Form 10-Q for Biolase Technology, Inc. re 3/31/06 period

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x

Number of shares outstanding of the registrant’s common stock, $0.001 par value, as of May 8, 2006: 23,301,908

BIOLASE^{^®}, and WaterLase^{^®} are registered trademarks, and Waterlase MD^™, Diolase Plus^™ and HydroPhotonics^™ are trademarks of BIOLASE Technology, Inc.

BIOLASE Technology Inc., (“the Company” or “BIOLASE”) incorporated in Delaware in 1987, is a medical technology company operating in one business segment that designs, manufactures and markets advanced dental, cosmetic and surgical lasers and related products.

The unaudited consolidated financial statements include the accounts of BIOLASE Technology, Inc. and its consolidated subsidiaries and have been prepared on a basis consistent with the December 31, 2005 audited consolidated financial statements and include all material adjustments, consisting of normal recurring adjustments and the elimination of all material intercompany transactions and balances, necessary to fairly present the information set forth therein. These unaudited, interim, consolidated financial statements do not include all the footnotes, presentations and disclosures normally required by accounting principles generally accepted in the United States of America (“GAAP”) for complete financial statements.

The preparation of these consolidated financial statements in conformity with 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, the realizability of goodwill and indefinite-lived intangible assets, stock-based compensation 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.

In 2005, the Financial Accounting Standards Board (FASB) issued Financial Accounting Standard (FAS) 154, Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3. This Statement is effective for accounting changes and corrections of errors made after January 1, 2006. This statement applies to voluntary changes in accounting principle and requires retrospective application of the new accounting principle to prior period financial statements. The adoption of this standard did not have a material effect on the Company’s financial statements.

The FASB also issued FAS 155, Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140. This Statement changes the accounting for various derivatives and securitized financial assets. This Statement shall be effective for all financial instruments acquired, issued or subject to a remeasurement (new basis) event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company does not expect the adoption of this standard to have a material impact on the Company’s financial statements.

In March 2006, the FASB issued FAS No. 156, “ Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140,” which changes the accounting for all loan servicing rights which are recorded as the result of selling a loan where the seller undertakes an obligation to service the loan, usually in exchange for compensation. FAS 156 amends current accounting guidance by permitting the servicing right to be recorded initially at fair value and also permits the subsequent reporting of these assets at fair value. FAS 156 is effective beginning January 1, 2007. The Company does not expect the adoption of this standard to have a material impact on the Company’s financial statements.

The Company has three stock-based employee compensation plans, the 1990 Stock Option Plan, the 1993 Stock Option Plan and the 2002 Stock Incentive Plan. The 1990 and 1993 Stock Option Plans have been terminated with respect to granting additional stock options. Under these plans, stock options are awarded to certain officers, directors and employees of the Company at the discretion of the Company’s management and/or Board of Directors. Options to employees generally vest over three years, with a 25% vesting on the first anniversary date and the balance vesting monthly during the remaining term.

On December 16, 2005, the Board of Directors and the Compensation Committee approved accelerating the exercisability of 1,337,500 unvested stock options outstanding under our 2002 stock incentive plan, effective as of December 16, 2005. The options are held by employees, including executive officers, and have a range of exercise prices of $5.98 to $14.36 per share. The closing price per share of our common stock on December 16, 2005, the last trading day before effectiveness of the acceleration, was $7.95. In order to prevent unintended personal benefits, shares of our common stock received upon exercise of an accelerated option remain subject to the original vesting period with respect to transferability of such shares and, consequently, may not be sold or otherwise transferred prior to the expiration of such original vesting period.

Effective January 1, 2006, the Company adopted the provisions of Financial Accounting Standard (“SFAS”) No. 123 (revised), “Share-Based Payment” (“SFAS 123R”) using the modified prospective transition method. Prior to the adoption of SFAS 123R, the Company accounted for share-based payments to employees using the intrinsic value method under Accounting Principles Board (APB) Opinion No. 25 “Accounting for Stock Issued to Employees”, and the related interpretations. Under the provisions of APB 25, stock option awards were accounted for using fixed plan accounting whereby the Company recognized no compensation expense for stock option awards because the exercise price of options granted was equal to the fair value of the common stock at the date of grant. In March 2005, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the SEC Staff’s interpretation of SFAS 123R which provides the Staff’s views regarding interactions between SFAS 123R and certain SEC rules and regulations and provides interpretations of the valuation of share-based payments for public companies. The Company has incorporated the provisions of SAB 107 in its adoption of SFAS 123R.

Under the modified prospective transition method, the provisions of SFAS 123R apply to new awards and to awards outstanding on January 1, 2006 and subsequently modified, repurchased or cancelled. Under the modified prospective transition method, compensation expense recognized in the first quarter of 2006 includes compensation costs for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123, and compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. Prior periods were not restated to reflect the impact of adopting the new standard.

We adopted SFAS 123R in the first quarter of the 2006 fiscal year and, therefore, the 2005 Annual Report on Form 10-K does not contain the incremental SFAS 123R disclosures. Therefore, we will include SFAS 123R disclosures in each Quarterly Report on Form 10-Q during the first year of adoption. The weighted average, estimated fair values of employee stock options granted during the three-month periods ended March 31, 2006 and March 31, 2005 were $3.91 and $4.77 per share respectively. The total pre-tax stock-based compensation expense included in our statements of operations for the quarters ended March 31, 2006 and March 31, 2005 was $199,000 and $0, respectively.

As of March 31, 2006, the unrecognized stock-based compensation expense related to non-vested options was approximately $1.3 million, which is expected to be recognized over a weighted average period of approximately 3 years. During the three-month period ended March 31, 2006 the total intrinsic value of stock options exercised was $73,000. The total fair value of options vested during the three-month periods ended March 31, 2006 and March 31, 2005 was $228,000 and $870,000, respectively. The Company issues new shares of common stock upon the exercise of stock options.

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. The Company’s options have characteristics significantly different from those of traded options, and changes in the subjective input assumptions can materially affect the fair value estimate. For options granted prior and subsequent to January 1, 2006, the Company did and will continue to estimate their fair values using the Black-Scholes option-pricing model. This option-pricing model requires the Company to make several assumptions regarding the key variables used in the model to calculate the fair value of its stock options. The risk-free interest rate used by the Company is based on the U.S. Treasury yield curve in effect for the expected lives of the options at their dates of grant. Beginning July 1, 2005, the Company has used a dividend yield of zero as it does not intend to pay dividends on its common stock in the foreseeable future. The most critical assumption used in calculating the fair value of stock options is the expected volatility of the entity’s common stock. The Company believes that the historic volatility of its common stock is a reliable indicator of future volatility, and accordingly, has used a stock volatility factor based on the historic volatility of it’s common stock over a period of time approximating the estimated lives of its stock options. Compensation expense is recognized using the straight-line method for all stock-based awards issued after January 1, 2006. Compensation expense is recognized only for those options expected to vest, with forfeitures estimated at the date of grant based on the Company’s historical experience and future expectations. SFAS 123R requires forfeitures to be estimated at the time of the grant and revised as necessary in subsequent periods if actual forfeitures differ from those estimates. The stock option fair values were estimated using the Black-Scholes option-pricing model with the following assumptions:

A summary of option activity under our stock option plans for the three months ended March 31, 2006 is as follows:

Cash proceeds and the intrinsic value related to stock options exercised during the fiscal years 2006 and 2005 to date, are provided in the following table (in thousands):

A summary of the status of the company’s unvested options as of December 31, 2005, and changes during the three months ended March 31, 2006, is presented below:

Pro forma net loss and net loss per share, as if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based compensation for the three months ended March 31, 2005, is as follows (in thousands, except per share amounts):

Basic net loss per share is computed by dividing loss available to common stockholders by the weighted-average number of common shares outstanding for the period.

Stock options totaling 4,348,000 and 4,146,000 shares were not included in the diluted loss per share amounts for the three months ended March 31, 2006 and March 31, 2005, respectively, as their effect would have been anti-dilutive.

The inventory is valued at the lower of cost or market (determined by the first-in, first-out method). Inventory is comprised of the following (in thousands):

Inventory is net of the allowance for excess and obsolete inventory of $639,000 and $573,000 at March 31, 2006 and December 31, 2005, respectively.

Property, plant and equipment, net is comprised of the following (in thousands):

In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill and other intangible assets with indefinite lives are no longer subject to amortization but are tested for impairment annually or whenever events or changes in circumstances indicate that the asset might be impaired. The Company conducted its annual impairment analysis of goodwill and trade names as of June 30, 2005 and concluded there had not been any impairment

Intangible assets with finite lives continue to be subject to amortization, and any impairment is determined in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The Company believes that no event has occurred that would trigger an impairment of these intangible assets. The Company recorded amortization expense for the three months ended March 31, 2006 and March 31, 2005 of $93,000 and $82,000, respectively. Other intangible assets consist of an acquired customer list and a non-compete agreement.

The following table presents details of the Company’s intangible assets, related accumulated amortization and goodwill (in thousands):

Accounts payable includes $139,000 and $197,000 of customer deposits at March 31, 2006 and December 31, 2005, respectively. Accrued liabilities is comprised of the following (in thousands):

Changes in the product warranty accrual, including expenses incurred under the Company’s initial and extended warranties, for the three months ended March 31, 2006 and 2005 were as follows (in thousands):

The Company has a $10.0 million credit facility with a bank that expires on September 30, 2006. At March 31, 2006, $5.0 million was outstanding on the credit facility. The facility is collateralized with the Company’s short-term investment in U.S. Treasury debt securities which had a fair market value of $9.9 million as of March 31, 2006, and which is shown as short-term investments, restricted on the consolidated balance sheets. In addition, the Company granted the bank a security interest in and to all equipment, inventory, accounts receivable and other assets of the Company. Borrowings under the amended facility bear interest at LIBOR plus 2.25% for minimum borrowing amounts of $500,000 and with two business days notice or at a variable rate equivalent to prime rate for amounts below $500,000 or with less than two business days notice, and are payable on demand upon expiration of the facility. All borrowings during the three months ended March 31, 2006 were at prime rate. In November 2005, the Company entered into a fourth amendment to our credit facility with the bank which eliminated all of the financial covenants.

In December 2005, the Company financed $911,000 of insurance premiums payable in ten equal monthly installments of approximately $93,000 each, including a finance charge of 4.99%. As of March 31, 2006, the Company had approximately $673,000 remaining as outstanding.

