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 25, 2004
or
[ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the Transition Period from to
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Commission File Number: 1-11064
BRITESMILE, INC.
(Exact name of registrant as specified in its charter)
UTAH 87-0410364
---------------------------------------------- ----------------------------
(State or other jurisdiction of incorporation (IRS employer identification no.)
or organization)
490 North Wiget Lane
Walnut Creek, California 94598
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(Address of principal executive offices) (Zip Code)
(925) 941-6260
(Issuer's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
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 an accelerated filer (as
defined in Exchange Act Rule 12b-2 of the Exchange Act)
Yes __ No X
-
The Company had 10,340,920 shares of common stock outstanding at November 4,
2004.
During the fourth quarter of 2003, the Board of Directors approved a 5 for 2
stock split, which took effect January 30, 2004. All shares and per share
amounts herein have been adjusted for the 5 for 2 stock split.
BRITESMILE, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of September 25, 2004 and December 27, 2003.............4
Condensed Consolidated Statements of Operations for the 13 and 39 weeks ended
September 25, 2004 and September 27, 2003........................................................6
Condensed Consolidated Statements of Cash Flows for the 39 weeks ended
September 25, 2004 and September 27, 2003, respectively..........................................7
Notes to Condensed Consolidated Financial Statements.............................................8
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...........13
Item 3. Quantitative and Qualitative Disclosures About Market Risk......................................21
Item 4. Controls and Procedures.........................................................................21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................................21
Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities................23
Item 3. Default upon Senior Securities...................................................................23
Item 4. Submission of Matters to a Vote of Security Holders.............................................23
Item 5. Other Information................................................................................23
Item 6. Exhibits and Reports on Form 8-K.................................................................23
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
BRITESMILE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS(unaudited)
($ in thousands, except share data)
September 25, 2004 December 27, 2003
----------------------- ---------------------
CURRENT ASSETS:
Cash and cash equivalents........................................ $ 8,274 $ 5,884
Trade accounts receivable, net of allowances of $391 and $467.... 2,342 3,554
Inventories...................................................... 2,028 1,746
Prepaid expenses and other....................................... 456 569
----------------------- ---------------------
Total current assets................................. 13,100 11,753
----------------------- ---------------------
----------------------- ---------------------
PROPERTY AND EQUIPMENT, net.......................................... 13,352 16,523
OTHER ASSETS......................................................... 3,925 3,620
INTANGIBLES, net..................................................... 5,631 6,120
----------------------- ---------------------
TOTAL ASSETS......................................................... $ 36,008 $ 38,016
======================= =====================
See notes to condensed consolidated financial statements.
4
BRITESMILE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (continued)
LIABILITIES AND SHAREHOLDERS' EQUITY
(unaudited)
($ in thousands, except share data)
September 25, 2004 December 27, 2003
----------------------- ---------------------
CURRENT LIABILITIES:
Accounts payable................................................. $ 4,430 $ 7,173
Accrued expenses ................................................ 5,556 5,624
Gift certificate and prepaid appointments........................ 562 962
Deferred revenue ................................................ 740 597
Accrual for Center closure....................................... 267 298
Current portion of long-term debt................................ 329 3,039
Capital lease obligations with related parties - current portion. 1,388 761
----------------------- ---------------------
Total current liabilities.............................. 13,272 18,454
----------------------- ---------------------
LONG TERM LIABILITIES:
Capital lease obligations with related parties - less current portion 441 1,130
Accrual for Center closure....................................... 608 783
Long-term debt, less current portion.............................. 5,123 4,164
Other long-term liabilities...................................... 827 861
----------------------- ---------------------
Total long-term liabilities...................... 6,999 6,938
----------------------- ---------------------
Total liabilities...................................... 20,271 25,392
----------------------- ---------------------
SHAREHOLDERS' EQUITY:
Common stock, $.001 par value; 50,000,000 shares authorized;
10,332,899 and 9,525,265 shares issued and outstanding, respectively
38 38
Additional paid-in capital....................................... 170,413 162,823
Accumulated deficit.............................................. (154,714) (150,237)
----------------------- ---------------------
Total shareholders' equity ............................ 15,737 12,624
----------------------- ---------------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........................... $ 36,008 $ 38,016
======================= =====================
See notes to condensed consolidated financial statements.
5
BRITESMILE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
($ in thousands except share data)
13 Weeks Ended 13 Weeks Ended 39 Weeks 39 Weeks
September 25, September 27, Ended Ended
2004 2003 September 25, September 27,
2004 2003
----------------- ----------------- ----------------- -----------------
REVENUES:
Center whitening fees, net........................$ 4,346 $ 4,616 $ 13,590 $ 11,985
Associated Center whitening fees, net............. 5,646 5,387 16,608 15,937
Product sales..................................... 1,884 1,434 6,179 3,470
----------------- ----------------- ----------------- -----------------
Total revenues, net............................ 11,876 11,437 36,377 31,392
----------------- ----------------- ----------------- -----------------
OPERATING COSTS AND EXPENSES:
Operating and occupancy costs..................... 4,491 5,013 12,665 12,849
Selling, general and administrative expenses...... 7,845 8,779 22,101 21,961
Research and development expenses................. 110 403 425 772
Depreciation and amortization..................... 1,692 1,688 5,042 4,883
----------------- ----------------- ----------------- -----------------
Total operating costs and expenses............. 14,138 15,883 40,233 40,465
----------------- ----------------- ----------------- -----------------
Loss from operations........................ (2,262) (4,446) (3,856) (9,073)
----------------- ----------------- ----------------- -----------------
OTHER INCOME (EXPENSE), net........................... (214) (331) (534) (670)
----------------- ----------------- ----------------- -----------------
Loss before income tax provision............ (2,476) (4,777) (4,390) (9,743)
INCOME TAX............................................ 32 --- 89 4
----------------- ----------------- ----------------- -----------------
Net loss ...................................$ (2,508) $ (4,777) $ (4,479) $ (9,747)
================= ================= ================= =================
BASIC AND DILUTED NET LOSS PER SHARE..................$ (0.24) $ (0.70) $ (0.44) $ (1.54)
================= ================= ================= =================
WEIGHTED AVERAGE SHARES - BASIC AND DILUTED........... 10,329,190 6,796,368 10,275,854 6,342,383
================= ================= ================= =================
See notes to condensed consolidated financial statements.
