenue in 2002. Four of these patents expire in 2009, and 11%the balances have expiration dates ranging from 2010 to 2015.

We are currently involved in two patent lawsuits related to our Waterlase system with Diodem, LLC, a privately held California limited liability company. In May 2003, we initiated a lawsuit against Diodem, in which we are seeking a judicial declaration that technology in our Waterlase does not infringe four patents owned by Diodem. Diodem was founded by the former chief executive officer of Premier Laser Systems, Inc., respectively,a medical laser company which filed for bankruptcy protection in March 2000. Diodem claims to have acquired the four patents at issue in the case from Premier Laser. Also, in May 2003, Diodem added us as a party to a patent infringement lawsuit it had previously filed. Diodem alleges that the technology in our Waterlase system infringes the four patents it acquired from Premier Laser. Diodem’s suit seeks monetary damages, an injunction and other relief. Both of these lawsuits are in their preliminary stages, and may proceed for an extended period of time. Although the outcome of these actions cannot be determined with certainty, we believe our technology and products do not infringe any valid patent rights owned by Diodem, and we intend to continue to vigorously defend against Diodem’s infringement action and pursue our declaratory relief action against Diodem.

Competition

We compete with a number of companies that market traditional dental products, such as dental drills, as well as other companies that market laser technologies in dental and other medical markets. In the domestic hard tissue dental market, we believe our Waterlase product primarily competes with laser systems manufactured by Hoya ConBio, a subsidiary of Hoya Photonics, a large Japanese manufacturer primarily of optics and crystals, and OpusDent Ltd., a subsidiary of Lumenis, an Israeli company. In the international market, our Waterlase system competes primarily with products manufactured by several other companies, including KaVo, Deka Dental Corporation and Fotona d.d.

The Waterlase system also competes with non-laser based systems, including traditional high and low-speed dental drills and air abrasion systems that are used for dental procedures. Our LaserSmile system competes with other laser systems, as well as with scalpels, scissors and a variety of other cutting tools that have been traditionally used to perform soft tissue procedures. The LaserSmile also competes directly with a number of laser systems manufactured by a variety of companies, including the companies named above. In the market for tooth

whitening, the LaserSmile competes with other products and instruments used by dentists, as well as tooth whitening strips and other over the counter products.

Traditional and commonly used cutting tools are less expensive for performing dental procedures. For example, a high speed drill or an electrosurge device can be purchased for less than $1,000 each. However, we believe our systems offer substantial benefits that outweigh cost concerns. In addition, our systems are not designed to perform certain functions that high speed drills can perform, such as cutting metal fillings and certain polishing and grinding functions. High speed drills will still be needed for these functions, and our systems are not intended to replace all applications of the Company's sales. During fiscal 1997, Orbis High Tech Dental,high speed drill.

We also compete on the Company's German distributor, accounted for approximately 67%basis of proprietary technology, product features, performance, service and reputation. Some of the Company's sales. The Company's previous German distributor, Dental-Fachhandel, accounted for approximately 20% of the Company's sales in 1996. No other customers accounted for moremanufacturers that develop competing laser systems have greater financial, marketing and technical resources than 10% of the Company's sales in 1998, 1997 or 1996. The Company has various distribution agreements requiring minimum purchase commitmentswe do. In addition, some competitors have developed, and others may attempt to develop, products with applications similar to those performed by certain distributors of its Millennium(TM) system. The amount of unfilled orders on hand at December 31, 1998 was not significant. The Company maintains adequate inventories to supply current orders for its products, and no significant amount of backlog exists for such products. our laser systems.

Government Regulation - --------------------- The Company's

Our products are subject to significantregulated as medical devices. Accordingly, our product development, testing, labeling, manufacturing, processes and promotional activities are regulated extensively by government regulationagencies in the United States and other countries. To clinically test,countries in which we market and sell our products. We have clearance from the U.S. Food and Drug Administration, or FDA, to market our laser systems in the United States. We also have the approvals necessary to sell our laser systems in Canada, the European Union and other international markets. We are currently pursuing regulatory approval to market and sell our products in Japan.

United States

In the United States, the FDA regulates the design, manufacture, distribution, quality standards and marketing of medical devices. We have clearance from the FDA to market our Waterlase and LaserSmile systems in the United States for dental procedures on both adult and pediatric patients. In 1998, we received FDA clearance to market the Millennium, the earlier generation of our current Waterlase system, for certain dental hard tissue applications. This clearance allowed us to commence domestic sales and marketing of our technology for hard and soft tissue applications. During 1999 and 2000, to meet the demand for soft-tissue and cosmetic dentistry applications, we designed a semiconductor diode laser system, which is now marketed as our LaserSmile system. We received FDA clearance to market the system for a variety of soft-tissue medical applications in September 1999. In 2001, we received FDA clearance to market the LaserSmile system for cosmetic tooth whitening.

In 2002 and 2003, our Waterlase system became the first laser system to receive FDA clearance for three new types of procedures. In 2002, we received clearance to market the Waterlase system for root canal, encompassing all four of the fundamental steps of the procedure. We also received clearance in 2002 to market this system for cutting, shaving, contouring and resection of oral osseous tissues, or bone. In January 2003, we received FDA clearance to market the Waterlase for use in apicoectomy surgery, a procedure for root canal infections and complications that includes cutting gum, bone (to access the infected area) and the apex of the tooth to access the infected area. The clearance also relates to flap surgical procedures. Flaps are frequently performed in conjunction with many procedures, including periodontal, implant placement and recovery, extraction of wisdom teeth, exposure of impacted teeth for orthodontics as well as additional procedures.

Our newly acquired Diolase system received FDA clearances in 1997 to be marketed for a variety of soft tissue dental applications. FDA clearances were issued in 1994 to market the Pulsemaster system for a number of soft tissue procedures. We are in the process of transferring those clearances to our company.

As we develop new products and applications or make any significant modifications to our existing products, we will need to obtain the regulatory approvals necessary to market such products for human diagnosticdental, cosmetic and therapeutic use, the Company must comply with mandatory regulations and safety standards established by the FDA and comparable state and foreign regulatory agencies. Typically, products must meet regulatory standards as safe and effective for their intended use prior to being marketed for human applications. The clearance process is expensive and time consuming, and no assurance can be given that any agency will grant additional clearance for the sale of the Company's products for routine clinical applications, that the length of time the process will require will not be extensive, or that the cost of the process will not be substantial.other medical procedures in our target markets. There are two principal methods by which FDA regulated devices may be marketed in the United States. One method is under a Pre-Market Approval ("PMA").States: pre-market approval, or PMA, and 510(k) clearance. A PMA application is required for a Class III medical device that does not qualify for consideration under Sectionfor 510(k), discussed below. clearance. The review period for a PMA

application is fixed at 180 days, but the FDA typically takes much longer to complete itsthe review. As part of the approval of a PMA application, the FDA typically requires human clinical testing to determine safety and efficacy of the device. To conduct human clinical testing, typically the FDA must approve an Investigational Device Exemption, ("IDE"). Currently, the Company does notor an IDE. To date, none of our products have required a PMA applications pending for any of its products. The other method is under Sectionapplication.

To obtain 510(k) of the Food, Drug and Cosmetics Act where applicantsclearance, we must demonstrate that theour device for which clearance is sought is substantially equivalent to a previously cleared 510(k) device or other appropriate predicate device. The FDA'sFDA’s stated intention is to review 510(k) notifications as quickly as possible, generally within 90 days; however,days. However, the complexity of a submission or a requirement for additional information will typically extend the review period beyond 90 days. Domestic marketing of the product must be deferred until clearance is received by the applicant from the FDA. In some instances, an IDE is required for clinical trials for a 510(k) notification. 14 In the event thatclearance. If a request for 510(k) notificationclearance is turned down by the FDA, then a PMA is generally thenmay be required. The Company intendsWe intend to utilize the 510(k) notification procedure whenever applicable. In October 1998, the Company received its long-awaited FDA clearancepossible. To date, all of our products that have been subject to market the Millennium(TM) system, which incorporates the Company's proprietary Er,Cr:YSGG HydroKinetic(TM) technology, for certain dental hard tissue applications. The hard tissue clearance allowed the Company to commence sales and marketing domestically of its Millennium(TM) system for hard tissue applications during the fourth quarter of 1998. In July 1997, the Company received FDA clearance to market a laser system, incorporating the Company's Er,Cr:YSGG HydroKinetic(TM) technology, for a broad range of dermatological and general surgical soft tissue applications. The Company also received clearance fromregulation by the FDA have qualified for 510(k) clearance.

After a device receives 510(k) clearance, any modification that could significantly affect its LaserSpray(TM) tissue cooling systemsafety or effectiveness, or that would constitute a major change in 1995.its intended use, will require a new 510(k) clearance, or could even require a PMA application. The Company expectsFDA requires each manufacturer to pursue clearances to market its Er,Cr:YSGG HydroKinetic(TM) systems for other medical applications. The Company completed clinical studies in the U.S. related to certain hard tissue dental applications of its HydroKinetic(TM) technology that are on file withmake this determination initially, but the FDA in connectioncan review any such decision and can disagree with a manufacturer’s determination. If the Company's submission of itsFDA disagrees with a manufacturer’s determination, the FDA can require the manufacturer to cease marketing and/or recall the modified device until 510(k) application. Such data was the basis for the Company's successful clearance to market such technology in the U.S. for certain dental hard tissue applications. During 1996, the Company obtained clearance to market its Millennium(TM) system in Germany for various dental applications based upon clinical studies in Germany for both soft and hard tissue applications. or a PMA is obtained.

The FDA also imposes various requirements on manufacturers and sellers of products it regulates under its jurisdiction, such as labeling, manufacturing practices, record keeping and reporting. The FDA also may require post- marketingpost-marketing practices, record keeping and reporting requirements. There can be no assurance that additional approvals from

We also are subject to unannounced inspections by the FDA will be granted, thatfor both the process to obtain such approvals will not be expensive or lengthy, or thatU.S. and BIOLASE Europe offices, and the Company will have sufficient funds to pursue such approvals. The failure to receive requisite approvals for the Company's products or processes, whenFood and if developed, or significant delays in obtaining such additional approvals, could prevent the Company from commercializing its products as anticipated and could have a materially adverse effect on the financial condition, results of operations, cash flows and prospectsDrug Branch of the Company. The following table sets forthCalifornia Department of Health Services, and these inspections may include the statusmanufacturing facilities of FDA clearance of the Company's principal products:
- -------------------------------------------------------------------------------------------------------------- Product Market Date Cleared Status Millennium(TM) Dental October 8, 1998 Cleared To Market DermaLase(TM) Dermatology, General Surgery July 18, 1997 Cleared To Market LazerSmile(TM) Tooth Whitening N/A Clearance Not Required CanalFinder(TM) Endodontic Instrumentation N/A Clearance Not Required FlavorFlow(TM) Dental Fluid Conditioning N/A Application Not Yet Submitted - --------------------------------------------------------------------------------------------------------------
15 The Company isour subcontractors.

We are also subject to regulation under the Radiation Control for Safety and Health Act of 1968, (the "Safety Act")or the Safety Act, administered by the Center for Devices and Radiological Health, ("CDRH")or CDRH, of the FDA. The CDRH controls energy emissions of light and sound and electronic waves from electronic products. These regulations require a laser manufacturer to file new product and annual reports, to maintain quality control, product testing and sales records, to distribute appropriate operation manuals, to incorporate certain design and operating features in lasers sold to end-users and to certify and label each laser sold to end-users as one of four classes of lasers (basedbased on the level of radiation from the laser).laser. In addition, various warning labels must be affixed to the product and certain protective devices must be installed, depending upon the class of product. Under the Safety Act, the Company iswe are also required to register with the FDA as a medical device manufacturer and isare subject to inspection on a routine basis by the FDA for compliance with Good Manufacturing Practice, ("GMP")or GMP, regulations. The GMP regulations impose certain procedural and documentation requirements upon the Companyus relevant to itsour manufacturing, testing and quality control activities. We believe both of our facilities comply with the GMP guidelines. The CDRH is empowered to seek remedies for violations of these regulatory requirements under the Federal Food, Drug and Cosmetic Act. The Company believesWe believe that it iswe are currently in substantial compliance with these regulations.

Various state dental boards are considering the adoption of restrictions on the use of lasers by dental hygienists. Approximately 30 states currently allow dental hygienists to use lasers to perform certain dental procedures. In addition, dental boards in a number of states are considering educational requirements regarding the use of dental lasers. The scope of these restrictions and educational requirements is not now known, and they could have an adverse effect on sales of our laser-based products.

Failure to comply with applicable regulatory requirements can result in an enforcement action by the Company's laser- based products. FDA, which may include any of the following sanctions:

fines, injuctions and civil penalties;

recall or seizure of our products;

operating restrictions, partial suspension or total shutdown of production;

refusing our request for 510(k) clearance or PMA approval of new products;

withdrawing 510(k) clearance or PMA approvals that are already granted; and

criminal prosecution.

International

Foreign sales of the Company'sour laser-based products are subject to the regulatory requirements of the importingforeign country or, if applicable, the harmonized standards of the European Community.Union. These regulatory requirements vary widely among the countries and may include technical approvals, such as electrical safety, as well as demonstration of clinical efficacy. The Company isWe have a CE Mark for our Waterlase and LaserSmile systems, which permits us to commercially distribute these systems throughout the European Union. We rely on export certifications from the FDA to comply with certain regulatory requirements in several foreign jurisdictions, such as New Zealand, Canada and countries in Western Europe. We also received clearance to market our Waterlase and LaserSmile systems in Canada and Australia for a variety of applications. We are currently working to meet certain foreign country regulatory requirements for certain of itsour products, and thereincluding Japan. There can be no assurance that additional approvals in Japan or elsewhere will be obtained. The Millennium(TM) system has been granted

Other Regulatory Requirements

In addition to the "CE" mark evidencing compliance with quality,regulatory framework for product clearances and approvals, we are subject to extensive and frequently changing regulations under many other laws administered by U.S. and foreign governmental agencies on the national, state and local levels, including requirements regarding occupational health and safety and performance requirements mandatedthe use, handling and disposing of toxic or hazardous substances.

Third Party Reimbursement

Many procedures performed with our laser systems are covered by insurance to the Medical Device Directive adoptedsame extent as they would be if performed using traditional dental instruments. Most therapeutic procedures performed with our laser systems are reimbursable to a certain extent under dental insurance plans, whereas cosmetic procedures are not. International market acceptance for our products may depend, in part, on the availability of reimbursement within prevailing health care payment systems. Reimbursement and health care payment systems in international markets vary significantly by the European Community. The Medical Device Directive is the latest standardcountry, and include both government-sponsored health care and private insurance.

Employees

At August 31, 2003, we had 135 full-time employees, including 11 employees in our German facility. This represents an increase of medical device safety and performance which has been adopted by the fourteen member states of the European Community and requires that all medical device products be compliant to be eligible for marketing within the member states. The Millennium(TM) system has also been granted the Canadian Standards Association ("CSA") mark symbolizing compliance with certain safety and performance standards. The CSA mark allows the Company to import and market its Millennium(TM) system in Canada. The Company has not filed applications for regulatory approval with the Japanese Ministry of Health and Welfare for any of its products, but is developing clinical data in preparation for said application for the Millennium(TM) system. 16 The FDA and other governmental agencies, both in the United States and in foreign countries, may adopt additional rules and regulations that may affect the Company's ability to develop and market its products. There can be no assurances that the Company's existing products will meet any future legislative acts26 employees or requirements. Employees - --------- As of March 31, 1999, the Company employed 61 people on24% from 109 employees a full-time basis, consisting of 36 people in engineering/development/manufacturing, 8 in administration and 17 in sales/customer service. The Company'syear ago. Our employees are not represented by a labor union,any collective bargaining agreement and it has experienced no work stoppage. The Company believes that itswe believe our employee relations are good. 17 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results

Available Information

Copies of Operations - 1998 as Comparedour Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to 1997 Sales for 1998 were $1,465,000, comparedthose reports filed or furnished pursuant to $1,786,000 reported in 1997. The decrease in sales reflects primarily a decrease in shipmentsSection 13(a) or 15(d) of the Company's laser-based HydroKinetic(TM) systems duringSecurities Exchange Act of 1934 are available free of charge through our Web site (www.biolase.com) as soon as reasonably practicable after we electronically file the first nine months of 1998 due principallymaterial with, or furnish it to, the Securities and Exchange Commission. Refer to the Introductory Note for previously filed financial statements which should not be relied upon.

Item 3.Legal Proceedings

On October 31, 2002, we filed a reductionlawsuit in the Company's export sales during 1998, down approximately $709,000 from those reported in 1997. The reduction in export salesU. S. District Court for the Central District of California, Southern Division, against American Medical Technologies, Inc. (“AMT”). In the lawsuit, we alleged that AMT was due primarily to a decrease in salesinfringing certain patents we own, which relate to the Company's German distributor which had beenuse of laser technology in the most significant customer for Millennium(TM) systems in 1997. The German distributor requested a deferralmedical and dental fields. Our claims arose out of Millennium(TM) systems pending a partial redesign of the hand pieceAMT’s offer to address more effectively the requirements of the German market. The decrease was partially offset by an increase in sales during 1998 of $455,000 in aggregate to the Company's new Italiansell and Canadian distributors. The Company expects that completion of the hand piece redesign effort and the successful testing of the redesigned hand piece will result in a resumption of sales to the German market and further increase sales to other countries within the European community. The United States Food and Drug Administration ("FDA") in October 1998 granted clearance to the Company to market the Millennium(TM) systemsale in the United States for certain dental hard tissue applications. The FDA had previously granted clearance for the marketing of Millennium(TM) for certain soft tissue applications. The October 1998 action by the FDA has permitted the Company to commence active marketing of the Millennium(TM) system in the United States. Sales for December 1998 were $777,000, attributable primarily to sales of Millennium(TM) systems. This represents a dramatic increase over sales for October and November, bringing total 1998 fourth quarter sales to $879,000. Increased sales during December 1998 are attributable to initial domestic market acceptance of the Millennium(TM), more aggressive marketing through the Company's expanded domestic sales force and the addition of new international distributors. The Company expects that this level of increased sales will continue into 1999. Commencing June 1997, sales of Millennium(TM) systems replaced sales of an earlier generation of laser system which had been phased out by early 1997 and are currently not being sold or marketed by the Company. In August 1998, the Company introduced its first consumer product, the LazerSmile(TM) Tooth Whitening System, which utilizes a monochromatic optical energy light source embedded within a toothbrush in conjunction with a clear, non-abrasive tooth whitening gel. The Company recognized a nominal amount of revenue from LazerSmile(TM) test marketing in 1998. The Company is attempting to establish marketing and distribution alliances with third parties to effect the distribution of LazerSmile(TM). These alliances could include arrangements involving television shopping channels, specialty catalogs and traditional distribution arrangements. No assurances can be given that the Company will be successful in establishing these alliances or that, if they are established, they will result in the successful commercialization of LazerSmile(TM). The laser division represents management's primary focus. Laser division operating results are regularly reviewed by the Company's management in order to assess resources to be allocated and to assess overall performance. This division includes all of the Company's core technologies, research and development expenditures and substantially all operating activity. Management devotes substantially less time to the Endodontic division. The Company maintains the division primarily as an ancillary business to service recurring customers. Revenues from this division have been steadily declining, inventory balances are decreasing and management has no expansion plans for this division. Gross profits were $47,000, or 3% of net sales, in 1998, compared to $259,000, or 15% of net sales, in 1997. The Company's laser division reported a gross loss of $86,000 on net sales of $1,202,000 in 1998, compared to a gross profit of $79,000 on net sales of $1,398,000 in 1997. The decrease in gross profits in 1998 was due principally to production inefficiencies brought about by the delay in receipt of the anticipated FDA hard tissue clearance coupled with ongoing product development. Gross profit margins attributable to the Millennium(TM) were still below desired levels in 1998 and remain below desired levels into 1999. 18 The Company expects to realize improved margins on its Millennium(TM) sales during 1999 through improved production layouts, other production efficiencies and lower cost of materials. Gross profit in 1997 was adversely affected by a $164,000 increase in the inventory reserve related to the termination of the active marketing of the Company's prior generation of laser-based systems. The Company's endodontic division reported gross profits in 1998 of $133,000, compared to $180,000 in 1997. Operating expenses, net of write off of purchased research and development costs, increased $1,976,000, or 61%, to $5,234,000 in 1998, compared to $3,258,000 in 1997. Sales and marketing expenses increased $674,000, to $1,629,000 in 1998, compared to $955,000 reported in 1997. The increase was due mainly to greater participation by the Company at various dermatological and dental trade shows, payroll and other costs associated with the Company's establishment of a domestic sales force, its continued pursuitdental device that uses laser and water technology. We were seeking an award of qualified international distributors,monetary damages and injunctive relief against AMT. We settled the initial sales efforts associated with the introduction of LazerSmile(TM). General and administrative expenses increased $500,000, to $1,780,000lawsuit in 1998, compared to $1,280,000 reported in 1997. This change was primarily a result of increased expenses associated with advertising and promotion of the Company through various publications and investor forums, public relation announcements associated with the Company's products and regulatory clearances, and increases in employee related expenses associated with increased staffing and additions to management. Engineering and development expenses reported in 1998 were $1,825,000, compared to $1,023,000 reported in 1997. The increase relates principally to costs associated with the 1998 redesign of the Millennium(TM) hand piece, enhancements to the existing Millennium(TM) configuration and the finalization of the design of LazerSmile(TM) in anticipation of its product launch. In connection with the acquisition of Laser Skin Toner Inc.("LSTI"), the Company allocated the $5,135,000 purchase price to incomplete research and development. This allocation represents the estimated fair value based on cash flows estimated at the time of acquisition. The Company's management had the responsibility for estimating the fair value of the purchased in-process research and development ("IPR&D"). The value ascribed to IPR&D reflected the asset's completion percentage estimated at the time of acquisition of approximately 50%. At the acquisition date, the development of the LSTI technology had not reached technological feasibility, and the research and development in progress had no alternative future uses. Accordingly, these costs were expensed as of the acquisition date. The value assigned to the LSTI IPR&D was determined by identifying significant research elements for which technological feasibility had not been established. In the case of LSTI, these included the development, prototyping, and testing activities associated with the creation of a proprietary laser-based skin resurfacing system, which is a new laser system for the field of aesthetic skin rejuvenation. Valuation of development efforts in the future has been excluded from the appraisal of IPR&D. The nature of the efforts to develop the acquired IPR&D into a technologically and commercially viable product relates to the completion of all planning, designing, prototyping, and FDA approval activities that are necessary to establish that the proposed technologies meet their design specifications including functional, technical, and economic performance requirements. The value assigned to purchased IPR&D was determined by estimating the contribution of the purchased in-process technology in developing a viable product, estimating the expected net cash flows from the expected sales of 19 such a product, and discounting the estimated net cash flows to their present value using an appropriate discount rate. Revenue growth rates for LSTI were estimated as of the date of acquisition based on a detailed forecast prepared at that time by management of the Company and LSTI. Estimated revenue growth rates beyond 2001 were based on industry growth expectations. Allocation of total projected LSTI revenues to IPR&D was based on an analysis by the management of the Company and LSTI made as of the date of acquisition. All future revenue projected to be generated by the LSTI technology was expected to originate from the sale of products that were not yet completed. One of the significant risks associated with realizing forecasted revenues is the successful completion of the acquired R&D projects which, as of the acquisition date, had not reached technological feasibility. Operating profit projections were based upon estimates of (i) cost of goods sold, (ii) R&D expenses, and (iii) selling, general and administrative expenses. Cost of goods sold was projected at the date of acquisition to be approximately 31%, 26%, and 25% of revenues for 1999, 2000 and 2001, respectively. For R&D expenses, projections were based on the costs estimated to be necessary to complete the acquired elements and totaled approximately $2 million. R&D expense for 1999 was forecast at the time of acquisition at approximately 15% of 1999 revenues. R&D expense was forecast to decrease as a percent of revenues through 2001 to approximately 10% and was expected to remain constant thereafter throughout the projection period. Selling, general and administrative expenses were projected at the time of acquisition at 50% of revenues in 1999, and were expected to decrease to approximately 40% of revenue thereafter. These estimates of revenue and expense, made at the time of acquisition, would have provided an estimated pretax margin of approximately 4% in 1999, which was estimated to increase to approximately 25% in 2002. These profitability estimates were compared to reported results of similar public companies and were determined to be reasonable. Since LSTI was a development stage enterprise, the Company did not, at the time of acquisition, anticipate any expense reductions or other synergies as a result of the acquisition. Since the skin resurfacing market would be a new market for BioLase historical margins were not considered. The projections utilized in the transaction pricing and purchase price allocation analysis exclude the potential synergistic benefits related specifically to the Company's ownership. The rates utilized to discount the estimated net cash flows to their present value were based on venture capital rates of return. Due to the nature of the forecast and the risks associated with completion of the development project and the projections made at the time of acquisition regarding profitability and growth, a discount rate of 50% was deemed appropriate for the IPR&D. This discount rate was consistent with the stage of development for the LSTI technology; the uncertainties in the economic estimates described above; the inherent uncertainty at the time of the acquisition surrounding the successful development of the purchased in-process technology; the expected useful life of such technology; the estimated profitability levels of such technology; and, the inherent uncertainties of the technological advances that were indeterminable at the time of the acquisition. The forecasts used in valuing the IPR&D were based upon assumptions the Company believed to be reasonable at the time of the acquisition but which were inherently uncertain and unpredictable. For this reason, actual results may vary from projected results. In addition, all of the assumptions are interrelated; therefore they are all equally important. In the event the Company fails to complete the development of the LSTI technology, the revenues and profits estimated at the time of acquisition with respect to the IPR&D would not be realized by the Company. Commercial results will also be subject to uncertain market events and risks, which are beyond the Company's control, such as trends in technology, government regulations, market size and growth, product introduction or other actions by competitors and other factors. The in-process laser system technology acquired by the Company from LSTI consists of six critical components: (1) a coupling system; (2) a pneumatic control system; (3) a distal end; (4) packaging/cabinetry; (5) a pharmaceutical membrane; and (6) FDA clearance. Each of these components were estimated to require additional research and development efforts, as set forth below: Coupling System. The coupling system involves integration of the ---------------- laser receptacle, proximal end of the fiber, the fiber and jacket, the hand piece and the wand of the laser system, and allows the transfer of power through each phase of the laser. The transfer of power from the laser to the fiber delivery system and ultimately to the device that touches the patient's face (the distal end) involves linking different technologies; it also requires further development of the LSTI "SmartConnect" technology, which is intended to assure the appropriate therapeutic dose of laser energy and to monitor skin contraction during the procedure. Management had estimated at the time of acquisition that this component was less than 50% complete and would require the efforts of two mechanical engineers and one electrical engineer for three months, estimated at a cost of $70,000, to bring it to the production phase. In addition, the Company estimated at the time of acquisition that it would be required to incur $350,000 of non- recurring engineering fees for an original equipment manufacturer to provide the customized power source for the laser. Pneumatic Control System. The pneumatic control system is intended to ------------------------ ensure that the laser does not burn the patient. It is a cooling mechanism using a pressure system to maintain the correct temperature through a pump and fiber interface, and requires interaction with the laser, fiber and distal end. Steps remaining at the time of acquisition to complete this component included the selection of a suitable compressed air system, estimated at $30,000, and design and test of the pump and fiber interface. The Company estimated at the time of acquisition that approximately two engineers would be required to work on this project for three months at an estimated cost of $81,000. Distal End. The distal end of the laser system will provide the ----------- surgeon with control while housing all of the electronics needed to deliver the correct amount of power and pulse duration. At the time of acquisition, it was contemplated that the laser system would initially include three distal ends, each tailored for different sized wrinkles located on different parts of the body. At that time, it was also anticipated that three additional distal ends would be made available in the second half of 1999. Management of the Company had estimated at the time of acquisition that development of the distal end was then less than 40% complete. Completion of the initial three distal ends was estimated at the time of acquisition to require the efforts of two optical engineers for approximately three months, with an additional four months required for the remaining three distal ends. Estimated costs to complete this portion of the project were estimated at the time of acquisition to be $138,000. Packaging/Cabinetry. The packaging/cabinetry of the laser will -------------------- provide the housing or outer surface for the entire system. This housing can be quite elaborate and may be comprised of different types of metal or plastic. Management believes that this component of the system is the only one that will not require the development of technology in order to complete; however, the design of the packaging/cabinetry is required to ensure an efficient, aesthetically pleasing medical devise for the practitioner. The Company estimated at the time of acquisition that completion of this portion of the project would require the efforts of two engineers for approximately ten and one-half months at an estimated cost of $259,000. Pharmaceutical Membrane. LSTI contemplated that pharmaceutical ------------------------ membranes would be applied to the patient for a 90-day period after the resurfacing procedure. The membranes would carry an active pharmaceutical agent employing a specific concentration, mix and delivery of an anti- inflammatory agent, various anti-oxidants and a neo-collagen-promoting agent. At the time of the acquisition, the pharmaceutical membrane was in the initial phase of development. Significant tasks remaining at the time of acquisition included integration of the chemicals and membrane material, which had never before been accomplished, and design, development and integration of a time release system to be incorporated with the membrane system. Non-recurring engineering related the membranes was estimated at the time of acquisition to cost approximately $350,000 to $450,000, with an additional $50,000 to $75,000 for each of four clinical trials then expected. Management estimated at the time of acquisition that completion of this portion of the project would require approximately seven and one- half months of full-time effort by one engineer at an estimated cost of $40,000. FDA Clearance. The completed laser system must go through two FDA -------------- approval processes, one of which was subsequently received following theour acquisition of the LSTI technology. The remaining process was estimated atAmerican Dental Laser product line from AMT in May 2003.