In August 2004, the Company and certain of its officers were named as defendants in several putative shareholder class action lawsuits filed in the United States District Court for the Central District of California. The complaints purport to seek unspecified damages on behalf of an alleged class of persons who purchased the Company’s common stock between October 29, 2003 and July 16, 2004. The complaints allege that the Company and its officers violated federal securities laws by failing to disclose material information about the demand for its products and the fact that the Company would not achieve the alleged forecasted growth. The claimed misrepresentations include certain statements in the Company’s press releases

and the registration statement filed in connection with the public offering of stock in March 2004. In January 2006, the Company’s motion to dismiss the second amended consolidated class action complaint was granted and the action was dismissed, with leave to further amend, by the order of the Honorable David O. Carter, United States District Judge for the Central District of California. On March 10, 2006, the plaintiffs filed a third amended complaint. The third amended complaint makes the same allegations regarding violations of the federal securities laws but is limited to an alleged class of investors who purchased or otherwise acquired the Company’s common stock pursuant to or traceable to the public offering of the Company’s stock that closed in March 2004. In addition, three stockholders have filed derivative actions in the state court in California seeking recovery on behalf of BIOLASE, alleging, among other things, breach of fiduciary duties by those individual defendants and by the members of the Board of Directors. The class action lawsuit and the derivative actions are still in the pretrial stage and no discovery has been conducted by any of the parties. However, based on the facts presently known, management believes the Company has meritorious defenses to these actions and intends to vigorously defend them. As of March 31, 2006, no amounts have been recorded in the consolidated financial statements for these matters since management believes that it is not probable it has incurred a loss contingency.

In January 2005, the Company acquired the intellectual property portfolio of Diodem, LLC , or Diodem, consisting of certain U.S. and international patents of which four were asserted against the Company, and settled the existing litigation between the Company and Diodem, for consideration of $3,000,000 in cash, 361,664 shares of common stock (valued at the common stock fair market value on the closing date of the transaction for a total of approximately $3,500,000), and a five-year warrant exercisable into 81,037 shares of common stock at an exercise price of $11.06 per share. In addition, if certain criteria specified in the purchase agreement are satisfied on or before July 2006, 45,208 additional shares the Company has placed in escrow may be released to Diodem. As of March 31, 2006, the Company determined that it is probable that these shares will be released from escrow on or before July 2006. Accordingly, the Company recorded a patent infringement legal settlement charge of approximately $432,000 in the first quarter of 2006. The common stock issued, the escrow shares and the warrant shares have certain registration rights. The total consideration had an estimated value of approximately $7,400,000 including the value of the patents acquired in January 2005. As of December 31, 2004, the Company accrued approximately $6,400,000 for the settlement of the existing litigation with $3,000,000 included in current liabilities and $3,400,000 recorded as a long-term liability. In January 2005, the Company recorded an intangible asset of $530,000 representing the estimated fair value of the intellectual property acquired. The estimated fair value of the patents was determined with the assistance of an independent evaluation expert using a relief from royalty and a discounted cash flow methodology. As a result of the acquisition, Diodem immediately withdrew its patent infringement claims against the Company and the case was formally dismissed on May 31, 2005. The Company did not pay and has no obligation to pay any royalties to Diodem on past or future sales of the Company’s products, but the Company agreed to pay additional consideration if any of the acquired patents held by the Company are licensed to a third party. In order to secure performance by the Company of these financial obligations, the parties entered into an intellectual property security agreement, pursuant to which, subject to the rights of existing creditors and the rights of any future creditors to the extent provided in the agreement, the Company granted Diodem a security interest in all of their right, title and interest in the royalty patents.

The Company determined the fair value of the warrants, which totaled $443,000 using the Black-Scholes model with the following assumptions:

From time to time, the Company is involved in other legal proceedings incidental to its business, but at this time the Company is not party to any other litigation that is material to its business.

Following the restatement of the Company’s financial statements in September 2003, the Company received, in late October 2003, and subsequently in 2003 and 2004, informal requests from the Securities and Exchange Commission, or SEC, to voluntarily provide information relating to the restatement. The Company has provided information to the SEC and intends to continue to cooperate in responding to the inquiry. In accordance with its normal practice, the SEC has not advised us when its inquiry may be concluded, and the Company is unable to predict the outcome of this inquiry.

In August 2005, the Company’s Board of Directors voted to discontinue its dividend policy of paying a cash dividend of $0.01 per share every other month which the Board had adopted in July 2004.

The Company currently operates in a single business segment. For the quarter ended March 31, 2006, sales in Europe, Middle East and Africa (“EMEA”) accounted for approximately 15% of net revenue, and sales in Canada, Asia, Latin America and Pacific Rim countries accounted for approximately 23% of net revenue. For the quarter ended March 31, 2005, sales in EMEA accounted for approximately 9% of net revenue, and sales in Canada, Asia, Latin America and Pacific Rim countries accounted for approximately 15% of net revenue.

Net revenue by geographic location based on the location of customers was as follows (in thousands):

Revenue from the Company’s Waterlase system, its principal product, comprised 79% and 86% of total net revenues for the three months ended March 31, 2006, and 2005, respectively. The Company’s Diode system comprised 7% and 8% of total revenue for the same periods. Many of the dentists finance their purchases through third-party leasing companies. In these transactions, the leasing company is considered the purchaser. Approximately 31% and 31% of the Company’s revenue for the three months ended March 31, 2006 and March 31, 2005, respectively, was generated from dentists who financed their purchase through one leasing company, National Technology Leasing Corporation (“NTL”). There was one other customer, an international distributor, that accounted for greater than 10% of the sales for the three months ended March 31, 2006. Other than these transactions, no distributor or customer accounted for more than 10% of consolidated net sales for the three months ended March 31, 2006 and 2005.

The Company maintains its cash accounts with established commercial banks. Such cash deposits periodically exceed the Federal Deposit Insurance Corporation insured limit of $100,000 for each account. At March 31, 2006, the Company held short-term investments in U.S. treasury securities with a fair market value of $9,861,000.

Accounts receivable concentrations have resulted from sales to NTL and totaled approximately $1.5 million and $3.8 million, respectively, at March 31, 2006 and 2005.

The Company currently buys certain key components of its products from single suppliers. Although there are a limited number of manufacturers of these key components, management believes that other suppliers could provide similar key components on comparable terms. A change in suppliers, however, could cause a delay in manufacturing and a possible loss of sales, which would adversely affect operating results.

This Quarterly Report contains forward-looking statements that involve a number of risks and uncertainties. Forward-looking statements include, but are not limited to, statements pertaining to financial items, plans, strategies or objectives of management for future operations, our financial condition or prospects, and any other statement that is not historical fact, including any statement using terminology such as “may,” “might,” “will,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “estimate,” “predict,” “potential,” “plan,” or the negativities of these terms or other comparable terminology. For all of the foregoing forward-looking statements, we claim the protection of the Private Securities Litigation Reform Act of 1995. These statements are only predictions and actual events or results may differ materially from our expectations for a number of reasons including those set forth under “Risk Factors” in Item 1A of this quarterly report and our Annual Report on Form 10-K for the year ended December 31, 2005. These forward-looking statements represent our judgment as of the date hereof. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

The following discussion of our results of operations and financial condition should be read together with the unaudited consolidated financial statements and the notes to those statements included elsewhere in this report and our audited consolidated financial statements and the notes to those statements for the year ended December 31, 2005.

We are a medical technology company that develops, manufactures and markets lasers and related products focused on technologies for improved applications and procedures in dentistry and medicine. In particular, our principal products are dental laser systems that allow dentists, periodontists, endodontists, oral surgeons and other specialists to perform a broad range of dental procedures, including cosmetic and complex surgical applications. Our systems are designed to provide clinically superior performance for many types of dental procedures, with less pain and faster recovery times than are generally achieved with drills, scalpels and other dental instruments. We have clearance from the U.S. Food and Drug Administration, or FDA, to market our laser systems in the United States and also have the necessary approvals to sell our laser systems in Canada, the European Union and certain other international markets.

We offer two categories of laser system products: (i) Waterlase system and (ii) Diode system. Our flagship product category, 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 for cutting soft and hard tissue. We also offer a family of Diode laser system products to perform soft tissue and cosmetic procedures, including tooth whitening.

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires us to make judgments, assumptions and estimates that affect the amounts reported. The following is a summary of those accounting policies that we believe are necessary to understand and evaluate our reported financial results.

Revenue recognition. We sell products domestically to customers through our direct sales force, and internationally through a direct sales force and through distributors. We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition,” which requires that four basic criteria must be met before revenue can be recognized: (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred and title and the risks and rewards of ownership have been transferred to our customer, or services have been rendered; (iii) the price is fixed or determinable; and (iv) collectibility is reasonably assured.

We apply EITF 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables,” which requires us to evaluate whether the separate deliverables in our arrangements can be unbundled, in our revenue recognition. Sales of our Waterlase systems include separate deliverables consisting of the product, disposables used with the Waterlase system, installation and training. For these sales, we apply the residual value method, which requires us to allocate to the delivered elements the total arrangement consideration less the fair value of the undelivered elements. Sales of our Diode system include separate deliverables consisting of the product, disposables and training. For these sales, we apply the relative fair value method, which requires us to allocate the total arrangement consideration to the relative fair value of each element.

Deferred revenue attributable to the undelivered elements, primarily training and installation, are included in deferred revenue when the product is shipped and are recognized when the related service is performed.

The key judgment related to our revenue recognition relates to the collectibility of payment from the customer. We evaluate the customer’s credit worthiness prior to the shipment of the product. Based on our assessment of the credit information available to us, we may determine the credit risk is higher than normally acceptable, and we will either decline the purchase or defer the revenue until payment is reasonably assured.

Although all sales are final, we accept returns of products in certain, limited circumstances and record a provision for sales returns based on historical experience concurrent with the recognition of revenue. The sales returns allowance is recorded as a reduction of accounts receivable, revenue and cost of revenue.

We recognize revenue for royalties under licensing agreements for our patented technology when the product using our technology is sold. We estimate and recognize the amount earned based on historical performance and current knowledge about the business operations of our licensees. Our estimates have been consistent with amounts historically reported by the licensees.

Accounting for Stock-Based Payments. In December 2004, the FASB issued SFAS 123R, which revises SFAS 123 and supersedes APB 25. In March 2005, the Securities and Exchange Commission or SEC, issued SAB 107, which provides interpretive guidance on SFAS 123R. Accounting and reporting under SFAS 123R is generally similar to the SFAS 123 approach. We adopted SFAS 123R on January 1, 2006, under the modified prospective method. For additional information related to SFAS 123R, see Note 3 in the notes to unaudited consolidated financial statements included in this quarterly report.

