NOTE 1 — BASIS OF PRESENTATION

The Company

BIOLASE, Inc., (the “Company”) incorporated in Delaware in 1987, is a biomedical company operating in one business segment that develops, manufactures, and markets lasers in dentistry and medicine and also markets and distributes dental imaging equipment, including cone beam digital x-rays and CAD/CAM intra-oral scanners.

Basis of Presentation

The consolidated financial statements include the accounts of BIOLASE, Inc. and its wholly-owned subsidiaries. The Company has eliminated all material intercompany transactions and balances in the accompanying consolidated financial statements. Certain amounts for prior years have been reclassified to conform to the current year presentation.

Use of Estimates

The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires the Company to make estimates and assumptions that affect amounts reported in the consolidated financial statements and the accompanying notes. Significant estimates in these consolidated financial statements include allowances on accounts receivable, inventory and deferred taxes, as well as estimates for accrued warranty expenses, indefinite-lived intangible assets and the ability of goodwill to be realized, revenue deferrals for multiple element arrangements, effects of stock-based compensation and warrants, contingent liabilities and the provision or benefit for income taxes. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may differ materially from those estimates.

Fair Value of Financial Instruments

The Company’s financial instruments, consisting of cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities, approximate fair value because of the short maturity of these items. Financial instruments consisting of lines of credit approximate fair value, as the interest rates associated with the lines of credit approximates the market rates for debt securities with similar terms and risk characteristics.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal market or, if none exists, the most advantageous market, for the specific asset or liability at the measurement date (referred to as the “exit price”). The fair value should be based on assumptions that market participants would use, including a consideration of nonperformance risk. Level 1 measurement of fair value is quoted prices in active markets for identical assets or liabilities.

Concentration of credit risk, interest rate risk and foreign currency exchange rate risk

Financial instruments which potentially expose the Company to a concentration of credit risk consist principally of cash and cash equivalents, restricted cash, and trade accounts receivable. The Company invests its cash and cash equivalents and restricted cash with established commercial banks. At times, balances may exceed federally insured limits. To minimize the risk associated with trade accounts receivable, management performs ongoing credit evaluations of customers’ financial condition and maintains relationships with the Company’s customers which allow management to monitor current changes in business operations respond as needed. The Company does not, generally, require customers to provide collateral before it sells them products; however is has required certain distributors to make prepayments for significant purchases of products. For the years ended December 31, 2012, 2011, and 2010, sales to Henry Schein, Inc. (“HSIC”) worldwide accounted for approximately 3%, 19%, and 38%, respectively, of our net sales.

Substantially all of the Company’s revenue is denominated in U.S. dollars, including sales to international distributors. Only a small portion of its revenue and expenses is denominated in foreign currencies, principally the Euro and Indian Rupee. The Company’s foreign currency expenditures primarily consist of the cost of maintaining offices, including the facilities, consulting services and employee-related costs. To date, the Company has not entered into any hedging contracts. Future fluctuations in the value of the U.S. dollar may, however, affect the price competitiveness of the Company’s products outside the United States.

Management’s primary objective in managing the Company’s cash balances has been preservation of principal and maintenance of liquidity to meet the Company’s operating needs. Most of the Company’s excess cash balances are invested in money market accounts in which there is minimal interest rate risk. An increase in the LIBOR rate associated with the Company’s lines of credit would increase the interest expense the Company must pay. The Company’s risk associated with fluctuation in interest expense is limited to its outstanding lines of credit balances. The Company does not use interest rate derivative instruments to manage exposure to interest rate changes.

Liquidity and Management’s Plans

Although the Company generated $1.9 million of cash from operations during the quarter ended December 31, 2012, the Company has suffered recurring losses from operations and has not generated cash from operations for the three years ended December 31, 2012. In order for the Company to continue operations and discharge its liabilities and commitments in the normal course of business, the Company must sell its products directly to end-users and through distributors; establish profitable operations through increased sales and reduced operating expenses; and potentially raise additional funds, principally through the additional sales of securities or debt financings to meet its working capital needs.

The Company intends to increase sales by increasing its product offerings, expanding its direct sales force and its distributor relationships both domestically and internationally. Accordingly, the Company has taken steps during Fiscal 2012 to improve its financial condition and ultimately improve its financial results, including increasing its product offerings with the launch of the new Epic diode laser system, for which the Company received the CE Mark in late September 2012 and FDA clearance in October 2012, executing a definitive five-year agreement with Copenhagen-based 3Shape Corporation (“3Shape”), making the Company a distributor of 3Shape’s TRIOS intra-oral CAD/CAM scanning technologies for digital impression-taking solutions in the U.S. and Canada, expanding our direct sales force and certain distributor relationships, and establishing two revolving credit facilities to meet quarterly working capital needs.

Management anticipates that the cash generated from operations and the borrowings available under the lines of credit with Comerica Bank will be sufficient to fund the working capital requirements of the Company for 2013.

At December 31, 2012, the Company had approximately $7.5 million in working capital. The Company’s principal sources of liquidity at December 31, 2012 consisted of approximately $2.5 million in cash and cash equivalents, $11.7 million of net accounts receivable, and $6.4 million of available borrowings under two revolving credit facility agreements.

On May 24, 2012, the Company entered into two revolving credit facility agreements with Comerica Bank which provide for borrowings of up to $8.0 million. The Company had approximately $1.6 million of borrowings outstanding under these lines of credit as of December 31, 2012. See Note 5 — Lines of Credit and Other Borrowings for additional information.