We are currently involved in two related patent lawsuits with Diodem, LLC, a California limited liability company. On May 2, 2003, we initiated a civil action in the date of acquisition to require approximately four to six months of data gathering prior to submission to the FDA for approval. The costs estimatedU.S. District Court for the approval process remainingCentral District of California against Diodem. In this lawsuit we are seeking a judicial declaration against Diodem that technology we use in our laser systems does not infringe four patents owned by Diodem. Diodem was founded by Collete Cozean, the former chief executive officer of Premier Laser Systems, Inc., a medical laser company which filed for bankruptcy protection in March 2000. Diodem claims to have acquired the four patents at issue in the date of acquisition were $312,000. The Company estimated at the time of acquisition that the additional research and development effort required to complete the LSTI technology would cost approximately $2,000,000 and would take approximately nine months of concentrated effort. At the time of acquisition, the Company intended to proceed with those additional research and development efforts promptlycase from Premier Laser. In 2000 we initiated a patent infringement lawsuit against Premier Laser seeking damages and to fund the costsprevent Premier from working capital. In anticipation of and then in response to the clearance it received in October 1998 from the FDA to market its Millennium(TM) tissue cutting system forselling competing dental hard tissue applications, the Company shortly after acquiring the LSTI technology decided to focus its limited resourceslasers on the marketinggrounds that they infringed on certain of its Millennium(TM) system, including a build-up of inventory and expansion of sales staff.our patents. The Company continuedlawsuit was stayed by the clinical trials related to the LSTI technology, while other research and development efforts required to complete and commercialize the LSTI technology were largely deferred. The Company has since determined that it is in the best interests of its stockholders to continue its focus on the marketing and further enhancement of products embodying its HydroKinetic(TM) (technology, including its Millennium(TM) system, and not to further develop the LSTI technology. The Company's efforts devoted to the LSTI technology since the date of acquisition have not provided a basisbankruptcy court after Premier filed for the Company either to revise or to validate its estimates made at the time of acquisition regarding the time and resources required to complete the development of the LSTI technology. 20 Interest income decreased $126,000, to $58,000 in 1998, compared to $184,000 in 1997. This decrease reflects lower 1998 average balances of cash, cash equivalents and interest-bearing marketable securities. Interest expense increased $73,000, to $82,000 in 1998, compared to $9,000 in 1997, due to the existence of borrowings under a line of credit during the entire 1998 period as compared to only one month during 1997. Results of Operations - 1997 as Compared to 1996 Sales for 1997 were $1,786,000, compared to $692,000 reported in 1996, an increase of $1,094,000, or 158%. The increase was primarily due to the laser division's shipments of the Company's new HydroKinetic(TM) tissue cutting system, the Millennium(TM) to the Company's German distributor. The Company's endodontic division reported sales of $388,000 in 1997 compared to sales of $402,000 in 1996. In July 1997, the Company received clearance from the FDA to market in the United States a laser-based surgical tissue cutting system that utilizes a variation of the Millennium(TM) technology for a broad range of dermatological and general surgical soft tissue applications. bankruptcy.

In response to our lawsuit against Diodem, on May 5, 2003, Diodem added us as a party to an infringement lawsuit it had previously filed in the U.S. District Court for the Central District of California. The other parties to this clearance,lawsuit are American Medical Technologies, Inc., Lumenis and its subsidiary OpusDent, Ltd., and Hoya Photonics and its subsidiary Hoya ConBio. OpusDent and Hoya ConBio manufacture and sell dental lasers pursuant to patents originally licensed to them by American Medical Technologies. We acquired the Company intendslicensed patents and related license agreements in our acquisition of the American Dental Laser product line from American Medical Technologies. Diodem’s lawsuit relates both to introduceour Waterlase and to the domestic market a laser-based systempatents and licenses we acquired from American Medical Technologies. Diodem alleges that technology used in a configurationour Waterlase infringes the four patents it acquired from Premier Laser. Diodem also alleges that is designed for lower power settings than those of the Millennium(TM) system. The Company is presently developing its marketing plan for such a systemproducts sold by OpusDent and expects it to begin to contribute to sales late in 1999. Gross profits were $259,000, or 15% of net sales in 1997, compared to $133,000, or 19% of net sales in 1996. The Company's laser division reported a gross profit of $79,000 on net sales of $1,398,000 in 1997, compared to a gross loss of $89,000 on net sales of $290,000 in 1996. Gross profit margins attributableHoya ConBio pursuant to the Millennium(TM) are still below desired levels. The continued designlicenses we acquired from American Medical Technologies infringe on the patents Diodem acquired from Premier Laser. Diodem’s infringement suit seeks treble damages, a preliminary and manufacturing of various test and production fixtures contributed to the manufacturing inefficiencies experienced during the year. Additionally, gross profit in 1997 was affected by an increase in the inventory reserve related to the Company's prior generation 21 Nylad(TM) laser-based systems of $164,000. The Company's endodontic division reported gross profits in 1997 of $180,000, compared to $222,000 in 1996. Operating expenses increased $636,000, or 24%, to $3,258,000 in 1997, compared to $2,622,000 in 1996. Sales and marketing expenses increased $336,000, to $955,000 in 1997, compared to $619,000 reported in 1996. The increase was due mainly to greater participation by the Company at various dermatological and dental trade shows, payrollpermanent injunction from further alleged infringement, attorneys’ fees and other costs associatedunspecified damages. Both of these lawsuits are in their preliminary stages, and may proceed for an extended period of time.

Although the outcome of these actions cannot be determined with certainty, we believe our technology and products do not infringe any valid patent rights owned by Diodem, and we intend to continue to vigorously defend against Diodem’s infringement action and pursue our declaratory relief action against Diodem.

We are not currently subject to any other material pending or threatened legal proceedings.

PART II

Item 6.Selected Consolidated Financial Data

The following table sets forth selected consolidated financial data for the periods presented. You should read this data along with our Consolidated Financial Statements and related Notes contained elsewhere in this report and in our subsequent reports filed with the Company's establishmentSEC, as well as the section of a domestic sales forcethis report and its continued pursuitour other reports entitled “Management’s Discussion and Analysis of qualified international distributors. GeneralFinancial Condition and administrative expenses increased $262,000, to $1,280,000 in 1997, compared to $1,018,000 reported in 1996. This change was due principally to increases in: (i) a chargeResults of $123,000 related to common stock issued in connectionOperations.”

   Years Ended December 31,

 
   2002

  2001

  2000

  1999

  1998

 
   (Restated) (2)

       
   (in thousands, except per share data) 

Consolidated Statements of Operations Data:

                     

Net sales

  $27,257  $16,546  $9,495  $7,004  $1,465 

Gross profit

   16,772   9,608   4,679   2,852   47 

Operating expenses (1)

   15,423   10,845   8,340   7,601   10,369 

Income (loss) from operations

   1,412   (1,158)  (3,661)  (4,749)  (10,322)

Cumulative effect of change in accounting principle

   —     —     (34)  —     —   

Net income (loss)

   1,498   (1,281)  (3,789)  (4,798)  (10,346)

Cumulative effect of change in accounting principle per share:

                     

Basic

   —     —     0.00   —     —   

Diluted

   —     —     0.00   —     —   

Net income (loss) per share:

                     

Basic

   0.08   (0.07)  (0.20)  (0.28)  (0.69)

Diluted

   0.07   (0.07)  (0.20)  (0.28)  (0.69)

Shares used in computing net income (loss) per share:

                     

Basic

   19,929   19,510   19,171   17,254   15,062 

Diluted

   21,303   19,510   19,171   17,254   15,062 
   December 31,

 
   2002

  2001

  2000

  1999

  1998

 
   (Restated) (2)

       
   (in thousands) 

Consolidated Balance Sheet Data:

                     

Working capital

  $1,418  $201  $(268) $(1,331) $89 

Total assets

   16,003   8,253   6,822   2,672   3,911 

Long-term liabilities

   142   205   1,175   —       —   

Stockholders’ equity (deficit)

   3,121   645   994   (939)  662 

(1)In 1998, there was a $5.1 million write-off of in-process research and development costs related to the purchase of the assets of Laser Skin Toner, Inc.

(2)See Management’s Discussion and Analysis of Financial Condition and Results of Operations under Restatement of Financial Statements.

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

The following discussion of our results of operations and financial condition should be read together with the Company obtaining a $2,500,000 credit facility forconsolidated financial statements and the financing of inventories, (ii) costs relatednotes to domesticthose statements included elsewhere in this report. This discussion may contain forward-looking statements that involve risks and foreign patents and patent applications, (iii) legal costs related primarily to regulatory, contractual and international matters, (iv) public relations costs incurred by promotion ofuncertainties. Our actual results could differ materially from the Company through various publications and investor forums, and (v) a $96,000 increaseresults anticipated in the provision for bad debtany forward-looking statements as a result of a bank claiming technical defectsvariety of factors, including those discussed in documentation“Risk Factors” and thereby refusingelsewhere in this report.

Restatement of Financial Statements

Staff Accounting Bulletin No. 101 (“SAB 101”), Revenue Recognition in Financial Statements, requires the transfer of title and the risks and rewards of ownership to honor a letterthe customer prior to the recognition of creditrevenue. We originally prepared our financial statements on the basis that this transfer of title occurred upon shipment. Subsequent to the issuance of our consolidated financial statements as of and for goods shipped to a foreign customer. The Company has recently filed a complaint against the foreign customer in the United States District Court for various claims including collection of the $96,000 debt. Engineering and development expenses reported in 1997 were $1,023,000, compared to $984,000 reported in 1996. The moderate increase in these expenses related primarily to costs incurredyear ended December 31, 2002, it was determined, with respect to clinical studies utilizing the Company's HydroKinetic(TM) technology in its effortsales to obtain clearance by the FDA to market the Millennium(TM) system for certain dental hard tissue applications and final development costs related to the Company's LazerSmile(TM). These 1997 year costs were partially offset by a reduction in 1997 project design costs related to the Millennium(TM) system as the present version was placed into production during the second quarterdomestic customers, that title transferred upon receipt of 1997. Interest income increased $154,000, to $184,000 in 1997, compared to $30,000 in 1996. This increase wasfull payment, due to higher levels of United States Treasury Notes held during 1997. FINANCIAL CONDITION The Company's working capital requirements have been financed over the past several years through the private placement of the Company's equity securities. Such placements generated net proceeds of $3,593,000, $720,000 and $4,400,000 during 1998, 1997 and 1996, respectively. In March 1999, the Company raised approximately $2,758,000 of net proceeds through a private placement of equity securities. In addition, the Company financed its 1998 inventory build-up through a $1,404,000 increaseclause in the amount drawn under a short-term line of credit. The aggregate of cash and cash equivalents and marketable securities decreased $165,000 during 1998. Operating activities in 1998 utilized $4,849,000 of cash. Investing activities in 1998, not including the liquidation of marketable securities, utilized $371,000 of cash, while 1998 financing activities provided $5,055,000 of cash. Accounts receivable decreased $496,000 during 1998. The decrease is attributable primarily to the payment during 1998 of $884,000 by the German distributor of Millennium(TM) for 22 sales made during 1997. The effect of this payment was partially offset by accounts receivable in 1998 relating to sales aggregating $777,000 made during December 1998. Inventories increased $971,000 from 1997 to 1998, reflecting the Company's decision to continue to build subassemblies for its Millennium(TM) system while awaiting completion of the redesign of the Millennium(TM) hand piece and clearance from the FDA to market Millennium(TM) in the United States for dental hard tissue applications. There was also a build-up of inventory in connection with the product launch of LazerSmile(TM). The Company believes that through 1998 its operations involved primarily research and development while awaiting key regulatory clearances and that accordingly its operations did not reflect normal business cycles, so that information about inventory turns would not be meaningful. The Company believes that such information should become meaningful once a pattern of deliveries of Millennium(TM) systems has been established. The Company's inventory reserve decreased by $393,000 during 1998, as the Company wrote-off its Nylad(TM) and Laser 35(TM) laser based systems, which are no longer being marketed or sold by the Company. Liability under a line of credit established in December 1997 to finance inventory increased $1,404,000 from 1997 to 1998. This increase is associated with the build-up of inventory required to support the Company's current sales level. The Company has extended this line of credit through June 1, 1999 and has the option to extend it for an additional six month period. The aggregate of accounts payable and accrued liabilities increased $546,000 from December 31, 1997 to December 31, 1998. This increase is attributable to increased purchases of materials late in 1998 in connection with an effort to increase Millennium(TM) production to 25 systems per month, as well as the Company's conservation of cash resources. Capital expenditures during 1998 totaled $300,000 primarily related to theour purchase of plastic injection molds for the production of the LazerSmile(TM). Patents, trademarks and licenses in 1998 increased $71,000 from 1997 principally asorders. As a result, of the Company pursuing patent and trademark protection for its proprietary technology, names and symbols. Stockholders' equity at December 31, 1998 was $662,000, compared to $2,095,000 at December 31, 1997. In May 1998, the Company completed a private placement of 1,320,000 shares of common stock for net proceeds of $3,593,000. In July 1998, the Company completed the acquisition of the assets of LSTI by issuing 1,467,000 shares of common stock, net of 183,000 held in escrow, valued at $5,135,000. These increases in stockholders' equity were offset by the current year loss of $10,346,000, which included a $5,135,000 write-off of purchased in-process research and development costs for which no alternative use existed. LIQUIDITY AND CAPITAL RESOURCES The Company remains dependent upon its ability to obtain outside financing either through the issuance of additional shares of its common or preferred stock or through borrowings until it achieves sustained profitability through increased sales and cost containment. The Company's business now focuses and is expected to continue to focus on the manufacturing and marketing of its laser- based HydroKinetic(TM) tissue cutting system, the Millennium(TM); a new, reduced-power variation of the Millennium(TM) which is being configured for 23 applications in dermatology and general soft-tissue surgery; and its recently- released consumer tooth-whitening system, the LazerSmile(TM) toothbrush. Financing the development of laser-based medical and dental devices and instruments and the operations of the Company has been achieved principally through the private placements of preferred and common stock and the exercise of stock options and warrants, though the Company has experienced increased sales of its Millennium(TM) system during December 1998 and the first quarter of 1999. During the three years ended December 31, 1998, the Company raised approximately $8,713,000 of equity funds in this manner. Management believes that the Company will require significant resources in 1999, principally to fund the Company's working capital needs to support the production and marketing of the Company's laser-based products for various dental and medical applications, efforts directed towards further extensions and refinements of existing products, and continuing research and development activities. The Company expects to generate the necessary resources for its 1999 business plan through a combination of the contribution from the sales of its products, the sale of equity securities in a private placement, and debt financing. No assurances can be given, however, that the Company will be able to obtain such additional resources. If the Company is unsuccessful in generating anticipated resources from one or more of the anticipated sources and is unable to replace any shortfall with resources from another source, the Company may be able to extend the period for which available resources would be adequate by deferring the creation or satisfaction of various commitments, deferring the introduction of various products or entry into various markets, and otherwise scaling back operations. If the Company were unable to generate the required resources, its ability to meet its obligations and to continue its operations would be adversely affected. The Company's financial statementswe have been prepared under the assumption of a going concern. Failure to generate required resources and to achieve sustained profitability would have an adverse effect on the financial position, results of operations, cash flows and prospects of the Company and ultimately on its ability to continue as a going concern. In March, 1999, the Company completed a private placement in which it issued 1,116,000 shares of its common stock, 550,000 redeemable warrants to purchase common stock at an exercise price of $3.50 per share and 99,000 redeemable warrants to purchase common stock at an exercise price of $2.75 per share. The warrants expire March 31, 2001 and allow for the Company to call the warrants, with not less than 30 days written notice, at a redemption price of $.01 each, provided that the average between the high and low prices at which the shares of common stock trade in the principal market in which they then trade exceeds 142% of the exercise price for ten consecutive trading days preceding the date of such call. Gross proceeds received from the private placement were $3,025,000. Net proceeds, after placement agent cash commissions and expenses of $242,000 and estimated expenses incurred by the Company of $35,000, were approximately $2,758,000. At December 31, 1998, the Company had $1,705,000 outstanding under a revolving credit agreement with a bank. The revolving credit agreement provides for borrowings of up to $2,500,000 for the financing of inventory and is collateralized by substantially all of the Company's accounts receivable and inventories. The interest rate is fixed throughout the term of the credit agreement and is computed based upon LIBOR plus 0.5% at the time of any borrowings. At December 31, 1998, the weighted average interest rate on the outstanding balance was 5.97%. The Company is required to reduce the outstanding loan balance by an 24 amount equal to the cost of goods sold associated with sales of inventory upon collection of sales proceeds. Effective December 1, 1998, the Company exercised its right to extend the credit agreement for an additional six months by issuing 18,300 shares of common stock and warrants to purchase 25,000 shares of the Company's common stock at an exercise price of $5.00 per share. The value of the shares and warrants so issued was $61,000 which was recorded as expense in 1998. The current revolving credit agreement expires on June 1, 1999, and the Company has one six-month renewal option remaining. The Company expects that it will exercise its option to extend the line of credit through December 1, 1999. The Company will be required, however, to pay off or refinance this line of credit by December 1, 1999. No assurances can be given that the Company will be able to refinance the line of credit or that the terms on which it may be able to refinance the line of credit will be as favorable as the terms of the existing line. If the Company is unable to refinance and therefore required to repay the line of credit, the diversion of resources to that purpose may adversely affect the Company's operations and financial condition. The Company is presently continuing its analysis of its computer software and hardware requirements, including non-information technology systems, and anticipates capital expenditures to increase significantly during 1999 in connection with the acquisition of such software and hardware. Included among the software to be purchased would be a new accounting system. That system, unlike the present system, would be Year 2000 compliant. The Company's present software and hardware is personal computer based and is unaltered from its original purchased state except for those upgrades offered by the suppliers of such software. The Company has received assurances from the suppliers of the software it employs, other than the accounting system software, that such software is Year 2000 compliant. The Company intends to obtain certification that any computer software and hardware purchased in 1999 is Year 2000 compliant. The Company does not believe that its insistence upon Year 2000 compliant hardware or software will materially increase the cost of any hardware or software acquired. Should the Company be unable to obtain Year 2000 compliant software or hardware, the worst case scenario would require the Company to transition to a manual financial reporting and information gathering system. The Year 2000 problem arises out of the convention by which years have been represented in computer programs by a two digit number representing the final two digits in the year's designation and concern that time sensitive components could fail or provide erroneous output if they do not correctly recognize years beginning with 20 rather than 19. The Company currently has limited information regarding the Year 2000 compliance status of its principal suppliers of goods and services and of its principal customers. The Company has initiated formal communications with all such suppliers and customers with respect to the status of such persons' computer systems in terms of Year 2000 compliance. If any principal customers lack systems that are Year 2000 compliant or programs that provide reasonable assurance that such systems will be Year 2000 compliant well before the end of 1999, the Company will attempt to establish communications channels with such customers that bypass the non-compliant computer systems. If any principal suppliers lack systems that are Year 2000 compliant or programs that provide reasonable assurance that such systems will be Year 2000 compliant well before the end of 1999, the Company will attempt to identify and establish relations with alternate suppliers who have Year 2000 compliant systems. There is a single source supplier of optic fiber for the Millennium(TM) which could not be easily replaced if it has non-compliant systems, and in the event such supplier had a non-compliant system, the Company would attempt to establish communications channels with such supplier that bypass the supplier's non- compliant computer system. There can be no assurance however that the 25 Company would be successful in locating new suppliers and an inability to do so could create difficulties in the Company obtaining certain components used in its manufacturing process. The Company believes that the costs associated with monitoring Year 2000 compliance by suppliers and customers and dealing with any non-compliance will not be material. The failure of the Company or any of its principal suppliers and customers to become Year 2000 compliant in a timely manner and the failure to establish alternate communications channels could have a material adverse effect on the Company's business, financial condition, results of operations and cash flow. New Accounting Pronouncements In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting Comprehensive Income. SFAS No. 130 establishes standards for the reporting and display of comprehensive income and becomes effective for the Company for the year ending December 31, 1998. Comprehensive income includes such items as foreign currency translation adjustments and unrealized holding gains and losses on available-for-sale securities. SFAS No. 130 does not affect current principles of measurement of revenues and expenses and accordingly the adoption of SFAS No. 130 will not have any effect on the Company's results of operations or financial position. Also in June 1997, the FASB issued SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. SFAS No. 131 establishes standards for disclosure about operating segments in annual financial statements and selected information in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement supersedes SFAS No. 14, Financial Reporting for Segments of a Business Enterprise. The new standard became effective for the Company for the year ending December 31, 1998, and requires that comparative information from earlier years be restated to conform to the requirements of this standard. In June 1998, FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes accounting and reporting standards for derivative instruments and becomes effective for the Company for the first quarter of 2000. The Company does not currently engage in any program of hedging and consequently the Company does not expect the adoption of SFAS No. 133 to have a material effect on the Company's consolidated financial position, cash flows, or results of operations. Impact of Changing Prices on Sales and Income The Company attempts to minimize the impact of inflation on production and operating costs through cost control programs and productivity improvements. Over the past three years, the inflation rate has been relatively low. Nonetheless, the Company has continued to experience increases in the cost of labor and some materials, in the face of requests for price reductions from customers. Due to competitive forces in 1998, the Company was not able to raise prices to its customers to pass along the cost increases experienced. The Company, however, shall continue to pursue price reductions from its materials vendors in an attempt to improve or maintain margins. 26 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Theour consolidated financial statements as of the Company at December 31, 19982002 and 1997December 31, 2001 and for each of the three years in the period ended December 31, 2002 to defer revenue upon shipment and to recognize it upon receipt of full payment for our domestic customers. We have reflected the impact of this change, as measured at January 1, 2000, as the cumulative effect of a change in accounting principle for the adoption of SAB 101. The $34,000 cumulative effect of change in accounting principle was recognized as income during the year ended December 31, 2000. It was also determined that revenue recognition for products shipped directly to customers in Europe, which we commenced in 2002, is appropriate at the time of installation, which is when the customer is obligated to pay, and not at the time of shipment as recognized in the previously filed financial statements. In conjunction with these revisions, we have deferred the revenue, the related cost of inventory and related sales commissions. Our revenue recognition policy in Note 3 has been revised to reflect these changes.