Valuation of Accounts Receivable. We maintain an allowance for uncollectible accounts receivable to estimate the risk of extending credit to customers. We evaluate our allowance for doubtful accounts based upon our knowledge of customers and their compliance with credit terms. The evaluation process includes a review of customers’ accounts on a regular basis which incorporates input from sales, service and finance personnel. The review process evaluates all account balances with amounts outstanding 60 days and other specific amounts for which information obtained indicates that the balance may be uncollectible. The allowance for doubtful accounts is adjusted based on such evaluation, with a corresponding provision included in general and administrative expenses. Account balances are charged off against the allowance when we feel it is probable the receivable will not be recovered. We do not have any off-balance-sheet credit exposure related to our customers.

Valuation of Inventory. Inventory is valued at the lower of cost (determined using the first-in, first-out method) or market. We periodically evaluate the carrying value of inventory and maintain an allowance for excess and obsolete inventory to adjust the carrying value as necessary to the lower of cost or market. We evaluate quantities on hand, physical condition and technical functionality, as these characteristics may be impacted by anticipated customer demand for current products and new product introductions. Unfavorable changes in estimates of excess and obsolete inventory would result in an increase in cost of revenue and a decrease in gross profit.

Valuation of Long-Lived Assets. Property, plant and equipment, and certain intangibles with finite lives are amortized over their useful lives. Useful lives are based on our estimate of the period that the assets will generate revenue or otherwise productively support our business goals. We monitor events and changes in circumstances, which could indicate that the carrying balances of long-lived assets may exceed the undiscounted expected future cash flows from those assets. If such a condition were to exist, we would recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets.

Valuation of Goodwill and Other Intangible Assets. Goodwill and other intangible assets with indefinite lives are not amortized but are tested for impairment annually or whenever events or changes in circumstances indicate that the asset might be impaired. We conducted our annual impairment analysis of our goodwill and trade names as of June 30, 2005 and concluded there had been no further impairment in trade names and no impairment in goodwill.

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. Estimated warranty expenses are recorded as an accrued liability, with a corresponding provision to cost of revenue. This estimate is recognized concurrent with the recognition of revenue. 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 expense relating to contingencies. To be recorded as expense, a loss contingency must be both probable and reasonably estimable. If a loss contingency is material but is not both probable and estimable, we will disclose the matter in the notes to the financial statements.

Income Taxes. We estimate our actual current tax expense together with assessing any temporary differences resulting from the different treatment of certain items, such as the timing for recognizing revenue and expenses, for tax and financial reporting purposes. These differences may result in deferred tax assets and liabilities, which are included in our consolidated balance sheet. We are required to assess the likelihood that our deferred tax assets, which include net operating loss carryforwards and temporary differences that are expected to be deductible in future years, will be recoverable from future taxable income or tax planning strategies. If we conclude that our deferred tax assets are more likely than not to be realized (a probability level of more than 50%), a valuation allowance is not recorded.

Off-Balance Sheet Arrangements. We have no off-balance sheet financing, or contractual arrangements.

Quarter ended March 31, 2006 compared with the Quarter ended March 31, 2005

The following table presents our results of operations as percentages of revenue:

Net Revenue. Net revenue was $16.9 million for the quarter ended March 31, 2006 versus $16.8 million for the quarter ended March 31, 2005. During the quarter ended March 31, 2006, we had higher non-laser system revenues, including the recognition of approximately $0.7 million in revenue previously recorded as a deferred revenue obligation and which was subsequently released by the customers, as well as increased sales of extended warranty packages and peripherals, such as handpieces and laser tips. Sales of laser systems decreased in the first quarter of 2006 compared to the first quarter of 2005. We believe that four primary factors have contributed to the trend of decreased laser systems sales that began in early 2005:

Sales of our Waterlase systems comprised approximately 79% and 86% of our net revenue and sales of our Diode systems comprised approximately 7% and 8% of our net revenue for the quarters ended March 31, 2006 and 2005, respectively. We expect the Waterlase system will continue to account for the majority of our net revenue. International revenue for the quarter ended March 31, 2006 was $6.5 million, or 38% of net revenue, as compared with $4.0 million, or 23% of net revenue, for the quarter ended March 31, 2005.

Gross Profit. Gross profit for the quarter ended March 31, 2006 was $8.7 million, or 52% of net revenue, a decrease of $0.7 million, as compared with gross profit of $9.4 million, or 56% of net revenue for the quarter ended March 31, 2005. The

decrease in gross profit as a percentage of revenue was caused primarily by an increase in the proportion of lower-margin international sales to total sales, an increase in total warranty expenses as the mix of systems under warranty has shifted predominantly to the Waterlase MD system, and an increase in fixed manufacturing infrastructure, including quality control, materials management, and other support activities. With our recent improvement in Waterlase MD reliability and quality, we expect to experience a gradual improvement in our gross margin in the later part of 2006.

Operating Expenses. Operating expenses for the quarter ended March 31, 2006 were $11.0 million, or 65% of net revenue, a $2.7 million decrease as compared with $13.7 million, or 81% of net revenue, for the quarter ended March 31, 2005. The decrease was driven mainly by lower spending on legal and compliance costs described below under General and Administrative Expense and the absence of costs comparable to the first quarter 2005 purchase of the SurgiLight license described below under Engineering and Development Expense.

Sales and Marketing Expense. Sales and marketing expenses for the quarter ended March 31, 2006 decreased by $0.1 million, or approximately 2%, to $6.0 million, or 36% of net revenue, as compared with $6.1 million, or 36% of net revenue, for the quarter ended March 31, 2005. The decrease related primarily to a reduction in domestic sales commissions and reduced facilities fees for after-sale training activities.

General and Administrative Expense. General and administrative expenses for the quarter ended March 31, 2006 decreased by $1.2 million, or 30%, to $3.3 million, or 19% of net revenue, as compared with $4.5 million, or 27% of net revenue, for the quarter ended March 31, 2005. The decrease in general and administrative expenses resulted primarily from reduced spending on audit fees, consulting fees, temporary labor and reduced personnel-related costs, partially offset by the recording of $0.2 million in stock-based compensation costs resulting from our January 1, 2006 adoption of SFAS 123R. Spending on the aforementioned items in the quarter ended March 31, 2005 was substantially higher because of activities associated with the delayed 2004 and 2005 financial statement filings as well as costs incurred to comply with Section 404 of the Sarbanes-Oxley Act.

Engineering and Development Expense. Engineering and development expenses for the quarter ended March 31, 2006 decreased by $1.8 million, or 59%, to $1.2 million, or 7% of net revenue, as compared with $3.0 million, or 18% of net revenue, for the quarter ended March 31, 2005. The decrease was primarily related to the $2.0 million purchase of the SurgiLight license in the first quarter of 2005, including transaction costs of $0.2 million.

Patent litigation Settlement. In connection with the Diodem patent settlement, 45,208 shares of our common stock were issued to Diodem and placed in an escrow account. As of March 31, 2006, we have determined it is probable that these shares will be released from escrow, and accordingly, we have recorded a $0.4 million charge based on the fair market value of our common stock of $9.55 per share on March 31, 2006.

Gain (Loss) on Foreign Currency Transactions. We realized a $50,000 gain on foreign currency transactions for the quarter ended March 31, 2006, compared to a loss of $0.1 million for the quarter ended March 31, 2005 due to the changes in exchange rates between the U.S. dollar and the Euro. We have not engaged in hedging transactions to offset foreign currency fluctuations. Therefore, we are at risk for changes in the value of the dollar relative to the value of the Euro, Australian dollars and New Zealand dollars which are the only non-U.S. dollar denominated currency in which we have transacted material business.

Interest Income. Interest income from interest earned on our cash and investments balances was approximately $0.1 million for the quarter ended March 31, 2006 which was comparable to the quarter ended March 31, 2005. While the average investments balance declined considerably in 2005 due to the amount of cash used in operating activities, the investments earned much higher interest rates.

Interest Expense. Interest expense consists primarily of interest on the outstanding balance on our line of credit. Interest expense for the quarter ended March 31, 2006 was $0.2 million as compared to under $0.1 million for the quarter ended March 31, 2005.

Income Taxes. An income tax provision of approximately $0.1 million was recognized for the quarter ended March 31, 2006 which was comparable to the quarter ended March 31, 2005. As of March 31, 2006, the valuation allowance for our net deferred tax liability was $28 million. Based upon our operating losses and the weight of the available evidence, management believes it is more likely than not that we will not realize all of these deferred tax assets.

At March 31, 2006, we had approximately $10.5 million in net working capital, a decrease of $2.3 million from $12.8 million at December 31, 2005. Our principal source of liquidity at March 31, 2006 consisted of our cash balance of $6.0 million and our $10.0 million revolving bank line of credit which expires September 30, 2006 and which is secured by our short-term investment in a U.S. Treasury debt security. Our investment in marketable securities of $9.9 million is collateralized against the line of credit facility and is not available for use. The outstanding balance on our bank line of credit was $5.0 million at March 31, 2006. Cash and cash equivalents decreased by $2.3 million from December 31, 2005 to March 31, 2006, while short-term investments remained at approximately $9.9 million.

In the quarter ended March 31, 2006, our operating activities used cash of $1.1 million. Significant changes in operating assets and liabilities included: accounts receivable increase of $1.7 million; inventory decrease of $0.9 million; and, accounts payable and accrued liabilities increase of $0.6 million.

Our credit facility is collateralized with our short-term investment in U.S. Treasury debt securities, all our accounts receivables, equipment, inventory, other assets and currently imposes no financial covenants on us. Borrowings under our revolving bank line of credit bear interest at LIBOR plus 2.25% for minimum borrowing amounts of $500,000 and with two business days notice, or at a variable rate equivalent to prime rate for amounts below $500,000 or with less than two business days notice, and are payable on demand upon expiration of the facility. All borrowings during the quarter ended March 31, 2006 were at prime rate.

On January 10, 2006 we entered into a five-year facility lease with initial monthly installments of $38,692 and annual adjustments over the lease term. These amounts are included in the outstanding obligations as of March 31, 2006 listed below.

