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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended: SEPTEMBER 30, 2006
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period from to ________ to ________
Commission File Number: 1-11064
BSML, INC.
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(Exact name of registrant as specified in its charter)
UTAH 87-0410364
------------------------------- -------------------
(State or other jurisdiction of (IRS employer
incorporation or organization) identification no.)
460 North Wiget Lane
Walnut Creek, California 94598
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(925) 941-6260
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(Issuer's telephone number, including area code)
Former name: BriteSmile, Inc.
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act.
[ ] Yes [X] No
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Exchange Act.
[ ] Yes [X] No
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.
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [ ] No [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
[ ] Yes [X] No
BSML, Inc. had 10,549,423 shares of common stock outstanding at September 30,
2006.
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BSML, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
--------------------------------
ITEM 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of September 30, 2006 and
December 31, 2005................................................................3
Condensed Consolidated Statements of Operations for the 13 weeks ended
September 30, 2006 and September 24, 2005 and for the 39 weeks ended
September 30, 2006 and September 24, 2005........................................4
Condensed Consolidated Statements of Cash Flows for the 39 weeks ended
September 30, 2006 and September 24, 2005........................................5
Notes to Condensed Consolidated Financial Statements..............................6
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations...........................................................14
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.......................19
ITEM 4. Controls and Procedures..........................................................19
PART II. OTHER INFORMATION
----------------------------
ITEM 1. Legal Proceedings................................................................21
ITEM 1A. Risk Factors.....................................................................23
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds......................28
ITEM 3. Defaults upon Senior Securities..................................................28
ITEM 4. Submission of Matters to a Vote of Security Holders..............................28
ITEM 5. Other Information................................................................28
ITEM 6. Exhibits.........................................................................28
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
BSML, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
($ in thousands, except share data)
September 30, December 31,
2006 2005
------------- -------------
(unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ................................................... $ 5,692 $ 5,518
Trade accounts receivable, net of allowances ................................ 610 113
Inventories ................................................................. 926 375
Assets held for sale ........................................................ -- 12,214
Cash, restricted as to use .................................................. 3,500
Prepaid expenses and other .................................................. 473 1,159
------------- -------------
Total current assets ............................................ 11,201 19,379
------------- -------------
Property and equipment, net ..................................................... 4,640 5,847
Cash, restricted as to use ...................................................... 7,812 1,466
Other assets .................................................................... 924 1,150
------------- -------------
TOTAL ASSETS .................................................................... $ 24,577 $ 27,842
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable ............................................................ $ 2,027 $ 3,695
Accrued liabilities ......................................................... 14,377 7,533
Accrual for Center closures ................................................. 179 403
Gift certificates and prepaid appointments .................................. 982 1,235
Smile Forever - deferred revenue ............................................ 1,872 1,197
Liabilities held for sale ................................................... -- 803
Accrued interest due to a related party ..................................... -- 264
Long-term debt with related party - current portion ......................... -- 6,024
Convertible debt - current portion .......................................... -- 6,828
Convertible debt with a related party - current portion ..................... -- 621
Financial instruments related to convertible debt - current portion ......... -- 9
Capital lease obligations with related parties - current portion ............ -- 73
------------- -------------
Total current liabilities ......................................... 19,437 28,685
------------- -------------
LONG TERM LIABILITIES:
Accrual for Center closures ................................................. 331 242
Other long-term liabilities ................................................. 935 1,053
Smile Forever deferred revenue .............................................. 972 313
------------- -------------
Total long-term liabilities ....................................... 2,238 1,608
------------- -------------
Total liabilities ................................................. 21,675 30,293
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SHAREHOLDERS' EQUITY (DEFICIT):
Common stock, $.001 par value; 50,000,000 shares authorized;
10,549,423 shares issued and outstanding for September 30, 2006 ............. 38 38
10,549,130 shares issued and outstanding for December 31, 2005 .............. -- --
Preferred Stock, no par value; 5,000,000 shares authorized and none issued or
outstanding .............................................................. -- --
Additional paid-in capital .................................................. 173,516 173,340
Accumulated deficit ......................................................... (170,652) (175,829)
------------- -------------
Total shareholders' equity (deficit) .............................. 2,902 (2,451)
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) ............................ $ 24,577 $ 27,842
============= =============
See notes to condensed consolidated financial statements.
3
BSML, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
($ in thousands, except share data)
13 Weeks 13 Weeks 39 Weeks 39 Weeks
Ended Ended Ended Ended
September 30, September 24, September 30, September 24,
2006 2005 2006 2005
------------- ------------- ------------- -------------
REVENUES
Center whitening fees, net ........................... $ 5,768 $ 4,178 $ 16,711 $ 12,758
Product and other revenue ............................ 943 972 3,795 2,798
------------- ------------- ------------- -------------
Total revenues, net .............................. 6,711 5,150 20,506 15,556
OPERATING COSTS AND EXPENSES:
Operating and occupancy costs ........................ 3,714 3,420 10,715 10,122
Selling, general and administrative expenses ......... 8,726 3,742 18,100 11,667
Research and development expenses .................... 45 266 135 607
Depreciation and amortization ........................ 415 660 1,235 1,822
------------- ------------- ------------- -------------
Total operating costs and expenses ............... 12,900 8,088 30,185 24,218
------------- ------------- ------------- -------------
Loss from operations ...................... (6,189) (2,938) (9,680) (8,661)
OTHER INCOME AND EXPENSES:
Amortization of discount on debt ..................... - (652) (530) (1,953)
Loss on early extinguishment of debt ................. - - (5,039) -
Gain (loss) on mark-to-market of financial
instrument related to convertible debt............... - 1,163 - 3,794
Gain on settlement of legal claim .................... - - 1,257
Other income (expense), net .......................... 185 (251) (660) (976)
------------- ------------- ------------- -------------
Loss from continuing operations before income
tax ................................................. (6,004) (2,678) (14,652) (7,796)
INCOME TAX ............................................... (271) 30 (225) 151
------------- ------------- ------------- -------------
Net loss from continuing operations .............. (5,733) (2,708) (14,427) (7,947)
------------- ------------- ------------- -------------
Discontinued Operations:
Gain (loss) from discontinued operations, net of tax
(39 weeks ended September 30, 2006 includes gain
from sale of business, $ 14,664, and gain from
lawsuit settlement, $5,202, net of tax) ................. - (1,777) 19,602 (6,530)
------------- ------------- ------------- -------------
Net Income (loss) .................................... $ (5,733) $ (4,485) $ 5,175 $ (14,477)
------------- ------------- ------------- -------------
NET LOSS PER SHARE - BASIC AND DILUTED:
Basic and diluted net loss per common share from
continuing operations ................................... $ (0.54) $ (0.25) $ (1.37) $ (0.75)
------------- ------------- ------------- -------------
Basic and diluted net gain/(loss) per common share
from discontinued operations ............................ $ - $ (0.17) $ 1.86 $ (0.62)
------------- ------------- ------------- -------------
Basic and diluted net gain/(loss) per common share ....... $ (0.54) $ (0.42) $ 0.49 $ (1.37)
------------- ------------- ------------- -------------
Weighted average shares - basic .......................... 10,549,423 10,549,130 10,549,326 10,529,321
Weighted average shares - diluted ........................ 10,549,423 10,549,130 10,565,632 10,529,321
------------- ------------- ------------- -------------
4
BSML, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED
($ in thousands, except share data)
39 Weeks 39 Weeks
Ended Ended
September 30, September 24,
2006 2005
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss from continuing operations .......................................... $ (14,427) $ (7,947)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization .......................................... 1,234 1,822
Loss on disposal of Assets ............................................. 109 343
Non-cash compensation expense .......................................... 156 505
Impairment of deferred cost asset ...................................... - 298
Amortization of discount of debt ....................................... 530 1,953
Gain on mark-to-market of financial instruments related to convertible
debt ............................................................... - (3,794)
Non-cash early extinguishment of debt .................................. 5,038 -
Expenses paid by related party ......................................... 20 269
Change in assets and liabilities net - continuing operations ................. 1,595 1,385
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Net cash provided by (used) in operating activities - continuing operations .. (5,745) (5,166)
Net cash provided by (used) in operating activities - discontinued operations 7,984 (3,046)
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Net cash provided by (used in) operating activities .................... 2,239 (8,212)
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CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sale of assets held for sale - Associated Centers business ...... 26,824 -
Cash restricted as to use/Other .............................................. (9,841) 25
Proceeds/(disbursement) from selling/(buying) investment ..................... 122 -
Purchase of property and equipment ........................................... (46) (2,086)
Investment in Thai Spa ...................................................... - (256)
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Net cash used in investing activities-continuing operations ................. 17,059 (2,317)
Net cash used in investing activities-discontinued operations ............... - (1,997)
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Net cash provided by (used in) investing activities ........... 17,059 (4,314)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease .................................................... (73) (1,372)
Payments on debt ............................................................. (19,051) -
Proceeds from exercise of stock options and warrant exercises ................ - 448
Proceeds from stock option issuance ......................................... - 73
------------- -------------
Net cash used in financing activities ......................... (19,124) (851)
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NET DECREASE IN CASH AND CASH EQUIVALENTS ....................................... 174 (13,378)
CASH AND CASH EQUIVALENTS AT BEGINNING
OF THE PERIOD ............................................................... 5,518 18,880
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CASH AND CASH EQUIVALENTS AT END OF THE PERIOD .................................. $ 5,692 $ 5,503
============= =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for income taxes .................................................. $ 89 $ 100
============= =============
Cash paid for interest ...................................................... $ 1,446 $ 618
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5
BSML, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
SEPTEMBER 30, 2006
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
BSML, Inc., a Utah corporation ("BSML" or the "Company", formerly
BriteSmile, Inc.), and its affiliates market and sell advanced teeth whitening
products and services through 17 Professional Teeth Whitening Centers
("Centers"). Prior to March 13, 2006, the Company also offered its products and
technologies through arrangements with existing independent dental offices known
as BriteSmile Professional Teeth Whitening Associated Centers ("Associated
Centers"). The Company's business is focused on one industry segment, products
and procedures to whiten teeth.
On March 13, 2006, the Company and its wholly owned subsidiaries,
BriteSmile International Limited, an Ireland corporation, and BriteSmile
Development, Inc., a Delaware corporation (collectively, the "Sellers")
completed an asset sale with Discus Dental, Inc., a California corporation
("Discus"), whereby Discus acquired the assets and the operations of the
Associated Centers for approximately $26.3 million plus the assumption of
certain operating liabilities, and the Company settled its litigation with
Discus for $8.7 million, resulting in total consideration of approximately $35
million to the Company.
On May 1, 2006, the Company gave notice to Dental Spas, LLC, an Iowa
limited liability company ("Dental Spas"), that the Company was exercising its
right to terminate the Limited Liability Company Membership Purchase Agreement
(the "Purchase Agreement") dated January 13, 2006 between the Company and Dental
Spas. A copy of the Purchase Agreement was filed as an exhibit to the Company's
Form 8-K filed with the Securities and Exchange Commission on January 19, 2006.
The agreed closing conditions were not satisfied and pursuant to its terms, the
Company terminated the Purchase Agreement. The Board of Directors of the Company
determined that it was in the best interests of the Company's shareholders to
terminate the Purchase Agreement with Dental Spas.
Since the agreement with Dental Spas to sell the Centers business was
terminated on May 1, 2006 and the Company continues to operate the Centers
business, the results of operations and financial position of the Centers
business for all periods presented in this report have been reclassified as
continuing operations. All assets and liabilities related to Centers that were
previously classified as held for sale have been reclassified as held and used
assets. The results of operations for the Associated Centers business, which was
sold in March 2006, for all periods presented in this report have been presented
as discontinued operations. All assets and liabilities related to Associated
Centers were classified as held for sale and in accordance with Statement of
Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets."
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions in Form 10-Q and Article 10 of Regulations S-X. Accordingly, they
do not include all of the information and footnotes required by accounting
principles generally accepted in the United States for annual financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the 39 weeks ended September 30, 2006 are not
necessarily indicative of the results that may be expected for the remainder of
the fiscal year ending December 30, 2006.
GOING CONCERN
To date, the Company has yet to achieve consistent bottom-line
profitability. The Company's principal sources of liquidity historically have
been proceeds from issuance of common stock and debt and related financial
instruments, and more recently, from the sale of its Associated Centers
business. At September 30, 2006, the Company had $5.7 million in unrestricted
cash. The Company's outstanding long-term debt was fully paid in March 2006 from
the proceeds of the sale transaction with Discus in March 2006 as required by
consents obtained from certain debt holders of the Company. As of September 30,
2006, the Company had $11.3 million in restricted cash, including $3.5 million
held in escrow related to the sale of the Associated Centers business until June
2007. Also included in this restricted cash balance is $6.5 million as a result
of a court writ of attachment in connection with the litigation with Mayer,
Brown, Rowe & Maw LLP. (See Note 8). The remaining restricted cash amount of
$1.3 million is related to merchant banking reserve requirements and spa lease
security requirements. This amount is included in "Cash, restricted as to use"
on the balance sheet.
6
Furthermore, the Company has agreed to a standby $1.5 million writ of
attachment in connection with the Smile Asia Pte, Inc. litigation (See note 7),
if and when the $6.5 million writ of attachment from the Mayer Brown litigation
is discharged or terminated. The Mayer Brown cash restriction, and any other
additional cash restriction, could have a significant adverse impact on the
Company's ability to fund operations in the near term.