As a result of the restatement, our net revenue for 2002 decreased by $1,942,000, our gross profit decreased by $1,325,000 and our net income was reduced by $1,132,000 ($0.05 per fully diluted share). For 2001, our net revenue decreased by $1,341,000 our gross profit decreased by $980,000 and our net loss increased by $873,000 ($0.05 per fully diluted share). In 2000 our net loss increased by $61,000 ($0.01 per fully diluted share).

The statements of operations have been restated as follows:

Year Ended December 31, 2002


  As Reported

  Restated

 

Net sales

  $29,199,000  $27,257,000 

Cost of sales

   11,102,000   10,485,000 

Operating expenses

   15,616,000   15,423,000 

Income from operations

   2,481,000   1,412,000 

Net income

  $2,630,000  $1,498,000 

Net income per share:

         

Basic

  $0.13  $0.08 

Diluted

  $0.12  $0.07 

Year Ended December 31, 2001


  As Reported

  Restated

 

Net sales

  $17,887,000  $16,546,000 

Cost of sales

   7,299,000   6,938,000 

Operating expenses

   10,952,000   10,845,000 

Loss from operations

   (364,000)  (1,158,000)

Net loss

  $(408,000) $(1,281,000)

Net loss per share:

         

Basic

  $(0.02) $(0.07)

Diluted

  $(0.02) $(0.07)

Year Ended December 31, 2000


  As Reported

  Restated

 

Net sales

  $9,657,000  $9,495,000 

Cost of sales

   4,829,000   4,816,000 

Operating expenses

   8,462,000   8,340,000 

Loss from operations

   (3,634,000)  (3,661,000)

Loss before cumulative effect of change in accounting principle

   (3,728,000)  (3,755,000)

Cumulative effect of change in accounting principle

   —     (34,000)

Net loss

  $(3,728,000) $(3,789,000)

Cumulative effect of change in accounting principle per share:

         

Basic

  $0.00  $0.00 

Diluted

  $0.00  $0.00 

Net loss per share:

         

Basic

  $(0.19) $(0.20)

Diluted

  $(0.19) $(0.20)

The balance sheets have been restated as follows:

December 31, 2002


  As Reported

  Restated

Working capital

  $3,484,000  $1,481,000

Total assets

   14,395,000   16,003,000

Stockholders’ equity

   5,187,000   3,121,000

December 31, 2001


  As Reported

  Restated

Working capital

  $1,135,000  $201,000

Total assets

   7,561,000   8,253,000

Stockholders’ equity

   1,579,000   645,000

Overview

We are the world’s leading dental laser company. We design, manufacture and market proprietary dental laser systems that allow dentists, oral surgeons and other specialists to perform a broad range of common dental procedures, including cosmetic applications. Our systems provide superior performance for many types of dental procedures, with less pain and faster recovery times than are generally achieved with drills and other dental instruments. We have clearance from the U. S. Food and Drug Administration to market our laser systems in the United States. We also have the approvals necessary to sell our laser systems in Canada, the European Union and other international markets. Since 1998, alongwe have sold more than 2,000 laser systems in over 20 countries.

We have the following principal product lines: (i) Waterlase system; (ii) LaserSmile system; (iii) American Dental Laser products, including the Diolase and Pulsemaster systems, and (iv) related accessories and disposables for use with our laser systems. Our product, the Waterlase system, is used for hard and soft tissue dental procedures, and can be used to perform most procedures currently performed using dental drills, scalpels and other traditional dental instruments. The LaserSmile system is used for a range of soft tissue procedures and tooth whitening. Our newly acquired Diolase and Pulsemaster systems are primarily used for soft tissue procedures. We also manufacture and sell accessories and disposables, such as handpieces, laser tips and tooth whitening gel, for use with our dental laser systems.

Accounting Policies

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

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

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

persuasive evidence of an arrangement exists;

delivery has occurred and title and the risks and rewards of ownership have been transferred to our customer or services have been rendered;

the price is fixed and determinable; and

collectibility is reasonably assured.

Assuming that all of the above criteria have been met, we record revenue for domestic sales when we receive payment in full, due to a clause in our purchase order that states title transfers upon payment in full; we record revenue for international direct sales when the product is installed, which is when the customer is obligated to pay; and we record revenue for sales to distributors upon delivery.

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

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

Valuation of Long-Lived Assets. Property, plant and equipment, intangible and certain other long-lived assets are amortized over their useful lives. Useful lives are based on our estimate of the period that the assets will generate revenue or otherwise productively support our business goals. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable through future business operations. In our estimate, no provision for impairment is currently required on any of our long-lived assets.

Warranty Cost. Products sold directly to end-users are covered by a warranty against defects in material and workmanship for a period of one year. Products sold internationally to distributors are covered by a warranty on parts for up to fourteen months with additional coverage on certain components for up to two years. We accrue a warranty reserve to estimate the risk of incurring costs to provide warranty services. The accrual is based on our historical experience and our expectation of future conditions. An increase in warranty claims or in the costs associated with servicing those claims would result in an increase in the accrual and a decrease in gross profit.

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

Results of Operations

The following table sets forth certain data from our consolidated income statements for the years ended December 31, 2002, 2001 and 2000, expressed as a percentage of net sales:

   

Years Ended

December 31,


 
   2002

  2001

  2000

 
   (Restated) 

Net sales

  100.0 % 100.0 %  100.0 %

Cost of sales

  38.5  41.9  50.7 
   

 
  

Gross profit

  61.5  58.1  49.3 

Other income

  0.2  0.5  —   

Operating expenses

          

Sales and marketing

  39.4  44.2  44.4 

General and administrative

  11.0  12.2  19.4 

Engineering and development

  6.2  9.2  24.1 
   

 
  

Total operating expense

  56.6  65.6  87.9 

Income (loss) from operations

  5.1  (7.0)  (38.6)

Non-operating income (loss)

  0.4  (0.7)  (1.0)
   

 
  

Income (loss) before cumulative effect of change in accounting principle

  5.5  (7.7)  (39.6)

Cumulative effect of change in accounting principle

  —    —    (0.4)
   

 
  

Net income (loss)

  5.5% (7.7 )%  (40.0 )%
   

 
  

Net Sales. Net sales consists of sales of our laser systems, related disposables and accessories and service revenue. We have at various times experienced fluctuations in sales due to seasonality. In our experience, sales in the first quarter typically are lower than average, and sales in the fourth quarter typically are stronger than average, due to the buying patterns of dental professionals. The fourth quarter of 2002 accounted for 30% of our net sales for the year, whereas the first quarter of 2002 accounted for 18% of net sales for the year. Sales in the third quarter tend to be even with and may sometimes be lower than sales in the second quarter due to vacation patterns. The third quarter accounted for 25% of our net sales in 2002, whereas the second quarter accounted for 27% of our net sales in 2002. Our historical seasonality pattern is a recurring trend that we expect to continue. Consequently we do not necessarily match the timing of our expenditures to the expected quarterly seasonality effects on revenue but rather anticipate the expected sales over the full year as a determinant of our spending levels. Since many of our costs are fixed in the short term, if we have a shortfall in sales resulting from a change in our historical seasonality pattern, or otherwise, we may be unable to reduce expenses quickly enough to avoid losses.

Many dentists finance their purchases through third party leasing companies or banks. In these transactions, we receive payment in full from the leasing company or bank, or from the dentist, who receives funds from the leasing company or bank. The dentist pays the leasing company or bank in installments and we do not bear the credit risk that the dentist might not make payments. The leasing companies and banks do not have recourse to us for a dentist’s failure to make payments. Approximately 36% of our revenue in 2002, 43% of our revenue in 2001 and 38% of our revenue in 2000 were generated from dentists who financed their purchase through National Technology Leasing Corporation, an equipment leasing company.

Cost of Sales. Cost of sales is comprised of all costs to manufacture our products, including materials, labor and related overhead costs such as depreciation, warranty and service costs.

Sales and Marketing. Sales and marketing expenses consist of salaries and benefits, commissions, and other costs related to our direct sales force, advertising costs and expenses related to trade shows and seminars.

General and Administrative. General and administrative expenses consist of salaries and benefits of administrative personnel as well as insurance, professional and regulatory fees and provisions for doubtful accounts.

Engineering and Development. Engineering and development expenses consist of engineering personnel salaries and benefits, prototype supplies, contract services and consulting fees related to product development.

Non-Operating Income (Loss). Non-operating income (loss) consists of interest income and expense, foreign currency gains and losses and similar items not directly related to our operations. Interest income relates to interest earned on our cash balances, and interest expense relates to interest costs on our line of credit. We generate a substantial portion of our revenue from the sale of products outside the United States. Sales to customers or distributors outside the United States accounted for approximately 23% of our revenue for the year ended December 31, 2002. Sales in Europe and Canada accounted for approximately 11% of our revenue for the year ended December 31, 2002, while sales in Asia and countries in the Pacific Rim accounted for approximately 12% of our revenue for 2002. Our sales in Europe are denominated principally in Euros, and our sales in other international markets are denominated in dollars. As we do not engage in hedging transactions to offset foreign currency fluctuations, we are at risk for changes in the value of the dollar relative to the value of the Euro. An increase in the relative value of the dollar would lead to less income from sales denominated in Euros unless we increase prices, which may not be possible due to competitive conditions in Europe. Conversely, a decrease in the relative value of the dollar would lead to more income from sales denominated in Euros. Additionally, we are obligated to repay the debt on our German facility in Euros. Thus, we are also at risk for changes in the value of the dollar relative to the Euro with respect to our obligation to repay the debt on our German facility. An increase in the value of the dollar relative to the Euro would reduce the cost associated with repayment of the debt on our German facility, whereas a decrease in the relative value of the dollar would increase the cost associated with repayment of the debt on our German facility.

Income Taxes. At this time, no provision for income tax is recognized due to the availability of net operating loss carry forwards. At such times as the recoverability of deferred tax assets, including the net operating loss carry forwards, becomes more likely realizable than not, we will reduce the valuation allowance against our deferred tax assets, record an income tax benefit and subsequently record a provision for income taxes for financial statement purposes based on the amount of taxable net income.

Year Ended December 31, 2002 Compared With Year Ended December 31, 2001

Comparing the results of operations between the prior years, the most significant change affecting operating results is the increase in sales. Sales for the year ended December 31, 2002 increased 65% over sales for the year ended December 31, 2001.

Net Sales. Net sales for the year ended December 31, 2002 were $27.3 million, an increase of $10.8 million, as compared with net sales of $16.5 million for the year ended December 31, 2001. The increase in sales in both 2002 and 2001 resulted from the increased number of units sold of our laser systems. Our Waterlase system accounted for 77% of net sales in 2002 and 82% of net sales in 2001. Our LaserSmile system was introduced in the third quarter of 2001 and accounted for 18% of net sales in 2002 as compared with 16% of net sales in 2001.

International sales for the year ended December 31, 2002 were $6.2 million, or 23% of total net sales, as compared with $3.3 million, or 20% of total net sales, for the year ended December 31, 2001. The increase in international sales in 2002 was the result of a renewed effort to strengthen our network of international distributors after concentrating our resources in 2001 in the domestic market. The formation of BIOLASE Europe in 2002 and the acquisition of a production and service facility in Germany was an important step to increase our visibility in Europe as well as to improve our ability to service European customers. Sales of products manufactured at our German facility accounted for 9% of our revenue in 2002. In comparison, all of our revenue in 2001 was generated from the sale of products manufactured in the United States. We plan to continue to add resources to our international sales program to take advantage of the large market potential and we expect that our international sales will continue to grow over time as a percentage of our total net sales. Although most of our international sales are made through independent distributors, we began making direct sales to dentists in Europe in 2002 with the notes thereto,support of our German distributor. Based on the overall increase and detailed review of sales, we have increased our allowance on accounts receivable from $108,000 at December 31, 2001 to $202,000 at December 31, 2002.

Gross Profit. Gross profit for the years ended December 31, 2002 and 2001 was $16.8 million and $9.6 million, respectively. The gross margin on sales for those same periods was 62% and 58%, respectively. The increase in both gross profit and gross margin was attributable to leveraging the increase in our net sales against fixed and partially fixed manufacturing costs, reflecting better absorption of fixed manufacturing costs. The increase in gross profit is also due to increased manufacturing efficiencies and design changes through engineering and product development, which reduced the cost of materials by 10%. These efficiencies and cost savings were partially offset by the start-up costs for our German production and service facility of approximately $165,000 in 2002 and the Report Of Independent Accountants thereon,addition of production resources of approximately $621,000 to support anticipated sales growth. While we believe there is additional leverage to be realized from future increases in sales, increases in fixed costs will also accompany growth and may constrain increases in gross margin. In addition, an increase in the mix of sales to international distributors will also tend to decrease gross profit since such sales are made at wholesale prices.

Other Income. Other income consists of gain on sale of assets. The gain on sale of assets for the year ended December 31, 2002 of $63,000 was related to the sale and leaseback of our manufacturing facility in San Clemente, California in March 2001. This sale resulted in a gain of $316,000, which is being recognized over the remaining term of the lease, which expires in 2006. Gain on sales of assets in 2001 included this amortization of deferred gain plus a gain on the sale of certain other assets.

Operating Expenses

Operating expenses for the year ended December 31, 2002 were $15.4 million, or 57% of net sales, as compared with $10.8 million, or 66% of net sales, for the year ended December 31, 2001. Most of the increases in operating expenses for each year were sales and marketing costs that were incurred to generate the increase in sales, including a growing sales force and related expenses.

Sales and Marketing. Sales and marketing expenses for the year ended December 31, 2002 was $10.8 million, or 39% of net sales, as compared with $7.3 million, or 44% of net sales, for the year ended December 31, 2001. The increase in absolute dollars from year to year was attributable to higher commission expense related to the increased sales and to the cost of additional sales personnel of approximately $600,000 in the United States. In addition during 2002, we expanded the scope of our nationwide seminar-marketing program and our sponsorship of education and training programs for existing and potential customers, as a result of which we incurred additional expenses of $871,000. Although growing 47% in 2002 in absolute dollars, sales and marketing expense as a percentage of net sales decreased from 44% in 2001 to 39% in 2002 due to the increase in sales generated by these efforts. In 2002, in addition to a number of local and regional symposiums, we sponsored two national and two international symposiums presented by the World Clinical Laser Institute, an organization that provides education and training in laser dentistry.

General and Administrative. General and administrative expenses for the year ended December 31, 2002 was $3.0 million, or 11% of net sales, as compared with $2.0 million, or 12% of net sales, for the year ended December 31, 2001. The increase in absolute dollars in 2002 was due to administrative costs associated with the operations of BIOLASE Europe of $140,000, increases in the costs of legal fees relating to regulatory compliance and various legal proceedings in the amount of $201,000, and increases in the infrastructure needed to support the growth of our sales. Insurance premiums increased in 2001 as a result of the increase in net sales and increased by $328,000 in 2002 both as a result of the increase in sales and as a result of general insurance market conditions. We expect additional increases in 2003 due to adverse markets for workers compensation, group health insurance and liability insurance.

Engineering and Development. Engineering and development expenses for the year ended December 31, 2002 was $1.7 million, or 6% of net sales, as compared with $1.5 million, or 9% of net sales, for the year ended December 31, 2001. The increase in absolute dollars in 2002 was related to new product development and enhancements. The decrease in research and development expenses as a percent of net sales reflects the larger sales base and fluctuations in the scope of current research and development projects.

Non-Operating Income (Loss)

Unrealized Gain on Forward Exchange Contract. In the year ended December 31, 2002, we recognized an unrealized gain on forward contracts of $152,000 due to the increase in the fair market value of our forward exchange contract.

Interest Income. Interest income for the year ended December 31, 2002 was $18,000 compared with $44,000 in 2001. Even though our cash balances have increased over this period, continuing reductions in interest rates have resulted in lower interest income.

Interest Expense. Interest expense was $135,000 for the year ended December 31, 2002 compared with $167,000 in 2001. Interest expense in 2002 included the amortization of the cost of issuing stock in connection with the extension of our line of credit in December 2001. Interest expense in 2001 included three months of interest on the note payable on our San Clemente manufacturing facility, which was sold and leased back in March 2001.

Income Tax. No provision for income tax was recognized for the year ended December 31, 2002 due to the availability of net operating loss carry forwards. No income tax benefit was recognized in the year ended December 31, 2002 as there was no assurance that the benefit of the net operating loss carry forwards would be realized. At such time as the recoverability of deferred tax assets, including the net operating loss carry forward, becomes more likely realizable than not, we will reduce the valuation allowance against our deferred tax assets, record an income tax benefit and subsequently record a provision for income tax for financial statement purposes based on the amount of taxable net income. As of December 31, 2002, we had net operating loss carry forwards for federal and state purposes of approximately $34.9 million and $7.5 million, respectively, which began expiring in 2001. As of December 31, 2002, we had research and development credit carryforwards for federal and state purposes of approximately $332,000 and $170,000, respectively. The utilization of net operating loss and credit carry forwards may be limited under the provisions of Internal Revenue Code Section 382 and similar state provisions.

Year Ended December 31, 2001 Compared With Year Ended December 31, 2000

Comparing the results of operations between the prior years, the most significant change affecting operating results is the increase in sales. Sales for the year ended December 31, 2001 increased 74% over sales for the year ended December 31, 2000.

Net Sales. Net sales in 2001 were $16.5 million, an increase of $7.0 million, as compared with net sales of $9.5 million in 2000. This increase was due to a 176%, or $7.6 million growth in domestic sales of our Waterlase system. The Waterlase systems accounted for approximately 84% of net sales for the year ended December 31, 2001, as compared with 97% of net sales for the year ended December 31, 2000. Domestic sales also increased by $1.5 million in the third and fourth quarters of 2001 due to the introduction of our LaserSmile system. These increases were offset by a 28%, or $1.1 million decrease in international sales in 2001 as we concentrated our resources on growing sales in the domestic market.

Gross Profit. Gross profit increased 104% to $9.6 million in 2001 from $4.7 million in 2000. Gross margin increased from 49% of net sales in 2000 to 58% of net sales in 2001. This increase was the result of spreading the fixed costs of manufacturing over more units, an improvement in labor productivity, and engineering cost reductions, which collectively produced a 9% reduction in the material components of the products.

Other Income. Other income consists of gain on sale of assets. The gain on sale of assets of $79,000 in 2001 is related to two transactions. In 2000, we purchased our San Clemente manufacturing facility and offices in order to avoid moving our operations. In 2001, we sold the facility and leased it back for a five-year term with an additional five year option, resulting in a gain of $316,000. We are recognizing that gain for accounting purposes over the term of the lease. In 2001, we recognized $48,000 of this gain. We also sold inventory and assets relating to our inactive subsidiary, Societe Endo Technic, in 2001 for a gain of $31,000.

Operating Expenses

Sales and Marketing. Sales and marketing expenses for the year ended December 31, 2001 was $7.3 million, or 44% of net sales, as compared with $4.2 million, or 44% of net sales, for the year ended December 31, 2000. The increase in absolute dollars was due to the 85% increase in net sales in 2001 and included increased sales commissions and increased cost of $536,000 associated with an increase in the number of sales representatives. Marketing costs also increased by $945,000 as we increased the number of trade shows, seminars and symposiums that we attended and sponsored.

General and Administrative. General and administrative expenses for the year ended December 31, 2001 was $2.0 million, or 12% of net sales, as compared with $1.8 million, or 19% of net sales, for the year ended December 31, 2000. The increase in absolute dollars in 2001 related to the cost of infrastructure needed to support the growth of the business.

Engineering and Development. Engineering and development expenses for the year ended December 31, 2001 was $1.5 million, or 9% of net sales, as compared with $2.3 million, or 24% of net sales, for the year ended December 31, 2000. This decrease was related to the change in the development cycle for our products. Engineering costs also decreased by approximately $100,000 as a result of process improvements, which reduced the number of employees needed to sustain the activities of the function.

Non-Operating Income (Loss)

Interest Income. Interest income for the year ended December 31, 2001 was $44,000 compared with $69,000 for the period ended December 31, 2000. Even though our cash balances have increased over this period, continuing reductions in interest rates have resulted in lower interest income.

Interest Expense. Although the variable interest rate on our line of credit decreased with other short-term interest rates in 2001, we incurred interest expense on the mortgage note payable that financed the purchase of our facility. The interest expense from the mortgage note for three months of 2001 offset the decrease in interest on our line of credit.

Cumulative Effect of Change in Accounting Principle

Effective January 1, 2000, we adopted SAB 101 resulting in a $34,000 cumulative effect of change in accounting principle. There was no change in accounting principle for the year ended December 31, 2001.

Liquidity and Capital Resources

At December 31, 2002 we had $1.4 million in net working capital as compared to $201,000 at December 31, 2001. Our principal source of liquidity at December 31, 2002 consisted of our cash balance of $3.9 million. Prior to 2001 we financed the development of our products and our operations through the private placement of common stock and the exercise of stock options and warrants. For the year ended December 31, 2002, our sources of cash were funds provided from operating activities of $635,000 and the exercise of stock options and warrants of $1.0 million. These sources of cash were reduced by investments in property and equipment of $478,000. The net effect on cash of operating, investing and financing transactions for the year ended December 31, 2002 was an increase of $1.3 million.

Accounts receivable, net, increased 127% to $5.0 million at December 31, 2002 from $2.2 million at December 31, 2001. This increase was due to the higher sales volume experienced in 2002. Inventories, net, increased 48% to $2.8 million at December 31, 2002 from $1.9 million at December 31, 2001. The increase was due to increased production to meet estimated sales demand.

As discussed in Note 7 to the Consolidated Financial Statements, 672,500 warrants with a weighted average exercise price of $2.46 are outstanding and are scheduled to expire in 2003. All of the warrants were exercised by June 30, 2003.

Several key indicators of liquidity are summarized in the following table (in thousands, except ratio amounts):

   

Years Ended

December 31,


 
   2002

  2001

  2000

 

Working capital (deficit) (restated)

  $1,418  $201  $(268)

Cash provided by (used in) operations

   635   (1,037)  (3,778)

Proceeds from the exercise of stock options and warrants

   1,035   803   3,201 

Current ratio (restated)

   1.1   1.0   0.9 

Accounts receivable collection period (days)

   44.5   32.1   20.3 

Inventory turnover

   5.3   5.1   4.8 

At December 31, 2002 we had $1.8 million outstanding under a $1.8 million revolving credit facility with BSI AG. This same amount was outstanding at December 31, 2001. In May 2003, we secured a $5.0 million credit facility through Bank of the West. The facility with Bank of the West is secured by all of our assets, is for a term of one year, bears interest at LIBOR plus 2.25% and is payable on demand upon expiration of the stated term. Approximately $1.8 million was drawn immediately to pay off the bank line of credit with BSI AG. At August 31, 2003, we had $1.8 million outstanding under our revolving credit facility with Bank of the West. Under the terms of our credit line with Bank of the West, we are subject to certain covenants, which include, among other things, covenants to maintain a specified minimum tangible net worth and a specified ratio of current assets to current liabilities, and a covenant to maintain profitability. If we fail to satisfy these covenants and we fail to cure any breach of these covenants within a specified number of days after receipt of notice, Bank of the West could accelerate the entire amount borrowed by us and cancel the line of credit. We currently have $6.6 million in available cash as of June 30, 2003. We believe any cancellation of our bank line would not have a material impact on our liquidity and that our cash from operations and our current cash balances will be sufficient to finance the cost of our operations. As a result of the restatement of our financial statements for the years ended December 31, 2002, 2001 and 2000, our accumulated deficit increased and our net tangible equity decreased as of June 30, 2003. Consequently we are not in compliance with three covenants: timely reporting of our financial statements for the period ended June 30, 2003, minimum tangible net equity, which is $6,897,000 as compared with a minimum required tangible net equity of $7,000,000, and the ratio of total liabilities to tangible net equity, which is 1.91 as compared with a maximum ratio of 1.75. We have obtained waivers from the bank for each item of non-compliance as of June 30, 2003. We anticipate that we will be in compliance on these items as of September 30, 2003.

We purchased our production facility in Germany in February 2002 for cash consideration of approximately Euros 1.2 million payable in installments through 2003, subject to reduction in certain circumstances. The maximum consideration was reduced in September 2003 to Euros 989,000 in accordance with the terms of the agreement with the seller. However, we are in discussions with the seller regarding a further reduction based on the seller’s failure to fulfill its responsibilities under the purchase agreement. The purchase agreement provides for a payment of Euros 582,000 by April 1, 2003, which has not been paid pending these discussions. Payments of Euros 175,000 and 232,000 are required under the purchase agreement to be paid on September 30 and December 1, 2003 respectively. Outstanding amounts under the purchase agreement bear interest at less than one percent per annum.

On May 21, 2003 we acquired the American Dental Laser product line from American Medical Technologies, Inc., or AMT, for approximately $5.8 million. The assets acquired included dental laser patents, customer lists, brand names and other intellectual property as well as laser products. No outstanding debt of AMT was assumed in the transaction. The consideration paid by us consisted of approximately $1.8 million cash, $134,000 in transaction costs directly attributable to the acquisition and 307,500 shares of common stock with a fair value of approximately $3.8 million. For purposes of computing the purchase price, the value of the common stock of $12.38 per share was determined by taking the average closing price of our common stock as quoted on the Nasdaq National Market between May 19, 2003 and May 23, 2003.

We had no material commitments for capital expenditures as of December 31, 2002 and have not entered into any material commitments after that date.