The following table presents our expected cash requirements for contractual obligations outstanding as of March 31, 2006 for the years ending as indicated below (in thousands):

Three of our executive officers have employment agreements that obligate us to pay them severance benefits under certain conditions, including termination without cause and resignation with good reason. In the event that all three officers were terminated by us without cause or they resigned with good reason, the total severance benefits payable would be approximately $0.6 million based on compensation in effect as of March 31, 2006. In addition, our executive officers and some members of management are entitled to certain severance benefits payable upon termination following a change in control. Also, we have agreements with certain employees to pay bonuses based on targeted performance criteria.

We believe we currently possess sufficient resources, including our revolving bank line of credit, to meet the cash requirement of our operations for at least the next year. Also, we plan to pursue an improved short-term credit facility to accommodate the working capital needs of our business, or at least seek an extension in the expiration date of the existing bank line of credit, which currently expires September 30, 2006. Our capital requirements will depend on many factors, including among other things, the effects of any acquisitions we may pursue as well as the rate at which our business grows, with corresponding demands for working capital and manufacturing capacity. We could be required or may elect to seek additional funding through public or private equity or debt financing. However, the improved or extended credit facility, or additional funds through public or private equity or other debt financing, may not be available on terms acceptable to us or at all.

See Note 2 of the Notes to Consolidated Financial Statements (Unaudited) included in this report.

Our revenue in Europe is denominated principally in Euros, and our revenue in other international markets is denominated in local currency. As a result, an increase in the relative value of the dollar to the foreign currencies would lead to less income from revenue denominated in foreign currencies, unless we increase prices, which may not be possible due to competitive conditions. 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. To date, we have not entered into any foreign exchange contracts to hedge our exposure to foreign exchange rate fluctuations. However, as our international operations grow, we may enter into such arrangements in the future. Foreign currency-denominated sales have not been significant.

We currently have a line of credit in the amount of $10.0 million at the variable interest rate equivalent to the Prime rate for advances less than $500,000 and with less than two business days notice, and at LIBOR plus 2.25% for advances of $500,000 or more and with two business days notice. This line of credit currently expires on September 30, 2006. At March 31, 2006, we had an outstanding balance of $5.0 million. Based on this balance, a change of one percent in the interest rates would result in a change in interest expense of $12,500 for the quarter ending March 31, 2006 and $50,000 for the year ending December 31, 2006

Our primary objective in managing our cash balances has been preservation of principal and maintenance of liquidity to meet our operating needs. Most of our excess cash balances are invested in a money market account and U.S. treasury securities in which there is minimal interest rate risk.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of March 31, 2006. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of March 31, 2006, our disclosure controls and procedures were not effective because of the material weakness described below.

In our Annual Report on Form 10-K for the year ended December 31, 2005, we disclosed management’s assessment that our internal control over financial reporting contained a material weakness with respect to the controls over the recording of inventory transactions and the valuation of our inventory. The assessment by our management as of March 31, 2006 was that while we have taken actions to address this material weakness, such measures have not been sufficient to effectively remediate the noted weakness. As a result, we believe a material weakness still exists in this area. To address the material weakness, we continue to implement the remediation measures identified in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2005. Except for the implementation of these remedial measures, no change in internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) occurred during the first quarter of 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

In August 2004, we and certain of our officers were named as defendants in several putative shareholder class action lawsuits filed in the United States District Court for the Central District of California. The complaints purport to seek unspecified damages on behalf of an alleged class of persons who purchased our common stock between October 29, 2003 and July 16, 2004. The complaints allege that we and our officers violated federal securities laws by failing to disclose material information about the demand for our products and the fact that the Company would not achieve the alleged forecasted growth. The claimed misrepresentations include certain statements in our press releases and the registration

statement we filed in connection with our public offering of stock in March 2004. In January 2006, our motion to dismiss the second amended consolidated class action complaint was granted and the action was dismissed, with leave to further amend, by the order of the Honorable David O. Carter, United States District Judge for the Central District of California. On March 10, 2006 the plaintiffs filed a third amended complaint. The third amended complaint makes the same allegations regarding violations of the federal securities laws but is limited to an alleged class of investors who purchased or otherwise acquired our common stock pursuant to or traceable to the public offering of our stock that closed in March 2004. In addition, three stockholders have filed derivative actions in the state court in California seeking recovery on behalf of BIOLASE, alleging, among other things, breach of fiduciary duties by those individual defendants and by the members of our Board of Directors. The class action lawsuit and the derivative actions are still in the pretrial stage and no discovery has been conducted by any of the parties. However, based on the facts presently known, our management believes we have meritorious defenses to these actions and intends to vigorously defend them. As of March 31, 2006, no amounts have been recorded in the consolidated financial statements for these matters since management believes that it is not probable we have incurred a loss contingency.

In January 2005, we acquired the intellectual property portfolio of Diodem, LLC , or Diodem, consisting of certain U.S. and international patents of which four were asserted against us, and settled the existing litigation between us and Diodem, for consideration of $3,000,000 in cash, 361,664 shares of common stock (valued at the common stock fair market value on the closing date of the transaction for a total of approximately $3,500,000), and a five-year warrant exercisable into 81,037 shares of common stock at an exercise price of $11.06 per share. In addition, if certain criteria specified in the purchase agreement are satisfied on or before July 2006, 45,208 additional shares we have placed in escrow may be released to Diodem. As of March 31, 2006, we have determined that it is probable that these shares will be released from escrow on or before July 2006. Accordingly, we recorded a patent infringement legal settlement charge of approximately $432,000 in the first quarter of 2006. The common stock issued, the escrow shares and the warrant shares have certain registration rights. The total consideration had an estimated value of approximately $7,500,000 including the value of the patents acquired in January 2005. As of December 31, 2004, we accrued approximately $6,400,000 for the settlement of the existing litigation with $3,000,000 included in current liabilities and $3,400,000 recorded as a long-term liability. In January 2005, we recorded an intangible asset of $530,000 representing the estimated fair value of the intellectual property acquired. The estimated fair value of the patents was determined with the assistance of an independent evaluation expert using a relief from royalty and a discounted cash flow methodology. As a result of the acquisition, Diodem immediately withdrew its patent infringement claims against us and the case was formally dismissed on May 31, 2005. We did not pay and have no obligation to pay any royalties to Diodem on past or future sales of our products, but we agreed to pay additional consideration if any of the acquired patents held by us are licensed to a third party. In order to secure performance by us of these financial obligations, the parties entered into an intellectual property security agreement, pursuant to which, subject to the rights of existing creditors and the rights of any future creditors to the extent provided in the agreement, we granted Diodem a security interest in all of their right, title and interest in the royalty patents.

From time to time, we are involved in other legal proceedings incidental to its business, but at this time we are not party to any other litigation that is material to its business.

The factors described below represent our principal risks. Except as otherwise indicated, these factors may or may not occur and we are not in a position to express a view on the likelihood of any such factor occurring. Other factors may exist that we do not consider to be significant based on information that is currently available or that we are not currently able to anticipate.

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 the potential performance advantages of our laser systems over traditional methods of treatment and over competitive laser systems to a broad spectrum of dentists and patients. Historically, we have experienced long sales cycles because dentists have been, and may continue to be, slow to adopt new technologies on a widespread basis. As a result, we generally are required to invest a significant amount of time and resources to educate customers about the benefits of our products in comparison to competing products and technologies before completing a sale, if any.

Factors that may inhibit adoption of laser technologies by dentists include cost and concerns about the safety, efficacy and reliability of lasers. The list selling price of our Waterlase MD laser system is in excess of $75,000, which is substantially more than the cost of competing non-laser technologies. In order invest in a Waterlase MD laser system, a dentist generally would need to invest time to understand the technology, the benefits of such technology with respect to clinical outcomes and patient satisfaction, and the return on investment of the product. Absent an immediate competitive motivation, a dentist may not feel compelled to invest the time required to learn about the potential benefits of using a laser system. We also believe that clinical evidence supporting the safety and efficiency of our products, as well as recommendations and support of our laser systems by influential dental practitioners, are important for market acceptance and adoption. In addition, economic pressure, caused for example by an economic slowdown, changes in healthcare reimbursement or by competitive factors in a specific market, may make dentists reluctant to purchase substantial capital equipment or invest in new technologies. Patient acceptance will depend on the recommendations of dentists and specialists, as well as other factors, including without limitation, the relative effectiveness, safety, reliability and comfort of our systems as compared to other instruments and methods for performing dental procedures. The failure of dental lasers to achieve broad market acceptance would limit sales of our products and have an adverse effect on our business and results of operations.

Fluctuations in our revenue and operating results on a quarterly and annual basis could cause the market price of our common stock to decline.

Our revenue and operating results fluctuate from quarter to quarter due to a number of factors, many of which are beyond our control. Historically, we have experienced fluctuations in revenue from quarter to quarter due to seasonality. Revenue in the first quarter typically is lower than average and revenue in the fourth quarter typically is stronger than average due to the buying patterns of dental professionals. In addition, revenue in the third quarter may be affected by vacation patterns which can cause revenue to be flat or lower than in the second quarter of the year. Notwithstanding this pattern, in 2005, our net revenue has declined each quarter. If our quarterly revenue or operating results fall below the expectations of investors, analysts or our previously stated financial guidance, the price of our common stock could decline substantially. Factors that might cause quarterly fluctuations in our revenue and operating results include, among others, the following:

The expenses we incur are based, in large part, on our expectations regarding future net revenue. In particular, we expect to continue to incur substantial expenses relating to the marketing and promotion of our products. Since many of our costs are fixed in the short term, we may be unable to reduce expenses quickly enough to avoid losses if we experience a decrease in net revenue. Accordingly, you should not rely on quarter-to-quarter comparisons of our operating results as an indication of our future performance.

We may have difficulty achieving profitability and may experience additional losses.

We recorded a net loss of $2.3 million for the first quarter of 2006, and a net loss of $17.5 million for the year ended December 31, 2005 In order to achieve profitability, we must control our costs and increase net revenue through new sales. Failure to increase our net revenue and decrease our costs could cause our stock price to decline.

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 products. In order to achieve our business objectives, we intend to significantly expand our marketing and sales efforts on a domestic and international basis. We face significant challenges and risks in expanding, training, managing and retaining our sales and marketing teams, including managing geographically dispersed operations. In addition, we rely on independent distributors to market and sell our products in a number of countries outside of the United States. These distributors may not commit the necessary resources to effectively market and sell our products, and they may terminate their relationships with us at any time with limited notice. If we are unable to expand our sales and marketing capabilities domestically and internationally, we may not be able to effectively commercialize our products, which could harm our business and cause the price of our common stock to decline.