6
BRITESMILE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
($ in thousands, except share data)
39 Weeks Ended 39 Weeks Ended
September 25, 2004 September 27, 2003
----------------------- -----------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................................................ $ (4,479) $ (9,747)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization................................ 5,826 4,883
Increase in variable deferred payments to a related party.... 1,738 1,721
Expense paid for by related party............................ 746 -
Loss on disposal of assets................................... 2 297
Change in assets and liabilities, net............................... (3,414) (212)
----------------------- -----------------------
Net cash provided by (used in) operating activities.. 419 (3,058)
----------------------- -----------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment................................... (1,010) (1,949)
Purchase of intangibles.............................................. - (1,750)
----------------------- -----------------------
Net cash used in investing activities................ (1,010) (3,699)
----------------------- -----------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from debt financing......................................... - 4,726
Payments on capital lease ............................................ (61) (516)
Payments on debt ..................................................... (3,683) (543)
Proceeds from common stock offerings, net............................. 6,339 -
Proceeds from issuance of preferred stock by subsidiary.............. - 1,000
Proceeds from exercise of stock options .............................. 386 545
----------------------- -----------------------
Net cash provided by financing activities............ 2,981 5,212
----------------------- -----------------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,390 (1,545)
CASH AND CASH EQUIVALENTS AT BEGINNING
OF THE PERIOD...................................................... 5,884 3,527
----------------------- -----------------------
CASH AND CASH EQUIVALENTS AT END OF THE PERIOD......................... $ 8,274 $ 1,982
======================= =======================
See notes to condensed consolidated financial statements.
7
BRITESMILE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 25, 2004
1. Description of Business and Basis of Presentation
BriteSmile, Inc., a Utah corporation ("BriteSmile" or the "Company"), and its
affiliates develop, distribute, market, sell and lease advanced teeth whitening
technology, products, systems and services. Unless specified to the contrary
herein, references to BriteSmile 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 also offers its products and
technologies through arrangements with existing independent dental offices known
as BriteSmile Professional Teeth Whitening Associated Centers ("Associated
Centers"). As of September 25, 2004, the Company had 14 Centers and 5,099
Associated Centers in operation.
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 13 and 39 weeks ended September 25, 2004 are
not necessarily indicative of the results that may be expected for the remainder
of the fiscal year ending December 25, 2004.
2. Stock Based Compensation
The Company uses the intrinsic value method to account for its stock based
compensation plans. The alternative fair value accounting of the Company's
options was estimated at the date of grant using a Black-Scholes option pricing
valuation model with the following weighted-average assumptions: volatility of
.7268, .6875, .8509, and .9769 for the 13 and 39 week periods ended September
25, 2004, and September 27, 2003, respectively; a risk-free interest rate range
of 1.30% to 4.50% for the 13 and 39 week periods ended September 25, 2004, and
September 27, 2003; dividend yield of 0%; and a weighted-average expected life
of the option of 10 years. Had compensation cost for the Company's stock-based
compensation plans been determined using the Black-Scholes option pricing
valuation model, the Company's reported net loss applicable to common
shareholders and basic and diluted net loss per share would have been increased
to the pro forma amounts indicated below (in thousands, except per share data):
13 Weeks Ended 13 Weeks Ended 39 Weeks Ended 39 Weeks Ended
September 25, September 27, September 25, September 27,
2004 2003 2004 2003
----------------- ----------------- ----------------- -----------------
Loss as reported................... $ 2,508 $ 4,777 $ 4,479 $ 9,747
Compensation expense reported under APB25
$ - $ - $ 40 $ -
Compensation expense computed using fair
value method.......................... $ 712 $ 755 $ 2,378 $ 2,381
----------------- ----------------- ----------------- -----------------
Pro forma loss..................... $ 3,220 $ 5,532 $ 6,897 $ 12,128
================= ================= ================= =================
Pro forma basic and diluted
loss per share.................. $ (0.31) $ (0.81) $ (0.67) $ (1.91)
================= ================= ================= =================
8
BRITESMILE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
September 25, 2004
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Company's Annual Report on Form 10-K for the
52 weeks ended December 27, 2003.
3. Loss Per Common Share
Basic net loss per share is calculated as net loss divided by the
weighted-average number of common shares outstanding. Diluted net loss per share
is equal to basic net loss as the Company has recorded a net loss. Stock options
totaling 950,499 shares and warrants totaling 291,158 shares (using the treasury
stock method) and convertible notes payable have been excluded from the
calculation of net loss per share for the 13 and 39 week periods ending
September 25, 2004, as their effect is anti-dilutive. Stock options totaling
793,008 shares and warrants totaling 341,163 shares (using the treasury stock
method) and convertible notes payable have been excluded from the calculation of
net loss per share for the 13 and 39 week periods ending September 27, 2003, as
their effect is anti-dilutive.
4. Debt
During the third quarter of 2004, the Company paid off a loan with a remaining
principal amount of $0.8 million obtained in March 2001, to Excimer Vision
Leasing L.P. ("EVL"), a related party.
In December 2003, the Company and EVL amended their capital lease agreement to
provide that the variable rent portion of the monthly payment due beginning
November 2003 and the fixed rent portion of the monthly payment due beginning
January 2004 would be deferred and paid to EVL on February 15, 2005, with
interest payable on the deferred amount at a rate equal to LIBOR, plus 250 basis
points. In August 2004, the Company and EVL further amended their capital lease
agreement to provide that the total rents deferred under the December 2003 lease
amendment would be deferred further such that $1.0 million would be paid on
February 15, 2005, $1.0 million would be paid on February 15, 2006, and the
remaining balance due would be paid on February 15, 2007. As of September 25,
2004, the unpaid variable rent was $2.1million, of which $1.9 million is
included in long-term debt.
5. Expense Paid By Related Party
During the quarter ending September 25, 2004, the Company incurred a $0.75
million expense paid for by a principal stockholder/related party. The principal
stockholder/related party engaged a consulting firm to conduct a study related
to the Company. The cost of the study was paid for by the principal
stockholder/related party, and was recorded by the Company as an expense and an
increase to Additional Paid in Capital.
6. Legal Proceedings
The Company is the subject of certain legal actions. Management does not believe
that current pending litigation involving the Company will have a material
adverse effect on the Company's consolidated financial position or results of
operations. This conclusion has been developed in consultation with outside
counsel handling BriteSmile's defense in the matters. 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 BriteSmile's strategies related to these
legal actions.
9
BriteSmile, Inc. v. Discus Dental, Inc. and Salim Nathoo
This case was filed in the United States District Court for the Northern
District of California (the "Discus Patent Litigation"). The Company filed an
initial complaint against Discus Dental, Inc. ("Discus"), Culver City,
California, in July 2002, asserting claims of infringement of the Company's U.S.
Patents No. 6,343,933 and U.S. Patent No. 6,361,320. In February 2003, the
Company amended the Discus Patent Litigation by adding Salim Nathoo ("Nathoo")
as a defendant. The complaint, as amended, further alleges misappropriation of
the Company's trade secrets, civil conspiracy, and unfair competition and
business practices by Discus and Nathoo; breach of contract and breach of
fiduciary duty by Mr. Nathoo, and tortuous interference with contract by Discus.