The following table presents our expected cash requirements for contractual obligations outstanding as of December 31, 2002 (in thousands):

         Years Ending December 31,

   December
31, 2002


  2003

  2004

  2005

  2006

Line of credit

  $1,792  $1,792  $—    $—     $—  

Debt

   1,220   1,220   —     —     —  

Operating leases

   841   270   261   249   61
   

  

  

  

  

Total

  $3,853  $3,282  $261  $249  $61
   

  

  

  

  

We believe that our current cash balances, cash expected to be generated from our operations, together with additional cash expected to be received through the exercise of stock options will be adequate to meet our debt service requirements and sustain our operations for at least the next twelve months. Beyond the next twelve months, if we continue to grow our sales volume at approximately the rate it has grown over the past several years, the adequacy of our cash balances to meet operating and capital needs will depend on our ability to continue to generate sufficient cash flow from operations and our ability to borrow the funds necessary to support that growth rate. We my also address our financing needs beyond the next twelve months through the sale of equity securities. If such debt or equity is needed, we cannot assure you that we would be able to obtain such additional capital resources in a timely manner, on acceptable terms, or at all. If we were unable to raise additional funds, we might have to defer the creation or satisfaction of various commitments, defer the introduction of various products or entry into various markets, or otherwise scale back our operations. Such circumstances would have an adverse effect on our financial position, results of operations and cash flows.

Selected Quarterly Financial Data

   Quarters Ended

 
   March 31,

  June 30,

  September 30,

  December 31,

 
   (in thousands, except per share data) 
   (Restated) (2) 

2002

                 

Net sales

  $5,011  $7,264  $6,859  $8,123 

Gross profit

   3,113   4,335   4,117   5,207 

Income from operations

   162   561   414   275 

Net income

   132   652   382   332 

Net income per share (1):

                 

Basic

   0.01   0.03   0.02   0.02 

Diluted

   0.01   0.03   0.02   0.02 

2001

                 

Net sales

  $2,643  $4,713  $3,970  $5,220 

Gross profit

   1,447   2,840   2,376   2,945 

Income (loss) from operations

   (1,028)  154   (244)  (40)

Net (loss) income

   (1,098)  128   (256)  (55)

Net (loss) income per share (1):

                 

Basic

   (0.06)  0.01   (0.01)  0.00 

Diluted

   (0.06)  0.01   (0.01)  0.00 

(1)Net income per common share calculations for each of the quarters were based upon the weighted average number of shares outstanding for each period, and the sum of the quarters may not necessarily be equal to the full year net income per common share amount.
(2)The Company has amended Quarterly reports on Form 10-Q/A to restate the Company’s financial statements for the interim periods ended March 31, 2002, June 30, 2002 and September 30, 2002. See Management’s Discussion and Analysis of Financial Condition and Results of Operations under Restatement of Financial Statements.

Recent Accounting Pronouncements

In April 2002, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 145, Rescission of SFAS Nos. 4, 44 and 64, Amendment of SFAS No. 13, and Technical Corrections. The significant items from SFAS 145 that are relevant to us are the provisions regarding extinguishment of debt and the accounting for sale-leaseback transactions. The provisions of this statement are applicable for financial statements issued on or subsequent to May 15, 2002. The adoption of this statement did not have an impact on our consolidated financial statements.

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force, or EITF, Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). The provisions of this statement are effective for exit or disposal activities initiated after December 31, 2002. We expect the adoption of this statement will not have an impact on our consolidated financial statements.

In November 2002, the EITF reached a consensus on Issue No. 00-21. Accounting for Revenue Arrangements with Multiple Deliverables. This Issue provides guidance on when and how to separate elements of an arrangement that may involve the delivery or performance of multiple products, services and rights to use assets into separate units of accounting. The guidance in the consensus is effective for revenue arrangements entered into in fiscal periods, interim or annual, beginning after June 15, 2003. We will adopt Issue No. 00-21 in the quarter beginning July 1, 2003. We do not believe that the adoption of Issue No. 00-21 will have a material impact to our consolidated financial position, results of operations or cash flows.

In November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, or FIN 45. FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also requires that at the time a company issues a guarantee, the company must recognize an initial liability for the fair market value of the obligations it assumes under that guarantee and must disclose that information in its interim and annual financial statements. The initial recognition and measurement provisions of FIN 45 apply on a prospective basis to guarantees issued or modified after December 31, 2002. We expect the adoption of this statement will not have a significant impact on our consolidated financial statements.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123. This amendment provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirement of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS 148 is effective for fiscal years ending after December 15, 2002. Since we are continuing to account for stock-based compensation according to APB 25, our adoption of SFAS No. 148 requires us to provide prominent disclosures about the effects of FAS 123 on reported income and will require us to disclose these affects in the interim financial statements as well.

In May 2003, the FASB issued SFAS No. 150, Accounting For Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in

some circumstances) because that financial instrument embodies an obligation of the issuer. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We do not believe that the adoption of SFAS 150 will have a material impact to our consolidated financial position, results of operations, or cash flows.

Risk Factors

Investing in our common stock involves a high degree of risk. You should carefully consider the following risks and all the other information in this prospectus before making an investment decision about our common stock. While the risks described below are the ones we believe are most important for you to consider, these risks are not the only ones that we face. If any of the following risks actually occurs, our business, operating results or financial condition could suffer, the trading price of our common stock could decline and you could lose all or part of your investment.

Risks Relating to Our Business

Our quarterly sales and operating results may fluctuate in future periods and we may fail to meet expectations, which may cause the price of our common stock to decline.

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

variation in demand for our products, including variation due to seasonality;

our ability to research, develop, introduce, market and gain market acceptance of new products and product enhancements in a timely manner;

our ability to control costs;

the size, timing, rescheduling or cancellation of significant customer orders;

the introduction of new products by competitors;

long sales cycles and fluctuations in sales cycles;

the availability and reliability of components used to manufacture our products;

changes in our pricing policies or those of our suppliers and competitors, as well as increased price competition in general;

the mix of our domestic and international sales, and the risks and uncertainties associated with our international business;

costs associated with any future acquisitions of technologies and businesses;

limitations on our ability to use net operating loss carryforwards under the provisions of Internal Revenue Code Section 382 and similar provisions under applicable state laws;

developments concerning the protection of our proprietary rights; and

general global economic and political conditions, including international conflicts and acts of terrorism.

A significant amount of our sales in any quarter may consist of sales through distributors. Sales from distributors accounted for approximately 17% of our revenue in 2002, and no single distributor accounted for more than 10% of our sales in any given quarter. As a result, the timing of orders by distributors may impact our quarter-to-quarter results. The loss of or a substantial reduction in orders from distributors could seriously harm our business, financial condition and results of operations. Additionally, the amount of expenses we incur, in part, depends on our expectations regarding future sales. In particular, we expect to continue incurring substantial expenses relating to the marketing and promotion of our products. Since many of our costs are fixed in the short term, if we have a shortfall in sales, we may be unable to reduce expenses quickly enough to avoid losses. Accordingly, you should not rely on quarter-to-quarter comparisons of our operating results as an indication of our future performance.

Dentists and patients may be slow to adopt laser technologies, which could limit the market acceptance of our products.

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 to a broad spectrum of dentists and patients the potential performance advantages of our laser systems over traditional methods of treatment and over competitive laser systems. Dentists have historically been and may continue to be slow to adopt new technologies on a widespread basis. Factors that may inhibit adoption of laser technologies by dentists include cost, and concerns about the safety, efficacy and reliability of lasers. Economic pressure may make dentists reluctant to purchase substantial capital equipment or invest in new technologies. Patient acceptance will depend in part 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 with those of other instruments and methods for performing dental procedures. The failure of dental lasers to achieve broad market acceptance would have an adverse effect on our business, financial condition and results of operations. We cannot assure you that we will have sufficient resources to continue to successfully market our products to achieve broad market acceptance.

We may have difficulty managing our growth.

We have been experiencing significant growth in the scope of our operations and the number of our employees. This growth has placed significant demands on our management as well as our financial and operational resources. In order to achieve our business objectives, we anticipate that we will need to continue to grow. If this growth occurs, it will continue to place additional significant demands on our management and our financial and operational resources, and will require that we continue to develop and improve our operational, financial and other internal controls both in the United States and internationally. In particular, our growth has and, if it continues, will increase the challenges involved in implementing appropriate operational and financial systems, expanding manufacturing capacity and scaling up production, expanding our sales and marketing infrastructure and capabilities, providing adequate training and supervision to maintain high quality standards, and preserving our culture and values. The main challenge associated with our growth has been, and we believe will continue to be, our ability to recruit skilled sales, manufacturing and management personnel. Our inability to scale our business appropriately or otherwise adapt to growth would cause our business, financial condition and results of operations to suffer.

If we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur expenses to enforce our rights.

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. In part, we rely on patents to establish and maintain proprietary rights in our technology and products. While we hold a number of issued patents and have other patent applications pending on our products and technology, we cannot assure you that any additional patents will be issued, that the scope of any patent protection will exclude competition or that any of our patents will be held valid if subsequently challenged. Other companies also may independently develop similar products, duplicate our products or design products that circumvent our patents. Additionally, the laws of foreign countries may not protect our products or intellectual property rights to the same extent as do the laws of the United States.

We face substantial uncertainty regarding the impact that other parties’ intellectual property positions will have on the markets for dental and other medical lasers. Competitors may claim that we have infringed their current or future intellectual property rights. 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. We may not prevail in any future intellectual property infringement litigation given the complex technical issues and inherent uncertainties in litigation. Any claims, with or without merit, could be time-consuming and distracting to management, result in costly litigation, cause product shipment delays, or require us to enter into royalty or licensing agreements. Additionally, if an intellectual property claim against us is successful, we might not be able to obtain a license on acceptable terms or license a substitute technology or redesign our products to avoid

infringement. Any of the foregoing adverse events could seriously harm our business, financial condition and results of operations.

We are a party to two related patent infringement lawsuits involving patents relating to our core technology, which if determined adversely to us, could have a significant negative effect on our earnings.

We are currently involved in two patent related lawsuits with Diodem, LLC, a California limited liability company, which was founded by Collete Cozean, the former chief executive officer of Premier Laser Systems, Inc. On May 2, 2003, we initiated a civil action in the U.S. District Court for the Central District of California against Diodem, in which we are seeking a judicial declaration against Diodem that technology used in our laser systems does not infringe four patents owned by Diodem. Diodem claims to have acquired the patents from Premier Laser Systems, Inc., which filed for bankruptcy protection in March 2000. On May 5, 2003, Diodem added us as a party to an infringement lawsuit it had previously filed in the U.S. District Court for the Central District of California. Diodem alleges that our technology, including the technology used in our Waterlase system, infringes four patents it acquired from Premier. Diodem’s infringement suit seeks treble damages, a preliminary and permanent injunction from further alleged infringement, attorneys’ fees and other unspecified damages. Both of these lawsuits are in their preliminary stages, and may proceed for an extended period of time. There can be no assurance that our technology will not be found to infringe any of Diodem’s patents at issue in these proceedings or that we will not be liable for some or all of the damages alleged by Diodem or subject to some or all of the relief requested by Diodem.

In addition, these lawsuits could result in significant expenses and diversion of management’s time and other resources. If Diodem successfully asserts an infringement claim against us in its infringement lawsuit, our operations may be severely impacted, especially to the extent that it affects our right to use the technology incorporated in our Waterlase system, which accounted for approximately 77% of our revenue in 2002. Diodem’s infringement proceeding could also result in significant limitations on our ability to manufacture, market and sell our products, including our Waterlase system, as well as delays and costs associated with redesigning our products and payments of license fees, monetary damages and other payments. Additionally, we may be enjoined from incorporating certain technology into our products, all of which could significantly impede our operations, increase operating expenses, reduce our revenue and cause us to incur losses.

We depend on a limited number of suppliers and if we cannot secure alternate suppliers, the amount of sales in any period could be adversely affected.

We purchase certain materials and components included in our Waterlase system and other products from a limited group of suppliers using purchase orders, and we have no written supply contracts with our key suppliers. Our business depends in part on our ability to obtain timely deliveries of materials and components in acceptable quality and quantities from our suppliers. The introduction of our LaserSmile system in 2001 was delayed due to an interruption in the supply of components for the system, however, we have not otherwise experienced material delays in the supply of components. 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 handpieces used in our Waterlase system, which accounted for approximately 77% of our revenue in 2002, are each supplied by a separate single supplier. We have not experienced material delays from these suppliers, and we have identified and tested alternative suppliers for each of these three components. However, an unexpected interruption in a single source supplier could create manufacturing delays, and disrupt sales and cash flow as we sought to replace the supplier, which we estimate could take up to three months. Such an interruption could cause our business, financial condition and results of operations to suffer.

We have significant international sales and are subject to risks associated with operating in international markets.

International sales comprise a significant portion of our net sales and we intend to continue to pursue and expand our international business activities. International sales accounted for approximately 23% of our revenue in 2002. Political and economic conditions outside the United States could make it difficult for us to increase our international sales or to operate abroad. International operations, including our facility in Germany, are subject to many inherent risks, including:

adverse changes in tariffs;

political, social and economic instability and increased security concerns;

fluctuations in currency exchange rates;

longer collection periods and difficulties in collecting receivables from foreign entities;

exposure to different legal standards;

ineffectiveness of international distributors;

reduced protection for our intellectual property in some countries;

burdens of complying with a variety of foreign laws;

import and export license requirements and restrictions of the United States and each other country in which we operate;

trade restrictions;

the imposition of governmental controls;

unexpected changes in regulatory or certification requirements;

difficulties in staffing and managing international manufacturing and sales operations; and

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 sales, and we intend to further expand our international operations. Our sales in Europe are denominated principally in Euros, while our sales in other international markets are in dollars. As a result, an increase in the relative value of the dollar against the Euro would lead to less income from sales denominated in Euros, unless we increase prices, which may not be possible due to competitive conditions in Europe. We could experience losses from European transactions if the relative value of the dollar were to increase in the future. 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. We also expect that sales of products manufactured at our facility in Germany will account for an increasing percentage of our revenue, which will further increase our exposure to the above-described risks associated with our international operations. Sales of products manufactured at our German facility accounted for 9% of our revenue in 2002. Since expenses relating to our manufacturing operations in Germany are paid in Euros, an increase in the value of the Euro relative to the dollar would increase the expenses associated with our German manufacturing operations and reduce our earnings. In addition, we may experience difficulties associated with managing our operations remotely and complying with German regulatory and legal requirements for maintaining our manufacturing operations in that country. Any of these factors may adversely affect our future international sales and manufacturing operations and, consequently, negatively impact our business, financial condition and operating results. Despite these risks, we believe the market for our products outside the United States justifies our effort to expand our international operations.

If we are unable to meet customer demand or comply with quality regulations, our sales will suffer.

We manufacture our products at our California and German production facilities. In order to achieve our business objectives, we will at some point need to significantly expand our manufacturing capabilities to produce the systems and accessories necessary to meet demand. We intend to finance the cost of expansion through operating income, funds available under our bank credit line and potentially through the sale of equity securities. We may encounter difficulties in scaling-up production of our products, including problems involving production capacity and yields, quality control and assurance, component supply and shortages of qualified personnel. In addition, our manufacturing facilities are subject to periodic inspections by the U.S. Food and Drug Administration, state agencies and foreign regulatory agencies. Our success will depend in part upon our ability to manufacture our products in compliance with the U.S. Food and Drug Administration’s Quality System regulations and other regulatory requirements. Our business will suffer if we do not succeed in manufacturing our products on a timely basis and with acceptable manufacturing costs while at the same time maintaining good quality control and complying with applicable regulatory requirements.

Any failure to significantly expand sales of our products will negatively impact our business.

We currently handle a majority of the marketing, distribution and sales of our laser systems. In order to achieve our business objectives, we will need to significantly expand our marketing and sales efforts on a nationwide and global basis. We will face significant challenges and risks in expanding, training, managing and retaining our sales and marketing teams, including managing geographically dispersed efforts. In addition, we use third party distributors to sell our products in a number of countries outside the United States, and are dependent on the sales and marketing efforts of these third party distributors. These distributors may not commit the necessary resources to effectively market and sell our products. If we are unable to expand our sales and marketing capabilities, we may not be able to effectively commercialize our products.

Acquisitions could have unintended negative consequences, which could harm our business.

As part of our business strategy, we may acquire one or more businesses, products or technologies. Most recently, in May 2003, we acquired the American Dental Laser product line and related dental laser assets of American Medical Technologies, Inc., including the Diolase and Pulsemaster systems, and related inventory, patents and other intellectual property rights. We are currently in the process of integrating the assets relating to the American Dental Laser product line into our operations. We must effectively integrate the American Dental Laser product line into our operations in order to achieve profitability from it. We believe we can integrate the acquired assets into our sales and manufacturing infrastructure with minimal increase to our operating expenses because we acquired principally patents, brand names, customer lists and other intangibles and we did not assume the seller’s personnel, facilities or other overhead.

Acquisitions could require significant capital infusions and could involve many risks, including, but not limited to, the following:

we may encounter difficulties in assimilating and integrating the operations, products and workforce of the acquired companies;

acquisitions may negatively impact our results of operations because they may require large one-time charges or could result in increased debt or contingent liabilities, adverse tax consequences, substantial depreciation or deferred compensation charges, or the amortization or write down of amounts related to deferred compensation, goodwill and other intangible assets;

acquisitions may be dilutive to our existing stockholders;

acquisitions may disrupt our ongoing business and distract our management; and

key personnel of the acquired company may decide not to work for us.

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

We may be unable to comply with covenants contained in our credit agreement, which could result in the impairment of our working capital and alter our ability to operate our business.

In May 2003, we secured a new credit facility through Bank of the West. At August 31, 2003, the outstanding principal balance on this credit facility was $1.8 million. To maintain the right to borrow under this credit facility and avoid a default under our credit agreement with Bank of the West, we are required to satisfy certain financial tests and comply with certain operating covenants contained in that agreement. Our ability to satisfy required financial ratios and tests can be affected by events beyond our control, including prevailing economic, financial and industry conditions, and we cannot assure you that we will continue to meet those ratios and tests in the future. A breach of any of these covenants, ratios or tests could result in a default under our credit agreement. If we default, our lender will no longer be obligated to extend credit to us and could elect to declare all amounts

outstanding under the credit agreement, together with accrued interest, to be immediately due and payable. If we were unable to repay those amounts, our lender could proceed against the collateral granted to it to secure that indebtedness, which includes our intellectual property. The results of such action would have a significant negative impact on our results of operations and financial condition. Due to the restatement of our financial statements, we are not in compliance with three covenants at June 30, 2003. The bank has provided waivers as of June 30, 2003. We expect to be in compliance at September 30, 2003; however, we cannot assure you that we will be in compliance.

Material increases in interest rates may harm our sales.

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, these financing arrangements will be more expensive to our dental customers, which would effectively increase the price of our products to our customers and, thereby, may decrease overall demand for our products. Any reduction in the sales of our products would cause our business to suffer.

We may not be able to compete successfully against our current and future competitors.

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

Rapid changes in technology could harm the demand for our products or result in significant additional costs.

The markets in which our laser systems compete are subject to rapid technological change, evolving industry standards, changes in the regulatory environment, frequent new device introductions and evolving dental and surgical techniques. These changes could render our products uncompetitive or obsolete. The success of our existing and future products is dependent on the differentiation of our products from those of our competitors, the timely introduction of new products and the perceived benefit to the customer in terms of improved patient satisfaction and return on investment. The process of developing new medical devices is inherently complex and requires regulatory approvals or clearances that can be expensive, time consuming and uncertain. We cannot assure you that we will successfully identify new product opportunities, be financially or otherwise capable of completing the research and development required to bring new products to market in a timely manner or that products and technologies developed by others will not render our products obsolete.

The failure to attract and retain key personnel could adversely affect our business.

Our future success depends in part on the continued service of certain key personnel, including our Chief Executive Officer, our Executive Vice President responsible for sales, our Vice President of Research and Development and our Chief Financial Officer. We do not have employment agreements with any of our key employees, other than an employment agreement with our Chief Executive Officer, which expires in January 2004, and an employment agreement with our Executive Vice President responsible for sales, which can be terminated at will by the executive or by us.

Our success will also depend in large part on our ability to continue to attract, retain and motivate qualified engineering and other highly skilled technical personnel. Competition for certain employees, particularly

development engineers, is intense despite the effects of the economic slowdown. We may be unable to continue to attract and retain sufficient numbers of such highly skilled employees. Our inability to attract and retain additional key employees or the loss of one or more of our current key employees could adversely affect our business, financial condition and results of operations.

Product liability claims against us could be costly and could harm our reputation.

The sale of dental and medical devices involves the inherent risk of product liability claims against us. We currently maintain product liability insurance on a per occurrence basis with a limit of $11 million per occurrence and $12 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. There is no assurance that we will be able to obtain such insurance in the future on terms acceptable to us, or at all. We do not know whether claims against us with respect to our products, if any, would be successfully defended or whether our insurance would be sufficient to cover liabilities resulting from such claims. Any claims successfully brought against us would cause our business to suffer.

We are exposed to risks associated with the recent worldwide economic slowdown and related uncertainties.

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

We may not be able to secure additional financing to meet our future capital needs.

We expect to expend significant capital to further develop our products, increase awareness of our laser systems and our brand names and to expand our operating and management infrastructure as we increase sales in the United States and abroad. We may use capital more rapidly than currently anticipated. Additionally, we may incur higher operating expenses and generate lower revenue than currently expected, and we may be required to depend on external financing to satisfy our operating and capital needs, including the repayment of our debt obligations. We may be unable to secure additional debt or equity financing on terms acceptable to us, or at all, at the time when we need such funding. If we do raise funds by issuing additional equity or convertible debt securities, the ownership percentages of existing stockholders would be reduced, and the securities that we issue may have rights, preferences or privileges senior to those of the holders of our common stock or may be issued at a discount to the market price of our common stock which would result in dilution to our existing stockholders. If we raise additional funds by issuing debt, we may be subject to debt covenants, such as the debt covenants under our secured credit facility, which could place limitations on our operations including our ability to declare and pay dividends. Our inability to raise additional funds on a timely basis would make it difficult for us to achieve our business objectives and would have a negative impact on our business, financial condition and results of operations.

We have adopted anti-takeover defenses that could delay or prevent an acquisition of our company and may affect the price of our common stock.

Certain provisions of our certificate of incorporation and stockholder rights plan could make it difficult for any party to acquire us, even though an acquisition might be beneficial to our stockholders. These provisions could limit the price that investors might be willing to pay in the future for shares of our common stock.

In December 1998, we adopted a stockholder rights plan pursuant to which one preferred stock purchase right is distributed to our stockholders for each share of our common stock held by them. In connection with the stockholder rights plan, the Board of Directors may issue up to 500,000 shares of Series B Junior Participating Cumulative Preferred Stock. If any party acquires 15% or more of our outstanding common stock, the holders of

these rights will be able to purchase the underlying junior participating preferred stock as a way to discourage, delay or prevent a change in control of our company.

In addition, under our certificate of incorporation, the Board of Directors has the power to authorize the issuance of up to 500,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without further vote or action by the stockholders. Accordingly, our Board of Directors may issue preferred stock with terms that could have preference over and adversely affect the rights of holders of our common stock.

The issuance of any preferred stock may:

delay, defer or prevent a change in control of BioLase;

discourage bids for the common stock at a premium over the market price of our common stock;

adversely affect the voting and other rights of the holders of our common stock; and

discourage acquisition proposals or tender offers for our shares.

Our shares may be delisted if our stock price drops below $5.00 per share or if we otherwise fail to comply with applicable listing requirements.

We are required to maintain a stock price of approximately $5.00 per share in order to maintain our listing on the Nasdaq National Market. If our stock price drops below approximately $5.00 per share for an extended period of time or we are otherwise unable to satisfy the continued listing requirements of the Nasdaq National Market, our shares could be delisted from the Nasdaq National Market and the marketability, liquidity and price of our common stock would be adversely affected.

Risks Relating to Our Industry

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 U.S. Food and Drug Administration and comparable state and foreign agencies. Regulations adopted by the U.S. Food and Drug Administration are wide ranging and govern, among other things, product design, development, manufacture and testing, labeling, 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 U.S. Food and Drug Administration 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. 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, reduce our revenue and profits, and result in operating losses.

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, such as a cosmetic procedure, 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 tooth 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, financial condition and results of operations.

Item 7A.Quantitative and Qualitative Disclosures About Market Risk

As discussed in Note 4 to the Consolidated Financial Statements, we acquired a production facility in Germany in February 2002. The debt related to those assets is payable in Euros at the exchange rate in effect as of the date of acquisition. That exchange rate was 0.8591. In conjunction with portion of the debt due in 2003, we entered into forward contracts to purchase approximately $700,000 of Euros at an exchange rate of 0.8575. As of December 31, 2002, the exchange rate was 1.0482, resulting in an unrealized gain on those contracts of $152,000, which has been reflected in the Consolidated Statements of Operations. On February 3, 2003, the contracts expired and were not renewed, resulting in a cumulative realized gain on the contracts of $174,000.

Since February 3, 2003, we have not engaged in transactions to offset currency fluctuations, and we are at risk for changes in the value of the dollar relative to the Euro with respect to our obligation to repay the debt on our German facility. The value of the German facility itself as stated in dollars on our balance sheet will vary as the exchange rate of the dollar and the Euro varies. Our sales in Europe are denominated principally in Euros, and our sales in other international markets are denominated in dollars. As a result, an increase in the relative value of the dollar to the Euro would lead to less income from sales denominated in Euros, unless we increase prices, which may not be possible due to competitive conditions in Europe. Additionally, since expenses relating to our manufacturing operations in Germany are paid in Euros, an increase in the value of the Euro relative to the dollar would increase the expenses associated with our German manufacturing operations and reduce our earnings. Our bank line of credit bears interest at a variable rate tied to LIBOR plus 2.25%, which makes the current effective interest rate 3.4% at August 31, 2003. A 10% increase in LIBOR would increase the effective interest rate from 3.4% to 3.5%, which would not result in a material difference to our interest expense on our outstanding bank debt of $1.8 million.

Item 8.Financial Statements and Supplementary Data

All financial statements and supplementary data required by this Item are listed in Part IV, Item 15 of this Form 10-K/A, are presented beginning on Page F-1 and are incorporated herein by this reference.