Components used in our products are complex in design and any defects may not be discovered prior to shipment to customers, which could result in warranty obligations, reducing our revenue and increasing our cost.

In manufacturing our products, we depend upon third parties for the supply of various components. Many of these components require a significant degree of technical expertise to design and produce. If we fail adequately to design or if our suppliers fail to produce components to specification, or if the suppliers, or we, use defective materials or workmanship in the manufacturing process, the reliability and performance of our products will be compromised. We have experienced such non-compliance with manufacturing specifications in the past and may continue to experience such in the future, which could lead to higher costs of revenue and thus reduced gross margins.

Our products may contain defects that cannot be repaired easily and inexpensively, and we have experienced in the past and may experience in the future some or all of the following:

The occurrence of any one or more of the foregoing could materially harm our business.

Our distributors may cancel, reduce or delay orders of our products, any of which could reduce our revenue.

We employ direct sales representatives in certain European countries; however, we rely on independent distributors for a substantial portion of our sales outside of the United States. For the three months March 31, 2006, revenue from distributors accounted for approximately 20% of our total sales, and one distributor accounted for more than 10% of our revenue. For the three months March 31, 2005, revenue from distributors accounted for approximately 15% of our total sales, and no distributor accounted for more than 10% of our net revenue. Our ability to maintain or increase our revenue will depend in large part on our success in developing and maintaining relationships with our distributors and upon the efforts of these third parties. Our distributors have significant discretion in determining the efforts and resources they apply to the sale of our products. Our distributors may not commit the necessary resources to market and sell our products to the level of our expectations and, regardless of the resources they commit, they may not be successful. Additionally, most of our distributor agreements can be terminated with limited notice, and we may not be able to replace any terminating distributors in a timely manner or on terms agreeable to us, if at all. If we are unable to maintain our distribution network, if our distribution network is not successful in marketing and selling our products, if we experience a significant reduction in, cancellation or change in the size and timing of orders from our distributors, or if we experience delays in collecting accounts receivable from our distributors, our revenues could decline significantly.

We must continue to procure materials and components on commercially reasonable terms and on a timely basis to manufacture our products profitably. We have some single-source suppliers.

We have no written supply contracts with our key suppliers; instead, we purchase certain materials and components included in our products from a limited group of suppliers using purchase orders. Our business depends in part on our ability to obtain timely deliveries of materials and components in acceptable quality and quantities from our suppliers. Certain components of our products, particularly specialized components used in our lasers, are currently available only from a single source or limited sources. For example, the crystal, fiber and hand pieces used in our Waterlase systems are each supplied by a separate single supplier and from time to time we have experienced quality deficiencies in these materials.

Any interruption or delay in the supply of components or materials, or our inability to obtain components or materials from alternate sources at acceptable prices in a timely manner, could impair our ability to meet the demand of our customers and cause them to cancel orders or switch to competitive procedures.

We may not be able to compete successfully, which will cause our revenue and market share to decline.

We compete with a number of domestic and foreign companies that market traditional dental products, such as dental drills, as well as companies that market laser technologies in the dental and medical markets, including Hoya ConBio, a subsidiary of Hoya Photonics, OpusDent Ltd., a subsidiary of Lumenis, KaVo, Deka Dental Corporation, Ivoclar Vivadent AG, and Fotona d.d. If we do not compete successfully, our revenue and market share may decline. Some of our competitors have greater financial, technical, marketing or other resources than we have, 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. The ability of our competitors to devote greater financial resources to product development requires us to work harder to distinguish our products through improving our product performance and pricing, protecting our intellectual property, continuously improving our customer support, accurately timing the introduction of new products and developing sustainable distribution channels worldwide. In addition, we expect the rapid technological changes occurring in the healthcare industry to lead to the entry of new competitors, particularly if dental and medical lasers gain increasing market acceptance. We must be able to anticipate technological changes and introduce enhanced products on a timely basis in order to grow and remain competitive. New competitors or technological changes in laser products and methods could cause commoditization of our products, require price discounting or otherwise adversely affect our gross margins and our financial condition.

Rapidly changing standards and competing technologies could harm demand for our products or result in significant additional costs.

The markets in which our products compete are subject to rapid technological change, evolving industry standards, changes in the regulatory environment, and frequent introductions of new devices and evolving dental and surgical techniques. Competing products may emerge which could render our products uncompetitive or obsolete. The process of developing new medical devices is inherently complex and requires regulatory approvals or clearances that can be expensive, time consuming and uncertain. We cannot guarantee that we will successfully identify new product opportunities, identify new and innovative applications of our technology, or be financially or otherwise capable of completing the research and development required to bring new products to market in a timely manner. An inability to expand our product offerings or the application of our technology could limit our growth. In addition, we may incur higher manufacturing costs if manufacturing processes or standards change, and we may need to replace, modify, design or build and install equipment, all of which would require additional capital expenditures.

If we are unable to attract and retain personnel necessary to operate our business, our ability to develop and market our products successfully could be harmed.

We are heavily dependent on our current executive officers and management. The loss of any key employee or the inability to attract or retain qualified personnel, including engineers and sales and marketing personnel, could delay the development and introduction of, and harm our ability to sell our products and harm our reputation. We believe that our future success is highly dependent on the contributions of Jeffrey W. Jones, our President, Chief Executive Officer and Chief Technology Officer; Richard L. Harrison, our Executive Vice President and Chief Financial Officer; Keith G. Bateman, our Executive Vice President of Marketing; and James M. Haefner, our Executive Vice President of Global Sales. We have employment agreements with each of these individuals that provide either us or them with the ability to terminate their employment at will, subject to certain severance rights; however, their knowledge of our business and industry would be extremely difficult to replace. Our future success also depends on our ability to attract and retain additional qualified management, engineering, sales and marketing and other highly skilled technical personnel.

On May 9, 2006, Robert E. Grant announced his resignation as our President, Chief Executive Officer and Acting Chairman of the Board, and as a member of our Board of Directors. Jeffrey W. Jones, our Vice Chairman and Chief Technology Officer, has been named as President and Chief Executive Officer, effective on the same date. If our current management team is unable to effectively manage and maintain our business through the transition in management, our business could be adversely impacted.

Any problems that we experience with our manufacturing operations may harm our business.

In order to grow our business, we must expand our manufacturing capabilities to produce the systems and accessories necessary to meet any demand we may experience. We may encounter difficulties in increasing production of our products,

including problems involving production capacity and yields, quality control and assurance, component supply and shortages of qualified personnel. In addition, before we can begin commercial manufacture of our products, we must obtain regulatory approval of our manufacturing facilities, processes and quality systems, and the manufacture of our laser systems must comply with cGMP regulations. The cGMP regulations govern facility compliance, quality control and documentation policies and procedures. In addition, our manufacturing facilities are continuously subject to periodic inspections by the FDA, as well as various state agencies and foreign regulatory agencies. Our success will depend in part upon our ability to manufacture our products in compliance with the FDA’s Quality System regulations and other regulatory requirements. We recently have experienced quality issues with components of our products supplied by third parties. If we do not succeed in manufacturing our products on a timely basis and with acceptable manufacturing costs while at the same time maintaining good quality control and complying with applicable regulatory requirements, our business could be harmed.

Changes in government regulation or the inability to obtain or maintain necessary government approvals could harm our business.

Our products are subject to extensive government regulation, both in the United States and in other countries. To clinically test, manufacture and market products for human use, we must comply with regulations and safety standards set by the FDA and comparable state and foreign agencies. Regulations adopted by the FDA are wide ranging and govern, among other things, product design, development, manufacture and 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 FDA can result in an enforcement action which may include a variety of sanctions, including fines, injunctions, civil penalties, recall or seizure of our products, operating restrictions, partial suspension or total shutdown of production and criminal prosecution. The failure to receive or maintain requisite approvals for the use of our products or processes, or significant delays in obtaining such approvals, could prevent us from developing, manufacturing and marketing products and services necessary for us to remain competitive.

To date, we have been successful in obtaining 501(k) clearances from the FDA for our products. However, should we develop new products and applications or make any significant modifications to our existing products or labeling, we will need to obtain additional regulatory clearances or approvals necessary to market such products. Any modification that could significantly affect a product’s safety or effectiveness, or that would constitute a change in its intended use, will require a new 510(k) clearance, or could require a PMA application. The FDA requires each manufacturer to make this determination initially, but the FDA can review any such decision and can disagree with a manufacturer’s determination. If the FDA disagrees with a manufacturer’s determination, the FDA can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance or PMA is obtained. If 501(k) clearance is denied and a pre-market approval application is required, we could be required to submit substantially more data, may be required to conduct human clinical testing and would very likely be subject to a significantly longer review period.

Products sold in international markets are also subject to the regulatory requirements of each respective country. The regulations of the European Union require that a device have a CE Mark, indicating conformance with European Union laws and regulations before it can be sold in that market. The regulatory international review process varies from country to country. We rely on our distributors and sales representatives in the foreign countries in which we market our products to comply with the regulatory laws of such countries. Failure to comply with the laws of such countries could have a material adverse effect on our operations and, at the very least, could prevent us from continuing to sell products in such countries. We may not have effective internal controls if we fail to remedy any deficiencies we may identify in our system of internal controls.

In addition, unanticipated changes in existing regulatory requirements or the adoption of new requirements could impose significant costs and burdens on us, which could increase our operating expenses and harm our financial condition.

Regulatory proceedings relating to the restatement of our consolidated financial statements could divert management’s attention and resources.

We restated our previously issued financial statements in September of 2003 to reflect a change in the timing of revenue recognition for the fiscal years 2000 through 2002 and the three months ended March 31, 2002 through March 31, 2003. In addition, in July 2005, we restated our consolidated financial statements for the 2002 and 2003 fiscal years, the four quarters of 2003 and the first three fiscal quarters of 2004 due to a number of factors. We received informal requests from the SEC voluntarily to provide information relating to the September 2003 restatement of our consolidated financial statements. We provided information to the SEC and if we receive any additional requests for information, we intend to continue to do so. In accordance with its normal practice, the SEC has not advised us when its inquiry might be concluded. If the SEC elects

to request additional information from us or commences further proceedings, including as a result of our recent restatement, responding to such requests or proceedings could divert management’s attention and resources. Additionally, any negative developments arising from such requests or proceedings could harm our business and cause the price of our common stock to decline.