The complaint alleges that Nathoo and Discus conspired to misappropriate
BriteSmile's trade secrets in violation of Nathoo's contractual obligations to
the Company. The amended lawsuit alleges that, as BriteSmile's Medical Director,
Nathoo had, and continues to have, an obligation to keep BriteSmile's trade
secrets confidential. Beginning in 2001, Discus Dental and Nathoo entered into
an agreement whereby Discus Dental paid Nathoo at least $2.5 million over a less
than two year period for Nathoo's "consulting" services, which included paying
Nathoo to share with Discus certain of the Company's trade secrets. The lawsuit
alleges further that in December 2002, a third party informed BriteSmile of
Nathoo's activities, and that when confronted by BriteSmile, Nathoo admitted to
receiving $2.5 million from Discus. The Company seeks a permanent injunction
against both Discus and Nathoo to prevent further infringement of its patents
and improper disclosure of the Company's trade secrets, lost profits, treble
damages and attorneys fees for willful patent infringement, punitive damages,
and other relief.
In March 2003, Discus filed its Answer to the Amended Complaint and
Counterclaims. In its Answer, Discus denies any liability for BriteSmile's
claims. Discus also raises affirmative defenses, including claims that its
products and processes do not infringe BriteSmile's patents and that
BriteSmile's patents are invalid and unenforceable. Discus asserts counterclaims
against BriteSmile, seeking (i) judicial declarations that BriteSmile's patents
are invalid, unenforceable, and have not been infringed, (ii) tortuous
interference with prospective economic advantage and economic business
relations, and (iii) unfair competition. Discus also asks for declarations that
its products and processes do not violate BriteSmile's patents, that
BriteSmile's patents are unenforceable, that BriteSmile has no protectable trade
secrets, and that BriteSmile's contracts with Associated Center Dentists which
contain contractual restrictions on the purchase and use of competitive systems
are unenforceable and should be enjoined, and is seeking lost profits, treble
damages and attorneys fees.
In July 2003, the Company filed the Second Amended Complaint, asserting
additional clauses of infringement of the Company's US Patent No. 6,488,914, US
Patent No. 6,514,543, and US Patent No. 6,536,628.
In July 2003, the case of Salim Nathoo v. BriteSmile Leasing (discussed below)
was consolidated with the Discus Patent Litigation. All parties have produced
documents and written discovery responses in support of their claims and
defenses. Discovery is proceeding. The depositions of several key witnesses were
taken from August through December 2003.
In April 2004, the Company filed a motion for leave to amend its complaint,
which requested, among other things, dropping the Company's claims under its
U.S. Patent Nos. 6,488,914 and 6,361,320. That motion was granted, and the
Company has filed its Third Amended Complaint.
In April 2004, Nathoo filed an answer and counterclaim to the Company's
complaint, as well as a third party complaint against Eric Montgomery, who is a
director of the Company, and several of Montgomery's companies, alleging breach
of contract, breach of covenant of good faith and fair dealing, trade secret
misappropriation, patent infringement, and civil conspiracy. In August 2004,
Nathoo filed an amended answer and counterclaims to the Company's complaint. In
his new amended counterclaims, Nathoo brought claims for correction of
inventorship of several of the Company's patents; infringement by the Company of
those same patents; misappropriation of trade secrets by the Company and
selected named Company employees or directors; conversion by the Company, and
named Company employees or directors; constructive trust for the patents he
claims have incorrect inventorship; fraud against and breach of contract by the
Company and selected named Company employees and directors and CAP Advisors
Limited; tortious interference with contract by the Company; a declaration that
10
the Company has no protectable trade secrets; and unfair competition against the
Company and selected named Company officers and directors. In October
2004,Nathoo filed another amended answer and counterclaims in which he dropped
his allegations of patent infringement.
The Company is seeking compensatory and punitive damages against Discus and
compensatory damages against Nathoo. The exact amount of damages sought by both
defendants has not yet been determined.
Salim Nathoo v. BriteSmile Leasing
In March 2003, Nathoo filed a lawsuit against BriteSmile Leasing, a subsidiary
of the Company, in New Jersey state court. In this action, Nathoo alleges that
the Company breached its agreement to pay Nathoo money and that such failure
should result in the reversion of certain patent rights, which were previously
assigned by Nathoo to the Company, back to Nathoo. Nathoo also seeks the payment
of profits derived from the patent rights. The Company has filed an answer to
the complaint, together with counterclaims alleging the same causes of action as
in the Company's California litigation against Nathoo.
In May 2003, the court ordered that the case be transferred to California. In
July 2003, the case was consolidated with the Discus Patent Litigation in
California.
Smile Inc. Asia Pte. Ltd. v. BriteSmile
In April 2002, Smile Inc. Asia Pte. Ltd. ("Smile") sued the Company and
BriteSmile Management, Inc., a wholly owned subsidiary of the Company, in Utah
state court. The complaint alleges that BriteSmile Management breached its 1998
distributor agreement with Smile (exclusive as to Singapore and other
surrounding countries) by failing to fill orders placed 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 in amounts
material to the Company, based on alleged unjust enrichment, civil conspiracy,
breach of the duty of good faith and fair dealing, interference with contractual
and economic relations, and fraudulent transfer.
The Company denies these allegations and believes the alleged damages are
entirely unsupported, and will continue to vigorously defend this action.
In May 2002, the Company and BriteSmile Management filed their answer and
counterclaim. The counterclaim alleges that Smile breached the distributor
agreement by, among other things, failing to operate using a licensed dentist in
good standing (the license of the principal of Smile, Dr. Tan, was revoked
during 1999) and using BriteSmile's names and marks in a fashion not permitted
by the distributor agreement.
One of the principal defenses to Smile's claims is that the distributor
agreement 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 LATW or retail
products and cannot claim damages for BriteSmile's marketing of such products in
the exclusive territory described in the distributor agreement.
In May 2004, the Company filed a motion to compel Smile to participate in
mandatory binding arbitration and to stay the litigation pending arbitration. In
June 2004, the Court denied the Company's motion to compel arbitration. On July
16, 2004, the Company filed a Notice of Appeal on the issue of compelling this
case to be decided by mandatory binding arbitration. The case is stayed at the
trial level until the appellate court decides whether to compel Smile to
participate in arbitration.
Both parties have produced documents and written responses in support of their
claims and defenses, and depositions of certain key witnesses have been taken
and are continuing. However, the Company is still waiting to receive from Smile
documents and evidence to support Smile's calculation of damages.
11
BriteSmile v. Discus Dental, Inc.