Item 9A.Controls and Procedures

(a) Evaluation of disclosure controls and procedures. We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be fileddisclosed by us in responsereports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Based on their evaluation as of the end of the period covered by this Item 8, begin at page F-1Annual Report on Form 10-K/A for the year ended December 31, 2002, our Chief Executive Officer and Chief Financial Officer have concluded that, subject to the limitations noted above and except as indicated below in paragraph (b) of this report. 27 item, our disclosure controls and procedures were effective to ensure that material information relating to us, including our consolidated subsidiaries, is made known to them by others within those entities, particularly during the period in which this Annual Report on Form 10-K/A was being prepared.

(b) Changes in internal control over financial reporting. There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) identified in connection with the evaluation described in Item 9(a) above that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. However, we have been notified by our independent accountants that there exists a material weakness with respect to our internal controls

surrounding our evaluation of the terms and conditions of our arrangements with our customers to determine the appropriate timing of revenue recognition. The registrant has modified and standardized its purchase order forms to conform to the revenue recognition criteria in SAB 101 and is implementing controls over future modifications to its purchase order forms.

PART III

Item 11.Executive Compensation

The following table contains summary information concerning the annual compensation for the years ended December 31, 2000, 2001 and 2002 for our President and Chief Executive Officer, and our other executive officers who earned over $100,000 for the year ended December 31, 2002.

Annual Compensation

Long-Term
Compensation
Awards


Name and Principal Position


Year

Salary ($)

Bonus ($)

Other Annual
Compensation ($)


Securities
Underlying
Options (#)


Jeffrey W. Jones

    President and Chief

    Executive Officer

2002
2001
2000
$

240,000
240,000
240,000

$

96,000

—  

—  

(1)

$

20,540

54,634

4,500

(2)

(3)

(4)

—  
300,000
100,000

Keith G. Bateman

    Executive Vice President

2002
2001
2000


110,000
110,000
110,000

137,362

69,019

27,442

(5)

(5)

(5)

—  

—  

—  

—  
100,000
—  

Edson J. Rood

    Vice President and Chief

    Financial Officer

2002
2001

150,000
64,435

—  

—  

—  

—  

—  
200,000

(1)Represents annual bonus equal to 0.5% of all sales revenue in excess of $10,000,000.
(2)Represents car allowance of $17,640 and $2,900 of reimbursement for travel expenses.
(3)Includes housing allowance of $42,000 in lieu of bonuses, car allowance of $8,134 and $4,500 of reimbursement for travel expenses.
(4)Includes reimbursement for travel expenses.
(5)Represents commissions earned.

Stock Options and Stock Appreciation Rights

No stock options or stock appreciation rights were granted to the named executive officers during 2002.

Fiscal Year-End Option Values

The following table provides information, with respect to the named executive officers, concerning unexercised options held by them at the end of 2002. None of the named executive officers exercised any stock options during 2002 and no stock appreciation rights were held by the named executive officers at the end of such year.

   

Number of Securities Underlying
Unexercised Options at

Fiscal Year-End (#)


  

Value of Unexercised in-the-
Money

Options at

Fiscal Year-End ($)(1)


Name


  Exercisable

  Unexercisable

  Exercisable

  Unexercisable

Jeffrey W. Jones

  657,000  150,000  $1,754,055  $48,000

Keith G. Bateman

  162,500  62,500   428,719   20,000

Edson J. Rood

  100,000  100,000   110,000   110,000

(1)Based on the market price of $5.49 per share, determined on the basis of the closing sale price per share of our common stock on the Nasdaq National Market on the last day of the fiscal year ended December 31, 2002, less the option exercise price payable per share, multiplied by the number of shares underlying the options.

Employment Contracts, Termination of Employment and Change in Control Arrangements

In January 2002, we entered into an employment agreement with Jeffrey W. Jones, our President and Chief Executive Officer. Under the terms of the employment agreement, Mr. Jones receives a base annual salary of $240,000. In addition, Mr. Jones earned a bonus equal to 0.50% of all 2002 sales in excess of $10,000,000 and will earn a bonus equal to 0.63% of all 2003 sales in excess of $20,000,000. Mr. Jones received a monthly housing allowance of $3,500 for the fiscal year 2002 for expenses incurred in maintaining a residence in California in connection with his employment with us. The housing allowance was in lieu of any bonus in 2001. Mr. Jones also is entitled to receive an automobile allowance, four weeks’ paid vacation per year, reimbursement of reasonable periodic travel expenses for traveling to and from his permanent residence in Wyoming, and other executive benefits. The term of Mr. Jones’ agreement ends on December 31, 2003, but his employment will continue on a calendar quarter to calendar quarter basis on the terms existing at that time until terminated on at least 90 days prior notice by either party, or until the employment agreement is amended, renewed or extended. We may immediately terminate the employment agreement at any time for cause as defined in the employment agreement. If we terminate Mr. Jones’ employment other than for cause, Mr. Jones will be entitled to receive severance pay in an amount equal to six to 12 months’ base salary.

In connection with the execution of his employment agreement, Mr. Jones received a stock option on December 20, 2001 to purchase 300,000 shares of our common stock at an exercise price of $5.17 per share, which was the fair market value of our common stock on December 20, 2001. The stock option vests at a rate of 12,500 shares per month and expires ten years from the date of grant, subject to earlier termination should Mr. Jones cease to provide service to us. If Mr. Jones’ employment is terminated by us other than for cause, the stock option will continue to vest for the longer of the balance of the calendar year in which the termination occurs or six months following the termination.

In Mr. Jones’ employment agreement, we agreed to indemnify Mr. Jones to the maximum extent permitted under Delaware law against any expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement (with our written consent which shall not be unreasonably withheld) actually and reasonably incurred in connection with any action, suit or proceeding, whether civil, criminal, administrative or investigative, threatened or initiated against Mr. Jones by reason of the fact that he was serving as an officer, director, employee or agent of us or was serving at our request as an officer, director, employee or agent of another corporation, partnership, joint venture, trust or other enterprise.

In January 1999, we entered into an employment agreement with Keith G. Bateman, our Executive Vice President responsible for sales. The agreement is terminable at any time by us or Mr. Bateman. Under the agreement, we granted to Mr. Bateman options to purchase up to 100,000 shares of our common stock at a per share exercise price of $2.125, which are fully vested and exercisable. The agreement provided for an initial salary of $110,000. Mr. Bateman’s base salary was $110,000 for 1999 through 2002, and was increased to $150,000 for 2003. Mr. Bateman is currently entitled to receive a target bonus of up to $100,000 if he satisfies certain performance benchmarks. Under the terms of this agreement, in the event we are acquired or merged, the surviving entity either must offer Mr. Bateman a one-year employment agreement with at least equivalent compensation terms as he receives from us or must pay Mr. Bateman severance in an amount equal to his total compensation during the previous nine months, including base salary, commissions and bonus.

The Compensation Committee of our Board of Directors has the authority to provide for accelerated vesting of the shares of our common stock subject to any outstanding options held by the chief executive officer or any other executive officer or any unvested share issuances actually held by such individual, in connection with certain changes in control of us or the subsequent termination of the officer’s employment following the change of control event.

PART IV

Item 15.Exhibits, Financial Statement Schedules and Reports on Form 8-K.

(a) The following documents are filed as part of this amended Annual Report on Form 10-K/A beginning on the pages referenced below:

(1) Financial Statements:

Page

Report of Independent Accountants

F-2

Consolidated Balance Sheets as of December 31, 2002 and 2001 (Restated)

F-3

Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and 2000 (Restated)

F-4

Consolidated Statements of Stockholders’ Equity (Deficit) for the years ended December 31, 2002, 2001 and 2000 (Restated)

F-5

Consolidated Statements of Cash Flow for the years ended December 31, 2002, 2001 and 2000 (Restated)

F-6

Notes to the Consolidated Financial Statements

F-7

(2) Financial Statement Schedule:

Schedule II – Consolidated Valuation and Qualifying Accounts and Reserves for the years ended December 31, 2002, 2001 and 2000 (Restated)

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 amended Annual Report on Form 10-K/A or are incorporated by reference herein in accordance with the designated footnote references.

Exhibit
Number


Description


  3.1

Restated Certificate of Incorporation, as Amended. (2)

  3.2

Amended and Restated Bylaws. (3)

  4.1

Certificate of Designations, Preferences and Rights of Series A 6% Redeemable Cumulative Convertible Preferred Stock of BIOLASE Technology, Inc. (4)

  4.2

Rights Agreement dated as of December 31, 1998 between the Registrant and U.S. Stock Transfer Corporation. (5)

  4.4

Rights Agreement dated as of December 31, 1999, between the Registrant and U.S. Stock Transfer Corporation. (5)

  4.5

1990 Stock Option Plan. (1)

  4.6

1992 Stock Option Plan. (1)

  4.7

1993 Stock Option Plan. (2)

  4.8

2002 Stock Option Plan. (10)

10.1†

Employment Offer Letter dated January 8, 1999 from Jeffrey W. Jones, the Registrant’s Chief Executive Officer, to Keith G. Bateman, the Registrant’s Executive Vice President (8)

10.2

Employment Agreement dated January 1, 2002 between the Registrant and Jeffrey W. Jones (6)

10.3†

Asset Purchase Agreement, dated January 29, 2002 between Asclepion-Meditec AG and the Registrant’s subsidiary, BIOLASE Europe GmbH (9)

10.4

Agreement for the Purchase of a Built-Up Property, dated January 29, 2002 between Asclepion-Meditec AG and the Registrant’s subsidiary, BIOLASE Europe GmbH (6)

Exhibit

Number


Description


10.5†Agreement, dated January 29, 2002 between Asclepion-Meditec AG and the Registrant’s Subsidiary, BIOLASE Europe GmbH (8)
10.6†Letter modification to the January 29, 2002 Asset Purchase Agreement between Asclepion-Meditec AG and Registrant’s subsidiary BIOLASE Europe GmbH (7)
10.7†Distribution Agreement, executed June 13, 2002 between Registrant and IBC GmbH (7)
10.8Form of Stock Option Agreement under the 1993 Stock Option Plan. (2)
10.09Form of Purchase Order Terms and Conditions relating to domestic sales (effective for sales on or before August 4, 2003). (12)
10.10Form of Purchase Order Term and Conditions relating to domestic sales (effective for sales after August 4, 2003) (12)
10.11Right of First Refusal Agreement dated November 15, 2001, between National Technology Leasing Corporation and BioLase Technology, Inc. (12)
10.12BioLase and NTL Agreement dated August 5, 2003, between National Technology Leasing Corporation and BioLase Technology, Inc. (12)
10.13Form of Purchase Order Terms and Conditions from National Technology Leasing Corporation (12)
10.14Credit Agreement dated May 14, 2003, between Bank of the West and BioLase Technology, Inc.(12)
21.1Subsidiaries of the Registrant (11)
23.1Consent of Independent Accountants (12)
24.1Power of Attorney (included in Signature page)
31.1Certification of Jeffrey W. Jones pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended. (12)
31.2Certification of Edson J. Rood pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended. (12)
32.1Certification of Jeffrey W. Jones Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (12)
32.2Certification of Edson J. Rood Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (12)


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.

(1)Filed with the Registrant’s Registration Statement on Form S-1 filed October 9, 1992 and incorporated herein by reference.
(2)Filed with the Registrant’s Annual Report on Form 10-K filed April 14, 1994 and incorporated herein by reference.
(3)Filed with the Registrant’s Quarterly Report on Form 10-QSB filed September 15, 1995 and incorporated herein by reference.
(4)Filed with the Registrant’s Quarterly Report on Form 10-QSB filed November 19, 1996 and incorporated herein by reference.
(5)Filed with the Registrant’s Registration Statement on Form 8-A filed December 29, 1998 and incorporated herein by reference.
(6)Filed with the Registrant’s Quarterly Report on Form 10-Q filed May 15, 2002 and incorporated herein by reference.
(7)Filed with the Registrant’s Quarterly Report on Form 10-Q filed August 14, 2002 and incorporated herein by reference.
(8)Filed with the Registrant’s Quarterly Report on Form 10-Q/A filed July 24, 2002 and incorporated herein by reference.

(9)Filed with the Registrant’s Quarterly Report on Form 10-Q/A filed September 13, 2002 and incorporated herein by reference.
(10)Filed with the Registrant’s Definitive Proxy Statement filed April 22, 2002 and incorporated herein by reference.
(11)Filed with Registrant’s Report on Form 10-K filed March 24, 2003 and incorporated herein by reference.
(12)Filed herewith.

(b)Reports on Form 8-K.

None.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this amended report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: August 9, 1999 BIOLASE TECHNOLOGY, INC. a Delaware corporation /s/

Dated: December 16, 2003

BIOLASE TECHNOLOGY, INC.,

A Delaware Corporation

(registrant)

By:

/s/    JEFFREY W. JONES


Jeffrey W. Jones
President and Chief Executive Officer

POWER OF ATTORNEY

We, the undersigned officers and directors of BioLase Technology, Inc., do hereby constitute and appoint Jeffrey W. Jones ----------------------------- Jeffrey W. Jones President, Chief Executive Officer, and Director 28 Edson J. Rood, and each of them, our true and lawful attorneys-in-fact and agents, each with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this report, and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby, ratifying and confirming all that each of said attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

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/    JEFFREY W. JONES


President, Chief Executive Officer and
Jeffrey W. JonesDirector (Principal Executive Officer)December 16, 2003

/s/    FEDERICO PIGNATELLI


Director and Chairman of the BoardDecember 16, 2003
Federico Pignatelli

/s/    WILLIAM A. OWENS


DirectorDecember 16, 2003
William A. Owens

/s/    GEORGE V. D’ARBELOFF


DirectorDecember 16, 2003
George V. d’Arbeloff

/s/    EDSON J. ROOD


Vice President and Chief Financial OfficerDecember 16, 2003
Edson J. Rood(Principal Financial and Accounting Officer)

BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES __________

Index to Consolidated Financial Statements and Schedule


Page ---- FINANCIAL STATEMENTS

Report Ofof Independent Accountants

F-2

Consolidated Balance Sheets As Ofas of December 31, 1998 And 1997 2002 and 2001 (Restated)

F-3

Consolidated Statements of Operations For The Years Endedfor the years ended December 31, 1998, 1997 And 1996 2002, 2001 and 2000 (Restated)

F-4

Consolidated Statements of Stockholders'Stockholders’ Equity For The Years Ended(Deficit) for the years ended December 31, 1998, 1997 And 1996 2002, 2001 and 2000 (Restated)

F-5

Consolidated Statements of Cash Flows For The Years Endedfor the years ended December 31, 1998, 1997 And 1996 2002, 2001 and 2000 (Restated)

F-6

Notes Toto Consolidated Financial Statements

F-7

SCHEDULE
Schedule numbered in accordance with Rule 5.04 of Regulation S-X:
II. Consolidated Valuation and Qualifying Accounts and Reserves (Restated)

S-1

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. F-1 REPORT OF INDEPENDENT ACCOUNTANTS __________

Report of Independent Accountants

To the Board of Directors and Stockholders of

BioLase Technology, Inc. San Clemente, California

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of BioLase Technology, Inc. and its Subsidiarysubsidiaries at December 31, 19982002 and 1997,2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998,2002 in conformity with accounting principles generally accepted accounting principles.in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company'sCompany’s management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted auditing standardsin the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. The accompanying consolidated financial statements have been prepared assuming that BioLase Technology, Inc. and its Subsidiary will continue as a going- concern. our opinion.

As discussed in Note 2, to the Company has restated its consolidated financial statements at December 31, 2002 and 2001 and for each of the Company has suffered recurring losses from operations and shows a need for continued funding that raises substantial doubt about its abilitythree years ended December 31, 2002 to continue as a going-concern. Management's plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result fromcorrect the outcometiming of this uncertainty. /s/revenue recognition.

/s/    PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLP Newport Beach,

Orange County, California March 16, 1999 F-2

February 10, 2003, except for Note 2,

        as to which the date is September 3, 2003

BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS December 31, 1998 And 1997 __________
1998 1997 ---- ---- A S S E T S: Current assets: Cash and cash equivalents $ 424,539 $ 213,074 Marketable securities 251,485 627,817 Accounts receivable, less allowance of $118,015 in 1998 and $117,464 in 1997 563,236 1,060,252 Inventories, net of reserves of $227,694 in 1998 and $620,949 in 1997 1,930,117 1,008,777 Prepaid expenses and other current assets 168,725 110,094 ------------ ------------ Total current assets 3,338,102 3,020,014 Property and equipment, net 407,142 181,804 Patents, trademarks and licenses, less accumulated amortization of $129,312 in 1998 and $330,466 in 1997 147,199 95,508 Other assets 18,929 98,666 ------------ ------------ Total assets $ 3,911,372 $ 3,395,992 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY: Current liabilities: Line of credit $ 1,705,025 $ 301,233 Accounts payable 806,335 481,240 Accrued expenses 701,016 480,440 Accrued costs related to dissolution of foreign subsidiary 37,144 38,069 ------------ ------------ Total liabilities 3,249,520 1,300,982 ------------ ------------ Commitments and contingencies Stockholders' equity: Preferred stock, par value, $.001, 1,000,000 shares authorized: no shares issued and outstanding at December 31, 1998 and 1997 - - Common stock, par value, $.001, 50,000,000 shares authorized, issued 16,312,007 in 1998 (after deducting 182,880 of escrow shares) and 13,462,636 in 1997 16,312 13,463 Additional paid-in capital 38,614,948 29,755,652 Receivable from stockholders and unearned services - (50,766) Accumulated deficit (37,969,408) (27,623,339) Total stockholders' equity 661,852 2,095,010 ------------ ------------ Total liabilities and stockholders' equity $ 3,911,372 $ 3,395,992 ============ ============


   December 31,

 
   2002

  2001

 
   (Restated – Note 2) 

ASSETS

         

Current assets:

         

Cash and cash equivalents

  $3,940,000  $2,670,000 

Accounts receivable, less allowance of $202,000 and $108,000 in 2002 and 2001, respectively

   4,983,000   2,182,000 

Inventories, net of reserves of $239,000 and $232,000 in 2002 and 2001, respectively

   2,792,000   1,887,000 

Deferred charges on product shipped

   1,415,000   605,000 

Prepaid expenses and other current assets

   1,028,000   260,000 
   


 


Total current assets

   14,158,000   7,604,000 

Property, plant and equipment, net

   1,733,000   392,000 

Patents and trademarks, net

   67,000   91,000 

Other assets

   45,000   166,000 
   


 


Total assets

  $16,003,000  $8,253,000 
   


 


LIABILITIES AND STOCKHOLDERS’ EQUITY

         

Current liabilities:

         

Line of credit

  $1,792,000  $1,792,000 

Accounts payable

   2,082,000   1,656,000 

Accrued liabilities

   3,580,000   1,976,000 

Customer deposits

   329,000   290,000 

Deferred revenue on product shipped

   3,674,000   1,626,000 

Deferred gain on sale of building, current portion

   63,000   63,000 

Debt

   1,220,000   —   
   


 


Total current liabilities

   12,740,000   7,403,000 

Deferred gain on sale of building

   142,000   205,000 
   


 


Total liabilities

   12,882,000   7,608,000 

Stockholders’ equity:

         

Preferred stock, par value $0.001, 1,000,000 shares authorized, no shares issued and outstanding

   —     —   

Common stock, par value $0.001, 50,000,000 shares authorized; issued and outstanding—20,131,000 shares in 2002 and 19,734,000 shares in 2001

   20,000   20,000 

Additional paid-in capital

   49,497,000   48,462,000 

Accumulated other comprehensive loss

   (57,000)  —   

Accumulated deficit

   (46,339,000)  (47,837,000)
   


 


Total stockholders’ equity

   3,121,000   645,000 
   


 


Total liabilities and stockholders’ equity

  $16,003,000  $8,253,000 
   


 


See accompanying notes to consolidated financial statements. F-3

BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS For The Years Ended December 31, 1998, 1997 And 1996 __________
1998 1997 1996 ---- ---- ---- Net sales $ 1,465,191 $1,786,285 $ 691,829 Cost of sales 1,418,560 1,527,242 559,169 ------------- ------------ ------------ Gross profit 46,631 259,043 132,660 ------------- ------------ ------------ Operating expenses: Sales and marketing 1,628,821 955,192 618,964 General and administrative 1,780,015 1,280,171 1,018,270 Engineering and development 1,824,901 1,022,733 984,418 In-process research and development 5,134,920 - - ------------- ------------ ------------ Total operating expenses 10,368,657 3,258,096 2,621,652 ------------- ------------ ------------ Loss from operations (10,322,026) (2,999,053) (2,488,992) Interest income 57,591 184,245 30,142 Interest expense (81,634) (9,102) (4,409) ------------- ------------ ------------ Net loss ($10,346,069) ($2,823,910) ($2,463,259) ========== ========= ========= Loss per share - basic and diluted ($0.69) ($0.21) ($0.21) ==== ==== ==== Weighted-average shares outstanding - basic and diluted 15,061,814 13,385,318 11,531,527 ========== ========== ==========


   

Years Ended December 31,

(Restated – Note 2)


 
   2002

  2001

  2000

 

Net sales

  $27,257,000  $16,546,000  $9,495,000 

Cost of sales

   10,485,000   6,938,000   4,816,000 
   


 


 


Gross profit

   16,772,000   9,608,000   4,679,000 
   


 


 


Other income

   63,000   79,000   —   
   


 


 


Operating expenses:

             

Sales and marketing

   10,729,000   7,314,000   4,211,000 

General and administrative

   3,010,000   2,011,000   1,841,000 

Engineering and development

   1,684,000   1,520,000   2,288,000 
   


 


 


Total operating expenses

   15,423,000   10,845,000   8,340,000 
   


 


 


Income (loss) from operations

   1,412,000   (1,158,000)  (3,661,000)

Gain on foreign currency transactions

   51,000   —     —   

Gain on forward exchange contract

   152,000   —     —   

Interest income

   18,000   44,000   69,000 

Interest expense

   (135,000)  (167,000)  (163,000)
   


 


 


Income (loss) before cumulative effect of change in accounting principle

   1,498,000   (1,281,000)  (3,755,000)

Cumulative effect of change in accounting principle

   —     —     (34,000)
   


 


 


Net income (loss)

  $1,498,000  $(1,281,000) $(3,789,000)
   


 


 


Income (loss) per share before cumulative effect of change in accounting principle:

             

Basic

  $0.08  $(0.07) $(0.20)

Diluted

  $0.07  $(0.07) $(0.20)

Cumulative effect of change in accounting principle per share:

             

Basic

  $—    $—    $0.00 

Diluted

  $—    $—    $0.00 

Net income (loss) per share:

             

Basic

  $0.08  $(0.07) $(0.20)

Diluted

  $0.07  $(0.07) $(0.20)

Shared used in computing net income (loss) per share:

             

Basic

   19,929,000   19,510,000   19,171,000 

Diluted

   21,303,000   19,510,000   19,171,000 

See accompanying notes to consolidated financial statements. F-4

BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS'STOCKHOLDERS’ EQUITY For The Years Ended December 31, 1998, 1997 And 1996 ------------------
Preferred Stock Common Stock Shares Amount Shares Amount ------ ------ ------ ------ Balances at January 1, 1996 - $ - 11,241,164 $ 11,241 Private placement of preferred stock 100 - - - Exercise of stock options - - 88,766 89 Conversion of preferred stock to common stock (99) - 1,800,018 1,800 Issuance of shares for fractional interest on reverse split - - 1 - Net loss - - - - ------ ------- ----------- --------- Balances at December 31, 1996 1 - 13,129,949 13,130 Private placement of common stock - - 200,000 200 Exercise of stock options - - 99,000 99 Issuance of stock primarily for services - - 43,850 44 Issuance of stock primarily for unearned services - - 14,250 14 Cancellation of stock issued for unearned services - - (41,523) (41) Conversion of preferred stock to common stock (1) - 17,109 17 Issuance of shares from fractions interest in reverse split - - 1 - Net loss - - - - ------ ------- ----------- --------- Balances at December 31, 1997 - - 13,462,636 13,463 Private placement of common stock - - 1,320,000 1,320 Issuance of stock for Laser Skin Toner purchase - - 1,467,120 1,467 Issuance of stock and warrants for earned services - - 23,300 23 Exercise of stock options - - 38,950 39 Earned services - - - - Issuance of shares for fractional interest on reverse split - - 1 - Net loss - - - ------ ------- ----------- --------- Balances at December 31, 1998 - $ - 16,312,007 $ 16,312 ====== ======= =========== =========
Receivable From Additional Stockholders Paid-In And Unearned Accumulated Capital Services Deficit Total ------- -------- ------- ----- Balances at January 1, 1996 24,169,018 $ - $ (22,336,170) 1,844,089 Private placement of preferred stock 4,400,000 - - 4,400,000 Exercise of stock options 133,061 - - 133,150 Conversion of preferred stock to common stock (1,800) - - - Issuance of shares for fractional interest on reverse split - - - - Net loss - - (2,463,259) (2,463,259) ------------ ----------- -------------- ---------- Balances at December 31, 1996 28,700,279 - (24,799,429) 3,913,980 Private placement of common stock 719,685 - - 719,885 Exercise of stock options 137,151 - - 137,250 Issuance of stock primarily for services 147,761 - - 147,805 Issuance of stock primarily for unearned services 50,752 (50,766) - - Cancellation of stock issued for unearned services 41 - - - Conversion of preferred stock to common stock (17) - - - Issuance of shares from fractions interest in reverse split - - - - Net loss - - (2,823,910) (2,823,910) ------------ ---------- --------------- ---------- Balances at December 31, 1997 29,755,652 (50,766) (27,623,339) 2,095,010 Private placement of common stock 3,591,480 - - 3,592,800 Issuance of stock for Laser Skin Toner purchase 5,133,453 - - 5,134,920 Issuance of stock and warrants for earned services 75,976 - - 75,999 Exercise of stock options 58,387 - - 58,426 Earned services - 50,766 - 50,766 Issuance of shares for fractional interest on reverse split - - - - Net loss - - (10,346,069) (10,346,069) ------------ ---------- --------------- ---------- Balances at December 31, 1998 $ 38,614,948 $ - $(37,969,408) $ 661,852 ============ ========== ============== ============
(DEFICIT)


  