If we experience growth in our operations, our operational and financial systems, procedures and controls may need to be expanded, which will place significant demands on our management, distract management from our business plan and increase expenses. Our success will depend substantially on the ability of our management team to manage any growth effectively. These challenges may include, among others:

In addition, we incur significant legal, accounting, insurance and other expenses as a result of being a public company. The Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC and NASDAQ, has required changes in corporate governance practices of public companies. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. We also expect these rules and regulations to make it more difficult and more expensive for us to maintain director and officer insurance and, from time to time, we may be required to accept reduced policy limits and coverage or incur significantly higher costs to maintain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified persons to serve on our Board of Directors or as executive officers. We continue to evaluate and monitor developments with respect to these rules, and we cannot predict or estimate the amount of additional costs we may incur or the timing of such costs.

If we fail to secure or protect our intellectual property rights, competitors may be able to use our technologies, which could weaken our competitive position, reduce our revenue or increase our costs.

Our future success will depend, in part, on our ability to obtain and maintain patent protection for our products and technology, to preserve our trade secrets and to operate without infringing the intellectual property of others. We rely on patents to establish and maintain proprietary rights in our technology and products. We currently possess a number of issued patents and patent applications with respect to our products and technology; however, we cannot assure that any additional patents will be issued, that the scope of any patent protection will be effective in helping us address our competition or that any of our patents will be held valid if subsequently challenged. It is also possible that our competitors may independently develop similar 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 the laws of the United States. If we fail to protect our intellectual property rights adequately, our competitive position and financial condition may be harmed.

We may be sued by third parties for alleged infringement of their proprietary rights.

We face substantial uncertainty regarding the impact that other parties’ intellectual property positions will have on the markets for dental and other medical lasers. The medical technology industry has in the past been characterized by a substantial amount of litigation and related administrative proceedings regarding patents and intellectual property rights. From time to time, we have received, and expect to continue to receive, notices of claims of infringement, misappropriation or misuse of other parties’ proprietary rights. Some of these claims may lead to litigation. We may not prevail in any future intellectual property infringement litigation given the complex technical issues and inherent uncertainties in litigation. Any claims, with or without merit, may be time-consuming and distracting to management, result in costly litigation or cause product shipment delays. Adverse determinations in litigation could subject us to significant liability and could result in the loss of proprietary rights. A successful lawsuit against us could also force us to cease selling or redesign products that incorporate the infringed intellectual property. Additionally, we could be required to seek a license from the holder of the intellectual property to use the infringed technology, and it is possible that we may not be able to obtain a license on acceptable terms, or at all. Any of the foregoing adverse events could seriously harm our business.

In February 2005, we filed a lawsuit in the U.S. District Court for the Central District of California against Refocus Group, Inc. in order to obtain declaratory relief that certain of our planned activities in the field of presbyopia will not infringe the claims of a patent held by Refocus and/or that the Refocus claims are invalid. These claims were dismissed by the court in July 2005 without prejudice on the basis that we do not have a product that has been commercialized and, therefore, Refocus’ alleged infringement claims are not ripe. Once we have a commercial product in the field of presbyopia, we intend to renew our claim against Refocus. We cannot assure you that we will be successful in a lawsuit against Refocus. If we are not successful in such a lawsuit, we may not be able to market our presbyopia product or we may have to license certain patents from Refocus.

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

International sales comprise a significant portion of our net revenue and we intend to continue to pursue and expand our international business activities. For the three months ended March 31, 2006, international sales accounted for approximately 38% of our net revenue, as compared to approximately 28% or our net revenue for the same period in 2005. Political and economic conditions outside the United States could make it difficult for us to increase our international revenue or to operate abroad. International operations, including our operations in Germany, are subject to many inherent risks, including among others:

We believe that international sales will continue to represent a significant portion of our net revenue, and we intend to expand our international operations further. Our direct net revenue in Europe is denominated principally in Euros, while our net revenue in other international markets is in U.S. 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.

Expenses relating to our German operations are paid in Euros; therefore, 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 revenue and manufacturing operations and, consequently, negatively impact our business and operating results. We recently decided to eliminate our manufacturing operations at our facility in Germany. However, we have retained our ability to manufacture products there and could opt to do so in the future.

Our products are subject to recall even after receiving FDA clearance or approval, which would harm our reputation, business and financial results.

The FDA and similar governmental bodies in other countries have the authority to require the recall of our products in the event of material deficiencies or defects in design or manufacture. A government mandated or voluntary recall by us could occur as a result of component failures, manufacturing errors or design defects, including defects in labeling. Any recall would divert management’s attention and financial resources and harm our reputation with customers. Any recall involving our Waterlase systems could harm the reputation of the product and our company and would be particularly harmful to our business and financial results, in part because the Waterlase systems compose such an important part of our portfolio of products.

We may not successfully address problems encountered in connection with any future acquisition.

We expect to continue to consider opportunities to acquire or make investments in other technologies, products and businesses that could enhance our capabilities, complement our current products or expand the breadth of our markets or customer base. We have limited experience in acquiring other businesses and technologies. Potential and completed acquisitions and strategic investments involve numerous risks, including, among others:

If we fail to properly evaluate and execute acquisitions and strategic investments, our management team may be distracted from our day-to-day operations, our business may be disrupted and our operating results may suffer. In addition, if we finance acquisitions by issuing equity or convertible debt securities, our stockholders would be diluted.

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 and results of operations.

We are party to securities and derivative litigation that distracts our management, is expensive to conduct and seeks a damage award against us.

We and certain of our current and former officers have been named as defendants in several putative shareholder class action lawsuits filed in the United States District Court for the Central District of California. The complaints purport to seek

unspecified damages on behalf of an alleged class of persons who purchased our common stock between October 29, 2003 and July 16, 2004. The complaints allege that we and our officers violated federal securities laws by failing to disclose material information about the demand for our products and the fact that we would not achieve the alleged forecasted growth. The claimed misrepresentations include certain statements in our press releases and the registration statement we filed in connection with our public offering of stock which closed in March 2004. In January 2006, our motion to dismiss the second amended consolidated class action complaint was granted and the action was dismissed, with leave to further amend, by the order of the Honorable David O. Carter, United States District Judge for the Central District of California. On March 10, 2006 the plaintiffs filed a third amended complaint. The third amended complaint makes the same allegations regarding violations of the federal securities laws but is limited to an alleged class of investors who purchased or otherwise acquired our common stock pursuant to or traceable to the public offering of our stock that closed in March 2004. In addition, three stockholders have filed derivative actions in the state court in California seeking recovery on behalf of BIOLASE, alleging, among other things, breach of fiduciary duties by those individual defendants and by the members of our Board of Directors. The class action lawsuit and the derivative actions are still in the pretrial stage and no discovery has been conducted by any of the parties. However, based on the facts presently known, our management believes we have meritorious defenses to these actions and intends to vigorously defend them. As of March 31, 2006, no amounts have been recorded in the consolidated financial statements for these matters since management believes that it is not probable we have incurred a loss contingency.

Defending ourselves and our officers and directors in these lawsuits is expensive and time-consuming and detracts management’s attention from the operation of our business. We cannot assure you that we will be successful in defending against these claims. If we are unsuccessful, we may be subject to fines, penalties and sanctions that could negatively impact our financial condition and our ability to operate our business.

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

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 $12.0 million per occurrence and in the aggregate for all occurrences. The insurance is subject to various standard coverage exclusions, including damage to the product itself, losses from recall of our product and losses covered by other forms of insurance such as workers compensation. We cannot be certain that we will be able to successfully defend any claims against us, nor can we be certain that our insurance will cover all liabilities resulting from such claims. In addition, there is no assurance that we will be able to obtain such insurance in the future on terms acceptable to us, or at all. Regardless of merit or eventual outcome, any product liability claim brought against us could result in harm to our reputation, a decreased demand for our products, costs related to litigation, product recalls, loss of revenue, an increase in our product liability insurance rates or the inability to secure coverage in the future, and may cause our business to suffer.

Our operations are consolidated primarily in one facility. A disaster at this facility is possible and could result in a prolonged interruption of our business.

Substantially all of our administrative operations and our manufacturing operations are located at our facilities in San Clemente, California, which is near known earthquake fault zones. We expect to move to a new location in Irvine, California, an area which is also in or near a known earthquake fault zone. We have taken precautions to safeguard our facilities including insurance, disaster recovery planning and off-site backup of computer data; however, a natural disaster such as an earthquake, fire or flood, could seriously harm our business, adversely affect our operations and damage our reputation with customers. We maintain commercial insurance that includes business interruption coverage; however the insurance we maintain against such natural disasters and business interruption may not be adequate to cover our losses.

Section 382 of the Internal Revenue Code of 1986 generally imposes an annual limitation on the amount of net operating loss carryforwards that may be used to offset taxable income when a corporation has undergone significant changes in its stock ownership. In 2003, we completed an analysis to determine the applicability of the annual limitations imposed by Section 382 caused by previous changes in our stock ownership and determined that such limitations should not be significant. Based on our analysis, we believe that, as of December 31, 2005, approximately $57.9 million of net operating loss carryforwards were available to us for federal income tax purposes. Of this amount, approximately $54.4 million is available to offset federal taxable income or the taxable income generated in 2006 or in future years, if any. Additional net operating loss carryforwards will become available at the rate of approximately $1.0 million per year for the years 2006 through 2009. However, any ownership changes qualifying under Section 382 including changes resulting from or affected by our public offering or our stock repurchase plan may adversely affect our ability to use our remaining net operating loss carryforwards. If we lose our ability to use net operating loss carryforwards, any income we generate will be subject to tax earlier than it would be if we were able to use net operating loss carryforwards, resulting in lower profits.

Our business is capital intensive and the failure to obtain capital could require that we curtail capital expenditures.

To remain competitive, we must continue to make significant investments in the development of our products, the expansion of our sales and marketing activities and the expansion of our operating and management infrastructure as we increase sales domestically and internationally. We expect that substantial capital will be required to expand our operations and fund working capital for anticipated growth. We may need to raise additional funds through further debt or equity financings, which may affect the percentage ownership of existing holders of common stock and which may have rights, preferences or privileges senior to those of the holders of our common stock or may be issued at a discount to the market price of our common stock thereby resulting in dilution to our existing stockholders. If we raise additional funds by raising debt, we may be subject to debt covenants which could place limitations on our operations. We may not be able to raise additional capital on reasonable terms, or at all, or we may use capital more rapidly than anticipated. If we cannot raise the required capital when needed, we may not be able to satisfy the demands of existing and prospective customers and may lose revenue and market share.