In May 2002, the Company filed a complaint against Discus Dental, Inc. in Contra
Costa County Superior Court, California, alleging causes of action for
intentional interference with contractual relationship, negligent interference
with contractual relationship, violation of Unfair Business Practice Act - Loss
Leader, violation of Unfair Business Practice Act, trade libel and injunctive
relief. The complaint alleges that Discus Dental and other defendants yet to be
identified wrongfully interfered with the Company's contractual relationships
with its Associated Center Dentists, in part by writing letters with the purpose
of inducing certain of the Company's Associated Dentists to terminate their
contracts with the Company and switch to Discus' Zoom! system, and by making
false and disparaging statements concerning the Company's teeth whitening
system. The Complaint seeks damages for loss of business, punitive damages,
injunctive relief, and costs of suit. This case was stayed in March 2003 pending
the resolution of the Discus Patent Litigation.
Kalow & Springut v. BriteSmile et. al.
In April 2003, the law firm of Kalow & Springut ("KS") filed a complaint against
the Company, BriteSmile International, a subsidiary of the Company, and A.M.
Pilaro, the Company's Chairman, in New York state court. KS seeks to recover
alleged unpaid legal fees and expenses in the amount of $768,000. Plaintiff also
alleges that it was fraudulently induced to incur the legal fees and expenses
and seeks to recover punitive damages of at least $5 million.
On June 13, 2003, BriteSmile answered the Complaint and asserted counterclaims
against KS for negligence, malpractice and breach of contract.
Discovery proceedings have commenced. Motions have been filed to dismiss all
claims alleged against Mr. Pilaro and all claims alleged against the Company,
except for one breach of contract claim. The Company has also applied to the
court to compel KS to produce documents and to turn over certain Company files.
On April 9, 2004, the court granted KS partial summary judgment in the amount of
$299,468.97, and denied summary judgment on the balance of the fees and
disbursements claimed by KS. KS was ordered to turn over certain of BriteSmile's
legal files. In addition, the court granted BriteSmile's motion to dismiss
claims based on fraud, quasi-contract, unjust enrichment and quantum meruit, and
denied all claims for punitive damages asserted by KS. All claims against Mr.
Pilaro were dismissed.
BriteSmile has filed a Notice of Appeal to the Appellate Division of the Supreme
Court of New York with respect to the partial summary judgment monetary award to
KS. KS has filed a Notice of Cross-Appeal with respect to the dismissal by the
trial court of various of its additional claims. Briefs and papers on the appeal
will be prepared and submitted by early 2005 for argument at the March 2005 Term
of the Appellate Division. Discovery continues in the trial court with respect
to the unresolved part of the KS claim for legal fees and expenses. In addition,
BriteSmile has moved the trial court for permission to add additional
counterclaims of negligence and malpractice against KS.
The Procter & Gamble Company vs. Oraceutical LLC, IDEX Dental Sciences, Inc.,
Robert Eric Montgomery, BriteSmile, Inc. and BriteSmile Development, Inc.
This case was filed in the United States District Court for the Southern
District of Ohio. In June 2003, The Proctor & Gamble Company ("P&G") filed a
complaint against the defendants listed above alleging 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 on May 9, 2003. Montgomery is a director of the
Company. Oraceutical LLC, which is owned by Montgomery, is a consultant to the
Company. The complaint also seeks a declaratory judgment that US Patent Nos.
5,922,307, 6,331,292 and 6,488,914 (owned by the REM Group at the time the
complaint was filed) (the "Patents") are invalid and unenforceable, and that
P&G's Whitestrips product does not infringe the Patents. In its complaint P&G
asserts that the REM Group was obligated under the Standstill Agreement not to
take any action that would prevent it from granting rights to P&G under the
Patents sufficient at least for P&G's current Whitestrips products. P&G further
12
alleges that the REM Group breached that obligation by entering into the MOU
and, accordingly, P&G terminated the Standstill Agreement. P&G is seeking
monetary damages of at least $75,000 from the Company under the claims set forth
in its complaint. Defendants have filed a motion to dismiss P&G's declaratory
judgment action for non-infringement and invalidity as well as for breach of the
Standstill Agreement.
In February 2004, the defendants filed an answer, affirmative defenses, and
counterclaims. Affirmative defenses include anticipatory breach, unclean hands,
equitable estoppel, lack of justiciable controversy, and lack of jurisdictional
amount. The counterclaims asserted that P&G literally infringed U.S. Patent No.
6,488,914 by among other things, making, using, selling or offering to sell in
the United States the Crest Whitestrips. The counterclaims further allege that
P&G actively induced infringement of the patent in suit by providing marketing
assistance for, advertising and otherwise promoting the Crest Whitestrips
products to others for resale.
Discovery is proceeding, and both parties have served supplemental discovery
responses including answers to interrogatories and responses to requests for
production of documents.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-looking Statements and Risk Factors
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements that involve risks and
uncertainties. Such forward-looking statements may be deemed to include
information that is not historical. 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 10-K Annual Reports
filed with the SEC are part of doing business in the industry in which the
Company operates, 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:
o Government regulation of the Company's products and teeth whitening
procedures, including: (i) current restrictions or controls on the
practice of dentistry by general business corporations, and (ii)
future, unknown enactments or interpretations of current regulations
which could, in the future, affect the Company's operational structure
and relationships with licensed dentists;
o Failure of the Company to generate, sustain or manage growth,
including failure to develop new products and expand Center and
Associated Center locations and revenues;
o The loss of product market share to competitors and/or development of
new or superior technologies by competitors;
o Ongoing operating losses associated with the development, marketing
and implementation of new, light-activated teeth whitening
technologies;
13
o Failure of the Company to secure additional financing to support the
continued rollout of Centers and Associated Centers and to meet
working capital requirements;
o Unproven market for the Company's new whitening products, whitening
process, and "Whitening Center" and "Associated Center" concepts, in
light of competition from traditional take-home whitening products and
bleaching tray methods;
o Failure to develop marketing strategies and delivery methods to
penetrate U.S. and non-U.S. markets; and
o Lack of product diversity.
Critical Accounting Policies And Estimates
General
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 an on-going basis, the Company evaluates
its estimates, including those related to customer programs and incentives, bad
debts, inventories, income taxes, warranty obligations, financing operations,
restructuring, and 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.
The Company believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements.
Revenue Recognition
BriteSmile recognizes revenue related to retail products at the time such
products are sold 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 key cards and activation codes to Associated Centers
and recognizes the income over the estimated performance period.
BriteSmile's policy is not to accept any return of key cards or access codes
during the course of the agreement with an Associated Center.