Preferred

Stock


  

Common Stock and

Additional

Paid-in Capital


    

Accumulated

Other

Comprehensive

Loss


  

Accumulated

Deficit


  

Total

Stockholders’

Equity

(Deficit)


 
  Shares

 Amount

  Shares

  Amount

      

Balances at December 31, 1999

 —   $—    17,583,000  $41,827,000    $—    $(42,767,000) $(940,000)

Private placement of common stock, net

 —    —    1,250,000   2,450,000     —     —     2,450,000 

Issuance of stock and warrants for earned services

 —    —    37,000   73,000     —     —     73,000 

Cancellation of stock

 —    —    (525,000)  —       —     —     —   

Exercise of stock options

 —    —    203,000   322,000     —     —     322,000 

Exercise of warrants

 —    —    819,000   2,879,000     —     —     2,879,000 

Net loss (restated)

 —    —    —     —       —     (3,789,000)  (3,789,000)
  
 

  

 

    


 


 


Balances at December 31, 2000
(Restated – Note 2)

 —    —    19,367,000   47,551,000     —     (46,556,000)  995,000 

Issuance of stock and warrants for earned services

 —    —    20,000   128,000     —     —     128,000 

Exercise of stock options

 —    —    172,000   367,000     —     —     367,000 

Exercise of warrants

 —    —    175,000   436,000     —     —     436,000 

Net loss (restated)

 —    —    —     —       —     (1,281,000)  (1,281,000)
  
 

  

 

    


 


 


Balances at December 31, 2001
(Restated – Note 2)

 —    —    19,734,000   48,482,000     —     (47,837,000)  645,000 

Exercise of stock options

 —    —    182,000   472,000     —     —     472,000 

Exercise of warrants

 —    —    215,000   563,000     —     —     563,000 

Comprehensive income (loss):

                           

Net income (restated)

 —    —    —     —       —     1,498,000   1,498,000 

Foreign currency translation adjustment

 —    —    —     —       (57,000)  —     (57,000)
  
 

  

 

    


 


 


Total comprehensive income (restated)

 —    —    —     —       (57,000)  1,498,000   1,441,000 
  
 

  

 

    


 


 


Balances at December 31, 2002
(Restated – Note 2)

 —   $—    20,131,000  $49,517,000    $(57,000) $(46,339,000) $3,121,000 
  
 

  

 

    


 


 


See accompanying notes to consolidated financial statements. F-5

BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS For The Years Ended December 31, 1998, 1997 And 1996 __________
1998 1997 1996 ---- ---- ---- Cash flows from operating activities: Net loss ($10,346,069) ($2,823,910) ($2,463,259) Adjustments to reconcile net loss to net cash used by operating activities: Issuance of common stock and warrants for earned service 126,765 147,805 - In-process research and development 5,134,920 - - Depreciation and amortization 94,156 105,649 149,746 Provision for bad debts 551 95,507 (5,900) Provision for inventory write-off 49,247 164,488 37,663 Changes in assets and liabilities: Accounts receivable 496,465 (1,010,296) (74,941) Inventories (970,587) (796,786) (23,214) Prepaid expenses and other assets 21,106 (116,108) 98,850 Accounts payable and accrued expenses 544,746 224,385 129,984 ------------- ------------ ------------ Net cash used by operating activities (4,848,700) (4,009,266) (2,151,071) ------------- ------------ ------------ Cash flows from investing activities: Purchase of marketable securities (2,522,563) - (4,000,000) Sale of marketable securities 2,898,895 2,872,183 500,000 Additions to property and equipment (299,925) (90,523) (54,808) Additions to patents, trademarks and licenses ( 71,260) (67,145) (21,145) ------------- ------------ ------------ Net cash (used) provided by investing activities 5,147 2,714,515 (3,575,953) ------------- ------------ ------------ Cash flows from financing activities: Borrowings under the line of credit, net 1,403,792 301,233 - Payments of capital lease obligations - - (22,324) Proceeds from issuance of common stock, net 3,592,800 719,885 - Proceeds from exercise of stock options 58,426 137,250 133,150 Proceeds from issuance of preferred stock, net - - 4,400,000 ------------- ------------ ------------ Net cash provided by financing activities 5,055,018 1,158,368 4,510,826 ------------- ------------ ------------ Increase (decrease) in cash and cash equivalents 211,465 (136,383) (1,216,198) Cash and cash equivalents at beginning of year 213,074 349,457 1,565,655 ------------- ------------ ------------ Cash and cash equivalents at end of year $ 424,539 $ 213,074 $ 349,457 ============= ============ ============ Supplemental cash flow disclosure: Cash paid during the year for interest $ 74,370 $ 4,005 $ 4,410 ============= ============ ============


   

Years Ended December 31,

(Restated – Note 2)


 
   2002

  2001

  2000

 

Cash flows from operating activities:

             

Net income (loss)

  $1,498,000  $(1,281,000) $(3,789,000)

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

             

Cumulative effect of change in accounting principle

   —     —     (34,000)

Issuance of common stock and warrants for earned services

   —     127,000   73,000 

Depreciation and amortization

   246,000   165,000   166,000 

Gain on disposal of assets

   (63,000)  (43,000)  —   

Unrealized gain on forward exchange contract

   (152,000)  —     —   

Provision (benefit) for bad debts

   283,000   133,000   20,000 

Provision for inventory excess and obsolescence

   7,000   108,000   326,000 

Changes in assets and liabilities:

             

Accounts receivable

   (3,084,000)  (1,441,000)  (530,000)

Inventory

   (912,000)  (773,000)  (889,000)

Deferred charges on product shipped

   (810,000)  (497,000)  (108,000)

Prepaid expenses and other assets

   (495,000)  (242,000)  (12,000)

Accounts payable and accrued expenses

   2,030,000   1,276,000   514,000 

Deferred revenue on product shipped

   2,048,000   1,341,000   285,000 

Customer deposits

   39,000   90,000   200,000 
   


 


 


Net cash provided by (used in) operating activities

   635,000   (1,037,000)  (3,778,000)
   


 


 


Cash flows from investing activities:

             

Additions to property, plant and equipment

   (478,000)  (154,000)  (1,069,000)

Additions to patents and licenses

   —     (10,000)  —   

Proceeds from the sale of property, plant and equipment

   —     2,261,000   —   
   


 


 


Net cash (used in) provided by investing activities

   (478,000)  2,097,000   (1,069,000)
   


 


 


Cash flows from financing activities:

             

Borrowings under a line of credit, net

   —     —     450,000 

Payments on mortgage note payable

   —     (1,195,000)  (5,000)

Payments on note payable

   —     —     (428,000)

Proceeds from issuance of common stock, net

   —     —     2,450,000 

Proceeds from exercise of stock options and warrants

   1,035,000   803,000   3,201,000 
   


 


 


Net cash provided by (used in) financing activities

   1,035,000   (392,000)  5,668,000 
   


 


 


Effect of exchange rate changes on cash

   78,000   —     —   

Increase in cash and cash equivalents

   1,270,000   668,000   821,000 

Cash and cash equivalents at beginning of period

   2,670,000   2,002,000   1,181,000 
   


 


 


Cash and cash equivalents at end of period

  $3,940,000  $2,670,000  $2,002,000 
   


 


 


Supplemental cash flow disclosure:

             

Cash paid during the period for interest

  $51,000  $130,000  $148,000 
   


 


 


Cash paid during the period for taxes

  $2,000  $2,000  $2,000 
   


 


 


Non-cash financing activities:

             

Conversion of accrued expenses to a note payable

  $—    $—    $428,000 

Issuance of debt to purchase manufacturing facility

   —     —     1,200,000 

Debt incurred in connection with acquisition of production facility

   1,000,000   —     —   
   


 


 


   $1,000,000  $—    $1,628,000 
   


 


 


See accompanying notes to consolidated financial statements. F-6

BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1998, 1997 And 1996 ------------- 1. Summary Of Significant Accounting Policies:


NOTE 1—BASIS OF PRESENTATION

The Company

BioLase Technology Inc. (the "Company"), which changed its name from Laser Medical Technology, Inc. in May 1995, was incorporated in Delaware in February 1987. In 1987, the Company acquired 77%is a medical technology company operating in one business segment that designs, manufactures and markets advanced dental, cosmetic and surgical laser and related products.

Basis of the outstanding shares of Societe Endo Technic, S.A. ("SET"), a French corporation, which in turn had a 100%-owned subsidiary, Societe Endo Technic, Inc., doing business as Endo Technic Corporation (a California corporation). In 1994, the Company discontinued the operations of SET and purchased certain assets of SET, including 100% of the stock of Societe Endo Technic, Inc., for nominal consideration. The Company's primary business is developing, manufacturing and marketing advanced laser products for dental and other surgical applications, and distributing endodontic products manufactured by third parties. Principles Of Consolidation: --------------------------- Presentation

The consolidated financial statements include the accounts of the CompanyBioLase Technology, Inc. and its wholly ownedtwo wholly-owned subsidiaries: Societe Endo Technic, which is inactive and which we intend to dissolve, and BIOLASE Europe GmbH (“BIOLASE Europe”), a foreign subsidiary after eliminatingincorporated in Germany in December of 2001. We have eliminated all material intercompany transactions and balances in the accompanying financial statements. As of December 31, 2002, $1.7 million of net assets were located outside of the United States, in BIOLASE Europe.

Use of Estimates

In order to prepare the financial statements in accordance with GAAP, we use estimates and assumptions that may affect reported amounts and disclosures. Significant estimates in these financial statements include valuation allowances on accounts receivable and transactions. inventories, accrued warranty expenses, pro-forma effects of stock-based compensation and the provision for deferred taxes and related valuation allowances. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be based on amounts that differ from those estimates.

Reclassifications

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

NOTE 2—RESTATEMENT OF FINANCIAL STATEMENTS

Staff Accounting Bulletin No. 101 (“SAB 101”), Revenue Recognition in Financial Statements, requires the transfer of title and the risks and rewards of ownership to the current year's presentation. Revenue Recognition: ------------------- Salescustomer prior to the recognition of revenue. We originally prepared our financial statements on the basis that this transfer of title occurred upon shipment. Subsequent to the issuance of our consolidated financial statements as of and for the year ended December 31, 2002, it was determined, with respect to sales to domestic customers, that title transferred upon receipt of full payment, due to a clause in our purchase orders. As a result, we have restated our consolidated financial statements as of December 31, 2002 and December 31, 2001 and for each of the three years in the period ended December 31, 2002 to defer revenue upon shipment and to recognize it upon receipt of full payment for our domestic customers. We have reflected the impact of this change, as measured at January 1, 2000, as the cumulative effect of a change in accounting principle for the adoption of SAB 101. The $34,000 cumulative effect of change in accounting principle was recognized as income during the year ended December 31, 2000. It was also determined that revenue recognition for products shipped directly to customers in Europe, which we commenced in 2002, is appropriate at the time of installation, which is when the customer is obligated to pay, and not at the time of shipment as recognized in the previously filed financial statements. In conjunction with these revisions, we have deferred the revenue, the related cost of inventory and related sales are recognized upon shipmentcommissions. Our revenue recognition policy in Note 3 has been revised to reflect these changes.

As a result of products. the restatement, our net revenue for 2002 decreased by $1.9 million, our gross profit decreased by $1.3 million and our net income was reduced by $1.1 million ($0.05 per fully diluted share). For 2001, our net revenue decreased by $1.3 million our gross profit decreased by $980,000 and our net loss increased by $873,000 ($0.05 per fully diluted share). In 2000 our net loss increased by $61,000 ($0.01 per fully diluted share).

BIOLASE TECHNOLOGY, INC.


The Company's laser productsstatements of operations have been restated as follows:

Year Ended December 31, 2002


  As Reported

  Restated

 

Net sales

  $29,199,000  $27,257,000 

Cost of sales

   11,102,000   10,485,000 

Operating expenses

   15,616,000   15,423,000 

Income from operations

   2,481,000   1,412,000 

Net income

  $2,630,000  $1,498,000 

Net income per share:

         

Basic

  $0.13  $0.08 

Diluted

  $0.12  $0.07 

Year Ended December 31, 2001


  As Reported

  Restated

 

Net sales

  $17,887,000  $16,546,000 

Cost of sales

   7,299,000   6,938,000 

Operating expenses

   10,952,000   10,845,000 

Loss from operations

   (364,000)  (1,158,000)

Net loss

  $(408,000) $(1,281,000)

Net loss per share:

         

Basic

  $(0.02) $(0.07)

Diluted

  $(0.02) $(0.07)

Year Ended December 31, 2000


  As Reported

  Restated

 

Net sales

  $9,657,000  $9,495,000 

Cost of sales

   4,829,000   4,816,000 

Operating expenses

   8,462,000   8,340,000 

Loss from operations

   (3,634,000)  (3,661,000)

Loss before cumulative effect of change in accounting principle

   (3,728,000)  (3,755,000)

Cumulative effect of change in accounting principle

   —     (34,000)

Net loss

  $(3,728,000) $(3,789,000)

Cumulative effect of change in accounting principle per share:

         

Basic

  $0.00  $0.00 

Diluted

  $0.00  $0.00 

Net loss per share:

         

Basic

  $(0.19) $(0.20)

Diluted

  $(0.19) $(0.20)

The balance sheets have been restated as follows:

         

December 31, 2002


  As Reported

  Restated

 

Working capital

  $3,484,000  $1,418,000 

Total assets

   14,395,000   16,003,000 

Stockholders’ equity

   5,187,000   3,121,000 

December 31, 2001


  As Reported

  Restated

 

Working capital

  $1,135,000  $201,000 

Total assets

   7,561,000   8,253,000 

Stockholders’ equity

   1,579,000   645,000 

BIOLASE TECHNOLOGY, INC.


NOTE 3 —SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Cash and endodontic handpieces are generally under warranty against defects in material and workmanship for a period of one year. Cash Equivalents: ---------------- The Company considersEquivalents

We consider all highly liquid debt instrumentsinvestments with a maturityoriginal maturities of three months or less at the timeas cash equivalents. We invest excess cash primarily in a money market account consisting of purchase to be cash equivalents.U.S. Treasury securities. Cash equivalents are carried at cost, which approximates market. At December 31, 1998

Accounts Receivable

We regularly evaluate the collectibility of accounts receivable based upon our knowledge of customers and 1997, the Company had approximately $211,000compliance with credit terms. The allowance for doubtful accounts is adjusted based on such evaluation, with a corresponding provision included in general and $38,000, respectively, of cash balances that were in excess of the federally-insured limit of $100,000 per bank. F-7 BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997 And 1996 ------------- 1. Summary Of Significant Accounting Policies, Continued: Marketable Securities: --------------------- Marketable securities consist of United States government treasury notes having maturities greater than three months but less than one year at the time of acquisition. Marketable securities are classified as available- for-sale securities and are reported at fair value. Gross unrealized gains and losses on marketable securities at December 31, 1998 and 1997 are not material. Inventories: ----------- Inventories are valuedadministrative expenses.

Inventory

We value inventories at the lower of cost or market (determined by the first-in, first-out method). We periodically evaluate the carrying value of inventories. The allowance for obsolescence is adjusted based on such evaluation, with a corresponding provision included in cost of sales.

Property, And Equipment: ---------------------- PropertyPlant and Equipment

We state property, plant and equipment including property under capital lease agreements, are carried at acquisition cost less accumulated depreciation and amortization. Maintenance and repairs are expensed as incurred. Upon sale or disposition of assets, any gain or loss is included in the consolidated statementstatements of operations.

The cost of property, plant and equipment is generally depreciated using the straight-line method over the estimated useful lives of the respective assets, which are generally not greater than five years. Leaseholdyears, except for leasehold improvements, which are amortized over the lesser of the estimated useful lives of the respective assets or the related lease terms. terms and our German production facility which is depreciated over thirty years.

We continually monitor events and changes in circumstances, which could indicate that the carrying balances of property, plant and equipment may exceed the undiscounted expected future cash flows from those assets. If such a condition were to exist, we will recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets.

Patents, Trademarks And Licenses: -------------------------------- and Licenses

Costs incurred to establish and successfully defend patents, trademarks and licenses and to acquire productproducts and process technologytechnologies are capitalized. Costs incurred for internally developed technologies that we ultimately patent are expensed as incurred. All amounts assigned to these patents, trademarks and licenses are amortized on a straight-line basis over an estimated eight-year useful life.

The continuing carrying value of patents is assessed based upon the Company'sour operating experience, expected cash flows from related products and other factors as deemedwe deem appropriate. F-8

Fair Value of Financial Instruments

Our financial instruments consist of cash, accounts receivable, accounts payable and other accrued expenses that approximate fair value because of the short maturity of these items. The fair value of the foreign currency forward contracts is estimated by obtaining quotes from banks.

BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued


Foreign Currency Translation

For operations outside the United States (“U.S.”) that prepare financial statements in currencies other than the U.S. dollar, 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 related to net assets located outside the U.S. are shown as a component of accumulated other comprehensive 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 statement of operations.

Derivative Financial Instruments

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

At December 31, 1998, 1997 And 1996 ------------- 1. Summary Of Significant Accounting Policies, Continued: 2002, we had outstanding derivative financial instruments comprised of foreign exchange forward contracts with notional amounts of $697,000 and a fair value of $849,000 with the fair value gain of $152,000 recognized into net income for the year ended December 31, 2002. On February 3, 2003, the contracts expired and were not renewed, resulting in a cumulative realized gain on the contracts of $174,000.

Revenue Recognition

We sell products domestically to customers through our direct sales force, and internationally through a direct sales force and through distributors. We recognize revenue for products sold domestically when we have received a purchase order, the price is fixed or determinable, and payment has been received due to a clause in our purchase order that states title transfers upon payment in full. We recognize revenue for products sold internationally through our direct sales force when we have received a purchase order, the price is fixed or determinable, collectibility of the resulting receivable is probable and installation has been completed, which is when the customer is obligated to pay. We recognize revenue for products sold through our distributors internationally when we have received a purchase order, the price is fixed or determinable, collectibility of the resulting receivable is probable and the product has been delivered. Extended warranty contracts, which are sold to our non-distributor customers, are recorded as revenue on a straight-line basis over the period of the contracts, which is one year.

Deferred charges on product shipped represent the cost of inventory shipped to customers for which revenue and the related cost of sales have not been recognized since payment has not been received or the installation has not been completed. Deferred revenue on product shipped represents products shipped to customers for which revenue has not yet been recognized.

Provision for Warranty Expense

Products sold directly to end-users are under warranty against defects in material and workmanship for a period of one year. Products sold internationally to distributors are covered by a warranty on parts for up to fourteen months with additional coverage on certain components for up to two years. We estimate warranty costs at the time of product shipment based on historical experience. Estimated warranty expenses are recorded as an accrued liability, with a corresponding provision to cost of sales.

BIOLASE TECHNOLOGY, INC.


Changes in the product warranty accrual for the year ended December 31, 2002 was as follows:

Warranty accrual, December 31, 2001

  $561,000 

Change in liability for warranties issued during the period

   1,213,000 

Warranty expenditures

   (1,149,000)
   


Warranty accrual, December 31, 2002

  $625,000 
   


Shipping and Handling Costs and Revenues

All shipping and handling costs are expensed as incurred and are recorded as a component of cost of sales. Charges for shipping and handling are included as part of sales.

Advertising Costs

All advertising costs are expensed as incurred. Advertising costs incurred for the years ended December 31, 2002, 2001 and 2000, were approximately $939,000, $609,000 and $420,000, respectively.

Engineering And Development: --------------------------- Company-sponsored engineeringand Development

Engineering and development costs related to both present and future products are expensed as incurred. Estimates: --------- The preparation of

Income Taxes

Differences between accounting for financial statements in accordance with generally acceptedstatement purposes and accounting principles requires management to make estimates and assumptions that affect the reported amounts offor tax return purposes are stated as deferred tax assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Income Taxes: ------------ The Company follows Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes", which requires the recognition ofor deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the accompanying consolidated financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income.statements. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. We have established valuation allowances to reduce deferred tax assets until it is more likely than not those assets will be realized. The provision for income taxes represents the tax payable for the period and the change during the period in deferred tax assets and liabilities.

Stock-Based Compensation: ------------------------ The Company has adoptedCompensation

On December 31, 2002, the disclosure-only provisions ofFASB issued SFAS No. 123, "Accounting148, Accounting for Stock-Based Compensation", related to employee stock options.Stock Based Compensation Transition and Disclosure, which amends SFAS No. 123 defines a fair value based method of accounting for both employee123. SFAS No. 148 requires more prominent and non-employee stock options and warrants. Fair value of the stock option and warrant is determined considering factors such as the exercise price, the expected life, the current price of the underlying stock and its volatility, expected dividends on the stock, and the risk- free interest rate for the expected term. Under the fair value based method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service F-9 BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997 And 1996 ------------- 1. Summary Of Significant Accounting Policies, Continued: Stock-Based Compensation, Continued: ----------------------------------- period. Pro formafrequent disclosures for entities that elect to continue to measure compensation cost under the intrinsic method provided by Accounting Principles Board ("APB") No. 25 for employee stock options must includeabout the effects of all awards granted in fiscal years that begin afterstock-based compensation, which we have adopted for the year ended December 15, 1994. The fair value of options and warrants issued31, 2002. We will continue to non-employees is recorded as expense over the service period. Pursuantaccount for our stock based compensation according to the provisions of APB Opinion No. 25 and its related interpretations, the Company treats all members of the Board of Directors as functionally equivalent employees and, accordingly, no25.

BIOLASE TECHNOLOGY, INC.


If we had recognized compensation is recorded for stock option awards to such individuals if the exercise price of the stock option equals or exceeds the market value of the underlying stock oncost at the date of grant. Lossgrant, our pro-forma net income (loss) and pro-forma income (loss) per share would have been as follows:

   (Restated – Note 2)

 
   2002

  2001

  2000

 

Net income (loss), as reported

  $1,498,000  $(1,281,000) $(3,789,000)

Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects

   (1,258,000)  (935,000)  (462,000)
   


 


 


Pro forma net income (loss)

  $240,000  $(2,216,000) $(4,251,000)
   


 


 


Net income (loss) per share:

             

Basic – as reported

  $0.08  $(0.07) $(0.20)

Basic – pro forma

  $0.01  $(0.11) $(0.22)

Diluted – as reported

  $0.07  $(0.07) $(0.20)

Diluted – pro forma

  $0.01  $(0.11) $(0.22)

Shares used in computing net income (loss) per share:

             

Basic

   19,929,000   19,510,000   19,171,000 

Diluted

   21,303,000   19,510,000   19,171,000 

The pro forma amounts were estimated using the Black-Scholes option-pricing model with the following assumptions:

   2002

  2001

  2000

 

Expected term (years)

   3.50   3.50   3.50 

Volatility

   84%  64%  83%

Annual dividend per share

  $0.00  $0.00  $0.00 

Risk free interest rate

   3.05%  4.68%  6.21%

Weighted-average fair value of options granted

  $2.97  $2.19  $1.34 

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Our options have characteristics significantly different from those of traded options, and changes in the subjective input assumptions can materially affect the fair value estimate.

Income (Loss) Per Share - Share—Basic And Diluted: ---------------------------------- In 1997, the Company follows SFAS No. 128, "Earnings Per Share". and Diluted

Basic earnings per sharesshare is computed by dividing net income available to common stockholders(loss) by the weighted-averageweighted average number of common shares outstanding. In computing diluted earnings per share, the weighted-averageweighted average number of shares outstanding is adjusted to reflect the effect of potentially dilutive securities including options, warrants, preferred stock or contingently issuable (or escrowed) stock,securities.

Potential common shares totaling 365,000, 1,453,000 and income available to common stockholders is adjusted to reflect any changes in income or loss that would result from the issuance of the dilutive common shares. There2,000 were no potential common sharesnot included in the calculation of diluted lossearnings per share amounts for the years ended December 31, 1998, 19972002, 2001 and 1996, because the2000, respectively, as their effect would have decreased the loss per share amount and therefore been antidilutive. See Note 9 for a description of those securities that could potentially dilute earnings per share in the future, should the Company report income. Comprehensive Income: -------------------- Duringanti-dilutive. For the year ended December 31, 1998, the Company adopted SFAS No. 130 "Reporting 2002, potentially dilutive securities consisted of stock options and warrants and resulted in potential common shares of 1,693,000.

BIOLASE TECHNOLOGY, INC.


Comprehensive Income". The standard establishes guidelines for the reporting and display of comprehensive income and its components in financial statements. Income (Loss)

Comprehensive income generally represents(loss) encompasses the change in equity from transactions and other events and circumstances from non- owner sources. It includes all changes in stockholders' equity, except those resulting from investments by and distributions to stockholders. The Company has no items of other comprehensive income for the years ended December 31, 1998, 1997 and 1996. 2. Basis Of Presentation: The Company's consolidated financial statements have been presented on the basis that it will continue as a going-concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company reported net losses of $10,346,069, $2,823,910 and $2,463,259 for the years ended December 31, 1998, 1997 and 1996, respectively, and has an accumulated deficit of $37,969,408 at December 31, 1998. These recurring losses and the need for continued funding, discussed below, raise substantial doubt about the Company's ability to continue as a going-concern. F-10 BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997 And 1996 ------------- 2. Basis Of Presentation, Continued: The Company remains dependent upon its ability to obtain outside financing either through the issuance of additional shares of its common or preferred stock or through borrowings until it achieves sustained profitability through increased sales, continued efforts of engineering redesign, and cost containment. The Company's business now focuses on and is expected to continue to focus on the manufacturing and marketing of its laser-based HydroKinetic(TM) tissue cutting system, the Millenium(TM); a new reduced- power variation of the Millenium(TM) which is being configured for applications in dermatology and general soft-tissue surgery; and its recently-released consumer tooth-whitening system, the LazerSmile(TM) toothbrush. Financing the development of laser-based medical and dental devices and instruments and the operations of the Company has been achieved principally through private placements of preferred and common stock and the exercises of stock options and warrants. During the three years ended December 31, 1998, the Company has raised approximately $8,713,000 of equity funds. Management believes that the Company will require significant resources in 1999, principally to fund the Company's working capital needs to support the production and marketing of the Company's laser-based products for various dental and medical applications, efforts directed towards further extensions and refinements of existing products, and continuing research and development activities. The Company expects to generate the necessary resources for its 1999 business plan through a combination of the contribution from the sales of its products, the sale of equity securities in a private placement, and debt financing. No assurances can be given, however, that the Company will be able to obtain such additional resources. If the Company is unsuccessful in generating anticipated resources from one or more of the anticipatednon-owner sources and is unableincluded in the statement of stockholders’ equity. Accumulated other comprehensive loss consist of the effect of foreign currency translation adjustments.