The Company currently is able to pay its debts as they come due. However,
the Company is not yet sure that it will be able to achieve bottom-line
profitability on a sustained basis, primarily due to the unknown level of costs
associated with its legal claims in future months. Because of this uncertainty
of the outcome of legal claims against the Company and the related amount of
their future legal defense costs, the Company is not certain that its
unrestricted cash will be sufficient to maintain operations at least through the
next twelve months. Accordingly, BSML management believes that these factors
raise doubt as to whether the going concern basis of accounting reflected in
these financial statements continues to be appropriate. Our liquidity
projections may improve or deteriorate depending on these changing conditions.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2006, the FASB issued FASB Interpretation No.48, Accounting for
Uncertainty in Income Taxes-an interpretation of FAS 109. This interpretation
clarifies the accounting for uncertainty in income taxes recognized in a
company's financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes. This interpretation prescribes a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken in a tax return. It also provides guidance
on derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. Interpretation No. 48 is effective for
fiscal years beginning after December 15, 2006. Earlier application is
encouraged if the Company has not yet issued financial statements, including
interim financial statements, in the period Interpretation No. 48 is adopted.
The Company has evaluated the impact of the adoption of FASB No.48, and does not
believe the impact will be significant to the Company's overall results of
operations or financial position.
On September 9, 2006, the FASB issued FASB statement No.157. This Statement
defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles (GAAP), and expands disclosures about
fair value measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, the Board having
previously concluded in those accounting pronouncements that fair value is the
relevant measurement attribute. Accordingly, this Statement does not require any
new fair value measurements. However, for some entities, the application of this
Statement will change current practice. FAS 157, Fair Value Measurements, is
effective for financial statements issued for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. The Company
has evaluated the impact of the adoption of FASB No.157, and does not believe
the impact will be significant to the Company's overall results of operations or
financial position.
On September 9, 2006, the FASB issued a statement No. 158. This Statement
improves financial reporting by requiring an employer to recognize the
over-funded or under-funded status of a defined benefit postretirement plan
(other than a multiemployer plan) as an asset or liability in its statement of
financial position and to recognize changes in that funded status in the year in
which the changes occur through comprehensive income of a business entity or
changes in unrestricted net assets of a not-for-profit organization. This
Statement also improves financial reporting by requiring an employer to measure
the funded status of a plan as of the date of its year-end statement of
financial position, with limited exceptions. The requirement to measure plan
assets and benefit obligations as of the date of the employer's fiscal year end
statement of financial position shall be effective for fiscal years ending after
December 15, 2008, and shall not be applied retrospectively. The Company has
evaluated the impact of the adoption of FASB No.158, and does not believe the
impact will be significant to the Company's overall results of operations or
financial position.
2. STOCK BASED COMPENSATION
Effective January 1, 2006, we adopted FAS 123(R), which requires that
compensation cost relating to share-based payment transactions be recognized in
our financial statements. We have adopted FAS 123(R) on a modified prospective
basis, which requires that compensation cost relating to all new awards and to
awards modified, repurchased, or cancelled be recognized in our financial
statements beginning January 1, 2006. Additionally, compensation cost for the
portion of awards for which the requisite vesting period has not been completed
that are outstanding as of January 1, 2006 will be recognized as the requisite
vesting is rendered on or after January 1, 2006. The pro forma disclosures
previously permitted under SFAS No. 123, "Accounting for Stock-Based
Compensation," are no longer an alternative to financial statement recognition.
7
In January 1997, the Company adopted the 1997 Stock Option and Incentive
Plan (the "1997 Plan"). Under the terms of the 1997 Plan, as amended to date,
and as approved by the Company's shareholders, 1,900,000 of the Company's common
stock shares are available for issuance. Options may be granted at exercise
prices of no less than the fair market value on the date of the grant, as
determined by the Board of Directors and quoted market prices. Options generally
vest over a two to five-year period and have a maximum term of ten years.
For the 39-weeks period ended September 30, 2006, the Company recognized
compensation costs of $155,748 as a result of the adoption of SFAS 123R.
Based on current assumptions and option grants, the remaining value
expected to be recognized as compensation cost in the future is approximately
$190,000.
The following table represents stock option activity for the 39 weeks
period ended September 30, 2006:
Number of Wtd-Average
Shares Exercise Price
------------- --------------
Outstanding options at beginning of period 835,791 $ 11.83
Granted 0 $ 0
Exercised 0 $ 0
Forfeited 339,429 $ 8.36
Outstanding options at the end of the period 496,362 $ 14.21
Exercisable options at the end of the period 460,365 $ 14.59
We use the Black-Scholes option pricing model to estimate the fair value of
stock-based awards with the following assumptions:
13 WEEKS 39 WEEKS
ENDED ENDED
September 30, September 30,
2006 2006
------------- --------------
Risk-free interest rate 4.37% 4.37%
Expected life of options (in years) 2.66 2.66
Expected volatility 121% 121%
Expected dividend yield -- --
Forfeiture rate per year 10% 21%*
o Forfeiture rate for 39 weeks ended September 30, 2006 represents
the average forfeiture rate used in the first three quarters of
2006.
The assumptions above are based on multiple factors, including historical
exercise patterns of employees. We use historical data to estimate the options'
expected term, which represents the period of time that options granted are
expected to be outstanding. Volatility is also based on historical run-rate.
Since we have never paid any dividends and do not anticipate paying any
dividends at least through the expected life of our stock options outstanding,
we use an expected dividend yield of zero when calculating the fair value of
stock options. The risk-free interest rate for periods within the contractual
life of the option is based on the U.S. Treasury yield curve.
FAS 123(R) requires that we estimate forfeitures, or the number of shares
that are expected to be cancelled prior to vesting, at the time of grant, and
adjust for actual forfeitures in subsequent periods if they differ from our
original estimates. In the third quarter ended September 30, 2006, the expected
future forfeiture rate was revised down to 10% to reflect the fact that the
Company had completed virtually all of the unusually high level of employment
terminations associated with the restructuring of the Company after the sale of
the AC business in March 2006. In the Company's pro-forma information required
under FAS 123 for the periods prior to fiscal 2006, we accounted for forfeitures
as they occurred.
For the prior year 13 and 39 week periods ended September 24, 2005, had
compensation expense for the Company's employee stock option awards been
determined based on the Black-Scholes fair value at the grant dates for awards
under those plans consistent with the fair value method of FAS 123, the Company
would have recorded additional compensation expense and its net loss and loss
per share would have been changed to the pro forma amounts presented in the
following table:
8
13 WEEKS 39 WEEKS
ENDED ENDED
SEPTEMBER 24, SEPTEMBER 24,
2005 2005
------------- -------------
Reported net loss $ (4,485) $ (14,477)
Compensation expense for stock options (116) (830)
Pro forma net loss $ (4,601) $ (15,307)
Pro-Forma Net loss per share -- basic and
diluted: $ (0.43) $ (1.45)
Total compensation cost for share-based payment arrangements recognized in
income for the 39-week period ended September 30, 2006 was $155,748. We did not
recognize any material tax benefit related to these share-based arrangements as
we have been in a loss position historically and have a full valuation allowance
against our tax benefits.
3. INCOME/LOSS PER COMMON SHARE
Basic net income/loss per share is calculated as net income/loss divided by
the weighted-average number of common shares outstanding. For the 39-week period
ended September 30, 2006, stock options and warrants totaling 16,306 shares have
been included in the calculation of diluted net income per share, as their
effect is dilutive. Stock options and warrants totaling the following number of
shares have been excluded from the calculation of net loss per share for the
following periods in this report, as their effect is anti-dilutive:
Number of Option
and Warrant
Period Shares
---------------------------------------- ----------------
13 Weeks Ended September 30, 2006 864,252
13 and 39 Weeks Ended September 24, 2005 2,377,011
4. DISCONTINUED OPERATIONS
During 2005, the Company's Board of Directors took various actions to
evaluate the long-term prospects for continuing to operate the Company's
Associated Centers and Centers businesses. In mid-2005, the Board of Directors
and management had committed to seek potential buyers of both the Associated
Centers and the Centers. This search had identified buyers where a deal appeared
probable within the next twelve months and the operations were ready for
immediate sale. Therefore, the operations of the Associated Centers and the
Centers had been accounted for as discontinued operations as prescribed by
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" for the entire year of 2005 and
first two quarters of 2006.
On March 13, 2006, BSML completed an asset sale with Discus, whereby Discus
acquired the assets and the operations of the Associated Centers for
approximately $26.3 million plus the assumption of certain operating liabilities
and settled our litigation with Discus for $8.7 million, resulting in total
consideration of approximately $35 million to BSML. The assets sold to Discus
included certain intangible assets and proprietary rights related to the
Associated Centers business, including the BriteSmile name and trademark, and
substantially all of the intellectual property rights. Discus acquired
intellectual property subject to certain existing technology and trademark
licenses in favor of Sellers that permit the operation of the Centers and sales
of certain retail products under the BriteSmile trademark. Discus also acquired
all of the rights and claims against third parties relating to the intellectual
property, except for claims against third parties who may have infringed certain
patents in the whitening strips field, which were retained under a license from
Discus.
During the first quarter of 2006, Dental Spas agreed to purchase the
Company's Centers business. The purchase price was approximately $20 million,
plus the assumption of certain continuing obligations. In addition, the sale was
to include the Company's business of selling teeth whitening products, including
its BriteSmile-to-Go whitening pen, toothpaste and mouthwash products, directly
and through third party retail channels. However, on May 1, 2006, the closing
conditions set forth in the Purchase Agreement were not satisfied and pursuant
to its terms, the Company terminated the Purchase Agreement. The Board of
Directors of the Company determined that it was in the best interest of the
Company's shareholders to terminate the Purchase Agreement with Dental Spas and
to continue to operate the Centers.
The financial statements included in this report have been prepared in
accordance with the Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets". As a result of
the events that occurred over the last 39 week period related to the Associated
Centers business and the Centers business, the results of operations for the
Associated Centers for all periods presented have continued to be reflected as
discontinued operations. However, the results of operations for the Centers
business have been presented as continuing operations for all periods presented
in this report, due to the termination of the purchase agreement with Dental
Spas on May 1, 2006. All assets and liabilities related to the discontinued
operations of the Associated Centers business are classified as held for sale
for all comparative reporting periods presented.
9
The assets and liabilities that are shown as held for sale on the Balance
Sheet as of December 31, 2005 reflect the assets & liability of the discontinued
Associated Center business, and are as follows ($ Thousands):
December 31, 2005
-----------------
Assets held for sale:
Accounts receivable, net 1,479
Inventories 541
Prepaid expense and other 220
Property and equipment 4,403
Intangibles 4,839
Other assets 732
-----------------
Total Assets held for sale $ 12,214
Liabilities held for sale:
Gift certificates and prepaid appointments 60
Deferred revenue 430
Other long term liabilities 313
-----------------
Total Liabilities held for sale $ 803
5. DEBT
The Company utilized proceeds received from selling its Associated Centers
business in March 2006 to pay off all long-term debt, capital leases and accrued
interest. Previously, the Company's note payable held by LCO Investments Limited
and the Company's convertible debt had unamortized discounts totaling $5.0
million. The Company had been amortizing these discounts over the life of the
debt instrument. Concurrent with the debt pay off, the Company recorded a loss
in March 2006 on the early extinguishment of debt to record the unamortized
discount in the statement of operations.
Prior to March 2006, the Company had certain financial instruments related
to its convertible debt. The estimated fair value amounts were determined using
appropriate market information and valuation methodologies. In the measurement
of the fair value of these instruments, the Black-Scholes option pricing model
was utilized, which is consistent with the Company's historical valuation
techniques. The value of the Financial Instruments Related to Convertible Debt -
Conversion Feature was treated as a liability and marked-to-market based on the
current stock price with the resulting gain or loss reflected in the income
statement. In addition, all note holder warrants related to this debt were
cancelled upon payoff of the notes in March 2006.
6. RELATED PARTY PAYMENTS
THE FOLLOWING TABLE SUMMARIZES THE AMOUNTS PAID TO RELATED PARTIES IN THE FIRST
THREE QUARTERS OF 2006 and 2005:
13 WEEK ENDED 13 WEEK ENDED 39 WEEK ENDED 39 WEEK ENDED
RELATED DESCRIPTION OF SOURCE OF DEBT OR SEPTEMBER 30, SEPTEMBER 24, SEPTEMBER 30, SEPTEMBER 24,
PARTY RELATIONSHIP OBLIGATION 2006 2005 2006 2005
------------------ ------------------ ------------------- ------------- ------------- ------------- -------------
A former board Merchandise/Pack
Oraceutical, member is a out charges and
LLC co-founder and order fulfillment
managing services
director of
Oraceutical $ 670,452 $ 356,000 $ 2,085,014 $ 1,123,000
A former board Consulting
Oraceutical, member is a
LLC co-founder and
managing
director of
Oraceutical $ 45,000 $ 45,000 $ 135,000 $ 135,000
LCO Deemed affiliate Monthly rent for
Properties, of the chairman New York Center
Inc. of the board $ 149,128 $ 143,000 $ 397,432 $ 340,000
LCO Deemed affiliate Interest and pay
Investments of the chairman off of debt and
Limited of the board pay out for
preferred stock 0 $ 58,000 $ 4,306,000 $ 75,000
CAP Deemed affiliate Interest and pay
America of the chairman off of debt
Trust of the board 0 $ 24,000 $ 1,582,000 $ 63,000
Excimer Deemed affiliate Variable fees,
Vision of the chairman fixed fees, pay
Leasing of the board off of deferred
lease balance 0 $ 740,000 $ 2,867,000 $ 2,795,000
10
In total, the Company paid related parties $ 1,366,000 during the 13 weeks ended
09/24/2005, and $ 864,580 during the 13 weeks ended 09/30/2006. The Company paid
related parties $ 4,531,000 during the 39 weeks ended 9/24/2005, and $
11,372,446 during the 39 weeks ended 9/30/2006.