In the third quarter of 2004, BriteSmile introduced the BriteSmile Forever
program where Center customers can pay an additional fee for the right to
receive an unlimited number of touch-up procedures over a two-year period. The
revenue associated with this program is deferred and recognized over the
two-year period.
Deferred Contract Costs
During 1999, the Company granted warrants to OCA in consideration of OCA
installing BS3000 machines in OCA centers. The value of the warrants was
capitalized as deferred contract costs and is being amortized as a reduction of
revenue over the life of the agreement (10 years).
14
During 2003, the Company introduced the Magic Mirror, a marketing product
designed to show potential customers what their teeth will look like after a
LATW procedure. The Company provides the Magic Mirror to Associated Centers who
sign a five year contract 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 have been
capitalized and are being amortized to revenue and cost of goods sold over the
life of the contract. The amount of deferred revenue and contract costs at
September 25, 2004 was a net deferred cost of $890,000.
Management will continually assess the recoverability of these costs.
Bad Debt
BriteSmile maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. A
considerable amount of judgment is required in assessing the ultimate
realization of accounts receivable including the current credit-worthiness of
each Associated Center. If the financial condition of BriteSmile's customers
were to deteriorate, resulting in an impairment of their ability to make
payments, additional allowances may be required. The allowance for doubtful
accounts at September 25, 2004 was $391,000.
Inventory
Inventories are stated at the lower of cost or market. BriteSmile writes down
its inventory for estimated obsolescence or unmarketable inventory equal to the
difference between the cost of inventory and the estimated market value based
upon assumptions about future demand and market conditions, as well as for
damaged goods. If actual market conditions are less favorable than those
projected by management, additional inventory write-downs may be required.
Property, Equipment and Improvements
BriteSmile evaluates its property, equipment and improvements for impairment
whenever indicators of impairment exist. No impairment charge was recorded
during the 39 weeks ended September 25, 2004. In the 39 weeks ended September
27, 2003, an impairment charge of $273,000 was recorded related to the
relocation of the Company's Houston Center.
Center Closures
During 2001, BriteSmile recorded significant reserves in connection with Center
closures. These reserves 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 the closures may differ from these estimates. The Company recorded an
additional $76,000 in the first quarter of 2004 for severance and lease
liabilities associated with the closure of the Honolulu Center in January 2004.
In total, the Center closure reserve decreased $206,000 in the 39 weeks ended
September 25, 2004, due to lease payments.
Overview
The following discussion should be read in conjunction with the Financial
Statements and the Notes thereto included in Item 1 of this Quarterly Report on
Form 10-Q and in the Company's Annual Report on Form 10-K for the fiscal year
ended December 27, 2003.
Revenue and Deferred Contract Costs: See Revenue Recognition above.
Operating and occupancy costs are composed primarily of three main groups: 1)
the cost of goods for both the Center and Associated Center whitening procedure
kits and retail products; 2) the lease costs for the devices in the Associated
Centers; and 3) the operating and occupancy costs for the Centers.
15
Selling, general and administrative expenses are composed of all selling and
market support expenses as well as expenses associated with all corporate and
administrative functions that support existing operations and provide an
infrastructure to support future growth, including management and staff
salaries, employee benefits, travel, information systems, operating costs of the
Call Center, training, field support, and marketing and advertising.
Research and development costs represent expenses related to safety and efficacy
studies as well as other research activities directed at expanding the Company's
leadership position in the teeth-whitening industry.
The following table sets forth unaudited operating results for the 13 week and
39 week periods ended September 25, 2004 and September 27, 2003, as a percentage
of sales in each of these periods. This data has been derived from the unaudited
financial statements.
13 Weeks 13 Weeks ended 39 Weeks 39 Weeks
ended ended ended
Sept 25, 2004 Sept 27, 2003 Sept 25, 2004 Sept 27, 2003
------------- ------------- ------------- -------------
Revenues:
Center whitening fees, net 36.6% 40.4% 37.4% 38.2%
Associated Center whitening
fees, net 47.5% 47.1% 45.6% 50.8%
Product sales 15.9% 12.5% 17.0% 11.0%
------------- ------------- ------------- -------------
Total revenues, net 100.0% 100.0% 100.0% 100.0%
------------- ------------- ------------- -------------
Operating Costs and Expenses:
Operating and occupancy costs 37.8% 43.8% 34.8% 40.9%
Selling, general and
administrative expenses 66.1% 76.8% 60.8% 70.0%
Research and development expenses 0.9% 3.5% 1.2% 2.5%
Depreciation and amortization 14.2% 14.8% 13.8% 15.5%
------------- ------------- ------------- -------------
Total operating costs and
expenses 119.0% 138.9% 110.6% 128.9%
------------- ------------- ------------- -------------
Loss from operations -19.0% -38.9% -10.6% -28.9%
------------- ------------- ------------- -------------
Interest expense, net and other -1.8% -2.9% -1.5% -2.1%
------------- ------------- ------------- -------------
Loss before income tax provision -20.8% -41.8% -12.1% -31.0%
Provision for income taxes 0.3% 0.0% 0.2% 0.0%
------------- ------------- ------------- -------------
Net Loss -21.1% -41.8% -12.3% -31.0%
============= ============= ============= =============
16
The following are explanations of significant period-to-period changes for the
13 weeks ended September 25, 2004 and September 27, 2003:
Revenues
Total Revenues, net. Total revenues, net increased by $0.4 million, or 4%, to
$11.9 million for the 13 weeks ended September 25, 2004, from $11.4 million for
the 13 weeks ended September 27, 2003.
Center Whitening Fees, net. Center whitening fees decreased by $0.3 million or
6% to $4.3 million for the 13 weeks ended September 25, 2004, from $4.6 million
for the 13 weeks ended September 27, 2003. The number of procedures performed in
the Centers decreased 13% to 9,024 in the third quarter of 2004, compared to
10,361 in the same quarter of 2003. During August 2003, BriteSmile offered a Buy
One Get One Free promotion resulting in a greater volume of procedures for the
third quarter of 2003. Average whitening fees per procedure increased 8% from
$446 per procedure to $482 per procedure in the third quarter of 2004, compared
to the same quarter of 2003, as a result of reduced discounting. Generally, the
level of discounting varies from period to period based on the market conditions
at the time. The company cannot forecast future trends in this regard.
Associated Center Whitening Fees, net. Associated Center whitening fees, net
increased by $0.3 million, or 5%, to $5.7 million for the 13 weeks ended
September 25, 2004, from $5.4 million for the 13 weeks ended September 27, 2003.
The total number of procedures in all Associated Centers increased 7% to 35,765
procedures in the third quarter of 2004 compared to 33,270 procedures in the
same quarter of 2003. Average whitening fees per procedure decreased 3% from
$162 per procedure to $158 per procedure for the 13 weeks ended September 25,
2004, compared to the same period of 2003, primarily due to increased
discounting. Generally, the level of discounting varies from period to period
based on the market conditions at the time. The company cannot forecast future
trends in this regard.