The following factors among others could affect our ability to obtain additional financing on favorable terms, or at all:

If we are unable to obtain sufficient capital in the future, we may have to curtail our capital expenditures. Any curtailment of our capital expenditures could result in a reduction in net revenue, reduced quality of our products, increased manufacturing costs for our products, harm to our reputation, reduced manufacturing efficiencies or other harm to our business.

Our charter documents and Delaware law may inhibit a takeover that our stockholders consider favorable and could also limit the price of our stock.

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 the existence of our stockholder rights plan, could make it difficult for any party to acquire us, even though an acquisition might be beneficial to our stockholders, and 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 was distributed to our stockholders for each share of our common stock held. In connection with the stockholder rights plan, the Board of Directors has designated 500,000 shares of Series B Junior Participating Cumulative Preferred Stock. If any party acquires 15% or more of our outstanding common stock while the stockholder rights plan remains in place (i.e., if such party does not negotiate with the Board of Directors, which has the power to redeem the rights and terminate the plan), the holders of these rights (other than the party acquiring the 15% position) will be able to purchase shares of our common stock (or other securities or assets) at a discounted price, causing substantial dilution to the party acquiring the 15% position. Following the acquisition of 15% or more of our stock by any person (without a redemption of the rights or a termination of the stockholder rights plan by the Board of Directors), if we are acquired by or merged with any other entity, holders of these rights (other than the party acquiring the 15% position) will also be able to purchase shares of common stock of the acquiring or surviving entity if the stockholder rights plan continues to remain in place.

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 that is currently undesignated, and to designate 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 such preferred stock may:

We are also subject to the provisions of Section 203 of the Delaware General Corporation Law, which may prohibit certain business combinations with stockholders owning 15% or more of our outstanding voting stock or any of our associates or affiliates who at any time in the past three years have owned 15% or more of our outstanding voting stock. These provisions and the others discussed above may have the effect of entrenching our management team and deprive stockholders of the opportunity to sell their shares to potential acquirers at a premium over market prices. The potential inability to obtain a control premium could reduce the price of our common stock.

Our common stock could be diluted by the conversion of outstanding convertible securities.

We have issued and will continue to issue convertible securities in the form of options and warrants as incentive compensation for services performed by our employees, directors, consultants and others. As of March 31, 2006, we had options and warrants to purchase 4,429,000 shares of our common stock outstanding, of which options and warrants to purchase 3,879,000 shares of common stock were exercisable. If these options or warrants were exercised, it would dilute the ownership of our stock and could adversely affect our common stock’s market price.

Management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles. In making its assessment of internal control over financial reporting as of December 31, 2005, management used the criteria described in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). A material weakness is a control deficiency, or combination of control deficiencies, that results in a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

Management determined that a material weakness in our internal control over financial reporting existed as of December 31, 2005. This material weakness is discussed under Item 9A, Controls and Procedures. Because of this material weakness, management concluded that our internal control over financial reporting was not effective as of December 31, 2005 based on the criteria of the Internal Control—Integrated Framework issued by COSO. Further, the material weakness identified resulted in an adverse opinion by our independent registered public accounting firm on the effectiveness of our internal control over financial reporting.

If we are unable to substantially improve our internal controls, our ability to report our financial results on a timely and accurate basis will continue to be adversely affected, which could have a material adverse effect on our ability to operate our business. We are in the process of implementing remediation measures that are designed to eliminate the material weakness in our internal control over financial reporting. We cannot provide assurances regarding the timing or effectiveness of the remediation measures. While management will continue to review the effectiveness of our disclosure controls and procedures and internal control over financial reporting, we can not assure you that our disclosure controls and procedures or internal control over financial reporting will be effective in accomplishing all control objectives all of the time. Other deficiencies, particularly a material weakness in internal control over financial reporting which may occur in the future could result in misstatements of our results of operations, restatements of our financial statements, a decline in our stock price, or otherwise materially adversely affect our business, reputation, results of operations, financial condition or liquidity.

Our failure to comply with certain conditions required for our common stock to be listed on the NASDAQ National Market could result in the delisting of our common stock from the NASDAQ National Market.

As a result of our failure to timely file our Annual Report on Form 10-K for the fiscal year ended December 31, 2004 and our Quarterly Reports on Forms 10-Q for the three months ended March 31, 2005 and June 30, 2005, and certain required restatements of our financial statements for prior periods, we were not in full compliance with NASDAQ Marketplace Rule 4310(c)(14), which requires us to make, on a timely basis, all filings with the SEC required by the Securities Exchange Act of 1934. We are required to comply with NASDAQ Marketplace Rule 4310(c)(14) as a condition for our common stock to continue to be listed on the NASDAQ National Market.

In April 2005, we received a notification from NASDAQ with respect to the late Form 10-K, and in July 2005, the NASDAQ granted us an extension of time until August 1, 2005 in which to file our Form 10-K, the restatements with respect to our historical financial statements, our Form 10-Q for the first quarter ended March 31, 2005, our Form 10-Q for the second quarter ended June 30, 2005 and to otherwise meet all necessary listing standards of the NASDAQ Market. On July 19, 2005, we filed (i) our Form 10-K for the fiscal year ended December 31, 2004 which included consolidated financial statements for the year ended December 31, 2004 and restated consolidated financial statements as of December 31, 2003 and the two years then ended and (ii) Forms 10-Q/A for the three months ended March 31, 2004, June 30, 2004 and September 30, 2004 which included restated financial statements for the prior comparative periods as well. In July 2005, we requested an additional extension of time from NASDAQ in which to file our Form 10-Q for the fiscal quarter ended March 31, 2005 and our Form 10-Q for the second quarter ended June 30, 2005. In August 2005, we received additional notices from NASDAQ regarding the late filing of the first quarter Form 10-Q and granting us the requested extension of time until September 30, 2005 in which to file both our first quarter Form 10-Q and our second quarter Form 10-Q, and to otherwise meet all necessary listing standards. On September 30, 2005, we filed our Form 10-Q for the first and second quarters of 2005, and subsequently NASDAQ confirmed that we are in compliance with the continued listing requirements.

If we are unable to maintain compliance with the conditions for continued listing required by NASDAQ, then our shares of common stock are subject to delisting from the NASDAQ Market. If our shares of common stock are delisted from the NASDAQ Market, they may not be eligible to trade on any national securities exchange or the over-the-counter market. If our common stock is no longer traded through a market system, it may not be liquid, which could affect its price. In addition, we may be unable to obtain future equity financing, or use our common stock as consideration for mergers or other business combinations.

Changes in government regulation or the inability to obtain or maintain necessary government approvals could harm our business.

requirements or the adoption of new requirements could impose significant costs and burdens on us, which could increase our operating expenses and harm our financial condition.

We lack published long-term randomized trial data comparing the efficacy of our Waterlase systems with traditional dental procedures. If future data proves to be inconsistent with our clinical results, our revenues may decline.

Currently, there is no randomized trial data comparing the long-term efficacy of our Waterlase laser systems to alternative treatment methods. Additional long-term patient follow-up studies may indicate that the Waterlase systems are not as safe and effective as traditional dental treatments, such as drilling. If new studies or comparative studies generate results that are not as favorable as our clinical results, our revenues may decline. Furthermore, physicians may choose not to purchase our Waterlase system until they receive additional published long-term clinical evidence and recommendations from prominent physicians that indicate our Waterlase system is effective for dental applications.

Any failure in our efforts to train dental practitioners could reduce the market acceptance of our Waterlase system and reduce our revenues.

There is a learning process involved for dental practitioners to become proficient in the use of our Waterlase systems. It is critical to the success of our sales efforts to adequately train a sufficient number of dental practitioners and to provide them with adequate instruction in the use of our Waterlase systems. Following completion of training, we rely on the trained dental practitioners to advocate the benefits of our products in the broader marketplace. Convincing dental practitioners to dedicate the time and energy necessary for adequate training is challenging, and we cannot assure you that we will be successful in these efforts. If dental practitioners are not properly trained, they may misuse or ineffectively use our products, or fail to recognize the benefits provided by our Waterlase systems. This may also result in unsatisfactory patient outcomes, patient injury, negative publicity or lawsuits against us, any of which could negatively affect our reputation and sales of our Waterlase systems.

We spend considerable time and money complying with federal, state and foreign regulations and, if we are unable to fully comply with such regulations, we could face substantial penalties.

We are directly or indirectly, through our customers, subject to extensive regulation by both the federal government and the states and foreign countries in which we conduct our business. The laws that directly or indirectly affect our ability to operate our business include, but are not limited to, the following:

If our past or present operations are found to be in violation of any of the laws described above or the other governmental regulations to which we or our customers are subject, we may be subject to the applicable penalty associated with the violation, including civil and criminal penalties, damages, fines, exclusion from the Medicare and Medicaid programs and the curtailment or restructuring of our operations. If we are required to obtain permits or licensure under these laws that we do not already possess, we may become subject to substantial additional regulation or incur significant expense. Any penalties, damages, fines, curtailment or restructuring of our operations would adversely affect our ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by applicable regulatory authorities or the courts, and their provisions are open to a variety of interpretations and additional legal or regulatory change. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses, divert our management’s attention from the operation of our business and damage our reputation.

Product sales or introductions may be delayed or canceled as a result of the FDA regulatory process, which could cause our sales or profitability to decline.

The process of obtaining and maintaining regulatory approvals and clearances to market a medical device from the FDA and similar regulatory authorities abroad can be costly and time consuming, and we cannot assure you that such approvals and clearances will be granted. Pursuant to FDA regulations, unless exempt, the FDA permits commercial distribution of a new medical device only after the device has received 510(k) clearance or is the subject of an approved pre-market approval application. The FDA will clear marketing of a medical device through the 510(k) process if it is demonstrated that the new product is substantially equivalent to other 510(k)-cleared products. The pre-market approval application process is more costly, lengthy and uncertain than the 510(k) process, and must be supported by extensive data, including data from preclinical studies and human clinical trials. Because we cannot assure you that any new products, or any product enhancements, that we develop will be subject to the shorter 510(k) clearance process, significant delays in the introduction of any new products or product enhancement may occur. We cannot assure you that the FDA will not require a new product or product enhancement to go through the lengthy and expensive pre-market approval application process. Delays in obtaining regulatory clearances and approvals may:

Although we have obtained 510(k) clearance from the FDA to market our Waterlase and Diode laser systems, we cannot assure you that the clearance of these systems will not be withdrawn or that we will not be required to obtain new clearances or approvals for modifications or improvements to our products.