7. LEGAL PROCEEDINGS
The Company is the subject of certain legal actions. Management believes
that it has accrued the appropriate amount of liability for actions against the
Company. However, the litigation and other claims noted in this report are
subject to inherent uncertainties and it is possible that future results of
operations for any particular quarterly or annual period could be materially
affected by changes in management's assumptions and the effectiveness of BSML's
strategies related to these legal actions.
The following matters pending on December 31, 2005 or commenced thereafter,
---------------------------------------------------------------------------
have been settled:
------------------
BSML, Inc. v. Discus Dental, Inc. and Salim Nathoo, filed in federal court
in California (the "Discus Patent Litigation"). This case was dismissed with
prejudice in March 2006. The Company filed a complaint against Discus Dental,
Inc. ("Discus") in July 2002, and added Salim Nathoo ("Nathoo") as a defendant
in February 2003. As subsequently amended, the complaint asserted claims of
patent infringement, misappropriation of the Company's trade secrets, civil
conspiracy, and unfair competition and business practices by Discus and Nathoo
jointly and other claims against Discus and Nathoo, individually. Discus filed
counterclaims seeking declarations of invalidity and non-infringement of several
BriteSmile patents, and for other claims.
On March 13, 2006, the parties settled all litigation proceedings between
them, including the Discus Patent Litigation and the litigation described in the
two following paragraphs. Discus and the Company agreed to settle the Discus
Patent Litigation and the litigation described in the following two paragraphs
for consideration to the Company of $8.7 million.
BriteSmile Development, Inc. v. Discus Dental, Inc. BriteSmile Development,
Inc. ("BDI"), a wholly owned subsidiary of BSML, Inc. filed in October 2005, a
patent infringement suit against Discus in federal court in California. The suit
alleged that Discus' Zoom! 2 tooth whitening system infringed a patent issued to
BDI in October 2005. This case was dismissed in March 2006, as described above.
BriteSmile v. Discus Dental, Inc., filed in May 2002 in California state
court. The Company filed a complaint against Discus alleging state law causes of
action for intentional interference with contractual relationship, negligent
interference with contractual relationship, unfair business practices and
related claims. This case was dismissed in March 2006, as described above.
The Procter & Gamble Company v. Oraceutical LLC, IDEX Dental Sciences,
Inc., Robert Eric Montgomery, BriteSmile, Inc. and BriteSmile Development, Inc.,
filed in June 2003 in federal court in Ohio. This case was dismissed in February
2006 in connection with a settlement payment from the Procter & Gamble Company
("P&G"). In its complaint P&G alleged that Oraceutical LLC, IDEX Dental
Sciences, Inc. and Eric Montgomery (collectively, the "REM Group") had breached
an agreement between the REM Group and P&G (the "Standstill Agreement") by
entering into a binding memorandum of understanding (the "MOU") with the Company
and BDI in May 2003. Montgomery is a former director of the Company, and
Oraceutical LLC, which is owned by Montgomery, is a consultant to the Company.
The complaint also sought a declaratory judgment that certain U.S. patents
previously owned by the Company (but owned by the REM Group at the time the
complaint was filed) (the "Patents") were invalid and unenforceable, and that
P&G's Whitestrips product did not infringe the Patents. In February 2004, the
defendants filed an answer and counterclaims.
11
In February 2006 the parties settled the litigation proceedings between
them. As part of the settlement, the Company granted to P&G a nonexclusive
license to certain patents relating to teeth whitening strips and P&G agreed to
pay $4 million. The Company recorded a gain of approximately $1.3 million from
its portion of the settlement proceeds.
Green River Junction v. BriteSmile, filed in November 2005, in Pennsylvania
state court. In its complaint Green River Junction, Inc. ("Green River") sought
to recover approximately $85,000 from the Company on breach of contract and
related claims. BriteSmile denied the allegations of the complaint and filed an
answer.
In May 2006, the parties entered into a settlement agreement, whereby
BriteSmile paid Green River $60,000 plus agreed to pay royalties on certain
future revenues of the Company received from the QVC network until April 2008.
BriteSmile v. Oraceutical LLC, Oraceutical Innovative Properties LLC, and
Eric Montgomery, filed in March 2006 in Utah state court. In its complaint, the
Company asserted claims for breach of contract/specific performance, declaratory
judgment, breach of fiduciary duty and punitive damages. These claims arose from
the refusal of the defendants to sign documents confirming the assignment of
certain patent rights to the Company as required under contracts with the
Company.
In May 2006, the parties agreed to settle the litigation proceedings upon
defendants' agreement to sign assignment documents satisfactory to the Company.
Gregg A. Coccari v. BriteSmile, Inc. commenced in August 2005 as an
arbitration proceeding before the American Arbitration Association. In this
proceeding, Coccari, the Company's former chief executive officer, asserted
claims for breach of his employment contract with the Company, fraudulent
inducement, negligent misrepresentation, violations of certain sections of the
California Labor Code, tortious wrongful discharge in violation of public
policy, and other state law claims relating to his alleged wrongful discharge by
the Company. Coccari sought damages for alleged breaches of the termination and
other provisions of the employment contract and under his state law claims, plus
attorneys' fees and punitive damages. The Company denied Coccari's allegations
and asserted counterclaims.
In September 2006, the parties settled the arbitration proceeding. Under
the settlement, the Company agreed to pay Coccari $700,000 (a portion of which
was paid by the Company's insurance carrier) and that 160,000 of the 240,000
shares of the Company's common stock granted to Coccari in 2005 could be
retained by Coccari. For his part, Coccari returned to the Company 80,000 shares
of the Company's common stock and relinquished any rights to 600,000 options
to purchase the Company's common stock. A liability equal to the value of this
settlement has been accrued on the Company's September 30, 2006 balance sheet.
Mayer, Brown, Rowe & Maw LLP v. BriteSmile, Inc. and BriteSmile
Development, Inc., filed in California state court (the "Mayer Brown Action").
Mayer, Brown, Rowe & Maw LLP ("MBR&M"), the Company's former counsel in the
Discus Patent Litigation, filed a complaint alleging causes of action for breach
of contract, breach of the implied covenant of good faith and fair dealing, and
unjust enrichment arising from the attorney-client relationship between MBR&M
and the Company. The Complaint alleged that MBR&M was entitled to more than $12
million in attorney's fees allegedly due under the Contingent Fee Agreement
entered into between MBR&M and the Company relating to the Discus Patent
Litigation and other miscellaneous hourly fees. BriteSmile denied the
allegations of MBR&M's complaint.
Concurrently with filing its Complaint, MBR&M filed an application for a
right to attach order, a writ of attachment, and a temporary protective order
attaching $12,803,713 (the "MBR&M Application") of the proceeds obtained by the
Company from its sale of the Associated Centers business to Discus. The Company
opposed the MBR&M Application, but in April 2006, the court approved a writ of
attachment on approximately $6.5 million of the proceeds received by the Company
from Discus from the sale of the Associated Centers business
In November 2006, the Company and MBR&M agreed in principle to settle the
Mayer Brown Action. Under this agreement, the Company will pay MBR&M $5 million
in satisfaction of all of the claims in the Mayer Brown Action. The settlement
proceeds will be paid from the $6.5 million, held pursuant to the writ of
attachment granted in April 2006, and has been fully accrued as a liability as
of September 30, 2006.
12
The following cases or claims remain active and pending against the
-------------------------------------------------------------------
Company:
--------
Smile Inc. Asia Pte. Ltd. v. BriteSmile filed in April 2002 in Utah state
court. Smile Inc. Asia Pte. Ltd. ("Smile") sued the Company and BriteSmile
Management, Inc., a wholly owned subsidiary of the Company ("BriteSmile
Management") for $10 million of claimed damages alleging that BriteSmile
Management breached its 1998 distributor agreement with Smile (exclusive as to
Singapore and other surrounding countries) for laser-aided teeth whitening
devices by failing to fill orders and to perform other obligations under the
agreement. The complaint also alleges that BriteSmile Management and the Company
fraudulently induced Smile to enter into the distributor agreement, and includes
claims for alleged damages, based on theories of breach of contract, conversion,
unjust enrichment, civil conspiracy, breach of the duty of good faith and fair
dealing, interference with contractual and economic relations, and fraudulent
transfer. The trial court recently dismissed the claims for unjust enrichment
and conversion.
In May 2002, the Company and BriteSmile Management filed their answer and
counterclaim. The counterclaim alleges that Smile breached the distributor
agreement by using BriteSmile's names and marks in a fashion not permitted by
the distributor agreement and opposing the Company's efforts to register its
marks in Singapore.
One of the principal defenses to Smile's claims is that the distributor
agreement for the laser-aided teeth whitening devices expressly excludes
"non-laser-aided teeth whitening products and processes" sold by the Company.
Accordingly, in the lawsuit the Company asserts that Smile has no rights to
market and sell the Company's current light activated teeth whitening or retail
products and cannot claim damages for BriteSmile's marketing of such products in
the exclusive territory described in the distributor agreement. Another
important defense is that the market for laser-aided devices and procedures was
rapidly shrinking during the relevant time period, which limits any potential
damages claimed by Smile. The Company disputes liability and will continue to
defend these claims. In December 2006 the court will conduct an evidentiary
hearing regarding the reliability of Smile's expert witness testimony. The court
has vacated the trial date, previously set for November 28, 2006.
On April 27, 2006, the court entered a prejudgment writ of attachment based
on a stipulation of the parties whereby the court attached $1.5 million of the
approximate $6.5 million that is currently subject to the writ of attachment
issued in Mayer Brown litigation, as described above. In connection with the
settlement of the Mayer Brown action, the Company will establish a separate
account for the deposit of $1.5 million for the prejudgment writ of attachment.
Claims of Oraceutical LLC, Oraceutical Innovative Properties LLC, and Eric
Montgomery. In July 2003, Oraceutical LLC, Oraceutical Innovative Properties
LLC, and Eric Montgomery (collectively, "Oraceutical") and the Company and BDI
entered into an Asset Purchase Agreement (the "Purchase Agreement"). Pursuant to
the Purchase Agreement, as subsequently amended in November 2003, BDI acquired
intellectual property consisting primarily of certain United States and foreign
patents, patent applications, continuations, continuations-in-part, trade
secrets, technologies, know-how, trademarks and trade names relating to human
oral care for a purchase price of $6.4 million, plus a 50% participation
interest in third party royalties and infringement recoveries relating to the
intellectual property acquired. The intellectual property acquired from
Oraceutical was sold to Discus in March 2006. Following the sale to Discus and
the settlement of the Discus Patent Litigation, Oraceutical asserted various
claims against the Company, including that under the terms of the Purchase
Agreement it is entitled to a portion of the consideration paid by Discus. The
Company has denied the claims of Oraceutical, but agreed to arbitrate
Oraceutical's claims. No date for an arbitration proceeding has been set.
The Company is also subject to legal proceedings and claims in the ordinary
course of business, including claims of alleged personal injury, infringement of
trademarks and other intellectual property rights. However, the Company believes
any such claims that have been presented to the Company as of the date of this
report are without merit and the Company will vigorously defend against any such
claims.
8. SUBSEQUENT EVENTS
On November 1, 2006, the Company changed its corporate legal name from
BriteSmile, Inc. to BSML, Inc. This requirement to change the name of the
Company arose in connection with the sale of the Associated Center business to
Discus, which transaction is explained below. While the legal name of the
corporate entity is changed, the Company will continue to do business as
BriteSmile in respect of its whitening centers, its services and retail product
branding, and its online marketing website.
On November 3, 2006, the Company announced that its CEO and President, John
Reed, will leave the Company effective November 15, 2006. Mr. Reed will remain a
director of the Company. Dr. Julian Feneley , presently a director of the
Company, will re-join the Company on November 15, 2006 as its CEO and President.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
--------
The Company's discussion and analysis of its financial condition and
results of operations are based upon the Company's consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these
financial statements requires the Company to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. On this basis, the
Company evaluates its estimates, including those related to customer programs
and incentives, bad debts, inventories, income taxes, warranty obligations,
financing operations, restructuring, contingencies and litigation. The Company
bases its estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
BSML, Inc., and its affiliates, market and sell advanced teeth whitening
products and services. Unless specified to the contrary herein, references to
BSML or to the Company refer to the Company and its subsidiaries on a
consolidated basis. The Company's operations include the development of
technologically advanced teeth whitening processes that are distributed in
professional salon settings known as BriteSmile Professional Teeth Whitening
Centers "Centers".
The Company's products and services are ultimately directed to consumers
in the global marketplace for aesthetic enhancement. As such, general economic
factors that affect consumer confidence and spending also affect the Company.
The primary source of revenue for the Company is from consumers who are seeking
to whiten their teeth using the most advanced technology available. This
technology is offered through the Company's 17 Centers in 11 metropolitan areas
in the U.S. The Company promotes demand for its products and services by
advertising directly to the consumer, while also offering a range of whitening
and post-whitening maintenance retail products that generate additional revenue.
Management of the Company focuses on optimizing the productivity of the
existing Center locations, both in terms of the number of procedures performed
per system and retail product revenue per procedure or venue. The marketing
initiatives of the Company are usually constructed and monitored in such a way
that management can determine their impact on revenue generation.