Product Sales and Other Revenue. Product sales increased by 31% to $1.9 million
for the 13 weeks ended September 25, 2004, from $1.4 million for the 13 weeks
ended September 27, 2003, primarily due to the sales of BriteSmile To Go (BTG),
which was launched in the third quarter of 2003. Sales of BTG were $0.8 million
for the 13 weeks ended September 25, 2004. BTG is sold at Centers and Associated
Centers, through partners such as Nordstrom and Henry Schein, directly by the
Company's Call Center, and on the Company's website. Product sales also include
the Company's toothpaste, mouthwash, whitening gum, toothbrushes and Magic
Mirrors.
Operating Costs and Expenses
Operating and Occupancy Costs. Operating and occupancy costs as a percentage of
net revenues was 38% for the 13 weeks ended September 25, 2004, compared to 44%
in the 13 weeks ended September 27, 2003. This improvement was due to sales
growth and a decrease in Occupancy & Operating expenses for the quarter compared
to the same quarter in 2003. The major expense components in this category are
cost of goods sold for all products and services, lease financing, and operating
costs of Centers, which include salaries for the dentist and supporting staff,
and rent. Cost of goods sold in the third quarter of 2003 reflects a $343,000
inventory valuation adjustment.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased as a percentage of net revenues to 66% for the
13 weeks ended September 25, 2004 compared to 77% in the 13 weeks ended
September 27, 2003. This improvement was due to sales growth and a decrease in
SG&A expenses for the quarter compared to the same quarter in 2003. The $0.9
million decrease in SG&A resulted from lower professional fees, and lower
advertising and travel expenses, as well as a center restructuring accrual
true-up that occurred in September 2003. Third quarter 2004 was also impacted by
the accrual of all fees related to the separation of Bruce Fleming as CEO of the
Company, and a $0.75 million expense to BriteSmile required by accounting rules
for certain consulting work initiated and paid for by a principal
stockholder/related party.
Research and Development Expenses. Research and development expenses of $110,000
were 1% of net revenues for the third quarter of 2004 compared to $403,000, or
4%, in the corresponding period in 2003. The decrease in research and
development expenses was primarily due to costs incurred with the development of
the company's Magic Mirror in the third quarter of 2003 that were not incurred
in the same quarter of 2004.
17
Depreciation and Amortization. Depreciation and amortization decreased slightly
as a percentage of net sales to 14% for the third quarter of 2004, compared to
15% in the corresponding period in 2003, as a result of sales growth. The net
increase of $4,000 in depreciation and amortization expense to $1.7 million for
the third quarter of 2004 is primarily due to higher amortization associated
with the intellectual property purchased in the third quarter of 2003 of
$63,000, offset by lower depreciation of $59,000 due to fixed assets becoming
fully depreciated.
Interest Expense, net and other. Interest expense, net decreased $117,000 to
$214,000, or 2% of net revenue for the third quarter of 2004 from $331,000, or
3% of net revenue, for the corresponding period in 2003. The decrease was
primarily due to lower debt balances in 2004.
The following are explanations of significant period-to-period changes for the
39 weeks ended September 25, 2004 and September 27, 2003:
Revenues
Total Revenues, net. Total revenues, net increased by $5.0 million, or 16%, to
$36.4 million for the 39 weeks ended September 25, 2004, from $31.4 million for
the 39 weeks ended September 27, 2003.
Center Whitening Fees, net. Center whitening fees increased by $1.6 million or
13% to $13.6 million for the 39 weeks ended September 25, 2004, from $12.0
million for the 39 weeks ended September 27, 2003. The number of procedures
performed in the Centers increased 7% to 27,640 for the 39 weeks ended September
25, 2004, compared to 25,947 for the same period of 2003. The opening of the
SoHo center in 2004 contributed to the increase in demand. Average whitening
fees per procedure increased 6% from $462 per procedure to $492 per procedure
for the 39 weeks ended September 25, 2004, compared to the same period of 2003,
primarily due to reduced discounting. Generally, the level of discounting varies
from period to period based on the market conditions at the time. The company
cannot forecast future trends in this regard.
Associated Center Whitening Fees, net. Associated Center whitening fees, net
increased by $0.7 million, or 4%, to $16.6 million for the 39 weeks ended
September 25, 2004, from $15.9 million for the 39 weeks ended September 27,
2003. The increase was primarily due to a 26% increase in procedures in
International Associated Centers. The total number of procedures in all
Associated Centers increased 9% to 104,440 procedures in the 39 weeks ending
September 25, 2004, compared to 96,075 procedures in the same period of 2003.
Average whitening fees per procedure decreased 4% from $166 per procedure to
$159 per procedure for the 39 weeks ended September 25, 2004, compared to the
same period of 2003, primarily due to increased discounting in the international
market. Generally, the level of discounting varies from period to period based
on the market conditions at the time. The company cannot forecast future trends
in this regard.
Product Sales and Other Revenue. Product sales increased by 78.1% to $6.2
million for the 39 weeks ended September 25, 2004, from $3.5 million for the 39
weeks ended September 27, 2003, primarily due to sales of BriteSmile To Go
(BTG), which was launched in the third quarter of 2003. Sales of BTG were $3.4
million for the 39 weeks ended September 25, 2004. BTG is sold at Centers and
Associated Centers, through partners such as Nordstrom and Henry Schein,
directly by the Company's Call Center, and on the Company's website. Product
sales also include the Company's toothpaste, mouthwash, whitening gum,
toothbrushes and Magic Mirrors.
Operating Costs and Expenses
Operating and Occupancy Costs. Operating and occupancy costs as a percentage of
net revenues was 35% for the 39 weeks ended September 25, 2004, compared to 41%
for the 39 weeks ended September 27, 2003. This improvement was due to sales
growth and a decrease in Occupancy & Operating expenses in the 39 weeks ended
September 25, 2004 compared to the same period in 2003. The major expense
components in this category are cost of goods sold, lease financing, and
operating costs of Centers, which include salaries for the dentist and
supporting staff, and rent. The $184,000 decrease in Operating and Occupancy
18
costs was primarily due to lower cost of goods sold of $416,000, offset by
higher Occupancy cost of $232,000 in the 39 weeks ended September 25, 2004 when
compared to the same period in 2003. Cost of goods sold for the 39 weeks ended
September 27, 2003 reflects a $343,000 inventory valuation adjustment.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased as a percentage of net sales to 61% in the 39
weeks ended September 25, 2004, compared to 70% in the corresponding period in
2003. This improvement was due primarily to sales growth in the 39 weeks ended
September 25, 2004 compared to the same period in 2003. The $0.1 million
increase in SG&A resulted from lower advertising, salary, shipping, and travel
expenses, offset by higher professional and consulting fees, and insurance
costs. Consulting fees in 2004 include a $0.75 million expense to BriteSmile
required by accounting rules for certain consulting work initiated and paid for
by a principal stockholder/related party.