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


BIOLASE TECHNOLOGY, INC., a Delaware corporation

By:		/S/ RICHARD L. HARRISON
		Richard L. Harrison Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)


Delaware		87-0442441
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)


		Page
	PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited):

	Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005	3

	Consolidated Statements of Operations for the three months ended March 31, 2006 and March 31, 2005	4

	Consolidated Statements of Cash Flows for the three months ended March 31, 2006 and March 31, 2005	5

	Notes to Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	21

Item 4.	Controls and Procedures	21

	PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	21

Item 1A.	Risk Factors	23

Item 6.	Exhibits	37

Signatures		38


	March 31, 2006			December 31, 2005
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	5,974		$	8,272
Short-term investments, restricted		9,861			9,863
Accounts receivable, less allowance of $543 and $420 in 2006 and 2005, respectively		9,953			8,404
Inventory		7,648			8,623
Prepaid expenses and other current assets		1,015			1,293

Total current assets		34, 451			36,455
Property, plant and equipment, net		4,572			3,827
Intangible assets, net		1,738			1,831
Goodwill		2,926			2,926
Other assets		339			90

Total assets	$	44,026		$	45,129

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Line of credit	$	5,000		$	5,000
Accounts payable		9,698			7,759
Accrued liabilities		7,292			8,612
Deferred revenue		1,989			2,246
Deferred gain on sale of building, current portion		—			16

Total current liabilities		23,979			23,633
Deferred tax liability		237			202

Total liabilities		24,216			23,835

Stockholders’ equity:
Preferred stock, par value $0.001, 1,000 shares authorized, no shares issued and outstanding		—			—
Common stock, par value $0.001, 50,000 shares authorized; 25,253 shares and 25,218 shares issued; 23,290 and 23,254 outstanding in 2006 and 2005, respectively		26			26
Additional paid-in capital		107,318			106,484
Accumulated other comprehensive loss		(356	)		(322	)
Accumulated deficit		(70,779	)		(68,495	)

		36,209			37,693
Treasury stock (cost of 1,964 shares repurchased)		(16,399	)		(16,399	)

Total stockholders’ equity		19,810			21,294

Total liabilities and stockholders’ equity	$	44,026		$	45,129


	Three Months Ended March 31,
	2006			2005
Net revenue	$	16,880		$	16,834
Cost of revenue		8,134			7,465

Gross profit		8,746			9,369

Other income, net		16			16

Operating expenses:
Sales and marketing		6,040			6,126
General and administrative		3,262			4,486
Engineering and development		1,247			3,038
Diodem patent litigation settlement		432			—

Total operating expenses		10,981			13,650

Loss from operations		(2,219	)		(4,265	)
Non-operating gain, net		17			63

Loss before income taxes		(2,202	)		(4,202	)
Provision for income taxes		(82	)		(72	)

Net loss	$	(2,284	)	$	(4,274	)

Net loss per share:
Basic	$	(0.10	)	$	(0.19	)

Diluted	$	(0.10	)	$	(0.19	)

Shares used in the calculation of net loss per share:
Basic		23,272			22,830

Diluted		23,272			22,830


	Three Months Ended March 31,
	2006			2005
Cash flows from operating activities:
Net loss	$	(2,284	)	$	(4,274	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		474			244
Loss on sale of assets		—			16
Gain on disposal of assets		(16	)		(16	)
Provision for bad debts		126			251
Provision for inventory excess and obsolescence		66			417
Stock-based compensation		199			—
Issuance of common stock for patent litigation settlement		432			—
Income tax provision		35			72
Changes in assets and liabilities:
Accounts receivable		(1,675	)		(3,167	)
Inventory		909			(1,073	)
Prepaid expenses and other assets		283			285
Accounts payable and accrued liabilities		617			213
Accrued legal settlement		—			(3,000	)
Deferred revenue		(257	)		67

Net cash used in operating activities		(1,091	)		(9,965	)

Cash flows from investing activities:
Additions to property, plant and equipment		(1,108	)		(239	)
Sale of marketable securities		—			25,339
Purchase of marketable securities		—			(20,122	)

Net cash (used in) provided by investing activities		(1,108	)		4,978

Cash flows from financing activities:
Borrowings on line of credit		5,370			3,700
Payment on line of credit		(5,370	)		(1,850	)
Payments on insurance financing		(252	)		—
Proceeds from exercise of stock options and warrants		203			172
Payment of cash dividend		—			(229	)

Net cash (used in) provided by financing activities		(49	)		1,793

Effect of exchange rate changes on cash		(50	)		—

Decrease in cash and cash equivalents		(2,298	)		(3,194	)
Cash and cash equivalents at beginning of period		8,272			6,140

Cash and cash equivalents at end of period	$	5,974		$	2,946

Supplemental cash flow disclosure:
Cash paid during the period for:
Interest	$	149		$	18

Taxes	$	3		$	—

Non-cash financing activities:
Common stock issued for legal settlement	$	—		$	3,446

Common stock issued for Diodem patents	$	—		$	530

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	Three Months Ended March 31, 2006	Three Months Ended March 31, 2005
Expected term (years)	4.00	4.00
Volatility	58.00%	62.00%
Annual dividend per share	$0.00	$0.06
Risk free interest rate	4.54%	3.65%
Weighted average fair value	$3.91	$4.77


	Number of options		Weighted average exercise price		Weighted average remaining contractual term (years)	Aggregate intrinsic value ($)
Options outstanding at December 31, 2005	4,311,000		$	6.74	—		—
Plus: Options granted	130,000			7.97	—		—
Less:
Options exercised	(36,000	)		5.64	—		—
Options canceled or expired	(57,000	)		10.41	—		—

Options outstanding at March 31, 2006	4,348,000			6.75	6.7	$	12,193,000

Options exercisable at March 31, 2006	3,879,000			6.62	6.3	$	11,382,000


	Three Months Ended March 31,
	2006		2005
Proceeds from stock options exercised	$	204	$	172
Tax benefit related to stock options exercised (1)		NA		NA
Intrinsic value of stock options exercised (2)	$	73		120


Unvested Options	Options		Weighted-Average Grant- Date Fair Value ($)
Unvested options at December 31, 2005	421,000		3.94
Granted	130,000		3.91
Vested	(56,000	)	4.08
Forfeited	(26,000	)	4.04

Unvested options at March 31, 2006	469,000		3.91


	Three Months Ended March 31, 2005
Reported net loss	$	(4,274	)
Add: Stock-based compensation recorded as expense, net of tax		—
Deduct: Total stock-based employee compensation expense, net of tax		(1,052	)

Pro-forma net loss	$	(5,326	)

Basic net loss per share:
Reported	$	(0.19	)
Pro-forma	$	(0.23	)
Diluted net loss per share:
Reported	$	(0.19	)
Pro-forma	$	(0.23	)


	Three Months Ended March 31,
	2006	2005
	(in thousands)
Weighted average shares outstanding—basic	23,272	22,830
Dilutive effect of stock options and warrants	—	—

Weighted average shares outstanding—diluted	23,272	22,830


	March 31, 2006		December 31, 2005
Raw materials	$	2,948	$	3,116
Work-in-process		921		1,542
Finished goods		3,779		3,965

	$	7,648	$	8,623


	March 31, 2006			December 31, 2005
Land	$	288		$	283
Building		793			778
Leasehold improvements		477			279
Equipment and computers		4,023			3,271
Furniture and fixtures		1,160			1,018
Construction in progress		98			77

		6,839			5,706
Accumulated depreciation and amortization		(2,267	)		(1,879	)

Property, plant and equipment, net	$	4,572		$	3,827


	As of March 31, 2006										As of December 31, 2005
	Gross		Accumulated Amortization			Impairment			Net		Gross		Accumulated Amortization			Impairment			Net
Patents (4-10 years)	$	1,814	$	(598	)	$	—		$	1,216	$	1,814	$	(532	)	$	—		$	1,282
Trademarks (6 years)		69		(69	)		—			—		69		(69	)		—			—
Trade names (indefinite life)		979		—			(747	)		232		979		—			(747	)		232
Other (4 to 6 years)		593		(303	)		—			290		593		(276	)		—			317

Total	$	3,455	$	(970	)	$	(747	)	$	1,738	$	3,455	$	(877	)	$	(747	)	$	1,831

Goodwill (indefinite life)	$	2,926							$	2,926	$	2,926							$	2,926


	March 31, 2006		December 31, 2005
Payroll and benefits	$	2,379	$	2,808
Warranty		1,341		1,211
Sales Tax		604		667
Amounts due to customers		342		638
Accrued professional services		1,118		1,192
Accrued insurance premium		673		911
Other		835		1,185

Accrued liabilities	$	7,292	$	8,612


	Less Than 1 Year		1 to 3 Years		3 to 5 Years		More Than 5 years		Total
Operating leases	$	684	$	1,237	$	1,069	$	45	$	3,035
Capital expenditures*		500		—		—		—		500
SurgiLight agreement		25		50		25		—		100
Line of credit		5,000		—		—		—		5,000
Insurance premium financing		673		—		—		—		673

Total	$	6,882	$	1,287	$	1,094	$	45	$	9,308


	Three Months Ended March 31,
	2006			2005
Initial warranty accrual, Beginning balance	$	1,211		$	911
Provision for estimated warranty cost		1,076			903
Warranty expenditures-initial and extended		(946	)		(851	)

Initial warranty accrual, Ending balance	$	1,341		$	963


Term		5 years
Volatility		67%
Annual dividend per share		$0.00
Risk-free interest rate		3.73%


Exhibit No.		Description
10.1*		Lease dated January 10, 2006 between BIOLASE Technology, Inc. and The Irvine Company LLC.
10.2**		Amendment No. 1 to Employment Agreement of Robert E. Grant dated February 10, 2006
10.3**		Amendment No. 1 to Employment Agreement of Richard L. Harrison dated February 10, 2006
10.4**		Amendment No. 1 to Employment Agreement of Jeffrey W. Jones dated February 10, 2006
10.5**		Memo to Keith G. Bateman from Biolase Technology, Inc. regarding Severance Benefits Payable On Change of Control, dated February 10, 2006
10.6**		Memo to James M. Haefner from Biolase Technology, Inc. regarding Severance Benefits Payable On Change of Control, dated February 10, 2006
31.1		Certification of Robert E. Grant pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.
31.2		Certification of Richard L. Harrison pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.
32.1		Certification of Robert E. Grant pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of Richard L. Harrison pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.