In addition, management seeks to leverage a cost base that includes, among
other items, the cost of materials for the procedures and retail products,
property and lease expenses, employee salaries and marketing expenses.
On March 13, 2006, the Company and certain of the its wholly owned
subsidiaries completed an asset sale with Discus Dental, Inc., whereby Discus
acquired the assets and operations of the Associated Centers business for
approximately $26.3 million plus the assumption of certain operating
liabilities, and the Company settled its litigation with Discus for $8.7
million, resulting in total consideration of approximately $35 million to BSML.
On May 1, 2006, the Company gave notice to Dental Spas, LLC, an Iowa
limited liability company ("Dental Spas"), that the Company was exercising its
right to terminate the Limited Liability Company Membership Purchase Agreement
(the "Purchase Agreement") dated January 13, 2006 between the Company and Dental
Spas.
These financial statements reflected in this report have been prepared in
accordance with Statement of Financial Accounting Standards No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets." Accordingly, as a result
of the events in 2006, the results of operations for the Centers have been
presented as continuing operations for all periods presented and the results of
operations of the Associated Centers for all periods presented have been
presented as discontinued operations. All assets and liabilities related to
discontinued operations are classified as held for sale for all comparative
reporting periods presented. The continuing operations in the financial
statements consist of the results of the Centers business and the BSML corporate
entity.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
------------------------------------------
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States, which require the
Company to make estimates and assumptions. The Company believes that the
following critical accounting policies require significant management judgments,
estimates and assumptions in the preparation of the consolidated financial
statements.
14
Revenue Recognition
BSML recognizes revenue related to retail products at the time such
products are sold or shipped to customers.
The Company recognizes revenue from teeth whitening procedures performed at
its Centers when the procedures have been performed. The Company defers the
revenue generated on the sale of its Smile Forever touch up program over the
specified maintenance period for the program (currently a maximum of 4 touch-ups
over the following two years). The amount of revenue deferred related to the
Smile Forever sales depends upon the particular sale circumstances - for example
if the program was discounted as part of a bundle promotion or as a
complementary offering to the purchase of a whitening procedure, consistent with
EITF-0021 and FAS 104. In the case of bundled promotion sales including Smile
Forever, the Smile forever revenue is deferred based on the allocation of the
fair market values of all of the elements in each promotional type of
transaction.
Deferred Contract Costs
During 1999, the Company granted warrants to Orthodontic Centers of America
("OCA") in consideration of OCA installing the Company's BS3000 machines in OCA
centers. The value of the warrants was capitalized as deferred contract costs
and was being amortized as a reduction of revenue over the life of the agreement
(approximately 10 years). The unamortized balance of $268,000 is included in
"assets held for sale" on the balance sheet at December 31, 2005 and is not
reflected on the September 30, 2006 balance sheet as this deferred contract cost
was written-off upon the sale of the Associated Centers business to Discus in
March 2006.
During 2003, the Company introduced the Magic Mirror, a marketing product
designed to show potential customers what their teeth will look like after an
LATW procedure. The Company provided the Magic Mirror to Associated Centers
under five-year contracts to purchase a minimum number of key cards each month.
In accordance with EITF 01-09, "Accounting for Consideration Given to a Vendor
by a Customer (Including the Reseller of a Vendor's Products)," the associated
revenue and cost of the Magic Mirrors provided to customers were capitalized and
are being amortized to revenue and cost of goods sold over the life of the
contract. In the event a particular Associated Center abandoned the contract or
failed to order any procedures for six months, the remaining capitalized cost of
the Magic Mirror was written off. At December 31, 2005, the capitalized amount
included in "assets held for sale" on the balance sheet was $463,000, net of
deferred revenue received from the sale of Magic Mirrors to customers. Deferred
Magic Mirror cost is not reflected on the September 30, 2006 balance sheet as it
was written-off upon the sale of the Associated Centers business to Discus in
March 2006.
Inventories
Inventories are stated at the lower of average cost or market. BSML writes
down its inventory for estimated obsolescence or unmarketable inventory equal to
the difference between the cost of inventory and the estimate market value based
upon assumptions about future demand and market conditions, as well as for
damaged goods. If market conditions are less favorable than those projected by
management, additional inventory write-downs may be required.
Property, Equipment and Improvements
BSML evaluates its property, equipment and improvements for impairment
whenever indicators of impairment exist. No material impairment charge was
recorded in either the 39 weeks period ended September 30, 2006 or September 24,
2005.
Valuation of Financial Instruments Related to Convertible Debt
In December 2004, BSML sold to six investors in a private placement $12
million of Convertible Debt that was to be repaid over 36 months beginning in
June 2006 in cash or registered stock. The Convertible Debt was convertible into
common shares of the Company at a conversion price of $7.61 per share, which is
115% of the volume-weighted average price of the common stock during the 10-day
period prior to the transaction date (the "Financial Instruments Related to
Convertible Debt - Conversion Option"). In addition, the investors were issued
five-year warrants to purchase 544,253 shares of common stock at an exercise
price of $7.61 per share (the "Financial Instruments Related to Convertible Debt
- Warrants"). The investors also had an additional investment right that gives
the investors the option within 180 trading days to loan the Company up to an
additional $4 million under the same terms (the "Financial Instruments Related
to Convertible Debt - AIR"). The Financial Instruments Related to Convertible
Debt - Conversion Option, the Financial Instruments Related to Convertible Debt
- Warrants and the Financial Instruments Related to Convertible Debt - AIR
together are the "Financial Instruments Related to Convertible Debt." In
connection with the December 2004 financing, the Company filed a registration
statement with the Securities and Exchange Commission (the "SEC") in January
2005 to cover the underlying shares for the transaction. The SEC declared the
registration statement effective in February 2005.
15
The Company allocated the net proceeds from the sale of the Convertible
Debt between the Convertible Debt, the Financial Instruments Related to
Convertible Debt - Warrants, and the Financial Instruments Related to
Convertible Debt - AIR based on their relative fair values. The Company employed
the Black-Scholes model to value the embedded conversion option of the
Convertible Debt. The relative fair values of the Financial Instruments Related
to Convertible Debt - Warrants and the Financial Instruments Related to
Convertible Debt - AIR, and the fair value of the embedded conversion option
resulted in the recording of a discount on the Convertible Debt.
In accordance with APB No. 14, The Company accounted for the Financial
Instruments Related to Convertible Debt - Warrants separately as freestanding
instruments. The value of the Financial Instruments Related to Convertible Debt
- Warrants was determined utilizing the Black-Scholes option pricing model,
which was consistent with the Company's historical valuation methods. The
following assumptions and estimates were used in the Black-Scholes model:
volatility of 0.600; an average risk-free interest rate of 3.50%; dividend yield
of 0%; and an expected life of 4.42 years. The value of the Financial Instrument
Related to Convertible Debt - Warrants was treated as a liability and
marked-to-market based on the current stock price with the resulting gain or
loss reflected in the income statement. As of February 4, 2005, the Company's
registration statement relating to the warrants was declared effective which
triggered the financial instrument to convert to equity. The value of the
Financial Instrument Related to Convertible Debt - Warrants as of the date of
conversion was $1.2 million.
In accordance with APB No. 14, the Company accounted for the Financial
Instruments Related to Convertible Debt - Additional Investment Rights
separately as freestanding instruments. The value of the Financial Instruments
Related to Convertible Debt - Additional Investment Rights was determined
utilizing the Black-Scholes option pricing model, which is consistent with the
Company's historical valuation methods. The following assumptions and estimates
were used in the Black-Scholes model: volatility of 0.600; an average risk-free
interest rate of 3.50%; dividend yield of 0%; and an expected life of 0.75
years. The value of the Financial Instruments Related to Convertible Debt -
Additional Investment Rights has been recorded as a current liability and was
marked-to-market based on the current stock price with the resulting gain or
loss reflected in the income statement. As of September 4, 2005, the Additional
Investment Rights expired; the value of the financial instruments was written
off.
In accordance with SFAS No. 133 the Company has accounted for the Financial
Instruments Related to Convertible Debt - Conversion Option as a freestanding
instrument. The value of the Financial Instruments Related to Convertible Debt -
Conversion Option was determined utilizing the Black-Scholes option pricing
model, which is consistent with the Company's historical valuation methods. The
following assumptions and estimates were used in the Black-Scholes model:
volatility of 0.600; an average risk-free interest rate of 3.50%; dividend yield
of 0%; and an average expected life of 2.88 years. The value of the Financial
Instruments Related to Convertible Debt - Conversion Option has been recorded as
a long-term liability and was marked to market on December 31, 2005. The value
of the Financial Instruments Related to Convertible Debt - Conversion Option as
of December 31, 2005 was $9,205. The only change to the assumptions and
estimates used in the model was a reduction to the average expected life of one
year.
The discount on the Convertible Debt was being amortized to interest
expense over the life of the Convertible Debt using the effective yield method.
The Convertible Debt accrued interest at the greater of 5% or 6-month LIBOR plus
300 basis points (capped at 8%) payable in cash or registered stock. Interest
was payable quarterly in arrears.
The convertible debt was paid in full at the principal amount of $12.0
million, plus accrued interest, in March 2006, and all noteholder warrants
related to this debt were cancelled at that time. The remaining unamortized
discount was $4.6 million as of December 31, 2005, and was $4.1 million on March
13, 2006, the day the convertible debt was paid off, which was written off at
the time of debt repayment as a loss on the early extinguishment of debt in the
condensed consolidated statement of operations for the 13-week period ended
April 1, 2006.
Center Closures
The Company has recorded reserves in connection with Center closures. These
reserves, which are periodically adjusted, include estimates pertaining to
employee separation costs and the settlements of contractual obligations,
primarily property leases. Although the Company does not anticipate significant
changes, the actual costs related to closures may differ from these estimates.
Sales Tax Liability
Through the date of this report, certain states have issued initial
assessments against the Company claiming insufficient remittance of sales taxes
on revenues from past procedure sales to Associated Centers, which the Company
is disputing. Based upon the result of settlement of sales tax audits as well as
the circumstances and advice of its independent advisors on the matters that are
still pending, management has estimated and accrued approximately $2.1 million
as of September 30, 2006 for potential additional sales tax liability related to
these assessments and related state sales tax matters.
16
In the third quarter of 2006, the Company achieved settlement agreements on
assessments by both New York State and Texas. The Company's reported quarter-end
sales tax liability balance of $2.1 million reflects, among other matters, the
remaining balance owed to New York., while the Texas settlement has been paid in
full during the quarter.
The Company may further increase its tax accrual in the future in response
to outstanding sales tax audits or potential future audits and/or assessments.
The Company intends to vigorously challenge the imposition of any new tax
assessments if and when they arise, and believes it has substantial authority
for its position. Nonetheless, the Company may attempt to negotiate a resolution
of such potential assessments and may also initiate discussions with some other
states that have not asserted additional assessments against the Company. An
unfavorable outcome with respect to these sales tax matters could have a
material adverse affect on the Company's financial position and results of
operations, and no assurance can be given that these tax matters will be
resolved in the Company's favor in view of the inherent uncertainties involved
in tax proceedings. The Company believes that it has provided adequate accruals
for additional taxes and related interest expense that may ultimately result
from sales tax audits , and will re-evaluate the adequacy of its reserves as new
information or circumstances warrant.
FORWARD LOOKING STATEMENTS
The statements contained in this Report that are not purely historical are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act.
These statements relate to the Company's expectations, hopes, beliefs,
anticipations, commitments, intentions and strategies regarding the future. They
may be identified by the use of words or phrases such as "believes," "expects,"
"anticipates," "should," "plans," "estimates," and "potential," among others.
Forward-looking statements include, but are not limited to, statements contained
in Management's Discussion and Analysis of Financial Condition and Results of
Operations regarding the Company's financial performance, revenue and expense
levels in the future and the sufficiency of its existing assets to fund future
operations and capital spending needs. Actual results could differ materially
from the anticipated results or other expectations expressed in such
forward-looking statements. The Company believes that many of the risks set
forth here and in the Company's filings with the SEC, is part of doing business
in the industry in which the Company operates and competes and will likely be
present in all periods reported. The forward-looking statements contained in
this Report are made as of the date of this Report and the Company assumes no
obligation to update them or to update the reasons why actual results could
differ from those projected in such forward-looking statements. Among others,
risks and uncertainties that may affect the business, financial condition,
performance, development, and results of operations of the Company include those
risks set forth under "Item 1A. Risk Factors".
RESULTS OF OPERATIONS
THE FOLLOWING ARE EXPLANATIONS OF SIGNIFICANT CHANGES FOR THE 13-WEEKS
PERIOD ENDED SEPTEMBER 30, 2006 COMPARED TO THE 13-WEEKS PERIOD ENDED SEPTEMBER
24, 2005:
TOTAL REVENUES, NET increased 30% from $5.2 million for 2005 to $6.7
million in 2006. The increase was primarily due to Center whitening fee revenues
increasing 38% from $ 4.2 million for 2005 to $ 5.8 million in 2006. The
increase is due to two primary factors: 1) higher volume from a decrease in the
procedure price in April 2006 to $399; and 2) with the Associated Center ("AC")
business sold, calls to the call center were directed 100% to BSML spas instead
of a portion going to the AC dentists. Product and other revenue decreased 3%
from $972,000 for 2005 to $943,000 in 2006. This reduction was primarily due to
higher revenue deferral related to Smile Forever program promotions (approx.
$1.0 million), offset by an increase of approximately $670,000 in retail product
sales through the QVC television network channel and our Centers, and by a
reduction in prepaid deferred revenue liability (approx. $295,000).