Research and Development Expenses. Research and development expenses of $425,000
decreased as a percentage of net revenues to 1% in the 39 weeks ended September
25, 2004 compared to $772,000, or 2% in the corresponding period in 2003. The
decrease in research and development expenses was primarily due to costs
incurred with the development of the company's Magic Mirror and BTG products in
2003 that were not incurred in 2004.
Depreciation and Amortization. Depreciation and amortization decreased as a
percentage of net sales to 14% for the 39 weeks ended September 25, 2004,
compared to 16% in the corresponding period in 2003. The increase of $160,000 in
depreciation and amortization expense to $5.0 million for the 39 weeks ended
September 25, 2004 is primarily due to amortization associated with the
intellectual property purchased in the third quarter of 2003 of $390,000, offset
by lower depreciation of $230,000 due to fixed assets becoming fully
depreciated..
Interest Expense, net and other. Interest expense, net decreased $137,000 to
$534,000, or 2% of net revenue, for the 39 weeks ended September 25, 2004, from
$670,000, or 2% of net revenue, for the corresponding period in 2003. The
decrease was primarily due to lower debt balances in 2004, as well as increased
interest income from investments.
Liquidity and Capital Resources
General
The Company's principal sources of liquidity have been proceeds from issuances
of common stock and debt. At September 25, 2004, the Company had $8.3 million in
cash and $0.9 million in borrowing capacity under lines of credit. To date, the
Company has yet to achieve net profitability. The Company expects that its
principal uses of cash will be to provide working capital, to finance capital
expenditures, and to meet corporate expenses.
During 2003, the Company obtained a $2.5 million Center Loan with CAP America
Trust, a related party. This credit facility is for general working capital
needs ($0.8 million) and capital expenditures and specific revenue generating
initiatives ($1.7 million). The Company has drawn $1.6 million under this
arrangement, leaving $0.9 million currently available under this line.
Additionally, as discussed in "Sources of Cash" below, the Company obtained $8.5
million of cash through a private placement of 923,943 shares of Company common
stock to institutional investors, of which $1.7 million was received in December
2003 and $6.8 million was received in January 2004.
The Company believes that cash on hand, together with available borrowing
capacity discussed above and cash provided from operations, will be sufficient
to sustain operations through the next twelve months.
Cash Requirements
During the last three years, the primary uses of cash were for funding of
operations, purchases of property and equipment, and to a lesser degree, debt
repayments. During the first quarter of 2004, the Company repaid a $2 million
19
bridge loan (including interest) obtained in November 2003, to LCO Investments
Limited ("LCO"), a related party. LCO is the Company's primary shareholder.
During the third quarter of 2004, the Company paid off a loan with a remaining
principal amount of $0.8 million obtained in March 2001, to Excimer Vision
Leasing L.P. ("EVL"), a related party.
In December 2003, the Company and EVL amended their capital lease agreement to
provide that the variable rent portion of the monthly payment due beginning
November 2003 and the fixed rent portion of the monthly payment due beginning
January 2004 would be deferred and paid to EVL on February 15, 2005, with
interest payable on the deferred amount at a rate equal to LIBOR, plus 250 basis
points. In August 2004, the Company and EVL further amended their capital lease
agreement to provide that the total rents deferred under the December 2003 lease
amendment would be deferred further such that $1.0 million would be paid on
February 15, 2005, $1.0 million would be paid on February 15, 2006, and the
remaining balance due would be paid on February 15, 2007. As of September 25,
2004, the unpaid variable rent was $2.1 million, of which $1.9 million is
included in long-term debt.
The primary cash requirements of the Company are for maintaining current
operations, debt service and capital expenditures to grow the network of
Associated Centers and Company-managed Centers. In particular, spending on cost
of goods, advertising, rents, leases and employee salaries is required to
operate the business.
Sources of Cash, Liquidity and Capital Resources
In the 39 weeks ended September 25, 2004, the primary source of cash was the
Company's private placement of 923,943 shares to institutional investors. The
Company received $1.7 million in December 2003 and the balance of $6.3 million
(net of fees) in January 2004. Proceeds from the private placement were used to
retire the $2 million bridge loan obtained by the Company in November 2003, as
described above, and for working capital purposes.
During 2003 the Company converted to equity $15.3 million of its
interest-bearing debt, which will save the Company approximately $0.5 million in
interest expense in 2004.
Net cash provided from operations increased by $3.5 million to $0.4 million for
the 39 weeks ended September 25, 2004, from $3.1 million net cash used in 2003,
primarily as a result of the substantial decrease in net loss partially offset
by increased working capital requirements.
Net cash provided from financing activities was $3.0 million for the 39 weeks
ended September 25, 2004, compared to $5.2 million for the same period in 2003.
During the 39 weeks ended September 25, 2004, the Company both raised cash of
$6.8 million through equity offerings, and repaid debt of $3.7 million. In the
same period of 2003, the Company received debt financing of $5.7 million, raised
$0.5 million from stock option exercises, and made payments on debt and capital
leases of $1.0 million.
Capital expenditures were $1.0 million for the 39 weeks ended September 25,
2004, compared to $3.7 million for the same period in 2003. The capital
expenditures in the 39 weeks ended September 25, 2004 were primarily related to
the completion of the Company's new Center in the SoHo district of New York.
Investing activities in the 39 weeks ended September 27, 2003 included the
intellectual property purchase of $1.8 million.
While the Company does not maintain or invest in derivative financial
instruments or deal in interest rate swaps, it does have debt obligations that
are sensitive to changes in interest rates.
Inflation
In general, the Company does not believe that inflation has had a material
effect on its results of operations in recent years. However, there can be no
assurance that the Company's business will not be affected by inflation in the
future.
Seasonality
20
The Company believes that its business follows seasonal trends due to increased
consumer demand during the spring and around public and national holidays. As a
result, the Company's sales performance could potentially be affected.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
We believe there has been no material change in our exposure to Market Risk from
that discussed in our 2003 Annual Report on Form 10-K.
ITEM 4. CONTROLS AND PROCEDURES
During 2003, the Company identified an error in the recording of cost of sales.
