NOTE 1 — BASIS OF PRESENTATION

The Company

BIOLASE, Inc., (the “Company”) incorporated in Delaware in 1987, is a biomedical company that develops, manufactures, and markets lasers in dentistry and medicine and also markets and distributes dental imaging equipment, including cone beam digital x-rays and CAD/CAM intra-oral scanners, and in-office, chair-side milling machines and three dimensional (“3-D”) printers; products that are focused on technologies that advance the practice of dentistry and medicine.

Basis of Presentation

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

Use of Estimates

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

Fair Value of Financial Instruments

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal market (or, if none exists, the most advantageous market) for the specific asset or liability at the measurement date (referred to as the “exit price”). The fair value is based on assumptions that market participants would use, including a consideration of nonperformance risk. Under the accounting guidance for fair value hierarchy there are three levels of measurement inputs. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. Level 2 inputs are observable, either directly or indirectly, other than Level 1. Level 3 inputs are unobservable due to little or no corroborating market data.

The Company’s financial instruments, consisting of cash and cash equivalents (Level 1), and accounts receivable, accounts payable, and accrued liabilities (Level 3), approximate fair value because of the short maturity of these items. Financial instruments consisting of lines of credit (Level 3) approximate fair value, as the interest rates associated with the lines of credit approximates the market rates for debt securities with similar terms and risk characteristics.

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

Financial instruments which potentially expose the Company to a concentration of credit risk consist principally of cash and cash equivalents, restricted cash, and trade accounts receivable. The Company maintains its cash and cash equivalents and restricted cash with established commercial banks. At times, balances may exceed federally insured limits. To minimize the risk associated with trade accounts receivable, management performs ongoing credit evaluations of customers’ financial condition and maintains relationships with the Company’s customers which allow management to monitor current changes in business operations respond as needed. The Company does not, generally, require customers to provide collateral before it sells them products; however it has required certain distributors to make prepayments for significant purchases of products. For the years ended December 31, 2013, 2012, and 2011, worldwide sales to the Company’s largest distributor, Henry Schein, Inc. (“HSIC”), accounted for approximately 5%, 3%, and 19%, respectively, of our net sales.

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

Outstanding balances on the Company’s lines of credit expose it to variable interest rate risks associated with fluctuations in the daily prime rate and LIBOR rate. Under the Company’s current policies, it does not use interest rate derivative instruments to manage exposure to interest rate changes. An increase in the daily prime rate or LIBOR rate would increase the interest expense the Company must pay.

Liquidity and Management’s Plans

The Company has suffered recurring losses from operations and has not generated cash from operations for the three years ended December 31, 2013. The Company’s level of cash from operations, the potential need for additional capital, and the uncertainties surrounding its ability to raise additional capital, raises substantial doubt about its ability to continue as a going concern. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates that the Company will continue in operation for the next twelve months and will be able to realize its assets and discharge its liabilities and commitments in the normal course of business. The financial statements do not include any adjustments to reflect the possible future effects of recoverability and classifications of assets or the amounts and classifications of liabilities that may result from the Company’s inability to continue as a going concern.

At December 31, 2013, the Company had approximately $3.9 million in working capital. The Company’s principal sources of liquidity at December 31, 2013 consisted of approximately $1.4 million in cash and cash equivalents, $11.1 million of net accounts receivable, and available borrowings under two revolving credit facility agreements totaling approximately $3.4 million at December 31, 2013.

The available borrowing capacity on the Company’s lines of credit with Comerica Bank, discussed further in Note 5 — Lines of Credit and Other Borrowings, and the net proceeds from equity transactions, discussed further in Note 8 – Stockholders’ Equity, have been principal sources of liquidity during the year ended December 31, 2013. On September 6, 2013 and November 8, 2013, the Company amended its lines of credit with Comerica Bank. These amendments waived noncompliance with certain financial covenants and established future covenants, restrictions, and potential penalties for noncompliance. The amendment on November 8, 2013, includes liquidity ratio and liquid asset covenants, and an equity raise requirement. The Company met the equity raise requirement on February 10, 2014. On March 4, 2014, the Company received a waiver from Comerica Bank to waive noncompliance with certain financial and nonfinancial covenants as of January 31, 2014 and December 31, 2013. In connection with the waiver, Comerica Bank reduced the total aggregate available borrowings on the lines of credit to $5.0 million. These credit facilities expire May 1, 2014, and the Company is considering alternative solutions, including potentially issuing alternative debt securities, to mitigate any future liquidity constraints these covenants, restrictions, and maturities may impose on it.

On January 17, 2014, the Company filed a registration statement to register an indeterminate number of shares of common stock, preferred stock, and warrants with a total offering price not to exceed $12.5 million.

In order for the Company to continue operations and be able to discharge its liabilities and commitments in the normal course of business, the Company must sell its products directly to end-users and through distributors, establish profitable operations through increased sales, decrease expenses, and generate cash from operations or obtain additional funds when needed. The Company intends to improve its financial condition and ultimately improve its financial results by increasing revenues through expansion of its product offerings, continuing to expand and develop its direct sales force and distributor relationships both domestically and internationally, forming strategic arrangements within the dental and medical industries, educating dental and medical patients as to the benefits of its advanced medical technologies, and reducing expenses.

In February 2014, the Company completed the first phase of its planned cost saving measures by streamlining operations and reducing payroll and payroll related expenses by approximately $1.3 million, net (unaudited), on an annualized basis. For the second phase, the Company has begun to reallocate and rationalize certain marketing and advertising activities. We expect that we will begin to realize the impact of these cost saving measures in the quarter ending June 30, 2014.

Additional capital requirements may depend on many factors, including, among other things, the rate at which the Company’s business grows, demands for working capital, manufacturing capacity, and any acquisitions that the Company may pursue. From time to time, the Company could be required, or may otherwise attempt, to raise capital through either equity or debt offerings. The Company cannot provide assurance that it will enter into any such equity or debt financings in the future or that the required capital would be available on acceptable terms, if at all, or that any such financing activity would not be dilutive to its stockholders.

As disclosed in a press release on November 11, 2013, the Company’s Board of Directors (“Board”) has authorized the Company to seek the services of an investment bank to explore possible merger and acquisition transactions with the goal of maximizing shareholder value. The Company has engaged the services of Piper Jaffray & Co. (“Piper Jaffray”) and continues to explore opportunities, through either acquisitions or strategic alliances.

The Company cannot guarantee that it will be able to increase sales, reduce expenses, or obtain additional funds when needed or that such funds, if available, will be obtainable on terms satisfactory to the Company. If the Company is unable to increase sales, reduce expenses, or raise sufficient additional capital, it may be unable to continue to fund its operations, develop its products, or realize value from its assets and discharge its liabilities in the normal course of business. These uncertainties raise substantial doubt about the Company’s ability to continue as a going concern.