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES increased from $ 3.7 million
for the third quarter of 2005 to $8.7 million in the third quarter of 2006. The
increase was primarily due to a net increase of approximately $5.0 million in
legal expense and reserves related to on-going litigation.
RESEARCH AND DEVELOPMENT EXPENSES decreased from $266,000 in 2005 to
$45,000 in 2006. The Company performed minimal research activities since the
sale of its AC business..
DEPRECIATION AND AMORTIZATION expense decreased 37%, from $ 660,000 in 2005
to $ 415,000 in 2006. This decrease was primarily due to the depreciating Center
assets reaching the end of their depreciable lives in certain Centers over the
course of the last year.
GAIN ON MARK-TO-MARKET OF CONVERTIBLE NOTE INSTRUMENTS. To reflect the fair
value in each reporting period, the Financial Instruments Related to Convertible
Debt was revalued and marked-to-market based on the then stock price with the
resulting gain or loss reflected in the income statement. The total
mark-to-market adjustments on convertible note instruments in the third quarter
of 2005 resulted in a gain of approximately $1.2 million. No gain or loss
occurred in the third quarter of 2006 as the convertible debt was paid off in
first quarter 2006.
17
AMORTIZATION OF DISCOUNT ON CONVERTIBLE DEBT. The convertible debt issued
in December 2004 was valued net of discount. That discount was being amortized
over the life of the debt using the effective interest method up until the date
the debt was paid in March 2006. For the 13-week period ended September 24,
2005, the Company recorded $652,000 of amortization. The unamortized debt
discount remaining when the debt was paid off in March 2006 has been recorded as
a loss on the early extinguishment of debt ($5.0 million). For the 13-week
period ended September 30, 2006, there was no amortization of discount on
convertible debt, as the debt had been repaid.
OTHER INCOME AND EXPENSE, NET. For the 13 -week end September 30, 2006
other income net of expenses, was $185,000 and was composed primarily of
interest earned. As all debt was repaid in March 2006, we did not have any
interest expense in this period. For the comparable period in 2005, we had net
expense of $251,000 and this was mostly composed of interests expense.
THE FOLLOWING ARE EXPLANATIONS OF SIGNIFICANT CHANGES FOR THE 39-WEEK
PERIOD ENDED SEPTEMBER 30, 2006 COMPARED TO THE 39-WEEK PERIOD ENDED SEPTEMBER
24, 2005:
TOTAL REVENUES, NET increased 32% from $15.6 million for 2005 to $20.5
million in 2006. The Center whitening fee revenues increased 30% from $ 12.8
million for 2005 to $ 16.7 million in 2006. Product and other revenue increased
36% from $ 2.8 million for 2005 to $ 3.8 million in 2006. The reported revenue
level for 2006 was also impacted by the revenue deferral related to the free
Smile Forever promotion in the third quarter.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES increased 55% from $ 11.7
million for 2005 to $18.1 million in 2006. The primary reason for this increase
is legal expense related to litigation matters, as well as severance and lease
buyout costs associated with the restructuring of the Company after the sale of
the AC business.
RESEARCH AND DEVELOPMENT EXPENSES decreased from $607,000 for 2005 to
$135,000 in 2006. The Company performed minimal research activities during its
efforts to sell its business and after the sale of the AC business.
DEPRECIATION AND AMORTIZATION expense decreased approximately $600,000,
from $ 1.8 million in 2005 to $ 1.2 million in 2006. A part of the decrease is a
result of reaching the end of the depreciable lives of certain assets.
GAIN ON MARK-TO-MARKET OF FINANCIAL INSTRUMENTS RELATED TO CONVERTIBLE
DEBT. To reflect the fair value in each reporting period, the Financial
Instruments Related to Convertible Debt was revalued and marked-to-market based
on the then stock price with the resulting gain or loss reflected in the income
statement. The total mark-to-market adjustments in the first three quarters of
2005 resulted in a gain of $3.8 million. No gain or loss was recognized in the
first three quarter of 2006 as the convertible debt was paid off in March 2006.
AMORTIZATION OF DISCOUNT ON CONVERTIBLE DEBT. The convertible debt issued
in December 2004 was valued net of discount. That discount was being amortized
over the life of the debt using the effective interest method up until the date
the debt was paid in March 2006. For the 39-week period ended September 30,
2006, the Company recorded $530,000 of amortization. The debt was outstanding
the full 39 weeks of 2005, when we recorded $1.9 million of amortization. The
unamortized debt discount remaining when the debt was paid off in March 2006 has
been recorded as a loss on the early extinguishment of debt ($5.0 million).
There was no comparable extinguishment of debt for the 39-week period ended
September 24, 2005.
OTHER INCOME AND EXPENSE, NET. For the 39 weeks ended September 30, 2006,
other income and expenses, was net expense of $660,000. The principal component
was cost of $870,000 related to the termination of the agreement to sell the
Center business. For the comparable period in 2005, we reflect net expense of
$976,000 due mostly to net interest expense on debt.
LIQUIDITY AND CAPITAL RESOURCES
GENERAL
The Company's principal sources of liquidity have been proceeds from
issuances of common stock and debt, as well as, most recently, the proceeds from
the sale of the AC business in March, 2006. At September 30, 2006, the Company
had $5.7 million in unrestricted cash. To date, the Company has yet to achieve
bottom-line profitability on a sustained basis. The Company expects that its
principal uses of cash will be to provide working capital to meet corporate
expenses and satisfy outstanding liabilities, and if and when decided, to open
new whitening centers.
18
Proceeds received from the sale of the Associated Centers business on March
13, 2006 have been used or are reserved to be used in the foreseeable future to
pay off long-term debt, capital leases and accrued interest, ($19.4 million); to
establish an escrow account from which payment can be made for claims BSML has
agreed to indemnify Discus, ($3.5 million remaining in escrow as of September
30, 2006); to pay costs associated with the asset sale transaction, ($1.0
million); to pay outstanding legal bills related to the Discus patent
litigation, ($5 million); to pay employee severance, ($1.2 million through July
1, 2006); to resolve certain outstanding sales tax issues related to the
Associated Centers, (at least $2 million); and to pay potential income and other
tax related to the Discus transaction, ($1.0 million). Any remaining proceeds
will be used for working capital needs.
The financial statements reflect a going concern basis of accounting. While
the Company currently is able to pay its debts as they come due, and has a plan
to generate positive cash flow from its Centers business operations, it is not
certain that the Company will achieve bottom-line profitability on a sustained
basis, especially in light of the continuing legal fees associated with the
Company's litigation. In addition, a legal ruling restricted the use of $6.5
million of the Company's cash in connection with the on going litigation with
Mayer, Brown, Rowe & Maw LLP. This amount is included in "Investments,
restricted as to use" on the balance sheet. Furthermore, the Company has agreed
to a standby $1.5 million writ of attachment in connection with the Smile, Inc.
litigation, The Mayer Brown cash restriction and any other further cash
restriction could have a significant adverse impact on the Company's ability to
fund operations in the near term. In addition, it is possible that the Company
could have additional cash demands as a result of the legal claims against the
Company. The liquidity projections may improve or deteriorate depending on these
changing conditions.
Cash Requirements
During the last three years, the primary uses of cash were for funding of
operations, opening new whitening centers, purchase of equipment and debt
repayments. Some of the proceeds realized from selling the Associated Centers
business in March 2006 were used to pay all outstanding debt. Therefore, in the
near term, the primary use of cash is expected to be to support the Centers
business and related corporate overhead expenses as well as the liquidation of
litigation, tax, and other outstanding liabilities.
The Company has the following contractual obligations as of September 30,
2006:
PAYMENTS DUE BY PERIOD (IN THOUSANDS)
-------------------------------------------------------------------
LESS THAN 1-3 4-5 AFTER 5
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS YEARS
---------------------------------------- ----------- ----------- ----------- ----------- -----------
Operating Leases........................ $ 13,507 $ 3,720 $ 7,297 $ 1,724 $ 766
Service Contracts....................... $ 488 $ 248 $ 240 -- --
----------- ----------- ----------- ----------- -----------
Total Contractual Cash Obligations...... $ 13,995 $ 3,968 $ 7,537 $ 1,724 $ 766
=========== =========== =========== =========== ===========
SOURCES OF CASH, LIQUIDITY AND CAPITAL RESOURCES
In the 39 weeks ended September 30, 2006, net cash provided by operations was
$2.2 million.
Cash provided from investing activities was $17.1 million. The Company had no
material capital expenditures in the third quarter of 2006.
Net cash used in financing activities was $(19.1) million for the 39 weeks ended
September 30, 2006.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
We believe there has been no material change in the Company's exposure to
Market Risk from that discussed in the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 2005.
ITEM 4. CONTROLS AND PROCEDURES
Company management is aware of certain deficiencies in the design or
operation of the Company's disclosure controls and internal accounting controls.
19
In connection with its audit of the Company's 2004 financial statements,
Deloitte & Touche LLP, the Company's former independent registered public
accounting firm reported that (1) inadequacies in the design and execution of
the Company's internal control structure, and (2) improper application of
accounting principles in accordance with GAAP, constituted material weaknesses
in the Company's internal control structure for the year ended December 31,
2004. During 2005, the Company worked to improve its controls and reporting
processes. These efforts included, among other actions, the engagement of
outside consultants to identify solutions to control weaknesses and implement
corrective actions, clear assignment of account responsibilities among the
finance staff, more disciplined deployment of accounting close activities and
requirements, along with additional oversight and review of accounting entries
by finance management. As a result of these efforts, there has been improvement
in the internal controls and reporting processes. In the course of the 2005
audit, there were relatively few adjusting entries required to finalize the
Company's financial statements. The Company believes that all required
adjustments have been made and are properly incorporated in the reported results
of the Company for the year ended 2005. These efforts have continued during the
first three quarters of 2006 and the Company believes that all required
adjustments were made and properly incorporated in the reported results of the
Company for the period ended September 30, 2006.
The Company's management, with the participation of its Principal Executive
Officer and Chief Financial Officer, have evaluated the effectiveness of the
Company's "disclosure controls and procedures" (as defined in Exchange Act Rule
13a-15(e)) as of the end of the period covered by this report. During the course
of the evaluation, the additional procedures performed and controls instituted
by the Company to enhance its internal controls and mitigate the effect of
deficiencies and to prevent misstatements or omissions in its consolidated
financial statements were considered. However, since the Company was in the
process of selling its businesses during the first five months of 2006, there
was a significant amount of its finance resources shifted to the sale of its
businesses, with less emphasis on continued future process improvements. As a
result of the decision to sell its operations, there was also a significant
amount of turnover among the finance staff in the first two quarters of 2006. As
a result of these factors, the Company's Principal Executive Officer and Chief
Financial Officer have concluded that, while the Company's disclosure controls
and procedures have improved in the third quarter 2006, they are not yet
effective as of the period covered by this report.
However, since the Company has decided recently to continue in the Centers
business, Finance management has begun to stabilize its staffing by hiring a
Director of Finance and an accountant, and to re-focus its efforts on its
controls and reporting processes going forward. The Company has begun to make
improvements to its policies, procedures, systems and staff who have significant
roles in disclosure controls and in internal controls over financial reporting,
and will continue these efforts during the remainder of 2006 with a goal of
addressing any remaining deficiencies.
There were no significant changes in internal controls during the last
fiscal quarter, other than those referenced above that have materially affected
internal control over financial reporting.
20
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is the subject of certain legal actions. Management believes
that it has accrued the appropriate amount of liability for actions against the
Company. However, the litigation and other claims noted in this report are
subject to inherent uncertainties and it is possible that future results of
operations for any particular quarterly or annual period could be materially
affected by changes in management's assumptions and the effectiveness of BSML's
strategies related to these legal actions.
The following matters pending on December 31, 2005 or commenced thereafter,
---------------------------------------------------------------------------
have been settled:
------------------
BSML, Inc. v. Discus Dental, Inc. and Salim Nathoo, filed in federal court
in California (the "Discus Patent Litigation"). This case was dismissed with
prejudice in March 2006. The Company filed a complaint against Discus Dental,
Inc. ("Discus") in July 2002, and added Salim Nathoo ("Nathoo") as a defendant
in February 2003. As subsequently amended, the complaint asserted claims of
patent infringement, misappropriation of the Company's trade secrets, civil
conspiracy, and unfair competition and business practices by Discus and Nathoo
jointly and other claims against Discus and Nathoo, individually. Discus filed
counterclaims seeking declarations of invalidity and non-infringement of several
BriteSmile patents, and for other claims.
On March 13, 2006, the parties settled all litigation proceedings between
them, including the Discus Patent Litigation and the litigation described in the
two following paragraphs. Discus and the Company agreed to settle the Discus
Patent Litigation and the litigation described in the following two paragraphs
for consideration to the Company of $8.7 million.
BriteSmile Development, Inc. v. Discus Dental, Inc. BriteSmile Development,
Inc. ("BDI"), a wholly owned subsidiary of BSML, Inc. filed in October 2005, a
patent infringement suit against Discus in federal court in California. The suit
alleged that Discus' Zoom! 2 tooth whitening system infringed a patent issued to
BDI in October 2005. This case was dismissed in March 2006, as described above.
BriteSmile v. Discus Dental, Inc., filed in May 2002 in California state
court. The Company filed a complaint against Discus alleging state law causes of
action for intentional interference with contractual relationship, negligent
interference with contractual relationship, unfair business practices and
related claims. This case was dismissed in March 2006, as described above.