New Accounting Pronouncements

In April 2002, the FASB issued SFAS No. 145, Rescission of SFAS Nos. 4, 44 and 64, Amendment of SFAS No. 13, and Technical Corrections. The significant items from SFAS 145 that are relevant to replace any shortfall with resources from another source, the Company may be able to extendare the periodprovisions regarding extinguishment of debt and the accounting for which available resources would be adequate by deferring the creation or satisfactionsale-leaseback transactions. The provisions of various commitments, deferring the introduction of various products or entry into various markets, and otherwise scaling back operations. If the Company were unable to generate the required resources, its ability to meet its obligations and to continue its operations would be adversely affected. The Company'sthis statement are applicable for financial statements issued on or subsequent to May 15, 2002. The adoption of this statement did not have been prepared undera significant impact on our consolidated financial statements.

In July 2002, the assumptionFASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal. This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). The provisions of this statement are effective for exit or disposal activities initiated after December 31, 2002. We expect that adoption of this statement will not have a going-concern. Failuresignificant impact on our consolidated financial statements.

In November 2002, the EITF reached a consensus on Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. This Issue provides guidance on when and how to arrange such financing on acceptable termsseparate elements of an arrangement that may involve the delivery or performance of multiple products, services and rights to achieve profitability woulduse assets into separate units of accounting. The guidance in the consensus is effective for revenue arrangements entered into in fiscal periods, interim or annual, beginning after June 15, 2003. We will adopt Issue No. 00-21 in the quarter beginning July 1, 2003. We do not believe that the adoption of Issue No. 00-21 will have an adverse effect on thea material impact to our consolidated financial position, results of operations or cash flowsflows.

In November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and prospectsDisclosure Requirements for Guarantees, Including Indirect Guarantees of the Company and ultimately its ability to continue as a going- concern. The consolidated financial statements do not give effect to any adjustments that might be necessary if the Company were unable to meet its obligations or continue operations. F-11 BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997 And 1996 ------------- 3. AcquisitionIndebtedness of Laser Skin Toner, Inc.: On July 2, 1998, the Company acquired substantially all of the assets of Laser Skin Toner, Inc., a development stage company ("LSTI"Others (“Interpretation”). The assets acquired relate primarily toThis Interpretation elaborates on the proprietary laser-based technology being developed by LSTIexisting disclosure requirements for non-invasive laser treatment in the fieldmost guarantees, including loan guarantees such as standby letters of aesthetic skin rejuvenation, including all intellectual property rights consisting of patents, patent applications, a trademark application and certain know-how. Atcredit. It also requires that at the time ofa company issues a guarantee, the acquisition, the intellectual property embodying this developmental effort represented substantially all of LSTI's assets, and the developmental efforts did not appear applicable to any alternative use. As considerationcompany must recognize an initial liability for the assets acquired, the Company issued to LSTI an aggregate 1,600,000 shares of the Company's common stock (the "Shares"), including 182,880 shares of common stock retained by the Company pending the achievement by the business of specified performance objectives. Pursuant to a separate agreement, the Company also issued 50,000 shares of its common stock to O'Donnell Eye Centers, Incorporated, a Missouri corporation ("OECI"), in consideration for the license of technology that is the subject of a pending patent application and a continuation of the basic technology acquired from LSTI. The purchase price of $5,134,920 was based upon the fair market value of the common stock, based upon the quoted market price asobligations it assumes under that guarantee and must disclose that information in its interim and annual financial statements. The initial recognition and measurement provisions of the dateInterpretation apply on a prospective basis to guarantees issued or modified after December 31, 2002. We expect that the adoption of this statement will not have a significant impact on our consolidated financial statements.

In December 2002, the acquisition,FASB issued to LSTI, less the 182,880 performance shares,SFAS No. 148, Accounting for Stock-Based Compensation-Transition and the shares issued to OECI. A valuationDisclosure-an amendment of LSTI's in-process research and development effort asFASB Statement No. 123. This amendment provides alternative methods of the date of acquisition assignedtransition for a value of $5,134,920, the full amount of the consideration paid by the Company in its acquisition of LSTI's assets,voluntary change to the in-process research and development. The Company's management had the primary responsibility for estimating the value of the in-process research and development. Additionally, the value of the shares issued to OECI in consideration of the license agreement was included as part of the valuation of the in-process research and development due to a lack of any use for said licensed technology separate and apart from the technology acquired from LSTI. This allocation represented the estimated fair value based on future cash flows. The value ascribedmethod of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirement of Statement 123 to in-process researchrequire prominent disclosures in both annual and development atinterim financial statements about the timemethod of accounting for stock-based employee compensation and the effect of the acquisition reflectedmethod used on reported results. SFAS 148 is effective for fiscal years ending after December 15, 2002. Since we are continuing to account for stock-based compensation according to APB 25, our adoption of SFAS No. 148 requires us to provide prominent disclosures about the asset's estimated completion percentageeffects of approximately 50%. In accordance with Financial Accounting Standards Boards ("FASB") Interpretation No. 4, "Application of FASB No. 2FAS 123 on reported income and will require us to Business Combinations Accounted for bydisclose these affects in the Purchase Method", the $5,134,920 assigned to the in-process research and development effort, was charged to expense on the date of the acquisitioninterim financial statements as the development of this project had not yet reached technological feasibility and the research and development had no alternative future uses. The Income Approach was the primary technique utilized in valuing the purchased research and development. This approach included, but was not limited to, an analysis of (i) the costs associated with completing the development of the LSTI technology; (ii) the markets for products based on LSTI's technology; (iii) the anticipated cash flows attributable to the development of the LSTI technology and the products to be based on that technology; and (iv) the risks associated with realizing such cash flows. The assumptions underlying the cash flow projections were derived primarily from the business records and plans of the Company and LSTI, investment banking reports, independent analyst reports, and discussions with the management of LSTI. Basic financial assumptions, such as revenue growth and profitability, were compared to published results of public companies for similar activities, as well as industry analyst reports, to test the reasonableness of the assumptions. F-12 well.

BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997 And 1996 ------------- 3. Acquisition of Laser Skin Toner, Inc., Continued: The values assigned to this asset as of the date of the acquisition were determined by identifying significant research elements for which technological feasibility had not been established. In the case of LSTI, this included the development, prototyping, and testing activities associated with the creation of the proprietary laser-based skin resurfacing system, a new laser system for the field of aesthetic skin rejuvenation. Valuation of development efforts in the future has been excluded from the research and development appraisal. At the date of acquisition, the nature of the efforts to develop the acquired in-process technology into a technologically and commercially viable product related to the completion of all planning, designing, prototyping, and FDA approval activities that were necessary to establish that the proposed technologies met their design specifications including functional, technical, and economic performance requirements. The value assigned to purchased in-process technology was determined by estimating the contribution of the purchased in-process technology in developing a viable product, estimating the resulting net cash flows from the expected sales of such a product, and discounting the net cash flows to their present value using an appropriate discount rate. Revenue growth estimates were developed by management and based on an assessment of the industry. The preponderance of future revenues was expected to originate from the sale of products yet to be completed. At the date of acquisition, management believed that sales of the new laser system, if successfully completed, would have begun as early as the first quarter of 1999. Revenues were estimated to continue to climb in 2000 and 2001 and, after the peak in 2001, revenues for the in-process project were expected to decline for the next two years. Cost of goods sold for the project was expected at the date of acquisition to be comparable to percentages reported by similar public companies. These estimates were determined through management's expectations regarding the needed production costs anticipated to produce the laser system. Selling, general and administrative expenses and profitability estimates at the date of acquisition were determined by management forecasts, and these expenses were projected to be approximately 50% of revenue in 1999 and approximately 40% thereafter. Research and development expenses for the in-process project at the date of acquisition were expected to total approximately $2,000,000 as the Company brought the project to technological feasibility. The projections utilized in the transaction pricing and purchase price allocation analysis excluded the potential synergistic benefits related specifically to the Company's ownership. Due to the relatively early stage of the development and reliance on future, unproven products and technologies, the cost of capital (discount rate) for LSTI was estimated using venture capital rates of return. Due to the nature of the forecast and the risks associated with the projected growth and profitability of the development projects, a discount rate of 50% was used to discount cash flows from the in-process product. This discount rate was commensurate with LSTI's market position, the uncertainties in the economic estimates described above, the inherent uncertainty surrounding the successful development of the purchased in-process technology, the useful life of such technology, the profitability levels of such technology, and the uncertainty related to technological advances that could render even LSTI's development stage technologies obsolete. The Company believed that the foregoing assumptions used in the forecasts were reasonable at the time of the acquisition but were inherently uncertain. No assurance can be given, however, that the underlying assumptions used to estimate sales, development costs or profitability, or the events associated with such projections, will transpire as estimated. For these reasons, actual results may vary significantly from those utilized in the forecasts. Subsequent to the acquisition of the LSTI assets, the Company decided to defer development of the LSTI technology in order to devote maximum resources to the marketing of its Millennium(TM) laser-based system. The Company is uncertain as to when development of the LSTI technology may resume. The following table presents unaudited consolidated pro forma financial information for the twelve months ended December 31, 1998 and 1997, as though the acquisition made in 1998 occurred January 1, 1997:
Year Ended December 31, 1998 1997 ---- ---- Net sales $ 1,465,191 $ 1,786,285 Net loss (10,438,124) (3,129,002) Loss per share - basic and diluted ($0.69) ($0.23)
F-13 BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997 And 1996 ------------- 3. Acquisition of Laser Skin Toner, Inc., Continued: The unaudited pro forma consolidated financial information is presented for information purposes only and is not necessarily indicative of the operating results that would have occurred had the acquisition taken place on January 1, 1997. In addition, the pro forma results are not intended to be a projection of the future results and do not reflect any synergies that might be achieved from the combined operations. 4. Inventories: Inventories consist of the following at December 31:
1998 1997 ---- ---- Raw materials $1,372,172 $ 804,631 Work-in-process 183,889 36,609 Finished goods 374,056 167,537 ---------- ---------- $1,930,117 $1,008,777 ========== ==========
5. Property And Equipment: Property and equipment consist of the following at December 31:
1998 1997 ---- --- Leasehold improvements $ 170,927 $ 149,282 Equipment and computers 1,001,263 754,152 Furniture and fixtures 199,588 168,419 Demonstration units 247,354 247,354 ----------- ----------- 1,619,132 1,319,207 Less, Accumulated depreciation and amortization (1,211,990) (1,137,403) --------- --------- $ 407,142 $ 181,804 =========== ===========
F-14 BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997 And 1996 ------------- 6. Line Of Credit:


NOTE 4—SUPPLEMENTARY BALANCE SHEET INFORMATION

   2002

  2001

 

INVENTORIES:

         

Materials

  $1,124,000  $1,020,000 

Work-in-process

   695,000   656,000 

Finished goods

   973,000   211,000 
   


 


Inventories

  $2,792,000  $1,887,000 
   


 


PROPERTY, PLANT AND EQUIPMENT, NET:

         

Land

  $288,000  $—   

Building

   792,000   —   

Leasehold improvements

   89,000   54,000 

Equipment and computers

   763,000   448,000 

Furniture and fixtures

   184,000   202,000 
   


 


Total

   2,116,000   704,000 

Less accumulated depreciation

   (383,000)  (312,000)
   


 


Property, plant and equipment, net

  $1,733,000  $392,000 
   


 


PATENTS AND TRADEMARKS, NET:

         

Patents

  $112,000  $112,000 

Trademarks

   69,000   69,000 
   


 


Total

   181,000   181,000 

Less accumulated amortization

   (114,000)  (90,000)
   


 


Patents and trademarks, net

  $67,000  $91,000 
   


 


ACCRUED LIABILITIES:

         

Payroll and benefits

  $1,320,000  $652,000 

Warranty expense

   625,000   561,000 

Insurance

   318,000   —   

Sales taxes

   853,000   411,000 

Other deferred revenue

   180,000   37,000 

Other

   284,000   315,000 
   


 


Accrued liabilities

  $3,580,000  $1,976,000 
   


 


NOTE 5—DEBT

At December 31, 1998, the Company2002, we had $1,705,025$1,792,000 outstanding under a revolving credit agreement with a bank. The revolving credit agreement provides for borrowings of up to $2,500,000$1.8 million for financing inventories and is collateralized by substantially all of the Company's accounts receivable and inventories. The interest rate is fixed throughout the term of the credit agreement and is computed based upon LIBOR plus 0.5% at the time of any borrowings.. At December 31, 1998,2002, the weighted average interest rate on the outstanding balance was 5.97%1.92%. The effective interest rate for the year ended December 31, 2002, including the amortization of the fair value of warrants in connection with issuing our line of credit was 7.5%. The revolving credit agreement expires on JuneJuly 31, 2003.

In February 2002, our wholly owned subsidiary, BIOLASE Europe, purchased a production facility in Germany for $1,000,000 payable in Euros at the conversion rate of 0.8591. We are required to make a payment of

BIOLASE TECHNOLOGY, INC.


Euros 582,000 by April 1, 1999, subject2003. We are currently negotiating with the seller and a third party for that third party to pay between $300,000 and $500,000 of the purchase price in exchange for certain rights that would be granted to the Company's rightthird party. If we are not able to extend it forreach an additional six months. 7. Accrued Expenses: Accrued expenses consistagreement in this regard, we will be required to make another installment of $150,000 on September 30, 2003. The balance of amounts owed, if any, will be due by December 1, 2003. At December 31, 2002, the balance outstanding was Euros 1,164,000 or $1,220,000.

NOTE 6—COMMITMENTS AND CONTINGENCIES

Leases

In March 2001, we entered into a $2.2 million sale-leaseback transaction whereby we sold and leased back our manufacturing facility located in San Clemente, California. The result of the following atsale was a $316,000 gain, which was deferred and is being amortized over the five-year lease term. The related lease is being accounted for as an operating lease. In connection with the sale and leaseback of our manufacturing facility, the mortgage note was retired in March 2001.

We also lease certain office equipment under operating lease arrangements. Future minimum rental commitments under operating leases for each of the years ending December 31:
1998 1997 ---- ---- Accrued professional fees $ 89,124 $ 82,876 Accrued legal and settlement costs 144,166 91,880 Accrued warranty 40,315 83,000 Other 427,411 222,684 -------- -------- $701,016 $480,440 ======== ========
8. Commitments31 are as follows:

2003

  $270,000

2004

   261,000

2005

   249,000

2006

   61,000
   

Total

  $841,000
   

Rent expense was $250,000, $198,000 and Contingencies: Litigation: ----------- $97,000 for the years ended December 31, 2002, 2001 and 2000, respectively.

Litigation

On August 8, 1997,October 31, 2002, we filed a lawsuit in the Company initiated an actionU. S. District Court for the Central District of California, Southern Division, against American Medical Technologies, Inc. (“AMT”). In the lawsuit, we allege that AMT is infringing certain patents owned by us, which relate to the use of laser and water technology in the medical and dental fields. The Company’s claims arise out of AMT’s offer to sell and the sale in the United States District Court entitled, BioLase Technology, Inc. v. Rudolf Schneider,of a dental device that uses laser and water technology. In the lawsuit, we are seeking an award of monetary damages and injunctive relief against AMT. While we believe that the case is meritorious, there is no assurance that we will achieve a favorable outcome. No amounts have been recorded in -------------------------------------------- which the Company is seeking to recover from Rudolf Schneider ("Schneider"), a former distributor, (i) lost profits attributableconsolidated financial statements relating to the former distributor's failureoutcome of this matter.

From time to perform its obligations, particularly its commitmenttime, we are involved in other legal proceedings incidental to purchase minimum quantities of products, pursuant toour business. We believe that our pending actions, individually and in the distribution agreement between the Company and this distributor, and (ii) $96,000 claimed to be owed to the Company by this former distributor for goods sold and delivered and services performed by the Company. On March 6, 1998, Schneider answered the complaint denying liability and filed counterclaims against the Company. Schneider's counterclaims seek unspecified actual and punitive damages for alleged fraud, breach of contract and breach of warranty associated with the transactions on which the complaint is based. F-15 BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997, And 1996 ----------------- 8. Commitments and Contingencies, Continued: Litigation, continued: ---------------------- The Company doesaggregate, will not believe this lawsuit or any other lawsuits to which it is a party will have a material adverse effect on the Company'sour financial condition, results of operations financial condition or liquidity. Lease Commitments: ------------------ The Company leases plant and office facilities under long-term operating leases. The following iscash flows.

401(k) Plan

We have a scheduleSection 401(k) defined contribution retirement plan covering substantially all of future minimum rental payments required under operating leases that have initialour full-time employees. We are not obligated to match employee contributions or remaining noncancellable lease terms in excessmake other annual contributions to this plan. We made no contributions to the 401(k) plan other than administrative expenses paid on behalf of one year as of December 31, 1998: 1999 $140,780 2000 93,853 -------- $234,633 ========
Rent expense was $156,178, $141,385 and $136,938this plan, which were nominal for the years ended December 31, 1998, 19972002, 2001 and 1996, respectively. F-16 2000.

BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued


Concentration of Credit Risk and Key Suppliers

Significant customers consisted primarily of international distributors. We have distributorship agreements for dental lasers in Europe, Australia, the Middle East, the Far East, Canada and Mexico. For the years ended December 31, 1998, 1997, And 1996 ----------------- 9. Stockholders' Equity: 2002, 2001 and 2000, export sales were $6.8 million, $3.3 million and $4.2 million, respectively. Sales in Asia, Pacific Rim countries and Australia accounted for approximately 12% of our revenue in 2002, while sales in Europe and Canada accounted for 11% and 1% of our 2002 revenue, respectively. In 2001, sales in Europe accounted for approximately 9% of revenue for the year, whereas sales in Asia and Pacific Rim countries accounted for approximately 8% of the revenue. In 2000, sales in Europe accounted for approximately 24% of our revenue for the year, and sales in Asia and Pacific Rim countries accounted for approximately 11% of the revenue for the year. Many of the dentists finance their purchases through third-party leasing companies. In these transactions, the leasing company is considered the purchaser. Approximately 36%, 43% and 38% of our revenue in 2002, 2001 and 2000 were generated from dentists who financed their purchase through one leasing company. Other than these transactions, no distributor or customer accounted for more than 10% of consolidated sales in 2002. Sales to one distributor accounted for 11% and 13% of consolidated sales in 2001 and 2000, respectively.

We currently buy certain key components of our 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 a delay in manufacturing and a possible loss of sales, which would adversely affect operating results.

Financial instruments that subject us to concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. We maintain our cash accounts with established commercial banks. Such cash deposits periodically exceed the Federal Deposit Insurance Corporation insured limit of $100,000 for each account.

Accounts receivable concentrations have resulted from sales activity to three distributors in addition to the one leasing company mentioned above. Accounts receivable for such distributors totaled approximately $838,000, $517,000 and $529,000, respectively, at December 31, 2002, 2001 and 2000. Accounts receivable for the one leasing company totaled $936,000, $628,000 and $333,000 respectively at December 31, 2002, 2001 and 2000. No other single customer accounted for more than 10% of our accounts receivable at December 31, 2002, 2001 or 2000.

NOTE 7 – STOCKHOLDERS’ EQUITY

Equity Financing: ---------------- The Company hasFinancing

In March 2000, we raised equity capital through several private offerings in the three years ended December 31, 1998, as follows:
Number Of Shares Of Common Net Cash Years Ended December 31, Stock Consideration ----------------------- ---------------------------------------- 1998 1,320,000 $3,592,800 1997 217,109* $ 719,885 1996 1,800,018** $4,400,000
*Includes 17,109 shares

Year Ended

December 31,


 

Number of Shares

of Common Stock


 

Net Cash

Consideration


2000

 1,250,000 $2,450,000

In March 2000, we issued upon conversion of one share of Preferred Stock - see below. **Excludes one share of Preferred Stock - see below. Preferred Stock: --------------- On October 16, 1996, the Company completed a private placement (the "Placement") in which the Company issued and sold 100 units, each consisting of one share of its Series A 6% Redeemable Cumulative Convertible Preferred Stock (the "Preferred Stock") which, at the option of the holder, was convertible into a variable number of1,250,000 shares of common stock that could not exceed 18,182 shares, and 5,000 Redeemable Common Stock Purchase Warrants (the 1996 Warrants"). Gross proceeds625,000 stock purchase warrants in a private placement. An additional 63,000 warrants were issued in connection with the Placement were $5,000,000 and net proceeds, after commissions of $400,000 and estimated expenses, were approximately $4,400,000.placement. Each 1996 Warrantwarrant entitles the holder to purchase aone share of common stock at $3.50, subject to satisfactionan exercise price of certain conditions. The 1996 Warrants were initially$2.50 per share and was originally scheduled to expire in 1998, however, during 1998 the exercise period wason March 31, 2002, but has subsequently been extended through Aprilto June 30, 1999. An additional 190,9102003. During 2002, 165,000 of these warrants were exercised, leaving a balance outstanding as of December 31, 2002 of 523,000.

BIOLASE TECHNOLOGY, INC.


We have also issued common stock and warrants as compensation in connection with the annual extensions of our bank line of credit as follows:

Year


 

Shares of Stock


 

Warrants


 

Valuation


2000

 37,000 100,000 $115,000

2001

 20,000 —   $95,000

The value of the stock and warrants issued for services is charged to expense as compensation for services. The value of shares issued in December 2001 was charged to interest expense during 2002.

The following table summarizes warrant activity:

   Shares

  

Weighted-
Average

Exercise
Price

Per share


Warrants outstanding, December 31, 1999

  1,548,000  $3.66

Issuance of warrants

  787,500   2.87

Exercise of warrants

  (819,150)  3.51

Expired warrants

  (75,000)  4.67
   

 

Warrants outstanding, December 31, 2000

  1,441,350   3.32

Issuance of warrants

  50,000   3.00

Exercise of warrants

  (175,000)  2.50

Expired warrants

  (428,850)  3.00
   

 

Warrants outstanding, December 31, 2001

  887,500   2.50

Exercise of warrants

  (215,000)  2.62
   

 

Warrants outstanding, December 31, 2002

  672,500  $2.46
   

 

The following table summarizes additional information about the warrants, which are outstanding as of December 31, 2002:

Shares


 

Expiration Date


 

Exercise Price


522,500

 June 30, 2003 $2.50

50,000

 June 30, 2003 $3.00

100,000

 December 1, 2003 $2.00

    

672,500


    

In June 2002, we extended the expiration date of warrants to purchase 522,500 shares of common stock from September 30, 2002 to June 30, 2003. These warrants have an exercise price of $2.50 and were issued in connection with a private placement in 2000. In June 2002, we also extended the Placement, which are exercisable at $3.50 per share, and expire on April 30, 1999. F-17 BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997, And 1996 ----------------- 9. Stockholders' Equity, Continued: In November 1996, 99expiration date of the 100 shares of Preferred Stock were convertedwarrants to common stock at a rate of 18,182 common shares for each preferred share, resulting in an aggre- gate conversion to 1,800,018 shares of common stock. In November 1997, the remaining share of Preferred Stock was converted into 17,109 shares of common stock. Thepurchase 50,000 shares of common stock from December 1, 2002 to June 30, 2003. These warrants have an exercise price of $3.00 per share and were issued upon the conversions were "restricted securities" as defined in Rule 144 promulgated under the Securities Actconnection with previous annual extensions of 1933, as amended (the "Act"). Accord- ingly, such sharesour credit facility.

BIOLASE TECHNOLOGY, INC.


Preferred Stock

The Board of Directors, without further stockholder authorization, may be resold only pursuantissue from time to a registration statement under the Act or in accordance with an exemption from such registration requirement. The Company filed a registration statement covering the resale of suchtime up to 1,000,000 shares of commonour preferred stock. Of the 1,000,000 shares of preferred stock, which was declared effective during August, 1997. 500,000 shares are designated as Series B Junior Participating Cumulative Preferred Stock. None of the preferred stock is outstanding.

On December 18, 1998, theour Board of Directors adopted a stockholder rights plan under which one preferred stock purchase right was distributed on January 11, 1999 with respect to each share of Registrant'sour common stock outstanding at the close of business on December 31, 1998. The rights provide, among other things, that in the event any person becomes the beneficial owner of 15% or more of the Company'sour common stock while the rights are outstanding, each right will be exercisable to purchase shares of the common stock of the Company having a market value equal to two times the then current exercise price of a right (initially $30.00). The rights will also provide that, if on or after the occurrence of such event, the Company iswe are merged into any other corporation or 50% or more of the Company'sour assets or earning power isare sold, each right will be exercisable to purchase common sharesstock of the acquiring corporation having a market value equal to two times the then current exercise price.price of such stock. The rights will expire on December 31, 2008, unless previously triggered, and are subject to redemption by the Company at $.001$0.001 per right at any time prior to the first date upon which they become exercisable to purchase common shares.