This error resulted in the Company restating its financial statements for the
13-week period ended June 28, 2003. The error was the result of weaknesses in
the Company's internal inventory control structure. Deloitte & Touche LLP
communicated to management and the Audit Committee that these weaknesses are
considered material weaknesses. Management and the Audit Committee identified
and have commenced implementing certain changes that they feel are necessary to
strengthen the Company's accounting and reporting function, including
capabilities of its accounting personnel and adoption of more frequent reviews
and reconciliations of financial information. Management continues to evaluate
its control structure, to identify issues and resolve them in as timely a manner
as possible.
The Company's Management, with the participation of our Chief Executive Officer
and our 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. Based upon their
evaluation, the Company's Chief Executive Officer and Chief Financial Officer
have concluded, except as noted above, that the Company's disclosure controls
and procedures are effective.
Other than those discussed above, there were no significant changes in our
internal controls or in other factors that could significantly affect our
internal controls subsequent to the Evaluation Date.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is the subject of certain legal actions. Management does not believe
that current pending litigation involving the Company will have a material
adverse effect on the Company's consolidated financial position or results of
operations. This conclusion has been developed in consultation with outside
counsel handling BriteSmile's defense in the matters. 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 BriteSmile's strategies related to these
legal actions.
BriteSmile, Inc. v. Discus Dental, Inc. and Salim Nathoo, U.S. District Court
for the Northern District of California
See the Company's Quarterly Report on Form 10-Q for the 13 weeks ended June 26,
2004, in which this legal proceeding was reported.
In August 2004, Mr. Salim Nathoo filed an amended answer and counterclaims to
the Company's Third Amended Complaint. Nathoo's amendment supplements the
answers and counterclaims he initially filed in April 2004. In his new amended
counterclaims, Nathoo brought claims for correction of inventorship of several
of the Company's patents; infringement by the Company of those same patents;
misappropriation of trade secrets by the Company and selected named Company
21
employees or directors; conversion by the Company, and named Company employees
or directors; constructive trust for the patents he claims have incorrect
inventorship; fraud against and breach of contract by the Company and selected
named Company employees and directors and CAP Advisors Limited; tortious
interference with contract by the Company; a declaration that the Company has no
protectable trade secrets; and unfair competition against the Company and
selected named Company officers and directors. In October 2004, Nathoo filed
another amended answer and counterclaims in which he dropped his allegations of
patent infringement.
The Company is seeking compensatory and punitive damages against Discus and
compensatory damages against Nathoo. The exact amount of damages sought by both
defendants has not yet been determined.
Salim Nathoo v. BriteSmile Leasing
In May 2003, this case was consolidated with the BriteSmile v. Discus Dental
lawsuit discussed above. See the Company's Quarterly Report on Form 10-Q for the
13 weeks ended June 26, 2004, in which this legal proceeding was reported.
Smile Inc. Asia Pte. Ltd. v. BriteSmile
See the Company's Quarterly Report on Form 10-Q for the 13 weeks ended June 26,
2004, in which this legal proceeding was reported.
In May 2004, the Company filed a motion to compel Smile Inc. Asia Pte. Ltd.
("Smile") to participate in mandatory binding arbitration and to stay the
litigation pending arbitration. In June 2004, the Court denied the Company's
motion to compel arbitration. On July 16, 2004, the Company filed a Notice of
Appeal on the issue of compelling this case to be decided by mandatory binding
arbitration. The case is stayed at the trial level until the appellate court
decides whether to compel Smile to participate in arbitration.
Both parties have produced documents and written responses in support of their
claims and defenses, and depositions of certain key witnesses have been taken
and are continuing. However, the Company is still waiting to receive from Smile
documents and evidence to support Smile's calculation of damages.
BriteSmile v. Discus Dental, Inc., Contra Costa County Superior Court,
California
See the Company's Quarterly Report on Form 10-Q for the 13 weeks ended June 26,
2004, in which this legal proceeding was reported.
Kalow & Springut v. BriteSmile et. al.
See the Company's Quarterly Report on Form 10-Q for the 13 weeks ended June 26,
2004, in which this legal proceeding was reported.
BriteSmile has filed a Notice of Appeal to the Appellate Division of the Supreme
Court of New York with respect to the partial summary judgment monetary awarded
on April 9, 2004 to Kalow & Springut in the amount of $299,468.97. KS has filed
a Notice of Cross-Appeal with respect to the dismissal by the trial court of
various of its additional claims. Briefs and papers on the appeal will be
prepared and submitted by early 2005 for argument at the March 2005 Term of the
Appellate Division. Discovery continues in the trial court with respect to the
unresolved part of the KS claim for legal fees and expenses. In addition,
BriteSmile has moved the trial court for permission to add additional
counterclaims of negligence and malpractice against KS.
The Procter & Gamble Company vs. Oraceutical LLC, IDEX Dental Sciences, Inc.,
Robert Eric Montgomery, BriteSmile, Inc. and BriteSmile Development, Inc.
See the Company's Quarterly Report on Form 10-Q for the 13 weeks ended June 26,
2004, in which this legal proceeding was reported.
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ITEM 2. CHANGES IN SECURITIES.
During the13 week period ended September 25, 2004, the Company granted to key
employees and directors under its 1997 Stock Option and Incentive Plan
non-qualified options to purchase an aggregate of 29,000 shares of the Company's
common stock, at exercise prices ranging from $9.72 to $10.02 per share. The
options vest over a period of time following their respective dates of grant.
For all option grants, the Company claimed exemption from registration under the
Securities Act of 1933 in that the Company believes such grants were not "sales"
within the meaning of the Act. Shares issuable upon exercise of the options have
been or will be registered with the SEC pursuant to Registration Statements on
Form S-8.
ITEM 3. DEFAULT UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
On November 8, 2004, the Company filed a Current Report on Form 8-K for the
purpose of furnishing to the Commission a copy of its earnings release for the
13 weeks ended September 25, 2004. Certain Balance Sheet balances related to
debt as of September 25, 2004 included in that Current Report are hereby
re-classified as follows: "Current portion of long-term debt and capital lease
obligations" is changed from $3,655,000 to $1,717,000 resulting in "Total
current liabilities" of $13,272,000; and "Long-term debt and capital lease
obligations" is changed from $3,626,000 to $5,564,000, resulting in "Total
long-term liabilities" of $6,999,000.
The Balance Sheets of the Company contained in this Quarterly Report on Form
10-Q for the 13 weeks ended September 25, 2004 reflect the corrected
classification.
ITEM 6. EXHIBITS.
31.1 Certification of Acting Chief 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 Acting Chief 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).
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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.
BRITESMILE, INC.
/s/ Anthony M. Pilaro November 9, 2004
-------------------------------------- ----------------
Anthony M. Pilaro Date
Acting Chief Executive Officer
/s/ Ken Czaja November 9, 2004
Ken Czaja Date
Chief Financial Officer
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