The Procter & Gamble Company v. Oraceutical LLC, IDEX Dental Sciences,
Inc., Robert Eric Montgomery, BriteSmile, Inc. and BriteSmile Development, Inc.,
filed in June 2003 in federal court in Ohio. This case was dismissed in February
2006 in connection with a settlement payment from the Procter & Gamble Company
("P&G"). In its complaint P&G alleged that Oraceutical LLC, IDEX Dental
Sciences, Inc. and Eric Montgomery (collectively, the "REM Group") had breached
an agreement between the REM Group and P&G (the "Standstill Agreement") by
entering into a binding memorandum of understanding (the "MOU") with the Company
and BDI in May 2003. Montgomery is a former director of the Company, and
Oraceutical LLC, which is owned by Montgomery, is a consultant to the Company.
The complaint also sought a declaratory judgment that certain U.S. patents
previously owned by the Company (but owned by the REM Group at the time the
complaint was filed) (the "Patents") were invalid and unenforceable, and that
P&G's Whitestrips product did not infringe the Patents. In February 2004, the
defendants filed an answer and counterclaims.
In February 2006 the parties settled the litigation proceedings between
them. As part of the settlement, the Company granted to P&G a nonexclusive
license to certain patents relating to teeth whitening strips and P&G agreed to
pay $4 million. The Company recorded a gain of approximately $1.3 million from
its portion of the settlement proceeds.
Green River Junction v. BriteSmile, filed in November 2005, in Pennsylvania
state court. In its complaint Green River Junction, Inc. ("Green River") sought
to recover approximately $85,000 from the Company on breach of contract and
related claims. BriteSmile denied the allegations of the complaint and filed an
answer.
In May 2006, the parties entered into a settlement agreement, whereby
BriteSmile paid Green River $60,000 plus agreed to pay royalties on certain
future revenues of the Company received from the QVC network until April 2008.
21
BriteSmile v. Oraceutical LLC, Oraceutical Innovative Properties LLC, and
Eric Montgomery, filed in March 2006 in Utah state court. In its complaint, the
Company asserted claims for breach of contract/specific performance, declaratory
judgment, breach of fiduciary duty and punitive damages. These claims arose from
the refusal of the defendants to sign documents confirming the assignment of
certain patent rights to the Company as required under contracts with the
Company.
In May 2006, the parties agreed to settle the litigation proceedings upon
defendants' agreement to sign assignment documents satisfactory to the Company.
Gregg A. Coccari v. BriteSmile, Inc. commenced in August 2005 as an
arbitration proceeding before the American Arbitration Association. In this
proceeding, Coccari, the Company's former chief executive officer, asserted
claims for breach of his employment contract with the Company, fraudulent
inducement, negligent misrepresentation, violations of certain sections of the
California Labor Code, tortious wrongful discharge in violation of public
policy, and other state law claims relating to his alleged wrongful discharge by
the Company. Coccari sought damages for alleged breaches of the termination and
other provisions of the employment contract and under his state law claims, plus
attorneys' fees and punitive damages. The Company denied Coccari's allegations
and asserted counterclaims.
In September 2006, the parties settled the arbitration proceeding. Under
the settlement, the Company agreed to pay Coccari $700,000 (a portion of which
was paid by the Company's insurance carrier) and that 160,000 of the 240,000
shares of the Company's common stock granted to Coccari in 2005 could be
retained by Coccari. For his part, Coccari returned to the Company 80,000 shares
of the Company's common stock and relinquished any rights to 600,000 options to
purchase the Company's common stock. A liability equal to the value of this
settlement has been accrued on the Company's September 30, 2006 balance sheet.
Mayer, Brown, Rowe & Maw LLP v. BriteSmile, Inc. and BriteSmile
Development, Inc., filed in California state court (the "Mayer Brown Action").
Mayer, Brown, Rowe & Maw LLP ("MBR&M"), the Company's former counsel in the
Discus Patent Litigation, filed a complaint alleging causes of action for breach
of contract, breach of the implied covenant of good faith and fair dealing, and
unjust enrichment arising from the attorney-client relationship between MBR&M
and the Company. The Complaint alleged that MBR&M was entitled to more than $12
million in attorney's fees allegedly due under the Contingent Fee Agreement
entered into between MBR&M and the Company relating to the Discus Patent
Litigation and other miscellaneous hourly fees. BriteSmile denied the
allegations of MBR&M's complaint.
Concurrently with filing its Complaint, MBR&M filed an application for a
right to attach order, a writ of attachment, and a temporary protective order
attaching $12,803,713 (the "MBR&M Application") of the proceeds obtained by the
Company from its sale of the Associated Centers business to Discus. The Company
opposed the MBR&M Application, but in April 2006, the court approved a writ of
attachment on approximately $6.5 million of the proceeds received by the Company
from Discus from the sale of the Associated Centers business
In November 2006, the Company and MBR&M agreed in principle to settle the
Mayer Brown Action. Under this agreement, the Company will pay MBR&M $5 million
in satisfaction of all of the claims in the Mayer Brown Action. The settlement
proceeds will be paid from the $6.5 million, held pursuant to the writ of
attachment granted in April 2006 and has been fully accrued as a liability as of
September 30, 2006.
The following cases or claims remain active and pending against the
-------------------------------------------------------------------
Company:
--------
Smile Inc. Asia Pte. Ltd. v. BriteSmile filed in April 2002 in Utah state
court. Smile Inc. Asia Pte. Ltd. ("Smile") sued the Company and BriteSmile
Management, Inc., a wholly owned subsidiary of the Company ("BriteSmile
Management") for $10 million of claimed damages alleging that BriteSmile
Management breached its 1998 distributor agreement with Smile (exclusive as to
Singapore and other surrounding countries) for laser-aided teeth whitening
devices by failing to fill orders and to perform other obligations under the
agreement. The complaint also alleges that BriteSmile Management and the Company
fraudulently induced Smile to enter into the distributor agreement, and includes
claims for alleged damages, based on theories of breach of contract, conversion,
unjust enrichment, civil conspiracy, breach of the duty of good faith and fair
dealing, interference with contractual and economic relations, and fraudulent
transfer. The trial court recently dismissed the claims for unjust enrichment
and conversion.
In May 2002, the Company and BriteSmile Management filed their answer and
counterclaim. The counterclaim alleges that Smile breached the distributor
agreement by using BriteSmile's names and marks in a fashion not permitted by
the distributor agreement and opposing the Company's efforts to register its
marks in Singapore.
22
One of the principal defenses to Smile's claims is that the distributor
agreement for the laser-aided teeth whitening devices expressly excludes
"non-laser-aided teeth whitening products and processes" sold by the Company.
Accordingly, in the lawsuit the Company asserts that Smile has no rights to
market and sell the Company's current light activated teeth whitening or retail
products and cannot claim damages for BriteSmile's marketing of such products in
the exclusive territory described in the distributor agreement. Another
important defense is that the market for laser-aided devices and procedures was
rapidly shrinking during the relevant time period, which limits any potential
damages claimed by Smile. The Company disputes liability and will continue to
defend these claims. In December 2006 the court will conduct an evidentiary
hearing regarding the reliability of Smile's expert witness testimony. The court
has vacated the trial date, previously set for November 28, 2006.
On April 27, 2006, the court entered a prejudgment writ of attachment based
on a stipulation of the parties whereby the court attached $1.5 million of the
approximate $6.5 million that is currently subject to the writ of attachment
issued in Mayer Brown litigation, as described above. In connection with the
settlement of the Mayer Brown action, the Company will establish a separate
account for the deposit of $1.5 million for the prejudgment writ of attachment.
Claims of Oraceutical LLC, Oraceutical Innovative Properties LLC, and Eric
Montgomery. In July 2003, Oraceutical LLC, Oraceutical Innovative Properties
LLC, and Eric Montgomery (collectively, "Oraceutical") and the Company and BDI
entered into an Asset Purchase Agreement (the "Purchase Agreement"). Pursuant to
the Purchase Agreement, as subsequently amended in November 2003, BDI acquired
intellectual property consisting primarily of certain United States and foreign
patents, patent applications, continuations, continuations-in-part, trade
secrets, technologies, know-how, trademarks and trade names relating to human
oral care for a purchase price of $6.4 million, plus a 50% participation
interest in third party royalties and infringement recoveries relating to the
intellectual property acquired. The intellectual property acquired from
Oraceutical was sold to Discus in March 2006. Following the sale to Discus and
the settlement of the Discus Patent Litigation, Oraceutical asserted various
claims against the Company, including that under the terms of the Purchase
Agreement it is entitled to a portion of the consideration paid by Discus. The
Company has denied the claims of Oraceutical, but agreed to arbitrate
Oraceutical's claims. No date for an arbitration proceeding has been set.
.
The Company is also subject to legal proceedings and claims in the ordinary
course of business, including claims of alleged personal injury, infringement of
trademarks and other intellectual property rights. However, the Company believes
any such claims that have been presented to the Company as of the date of this
report are without merit and the Company will vigorously defend against any such
claims.
ITEM 1A. RISK FACTORS
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
-------------------------------------------
The following risk factors and other information included in this Report
should be carefully considered. The risks and uncertainties described below are
not the only ones we face. Additional risks and uncertainties not presently
known to us or that we currently deem immaterial also may impair business
operations. The following risks could materially adversely affect the business,
financial conditions, operating results and cash flows.
THE ASSET PURCHASE AGREEMENT WITH DISCUS EXPOSES US TO CONTINGENT LIABILITIES.
In connection with the sale of the Associated business to Discus, the
Company agreed to indemnify Discus for a number of matters, including the breach
of our representations, warranties and covenants contained in the Asset Purchase
Agreement with Discus, as well as any potential additional local sales, stamp,
or VAT tax obligations. A breach or inaccuracy of any of the representations,
warranties and covenants in the Asset Purchase Agreement could lead to an
indemnification claim against us by Discus. Any such indemnification claims
could require us to pay substantial sums and incur related costs and expenses
and have a material adverse effect on our liquidity, financial condition, future
prospects and ability to continue the operations of the spas. An escrow account
was established for $3.5 million from the Associated Centers' sale proceeds from
which any payments due Discus resulting from a breach of our representations,
warranties and covenants would be paid.
OUR ABILITY TO UTILIZE OUR NET OPERATING LOSS CARRYFORWARD MAY BE LIMITED OR
ELIMINATED IN ITS ENTIRETY.
We will recognize gains for federal income tax purposes on the sale of the
assets in the sale of our Associated Centers business. We have a substantial net
operating loss carryforward that we plan to use to offset our federal tax
liability to the extent allowable, other than alternative minimum tax, generated
from the sale of our Associated Centers business. Based on the final
determination of the purchase price allocation of the Associated Centers
business, we may be subject to additional tax in the Republic of Ireland above
the federal income tax.
23
If our net operating loss carryforward is found to be subject to annual
limitations, then our federal tax liability and available cash proceeds after
the sale may be materially different and our financial position could be
adversely affected. As of December 2005, we had net operating loss carryforwards
of approximately $155 million that we anticipate may be used in the future to
reduce our federal tax liability. We established a full valuation allowance
against the net operating loss carryforward, along with all other deferred tax
assets, to reflect the uncertainty of the recoverability of this asset. The
utilization of this asset in the future is dependent upon our having positive
earnings. Furthermore, the likelihood of an annual limitation on our ability to
utilize our net operating loss carryforward to offset future U.S. federal
taxable income is increased by (1) the issuance of certain convertible preferred
stock, options, warrants, or other securities exercisable for common stock, (2)
changes in our equity ownership occurring in the last three years and (3)
potential future changes in our equity ownership. The amount of an annual
limitation can vary significantly based on factors existing at the date of an
ownership change. If such limitations were imposed, they could have a material
adverse impact on our results of operations and cash flows.
WE FACE POSSIBLE DELISTING FROM THE NASDAQ SMALLCAP MARKET, WHICH WOULD RESULT
IN A LIMITED PUBLIC MARKET FOR OUR COMMON STOCK, AND MAY ADVERSELY AFFECT THE
PRICE AND TRADING VOLUME OF OUR COMMON STOCK.
There are several requirements for the continued listing of our common
stock on the Nasdaq SmallCap Market, including, but not limited to, maintaining
a minimum bid price of $1.00 per share, maintaining total shareholders' equity
of $2.5 million and maintaining an operating business.
At various times in the past, we were not in compliance with one or more of
the foregoing requirements, and received notices from Nasdaq to that effect.
While we believe that we currently are in compliance with Nasdaq's continued
listing requirements, we cannot guaranty that we will continue to be in
compliance in the future. If we fail to comply with Nasdaq's continued listing
requirements, our common stock may be delisted from Nasdaq.
If our common stock is delisted, trading our stock may become more
difficult and our stock price could decrease. If our common stock is not listed
on the Nasdaq SmallCap Market, many potential investors will not purchase it,
which would further limit the trading market for our common stock.
OUR STOCK PRICE MAY BE VOLATILE AND YOU COULD LOSE ALL OR PART OF YOUR
INVESTMENT.
We expect that the market price of our common stock will be volatile. Stock
prices have risen and fallen in response to a variety of factors, including:
o quarter-to-quarter variations in operating results; and
o market conditions in the economy as a whole.
The market price for our common stock may also be affected by our ability
to meet investors' or securities analysts' expectations. Any failure to meet
these expectations, even slightly, may result in a decline in the market price
of our common stock. In addition, the stock market is subject to extreme price
and volume fluctuations. This volatility has had a significant effect on the
market prices of securities issued by many companies for reasons unrelated to
the operating performance of these companies. In the past, following periods of
volatility in the market price of a company's securities, securities class
action litigation has often been instituted against that company. If similar
litigation were instituted against us, it could result in substantial costs and
a diversion of our management's attention and resources.