Cancellation of Common Stock: ------------ On May 19,Stock

In 1998, we acquired substantially all of the Company completedassets of Laser Skin Toner, Inc. (“LSTI”), a private placement in which it issued and sold 132 units to accredited investors. Each unit consisted of 10,000development stage company, for 1,600,000 shares of our common stock. We assigned the Company's common stockfull amount of the consideration we paid to in-process research and 5,000 Redeemable Stock Purchase Warrants ("development and charged the 1998 Warrants"). Gross proceeds fromentire amount to expense in 1998. In 1999, we exchanged the private placement were $3,960,000 before direct expensesLSTI technology for a royalty based upon future sale of $367,200. Theproduct covered by patents on the LSTI technology. In 2000, we entered into an agreement with the former shareholders of LSTI whereby the former shareholders agreed to return (for cancellation) 525,000 of the shares of common stock issued to them in connection with1998. Each party also exchanged general releases, including the private placement were "restricted securities" as defined in Rule 144 promulgated under the Act. Accordingly, such shares may be resold only pursuantrelease of all claims, if any, relating to a registration statement under the Act or in F-18 BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997, And 1996 ----------------- 9. Stockholders' Equity, Continued: accordance with an exemption from such registration requirement. A registration statement has been filed by the Company covering the resale of such shares of common stock but has not been declared effective. Each 1998 Warrant entitles the holder to purchase a share of common stock at $3.75 and expires on April 30, 2000. An additional 64,000 warrants were issued in connection with the placement, which are exercisable at $3.75 per share. On February 28, 1997, the Company completed a private placement in which it issued and sold 200,000 shares of its common stock to an accredited investor. Gross proceeds from the private placement were $725,000 before direct expenses of $5,115. The Company has occasionally issued shares of its common stock to individuals for services rendered. The estimated fair valueour acquisition of the common stock is charged to earnings as compensation for these services. The Company issued 23,300 shares for services valued at $64,185 in 1998. The Company issued 58,100 shares for services valued at $198,571 in 1997,assets of which 43,850 of the shares valued at $147,805 were for services rendered during 1997 and 14,250 of the shares valued at $50,766 were for services rendered in 1998. No shares were issued for services in 1996. LSTI.

Common Stock Options And Warrants: --------------------------------- The Company has adopted the 1990 Stock Option Plan (the "1990 Plan"), the 1992 Stock Option Plan (the "1992 Plan"), the 1993 Stock Option Plan (the "1993 Plan") and the 1998 Stock Option Plan (the "1998 Plan" and collectively with the 1990 Plan, 1992 Plan and 1993 Plan, the "Plans"). The 1998 Plan is subject to stockholder approval. Each of the Plans enables the Company

We have stock option plans that enable us to offer equity participation to employees, officers and directors and consultants of the Company through stock options and, with respect to the 1990 and 1992 Plans, stock appreciation rights. Aas well as certain non-employees. At December 31, 2002, a total of 375,0005,025,000 shares of common stock werehave been authorized for issuance, under the 1990 Plan, of which at December 31, 1998, 175,500 had941,933 shares have been issued upon option exercise, 185,750 werefor options which have been exercised, 2,887,684 shares have been reserved for issuance upon exercise ofoptions that are outstanding options and 13,750 were1,195,383 shares are available for the granting of additional options. A total of 150,000 shares of common stock were authorized for issuance under the 1992 Plan, of which, at December 31, 1998, 66,266 had been issued upon option exercise, 73,625 were reserved for issuance upon exercise of outstanding options and 10,109 were available for the granting of additional options. A total of 1,500,000 shares of common stock were authorized for issuance under the 1993 Plan, of which, at December 31, 1998, 86,600 had been issued upon option exercise, 1,309,585 were reserved for issuance upon exercise of outstanding options, and 103,815 F-19 BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997, And 1996 ----------------- 9. Stockholders' Equity, Continued: were available for the granting of additional options. A total of 1,000,000 shares of common stock were authorized for issuance under the 1998 Plan, of which, at December 31, 1998, 507,000 were reserved for issuance upon exercise of outstanding options, and 493,000 were available for granting of additional options. Any shares which are reserved for issuance under an outstanding option which expires or terminates unexer- cised, or any shares which are used by participants to pay all or part of the purchase price of any option exercised, may again be reserved for issuance upon exercise of newly granted options under the respective Plans. However, shares with respect to which stock appreciation rights have been exercised may not again be made subject to an award. At the discretion of the Board of Directors or a committee comprised of non-employee directors or other non- employees appointed by the Board of Directors (the "Committee"), employees, officers, directors and consultants of the Company and its subsidiary may become participants in the Plans upon receiving grants in the form of stock options or, in the case of the 1990 and 1992 Plans, stock appreciation rights.

Stock options may be granted as incentive or nonqualified stock options oroptions; however, no incentive stock options but incentive stockhave been granted to date. The exercise price of options may not be granted at agenerally equals or is greater than the market price less than 100% of the fair market value of the stock as of the date of grant (110% as to any 10% or greater stockholder at the time of grant); nonqualified stock options may not be granted at a price less than 85% of the fair market value of the stock as of the date of grant. Stock optionsOptions may be exercised no more thanvest over various periods but typically vest over three years. Options expire after ten years after the dateor within a specified time from termination of grant and no more than three years after death or disability, whichever occursemployment, if earlier. In the case of options granted under the 1993 Plan, payment of the purchase price for shares of stock acquired through the exercise of stock options must be paid in cash. At the discretion of the Committee, the purchase price for shares of stock acquired through the exercise of stock options under the 1998, 1992 and 1990 Plans may be paid by cash, shares of common stock valued at their fair market value at the date of exercise or by delivery of recourse promissory notes or a combination thereof. Under the 1998 Plan, 152,174 incentive stock options have been awarded; to date, no other incentive stock options have been awarded under any other plans. The following table summarizes the activity under the Plans: F-20

BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997, And 1996 ----------------- 9. Stockholders' Equity, Continued: Common Stock Options And Warrants, Continued: --------------------------------------------
Option Price Per Shares Share ------ ---------------- Options outstanding, December 31, 1995 1,139,450 $0.75 - $10.50 Granted 318,335 2.53 - 4.13 Exercised (88,766) 1.50 Surrendered (67,109) 1.50 - 2.80 --------- --------------- Options outstanding, December 31, 1996 1,301,910 0.75 - 10.50 Granted 234,500 3.00 - 3.94 Exercised (99,000) 0.75 - 3.00 Surrendered (95,000) 4.13 - 7.20 --------- --------------- Options outstanding, December 31, 1997 1,342,410 0.75 - 10.50 Granted 834,500 2.13 - 3.94 Exercised (38,950) 1.50 Surrendered (62,000) 3.75 - 10.50 --------- ---------------- Options outstanding, December 31, 1998 2,075,960 $0.75 - $4.13 ========= ================ Options exercisable, December 31, 1996 1,301,910 $0.75 - $10.50 ========= ================ Options exercisable, December 31, 1997 1,127,514 $0.75 - $10.50 ========= ================ Options exercisable, December 31, 1998 1,284,751 $0.75 - $4.13 ========= ================
Stock options granted under the 1990 Plan may include the right to acquire an Accelerated Ownership Nonqualified Stock Option ("AO"). If an option grant contains the AO feature and if the participant pays all or part of the purchase price of the option with shares of the Company's common stock held by the participant for at least six months, then upon exercise of the option, the participant is granted an AO to purchase at the fair market value as of the date of the AO grant the number of shares of common stock of the Company equal to the sum of the number of whole shares used by the participant in payment of the purchase price and the number of whole shares, F-21 BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997, And 1996 ----------------- 9. Stockholders' Equity, Continued: Common Stock Options And Warrants, Continued: -------------------------------------------- if any, withheld by the Company as payment for withholding taxes. An AO may be exercised between the date of grant and the date of expiration, which will be the same as the date of expiration of the option to which the AO is related. At December 31, 1998, there were no options outstanding under the 1990 Plan that included the AO feature. In addition to the Plans discussed above, the Company has several agreements with vendors and other persons under which options, not under any of the Plans, to purchase shares of the Company's common stock have been granted. The shares issuable upon exercise of such options have not been registered under the Act, except for 20,000 shares which were registered in conjunction with a registration statement declared effective in August 1997.


The following table summarizes option transactions outside the Plans:
Option Price Per Shares Share -------------- ----------------- Options outstanding, December 31, 1995 122,500 $2.00 - $12.00 Granted - - Surrendered - - Options outstanding, December 31, 1996 122,500 2.00 - 12.00 Granted 150,000 5.00 Surrendered - - ------- ---------------- Options outstanding, December 31, 1997 272,500 $2.00 - $12.00 Granted - - Surrendered - - ------- ---------------- Options outstanding, December 31, 1998 272,500 $2.00 - $12.00 ======= ================ Options exercisable, December 31, 1998 272,500 $2.00 - $12.00 ======= ================
F-22 activity:

   Shares

  

Weighted-Average

Exercise Price

Per Share


Options outstanding, December 31, 1999

  2,136,000  $2.35

Granted at fair market value

  271,000   2.26

Granted above fair market value

  281,000   2.23

Exercised

  (203,000)  1.59

Cancelled

  (175,000)  2.14

Forfeited

  (174,000)  2.96
   

   

Options outstanding, December 31, 2000

  2,136,000   2.19

Granted at fair market value

  971,000   4.37

Granted above fair market value

  25,000   2.50

Exercised

  (172,000)  2.13

Forfeited

  (206,000)  2.59
   

   

Options outstanding, December 31, 2001

  2,754,000   3.08

Granted at fair market value

  338,000   5.05

Exercised

  (182,000)  2.59

Forfeited

  (22,000)  4.15
   

   

Options outstanding, December 31, 2002

  2,888,000  $3.34
   

   

Options exercisable, December 31, 2000

  1,675,000  $2.40

Options exercisable, December 31, 2001

  1,885,000  $2.44

Options exercisable, December 31, 2002

  2,185,000  $2.87

BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued


The following table summarizes additional information for those options that are outstanding and exercisable as of December 31, 1998, 1997, And 1996 ----------------- 9. Stockholders' Equity, Continued: Common Stock2002:

Options outstanding


  

Exercisable


Range of Exercise Prices


  Number of
Shares


  

Weighted
Average

Exercise
Price


  Weighted
Average
Remaining
Life
(Years)


  Number of
Shares


  Weighted
Average
Exercise
Price


$0.75 to 3.95

  1,781,000  $2.35  5.84  1,727,000  $2.33

$4.00 to 6.59

  1,107,000  $4.92  4.82  458,000  $4.89
   
         
    
   2,888,000         2,185,000    
   
         
    

In addition to the options granted under our stock option plans, we have issued options to certain other individuals through various agreements. Options And Warrants, Continued: -------------------------------------------- A majorityto purchase 90,000 shares of the Company'scommon stock were outstanding at December 31, 1999; 2,500 options with a weighted average exercise price of $12.00 expired in 2002, leaving 87,500 options with a weighted average exercise price of $9.71 outstanding and exercisable at December 31, 1998 are exercisable at prices between $0.752002 and $3.94. Options outstanding and exercisable at December 31, 1998, had a weighted average exercise price of $3,00 and a weighted average remaining term of 6.9 years. In December 1997, the Company issued 75,000 warrantsscheduled to expire in connection with obtaining a $2,500,000 credit facility for financing inventories. Each warrant entitles the holder2003.

During 2001, options to purchase one share35,000 shares of common stock and vested fullywere granted to non-employees for services valued at date of issuance. Of such warrants, 50,000 were issued at an exercise price of $5.00 and 25,000 were issued at a per share exercise price of $4.00, all expiring December 1, 2000. In December 1998, the Company issued an additional 25,000 warrants in connection with the Company's exercise of an option to extend the term of the credit facility. Each warrant entitles the holder to purchase one share of common stock and vested fully at the date of issuance. The warrants were issued at a per share exercise price of $5.00 and expire on December 1, 2001. As of December 31, 1998, the Company has 660,000 (1998 Warrants) and 496,666 (1996 Warrants) redeemable warrants outstanding. At the sole option of the Company, it may call for redemption all of the then outstanding 1998 or 1996 Warrants provided the closing price of the Company's common stock has equaled or exceeded $6.00 per share for the 10 and 20 days, respectively, preceding the call for redemption. The notice of redemption shall specify a redemption date no less than 30 days after the date of such notice on which all of the then remaining unexercised 1996 and 1998 Warrants shall be redeemed by the Company at a cash price of $.01 per warrant.$17,000. The fair value of these options and warrants issuedwas charged to non-employees during the years ended December 31, 1998, 1997 and 1996 was not material. F-23 BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997, And 1996 ----------------- 9. Stockholders' Equity, Continued: Pro Forma Effect Of Stock-Based Compensation: -------------------------------------------- The Company has adopted the disclosure only provisions of SFAS No. 123 for options issued to employees. Accordingly, no compensation cost has been recognized for options granted under the Plans. Had compensation cost for the Company's Plans been determined based on the fair value at the grant date for awardsoperating expense in 1998, 1997 and 1996 consistent with the provisions of SFAS No. 123, the Company's net loss and loss per share would have been the pro forma amounts indicated below:
1998 1997 1996 ---- ---- ---- Net loss ($10,645,045) ($3,053,766) ($2,730,811) Loss per share -- basic and diluted (0.71) (0.23) (0.24)
The pro forma amounts were estimated using the Black-Scholes option-pricing model with the following assumptions:
1998 1997 1996 ---- ---- ---- Weighted-average life (years) 1.90 1.60 1.60 Volatility 75% 79% 53% Annual dividend per share $0.00 $0.00 $0.00 Risk-free interest rate 4.93% 5.77% 5.77% Weighted-average fair value of options $1.03 $1.30 $0.46 granted
F-24 BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997, And 1996 ----------------- 10. Income Taxes: 2001.

NOTE 8 – INCOME TAXES

The following table presents the current and deferred provision for federal and state income taxes for the years ended December 31, 1998, 1997 and 1996:
1998 1997 1996 ---- ---- ---- Current: Federal $ - $ - $ - State 1,600 1,600 1,600 ----- ------ ----- 1,600 1,600 1,600 Deferred: Federal - - - State - - - ------ ------ ------ $1,600 $1,600 $1,600 ====== ====== =====
31:

   2002

  2001

  2000

Current:

            

Federal

  $—    $—    $—  

State

   2,000   2,000   2,000
   

  

  

    2,000   2,000   2,000

Deferred:

            

Federal

   —     —     —  

State

   —     —     —  
   

  

  

   $2,000  $2,000  $2,000
   

  

  

The foregoing tax provisions are included in general and administrative expense in the accompanying consolidated statements of operations.

BIOLASE TECHNOLOGY, INC.


The tax effects of temporary differences whichthat give rise to the deferred tax provision atfor the years ended December 31 1998, 1997 and 1996 consist of:
1998 1997 1996 ---- ---- ----- Property and equipment ($41,135) $ (25,726) $ 20,796 Research and development 47,883 222,978 - Reserves not currently deductible (175,348) 129,170 (89,418) Inventories 15,155 7,542 (7,925) State taxes - - (226) Net operating losses 2,172,161 990,372 1,462,117 ------------- ------------ ----------- 2,018,716 1,324,336 1,385,344 Change in valuation allowance (2,018,716) (1,324,336) (1,385,344) ------------- ------------ ----------- Total $ - $ - $ - ============= ============ ===========
F-25 BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997, And 1996 ----------------- 10. Income Taxes, Continued: are as follows:

   2002

  2001

  2000

 

Property and equipment

  $38,000  $7,000  $(5,000)

Capitalized intangible assets

   194,000   (39,000)  227,000 

Reserves not currently deductible

   148,000   28,000   131,000 

Inventories

   61,000   40,000   79,000 

Deferred revenue on product shipped

   456,000   395,000   22,000 

Capital loss carryforward

   —     —     (275,000)

Research and development credits

   (114,000)  616,000   —   

Net operating losses

   (898,000)  (603,000)  1,286,000 
   


 


 


    (115,000)  444,000   1,465,000 

Change in valuation allowance

   115,000   (444,000)  (1,465,000)
   


 


 


   $—    $—    $—   
   


 


 


The provision for income taxes differs from the amount that would result from applying the federal statutory rate atas follows for the years ended December 31, 1998, 1997 and 1996 as follows:
1998 1997 1996 ---- ---- ---- Statutory regular federal income tax rate (34.0%) (34.0%) (34.0%) In-process research and development 16.9 - - Stock options (0.2) (3.1) (2.3) Change in valuation allowance 18.5 43.0 36.10 Other (1.2) (5.9) 0.2 ----- ----- ----- Total 0.0% 0.0% 0.0% ===== ===== =====
31:

   2002

  2001

  2000

 

Statutory regular federal income tax rate

  (34.0%) (34.0%) (34.0%)

Stock options

  24.7% (13.1%) (4.5%)

Change in valuation allowance

  21.5% 51.1% 38.1%

Other

  (12.2%) (4.0%) 0.4%
   

 

 

Total

  0.0% 0.0% 0.0%
   

 

 

The components of the deferred income tax assets as of December 31, 1998 and 1997 are as follows:
1998 1997 ---- ---- Property and equipment $ 274,900 $ 316,035 Research and development 270,861 222,978 Reserves not currently deductible 234,794 410,142 Inventories 56,290 41,135 Capital loss carryforward 277,498 277,498 State taxes 544 544 Net operating losses 11,816,477 9,644,316 ------------ ------------ 12,931,364 10,912,648 Valuation allowance (12,931,364) (10,912,648) ------------ ------------ Total $ - $ - ============ ============
The Company hasfollows at December 31:

   2002

  2001

 

Property and equipment

  $208,000  $170,000 

Capitalized intangible assets

   1,247,000   1,053,000 

Reserves not currently deductible

   637,000   489,000 

Inventories

   203,000   142,000 

Deferred revenue on product shipped

   873,000   417,000 

State taxes

   1,000   1,000 

Research and development credits

   502,000   616,000 

Net operating losses

   12,529,000   13,427,000 
   


 


    16,200,000   16,315,000 

Valuation allowance

   (16,200,000)  (16,315,000)
   


 


Total

  $—    $—   
   


 


BIOLASE TECHNOLOGY, INC.


We have established a valuation allowance against its deferred tax assets due to the uncertainty surrounding the realization of such assets. ManagementWe periodically evaluatesevaluate the recoverability of the deferred tax assets. Atassets and at such time as it is determined that deferred taxsuch assets are realizable, the valuation allowance will be reduced. F-26

BIOLASE TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued December 31, 1998, 1997, And 1996 ----------------- 10. Income Taxes, Continued: At December 31, 1998, the Company had a capital loss carryforward of $640,873, which will expire in 2000.


As of December 31, 1998, the Company2002, we had net operating loss carryforwards for federal and state purposes of approximately $30,323,000$34.9 million and $16,199,000, respectively. The federal net operating loss carryforward begins$7.5 million, respectively, which began expiring in 2002. The2001. As of December 31, 2002, we had research and development credit carryforwards for federal and state net operating loss carryforwards begin expiring in 1999.purposes of approximately $332,000 and $170,000, respectively. The utilization of net operating loss and credit carryforwards may be limited under the provisions of Internal Revenue Code Section 382 and similar state provisions. 11. Business Segment And Sales Concentrations:

NOTE 9 – SUBSEQUENT EVENTS (UNAUDITED)

We are involved in two related patent lawsuits with Diodem, LLC, a California limited liability company. On May 2, 2003, we initiated a civil action in the U.S. District Court for the Central District of California against Diodem. In 1998,this lawsuit we are seeking a judicial declaration against Diodem that technology we use in our laser systems does not infringe four patents owned by Diodem. Diodem was founded by the Company adopted SFAS No. 131, "Disclosures About Segmentsformer chief executive officer of Premier Laser Systems, Inc., a medical laser company which filed for bankruptcy protection in March 2000. Diodem claims to have acquired the four patents at issue in the case from Premier Laser. On May 5, 2003, Diodem added us as a party to an Enterpriseinfringement lawsuit it had previously filed in the U.S. District Court for the Central District of California. Diodem alleges that our technology, including the technology used in our Waterlase system, infringes the four patents it acquired from Premier Laser. Diodem’s infringement suit seeks treble damages, a preliminary and Related Information", which requirespermanent injunction from further alleged infringement, attorneys’ fees and other unspecified damages.

Although the outcome of these actions cannot be determined with certainty, we believe our technology and products do not infringe any valid patent rights owned by Diodem, and we intend to continue to vigorously defend against Diodem’s infringement action and pursue our declaratory relief action against Diodem.

On May 14, 2003 we entered into a $5,000,000 credit facility with a bank. The new facility is for a term of one year, bears interest at LIBOR plus 2.25% and is secured by all of our assets. Approximately $1,800,000 was drawn immediately to pay off our previous bank line of credit. We are not in compliance with three covenants required under our new facility: timely reporting certainof our financial information accordingstatements for the period ended June 30, 2003, minimum tangible net equity, and the ratio of total liabilities to tangible net equity. We have obtained waivers from the bank for each item of non-compliance as of June 30, 2003.

On May 21, 2003 we acquired the American Dental Laser product line and related dental laser assets of American Medical Technologies, Inc. (AMT) for approximately $5,765,000. Consideration was $1,825,000 cash, $134,000 in costs directly attributable to the "management approach." This approach requires reporting information regarding operating segmentsacquisition and 307,500 shares of stock valued at $12.38 per share based on the basis used internally by managementaverage closing price between May 19 and May 23, 2003. The assets included dental laser patents, customer lists, brand names and other intellectual property as well as laser products. No liabilities of AMT were assumed in the transaction. The purchase price will be allocated to evaluate segment performance. SFAS 131 also requires disclosures about productsthe tangible and services, geographic areas and major customers. The Statement was effective December 31, 1998 and has been adopted for all periods presented. The Company operates in one primary segment, Laser division, and one ancillary segment, Endodontic division. The Laser division includes allidentifiable intangible assets acquired based on their fair value with any residual amount recorded as goodwill. As a part of the Company's core technologies, researchpurchase transaction, we and development expendituresAMT agreed to dismiss with prejudice the lawsuit we had filed in October 2002 against AMT which alleged infringement of certain of our patents.

NOTE 10 – SUBSEQUENT EVENT (UNAUDITED)

Following our recent restatement of financial statements, in late October 2003, we received an informal request from the Securities and substantially all operating activity. Revenues generated by the Laser division are principally sales of the Millennium(TM) laser based system. The Company maintains the Endodontic division primarily as an ancillary businessExchange Commission to service recurring customers. The accounting policies of each of the divisions are the same as describe in Note 1. The table below presentsvoluntarily provide information about the two divisions for the years ended December 31, 1998, 1997 and 1996:
Revenues Operating income (loss) ------------------------------------------- ------------------------------------------------ 1998 1997 1996 1998 1997 1996 ------------- ------------- ------------- --------------- -------------- -------------- Laser Division $ 1,202,425 $ 1,398,127 $ 290,432 $ (10,357,188) $ (2,971,943) $ (2,647,033) Endodontic Division 262,766 388,158 401,397 35,162 (27,110) 158,041 ------------- ------------- ------------- --------------- -------------- -------------- Consolidated revenues and operating loss $ 1,465,191 $ 1,786,285 $ 691,829 (10,322,026) (2,999,053) (2,488,992) ============= ============= ============= Interest income 57,591 184,245 30,142 Interest expense (81,634) (9,102) (4,409) --------------- -------------- -------------- Net loss $ (10,346,069) $ (2,823,910) $ (2,463,259) =============== ============== ============== Assets ------------------------------------------- 1998 1997 1996 ------------- ------------- ------------- Laser Division $ 3,762,190 $ 3,294,833 $ 4,492,846 Endodontic Division 149,182 101,159 196,498 ------------- ------------- ------------- Consolidated assets $ 3,911,372 $ 3,395,992 $ 4,689,344 ============= ============= =============
During the years ended December 31, 1998, 1997 and 1996 depreciation and amortization was $94,156, $105,649 and $149,746 and capital expenditures were $299,925, $90,523 and $54,808, respectively, which relate solelyrelating to the Laser division.restatement. We intend to fully comply with this request. In 1998, 1997accordance with its normal practice, the Securities and 1996, major customers consisted primarilyExchange Commission has not advised us when its inquiry may be concluded, and we are unable to predict the outcome of domestic and international distributors. The Company has distributorship agreements for dental lasers in Canada, Europe, the Middle East and the Far East. In 1998, 1997 and 1996, export sales were $598,000, $1,307,000 and $328,000, respectively, of which 66%, 93% and 80%, respectively, were sales to Europe. Also in 1998, 27% of export sales were to Canada. Sales to two customers were approximately $160,000 and $296,000, respectively, for the year ended December 31, 1998. Sales to one customer were approximately $1,188,000 and $142,000 for the years ended December 31, 1997 and 1996, respectively. No other customer accounted for more than 10% of consolidated sales in 1998, 1997 or 1996. Financial instruments which subject the Company to concentrations of credit risk consist principally of accounts receivable. Accounts receivable concentrations have resulted from sales activity to individual customers. Accounts receivable for two customer totaled approximately $332,000 at December 31, 1998. Accounts receivable for one customer totaled approximately $884,000 at December 31, 1997. No other customer accounted for more than 10% of accounts receivable at December 31, 1998 or 1997. F-27

this inquiry.

BIOLASE TECHNOLOGY, INC.


   Allowance for
Doubtful
Accounts (A)


  Reserve for
Excess and
Obsolete
Inventory


  

Valuation
Allowance

for Deferred
Tax Asset (A)


 

Balances at December 31, 1999

  $118,000  $309,000  $14,406,000 

Charged (benefit) to operations

   (14,000)  326,000   1,465,000 

Write-offs

   (99,000)  (185,000)  —   
   


 


 


Balances at December 31, 2000, (Restated – Note 2)

   5,000   450,000   15,871,000 

Charged to operations

   133,000   108,000   444,000 

Write-offs

   (30,000)  (326,000)  —   
   


 


 


Balances at December 31, 2001, (Restated – Note 2)

   108,000   232,000   16,315,000 

Charged to operations

   283,000   7,000   (115,000)

Write-offs

   (189,000)  —     —   
   


 


 


Balances at December 31, 2002, (Restated – Note 2)

  $202,000  $239,000  $16,200,000 
   


 


 


(A)The allowance for doubtful accounts as originally filed was $121,000, $195,000 and $395,000 as of December 31, 2000, 2001 and 2002, respectively. The valuation allowance for deferred tax assets as originally filed was $15,849,000, $15,898,000 and $15,327,000 as of December 31, 2000, 2001 and 2002, respectively.