WE HAVE A HISTORY OF LOSSES AND ACCUMULATED DEFICIT AND THIS TREND OF LOSSES MAY
CONTINUE IN THE FUTURE.
For 2005, 2004 and 2003, we had a net loss of $17.8 million, $7.8 million
and $14.6 million, respectively. As of December 31, 2005, our accumulated
deficit was $175.8 million. We sold our Associated Centers business in the first
quarter of 2006, and our Centers business is our sole operating business. We
currently intend to continue to operate our Centers business. We have not been
able to operate profitably in the past, and while our business currently
consists of only our Centers business and not our Associated Centers business,
which we sold, we cannot guarantee that our business will be profitable on a
sustained basis.
INFLATION
Most of our products are purchased in finished form and packaged by the
supplier. We anticipate usual inflationary increases in the price of our
products and do not intend to pass these increases along to our customers. In
general, we do not believe that inflation has had a material effect on our
results of operations in recent years. However, there can be no assurance that
our business will not be affected by inflation in the future.
24
SEASONALITY
We believe that our business follows seasonal trends due to increased
consumer demand during certain seasons and around public and national holidays.
As a result, our sales performance could potentially be affected.
OUR SUCCESS WILL DEPEND ON ACCEPTANCE OF OUR LATW PROCESS AND POST-WHITENING
MAINTENANCE PRODUCTS.
We derive most of our revenues from our LATW procedures, one of many
teeth-whitening solutions offered to consumers. We also market BriteSmile
branded toothpaste, electric toothbrushes, mouthwash, the BriteSmile-to-Go pen,
and post-whitening procedure touchups through our Centers and on our website.
Our success will depend in large part on our ability to successfully encourage
consumers to switch from traditional and less expensive bleaching tray whitening
methods to our LATW system, and on our ability to successfully market our line
of whitening and post-whitening maintenance products. There can be no assurance
that consumers will accept our procedure or products. Typically, medical and
dental insurance policies do not cover teeth whitening procedures, including the
Company's LATW procedure, or whitening maintenance products, which may have an
adverse impact upon the market acceptance of our products and services.
OUR SUCCESS WILL DEPEND ON OUR ABILITY TO UPDATE OUR TECHNOLOGY TO REMAIN
COMPETITIVE.
The dental device and supply industry is subject to technological change.
As technological changes occur in the marketplace, we may have to modify our
products in order to become or remain competitive or to ensure that our products
do not become obsolete. We sold virtually our entire technology portfolio to
Discus and although we have a license to use the existing technology in the
Centers, we cannot give assurances that we will be able to either acquire or
develop newer technology in the future. If we fail to anticipate or respond in a
cost-effective and timely manner to government requirements, market trends or
customer demands, or if there are any significant delays in product development
or introduction, our revenues and profit margins may decline, which could
adversely affect our cash flows, liquidity and operating results.
WE MAY HAVE PROBLEMS FINANCING OUR FUTURE GROWTH.
Our growth strategy includes investment in and expansion of Centers
throughout the United States and internationally, increasing awareness of the
BriteSmile brand, and developing and marketing our brand name and retail
products. To finance our prior growth we have sold debt and equity securities;
however, additional funds may be needed in the future for continued expansion.
We cannot give assurance that additional financing will be available or that, if
available, it will be on terms favorable to our stockholders or us. If needed
funds are not available, we may be required to close existing Centers, and/or
limit or forego the establishment of new Centers and the development of new
products, or limit the scope of our current operations, which could have a
material adverse effect on our business, operating results and financial
condition. We may be required to take other actions that may lessen the value of
our common stock, including borrowing money on terms that are not favorable to
us. Raising the needed funds through the sale of additional shares of our common
stock or securities convertible into shares of common stock may result in
dilution to current stockholders.
WE ARE SUBJECT TO COMPETITION.
The market for teeth whitening products and services is highly competitive.
Competition in the market for teeth whitening products and services may
intensify in the future. Numerous well-established companies and smaller
entrepreneurial companies are focusing significant resources on developing and
marketing products and services that will compete with our products and
services. In addition, many of our current and potential competitors have
greater financial, technical, operational and marketing resources. Teeth
whitening products and services offered by our competitors include traditional
and often less expensive bleaching tray methods and other forms of heat or light
activated curing methods. We may not be able to compete successfully against
these competitors in developing, marketing and distributing our services and
products, which could result in the loss of customers and could have a material
adverse effect on our business. Competitive pressures may also force prices for
teeth whitening services down and such price reductions may adversely affect our
potential future revenue and profitability.
In addition, we recently sold our Associated business to Discus. BriteSmile
products and services offered through our Centers will compete directly with
BriteSmile products and systems offered through existing independent dental
offices.
25
WE MAY EXPERIENCE SHORTAGES OF THE SUPPLIES WE NEED BECAUSE WE DO NOT HAVE
LONG-TERM AGREEMENTS WITH CERTAIN SUPPLIERS AND RELY ON SOLE SOURCES FOR KEY
EQUIPMENT.
Successful operation of our Centers business depends to a degree on our
ability to provide our Centers a sufficient supply of teeth whitening gels and
maintenance products. Since our BS2000 was first used commercially, we have
relied upon manufacturing and supply agreements with multiple suppliers and a
single manufacturer of our LATW systems. Effective April 2001, the Company's
LATW systems are manufactured by Delphi Medical Systems Corporation, Longmont,
Colorado, pursuant to an agreement between the Company and Delphi.
We have no long-term purchase contracts or other contractual assurance of
continued supply, pricing or access to new products. While we believe that we
have good relationships with our suppliers and our manufacturer, if we are
unable to extend or secure manufacturing services or to obtain component parts
or finished products from one or more key vendors on a timely basis and on
acceptable commercial terms, our results of operations could be seriously
harmed.
OUR FUTURE GROWTH WILL DEPEND IN PART ON ADDING NEW CENTERS.
One driver of future growth will be expansion of the number of our Centers.
We cannot give assurance that we will be successful in expanding the number of
Centers or that such additions will achieve sales levels satisfactory to us.
Demand for the Company's services and products is driven by consumers whose
broad spending patterns are affected by general economic conditions. Over recent
years, we have observed some variability in demand as a result of changing
economic conditions, which we believe may relate to fluctuations in the level of
consumer discretionary spending. We believe that our performance will continue
to be affected by such economic parameters.
WE OPERATE OUR CENTERS USING INTELLECTUAL PROPERTY UNDER A LICENSE GRANTED TO US
BY DISCUS DENTAL, AND WE CANNOT GUARANTEE THAT THE UNDERLYING PATENTS WILL NOT
BE INFRINGED BY COMPETITORS, OR THAT CERTAIN PATENTS THAT HAVE BEEN APPLIED FOR
WILL BE GRANTED.
In connection with the sale of our Associated business to Discus, we sold
all of our intellectual property relating to our business to Discus, but we
retained a license from Discus permitting us to utilize the intellectual
property to operate our Centers business.
There is an expansive and growing portfolio of patents to protect the
intellectual property rights licensed to us. In 2002, two patents relating to
the LATW systems were granted, including a patent covering a method of whitening
teeth by exposing teeth treated with transparent composition including a
peroxide and photosensitizing compound to light, and a patent covering the light
source. There are also a number of patent applications related to the
composition of our whitening gel, tissue isolation useful in light-activated
teeth whitening, our business method and our unique system of delivery of light
to all teeth simultaneously. We also filed patent applications related to the
BriteSmile-to-Go pen.
THE RIGHTS RELIED UPON TO PROTECT THE INTELLECTUAL PROPERTY LICENSED TO US BY
DISCUS UNDERLYING OUR PRODUCTS AND SERVICES MAY NOT BE ADEQUATE, WHICH COULD
ENABLE THIRD PARTIES TO USE THE TECHNOLOGY USED BY US AND WOULD REDUCE OUR
ABILITY TO COMPETE IN THE MARKET.
The rights licensed to us by Discus rely on a combination of trade secrets,
copyright and trademark laws, non-disclosure agreements and other contractual
provisions and technical measures to protect our intellectual property rights.
Nevertheless, these measures may not be adequate to safeguard the technology
underlying our products and services. If these measures do not protect these
rights, third parties could use the same technology we use, and our ability to
compete in the market would be reduced. In addition, employees, consultants and
others who participate in the development of our products and services may
breach their agreements with us or Discus regarding intellectual property, and
we may not have adequate remedies for the breach. We or Discus also may not be
able to effectively protect these intellectual property rights in some foreign
countries. We also realize that our and Discus' trade secrets may become known
through other means not currently foreseen by us. Notwithstanding our and
Discus' efforts to protect this intellectual property, our competitors may
independently develop similar or alternative technologies or products that are
equal or superior to the technology and products used by us without infringing
on any of the intellectual property rights or designs we use.
OUR PRODUCTS OR SERVICES COULD INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF
OTHERS, WHICH MAY CAUSE US TO ENGAGE IN COSTLY LITIGATION AND, IF WE ARE NOT
SUCCESSFUL, COULD ALSO CAUSE US TO PAY SUBSTANTIAL DAMAGES AND PROHIBIT US FROM
SELLING OUR PRODUCTS OR SERVICES.
Third parties may assert infringement or other intellectual property claims
against us. We may have to pay substantial damages, including treble damages,
for past infringement if it is ultimately determined that our products or
services infringe a third party's proprietary rights.
26
Further, we may be prohibited from selling our products before we obtain a
license, which, if available at all, may require us to pay substantial
royalties. Even if these claims are without merit, defending a lawsuit takes
significant time, may be expensive and may divert management's attention from
other business concerns. Notwithstanding the foregoing, we are not aware of any
infringement claims asserted against us by others.
WE ARE SUBJECT TO GOVERNMENT REGULATION REGARDING THE CORPORATE PRACTICE OF
DENTISTRY.
Our corporate structure, the operation of Centers and contractual
relationships with the licensed dentists at our Centers are subject to
government regulation and may be reviewed by applicable state agencies governing
the practice of dentistry (such as a Board of Dental Examiners). We believe that
our present and contemplated operation of Centers is and will be in compliance
in all material respects with applicable federal, state and local laws and
regulations, and that favorable review of our corporate structure would be
obtained from any state agency which chooses to review our operational
structure. However, we cannot give assurance that such favorable review would be
obtained in all instances. If we are unable to obtain favorable review, we may
be subject to penalties. We continue to cooperate with state regulatory agencies
to respond to any requests for information about our business structure and to
obtain any necessary governmental approvals. We cannot give assurance that
future enactments, amendments or interpretations of government regulations will
not be more stringent, and will not require structural, organizational or
operational modifications to our existing or future contractual relationships
with the licensed dentists at our Centers who provide our services.
WE MAY BECOME SUBJECT TO GOVERNMENT REGULATION REGARDING OUR TEETH WHITENING
SERVICES AND PRODUCTS.
The light used in the LATW systems is categorized as a Class I Medical
Device as defined by the Food and Drug Administration ("FDA"). As long as the
light is used specifically to perform cosmetic dental procedures (teeth
whitening), it is not subject to pre-market notification requirements, although
we are subject to FDA requirements regarding handling of complaints and other
general FDA record keeping standards. There can be no assurance that some or all
of the existing government regulations will not change significantly or
adversely in the future, or that we will not become subject to compliance with
additional and stricter government regulations which could, in the future,
affect our revenue.
OWNERSHIP OF OUR COMMON STOCK IS CONCENTRATED IN A LIMITED NUMBER OF
SHAREHOLDERS.
Current directors and executive officers of the Company, or their
affiliates, own and control more than a majority of the outstanding common stock
of the Company and, therefore, have ultimate authority to make all major
decisions affecting our business, including the identity and make-up of the
Company's board of directors and any other matters requiring approval of the
shareholders of the Company.
OUR EFFORTS TO BUILD STRONG BRAND IDENTITY AND CUSTOMER LOYALTY MAY NOT BE
SUCCESSFUL.
We believe that establishing and maintaining brand identity and brand
loyalty is critical to attracting customers and strategic partners. In order to
attract and retain these groups and respond to competitive pressures, we intend
to continue advertising spending to create and maintain brand loyalty. However,
as a result of the sale of our Associated Centers business, we intend to reduce
spending on advertising. We do not yet know if the reduced advertising will
result in a material reduction in revenues. We believe that advertising rates,
and the cost of advertising campaigns in particular, could increase in the
future. If our branding efforts are not successful, our results of operations
could be adversely affected.
Promotion and enhancement of the Company's brand will also depend on our
success in consistently providing a high-quality customer experience for our
teeth whitening services and satisfaction with our products. If customers do not
perceive our service and product offerings to be of high quality, or if we
introduce new services and products that are not favorably received, the value
of the Company's brand could be harmed. Any brand impairment or dilution could
decrease the attractiveness of the Company, which could harm our reputation,
reduce our net revenue and cause us to lose customers.
CHANGES IN REQUIRED ACCOUNTING PRACTICES MAY AFFECT OUR REPORTED OPERATING
RESULTS AND STOCK PRICE.
Any future changes to applicable Generally Accepted Accounting Procedures
or additional SEC statements on relevant accounting policies may require us to
further change our practices. These uncertainties may cause our reported
operating results and stock price to decline.
27
FAILURES IN OUR INFORMATION TECHNOLOGY SYSTEMS OR THE SYSTEMS OF THIRD PARTIES
COULD ADVERSELY AFFECT OUR BUSINESS AND RESULT IN A LOSS OF CUSTOMERS.
Our web site and our Internet-based Scheduler system may experience slow
response times, decreased capacity to accommodate a large number of customers or
a temporary disruption in service for a variety of reasons. Additionally, power
outages and delays in such service may interrupt or prevent us from immediately
coordinating with the schedules of Centers, and may interrupt or prevent
customers from arranging for our services or from ordering our products through
our e-Commerce Internet site. Any of these potential problems could have an
adverse effect on business.
Computer hardware and software components to our Scheduler system are
located at a third party co-location. In addition, a back-up file server and
tape back-ups of the Scheduler database reside both at our headquarters and
off-site. Delays in scheduling teeth whitening procedures would result if we
were required to use our backup computer hardware and software systems.
Nevertheless, natural disasters such as floods, fires, power outages,
telecommunications failures, physical or electronic break-ins or vandalism,
viruses and other similar events could damage our hardware and software systems,
lead to a loss of data, cause substantial disruption in our business operations
and have a material adverse effect on our business.
WE ARE SUSCEPTIBLE TO PRODUCT LIABILITY SUITS AND IF A LAWSUIT IS BROUGHT
AGAINST US IT COULD RESULT IN US HAVING TO PAY LARGE LEGAL EXPENSES AND
JUDGMENTS.
Because of the nature of the dental device industry, there can be no
assurance that we will not be subject to claims against us related to our
products or services. Our products come into contact with vulnerable areas of
the human body, such as the mouth, tongue, teeth and gums, and, therefore, the
sale and support of dental products makes us susceptible to the risk of such
claims. A successful product liability claim or claim arising as a result of use
of our products or services brought against us, or the negative publicity
brought up by such claim, could have a material adverse effect on our business.
We maintain product liability insurance with coverage limits of at least $5
million per occurrence and $5 million per year. While we believe that we
maintain adequate insurance coverage that is reasonable and customary for our
business, we cannot give assurance that the amount of insurance will be adequate
to satisfy claims made against us in the future, or that we will be able to
obtain insurance in the future at satisfactory rates or in adequate amounts.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS.
3.01 Articles of Restatement of the Articles of Incorporation of the Company
as filed with the Utah Division of Corporations and Commercial Code on
January 17, 2003 (incorporated by reference to the Company's Annual
Report on Form 10-K for the fiscal year ended December 28, 2002).
3.02 Articles of Amendment to the Articles of Incorporation of the Company
as filed with the Utah Division of Corporations and Commercial Code
effective January 30, 2004 (incorporated by reference to the Company's
Annual Report on Form 10-K for the fiscal year ended December 27,
2003).
3.03 Bylaws adopted May 2, 1996, (incorporated by reference to the Company's
Annual Report on Form 10-K for the fiscal year ended March 31, 1996).
3.04 Amendment to Bylaws adopted July 23, 1999 (incorporated by reference to
the Company's Quarterly Report on Form 10-QSB for the quarter ended
June 30, 1999).
28
10.01 Registration Rights Agreement dated April 1, 1996 between the Company,
LCO Investments Limited, Richard S. Braddock, and Pinnacle Fund, L.P.
(incorporated by reference to the Current Report on Form 8-K of the
Company dated April 1, 1996).
10.02 Registration Rights Agreement dated May 8, 1997 among the Company, LCO
Investments Limited, and Richard S. Braddock (incorporated by reference
to the Company's Annual Report on Form 10-KSB for the fiscal year ended
March 31, 1997).
10.03 Registration Rights Agreement dated as of May 4, 1998 between the
Company and LCO Investments Limited (incorporated by reference to the
Company's Annual Report on Form 10-KSB for the fiscal year ended March
31, 1998).
10.04* Revised 1997 Stock Option and Incentive Plan of the Company, as amended
through June 20, 2001 (incorporated by reference to the Company's
Annual Report on Form 10-K for the 52 weeks ended December 29, 2001).
10.05* Form of Option Agreement between the Company and certain directors of
the Company (incorporated by reference to the Company's Annual Report
on Form 10-K for the 52 weeks ended December 29, 2001).
10.06* Form of Option Agreement between the Company and certain employees of
the Company (incorporated by reference to the Company's Annual Report
on Form 10-K for the 52 weeks ended December 29, 2001).
10.07 Registration Rights Agreement dated as of June 3, 1999 between the
Company and the non-management purchasers (incorporated by reference to
the Company's Current Report on Form 8-K as filed June 21, 1999).
10.08 Amended and Restated Registration Rights Agreement dated as of June 3,
1999 between the Company and the management purchasers (incorporated by
reference to the Company's Current Report on Form 8-K as filed June 21,
1999).
10.09 Registration Rights Agreement dated as of June 3, 1999 between the
Company and certain non-management purchasers in the June 1999 Private
Placement (incorporated by reference to the Company's Current Report on
Form 8-K dated June 4, 1999).
10.10 Amended and Restated Registration Rights Agreement dated as of June 3,
1999 between the Company and certain management purchasers
(incorporated by reference to the Company's Current Report on Form 8-K
as filed June 4, 1999).
10.11 Registration Rights Agreement dated as of January 18, 2000 between the
Company and the Pequot Funds (incorporated by reference to the
Company's Current Report on Form 8-K dated January 18, 2000).
10.12 Agreement of Sublease dated December 1999 between the Company and LCO
Properties, Inc. (incorporated by reference to the Company's Annual
Report on Form 10-KSB for the fiscal year ended April 1, 2000).
10.13 Form of Warrants granted to note purchasers pursuant to the Securities
Purchase Agreement dated as of June 27, 2000 (incorporated by reference
to the Company's Transition Report on Form 10-K for the Nine-month
Transition Period ended December 30, 2000).
10.14 Form of Registration Rights Agreement between the Company of the
purchasers of Notes pursuant to the Securities Purchase Agreement dated
as of June 27, 2000 (incorporated by reference to the Company's
Transition Report on Form 10-K for the Nine-month Transition Period
ended December 30, 2000).
10.15 Convertible Promissory Note dated December 5, 2000 in the principal
amount of $5,000,000 (incorporated by reference to the Company's
Current Report on Form 8-K dated December 5, 2000).
10.16 Warrant to Purchase 250,000 Shares of common stock of the Company dated
December 5, 2000 (incorporated by reference to the Company's Current
Report on Form 8-K dated December 5, 2000).
10.17 Amended and Restated Agreement between Excimer Vision Leasing L.P. and
the Company dated February 2001 (incorporated by reference to the
Company's Transition Report on Form 10-K for the Nine-month Transition
Period ended December 30, 2000).
10.18 Amendment dated September 18, 2002 to Amended and Restated Agreement
between Excimer Vision Leasing L.P. and the Company dated February 2001
(incorporated by reference to the Company's Annual Report on Form 10-K
for the 52 weeks ended December 28, 2002).
10.19 Amendment dated January 1, 2003 to Amended and Restated Agreement
between Excimer Vision Leasing L.P. and the Company dated February 2001
(incorporated by reference to the Company's Annual Report on Form 10-K
for the 52 weeks ended December 28, 2002).
10.20 Loan Agreement between Excimer Vision Leasing L.P. and the Company
dated as of March 1, 2001 (incorporated by reference to the Company's
Transition Report on Form 10-K for the Nine-month Transition Period
ended December 30, 2000).
10.21 Unsecured Credit Agreement between BriteSmile International and CAP
Advisers Limited dated March 2002 (incorporated by reference to the
Company's Annual Report on Form 10-K for the 52 weeks ended December
29, 2001).
29
10.22 Credit and Security Agreement dated December 13, 2001 between
BriteSmile International and CAP Advisers Limited (incorporated by
reference to the Company's Annual Report on Form 10-K for the 52 weeks
ended December 29, 2001).
10.23 Supplemental Agreement dated March 2002 to Credit and Security
Agreement dated December 13, 2001 between BriteSmile International and
CAP Advisers Limited (incorporated by reference to the Company's Annual
Report on Form 10-K for the 52 weeks ended December 29, 2001).
10.24 Supplemental Agreement dated July 19, 2002 to Credit and Security
Agreement dated December 13, 2001, as amended, and to Unsecured Credit
Agreement dated March 8, 2002 (incorporated by reference to the
Quarterly Report on Form 10-Q of the Company for the 13 weeks ended
June 29, 2002).
10.25 Supplemental Agreement dated January 9, 2003 to Credit and Security
Agreement dated March 2002 (incorporated by reference to the Company's
Annual Report on Form 10-K for the 52 weeks ended December 28, 2002).
10.26 Amendment to Lease Agreement between Excimer Vision Leasing L.P. and
the Company dated March 8, 2002 (incorporated by reference to the
Company's Annual Report on Form 10-K for the 52 weeks ended December
29, 2001).
10.27 Form of Guaranty of Fiscal 2002 Shortfall Summary of Terms dated March
2002 in connection with commitments from certain shareholders and/or
directors of the Company to secure up to $4 million of additional
working capital (incorporated by reference to the Company's Annual
Report on Form 10-K for the 52 weeks ended December 29, 2001).
10.28 Form of Convertible Promissory Note issued in connection with November
20, 2002 convertible note offering (incorporated by reference to the
Current Report on Form 8-K of the Company filed on November 25, 2002).
10.29 CAP Line Conversion Agreement dated as of November 20, 2003 between the
Company and LCO Investments Limited (incorporated by reference to the
Current Report on Form 8-K of the Company filed on November 28, 2003).
10.30 Demand Promissory Note dated November 20, 2003 payable by the Company
to LCO Investments Limited in the principal amount of $2,000,000
(incorporated by reference to the Current Report on Form 8-K of the
Company filed on November 28, 2003).
10.31 Amendment to Lease Agreement between Excimer Vision Leasing L.P. and
the Company dated December 12, 2003 (incorporated by reference to the
Company's Annual Report on Form 10-K for the fiscal year ended December
27, 2003).
10.32 Receivable Conversion Agreement dated November 20, 2003 between the
Company and Excimer Vision Leasing L.P. (incorporated by reference to
the Company's Annual Report on Form 10-K for the fiscal year ended
December 27, 2003).
10.33 Amended and Restated Consulting Agreement dated December 27, 2003
between the company and John Warner (incorporated by reference to the
Company's Annual Report on Form 10-K for the fiscal year ended December
27, 2003).
10.34* Employment Agreement, Confidentiality and Rights Ownership Agreement,
Common Stock Purchase Option and Restricted Stock Grant Agreement each
dated January 9, 2005 between the Company and Gregg A. Coccari
(incorporated by reference to the Company's Annual Report on Form 10-K
for the fiscal year ended December 25, 2004).
10.35 Form of Securities Purchase Agreement dated as of December 16, 2004,
between the Company and the Investors, together with exhibits including
form of Senior Convertible Note dated December 16, 2004, due December
16, 2009; form of Warrant to Purchase Common Stock of the Company dated
December 16, 2004; and form of Additional Investment Right between the
Company and the Investors (incorporated by reference to the Current
Report on Form 8-K of the Company filed on December 21, 2004).
10.36 July 2003 Asset Purchase Agreement between BDI and R. Eric Montgomery
(incorporated by reference to the Quarterly Report on Form 10-Q of the
Company filed on August 12, 2003).
10.37 Consulting Agreement between BDI and Oraceutical Innovative Properties
(incorporated by reference to the Quarterly Report on Form 10-Q of the
Company filed on August 12, 2003).
10.38 $2 million promissory note issued by BDI to LCO Investments Limited
(incorporated by reference to the Quarterly Report on Form 10-Q of the
Company filed on August 12, 2003).
10.39 Supply Agreement dated December 21, 2004 between the Company and
Oraceutical, LLC (incorporated by reference to the Company's Annual
Report on Form 10-K for the fiscal year ended December 25, 2004).
30
10.40 $2.5 million loan agreement between BSML and CAP America Trust: See
Agreement dated May 7, 2003 between the Company and CAP America Trust
(incorporated by reference to the Company's Annual Report on Form 10-K
for the fiscal year ended December 25, 2004).
10.41 Amendment to Lease Agreement between Excimer Vision Leasing L.P. and
the Company dated July 12, 2005 (incorporated by reference to the
Company's Quarterly Report on Form 10-Q filed on November 8, 2005).
10.42 Asset Purchase Agreement among BSML, BriteSmile International Limited,
BriteSmile Development, Inc. and Discus Dental, Inc. dated December 30,
2005 (incorporated by reference to the Current Report on Form 8-K of
the Company filed on January 4, 2006).
10.43 Limited Liability Company Membership Interest Purchase Agreement
between BSML and Dental Spas, LLC dated January 13, 2006 (incorporated
by reference to the Current Report on Form 8-K of the Company filed on
January 19, 2006).
10.44 Contribution Agreement between BSML and BriteSmile Spas, LLC dated
January 13, 2006. (incorporated by reference to the Current Report on
Form 8-K of the Company filed on January 19, 2006).
10.45* Letter Agreement between BSML and Ken Czaja dated May 4, 2006
(Incorporated by reference to the Company's Quarterly Report on Form
10-Q filed on August 21, 2006).
31.1 Certification of Principal Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002 (Filed Herewith).
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 (Filed Herewith).
32.1 Certification of Principal Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (Filed Herewith).
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (Filed Herewith).
* Denotes management contract or compensatory plan or arrangement.
31
SIGNATURES
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.
BSML, INC.
NOVEMBER 14, 2006 /S/ JOHN REED
----------------- -------------------------------
DATE JOHN REED
CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)
NOVEMBER 14, 2006 /S/ KEN CZAJA
----------------- -------------------------------
DATE KEN CZAJA
EVP, CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL AND
ACCOUNTING OFFICER)
32