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 16 Centers 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.

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.

Revenue Recognition

The Company recognizes revenue related to retail products at the time such products are shipped to customers and procedure revenues at the time the procedure is performed. Revenue is reported net of discounts and allowances. In the third quarter of 2004, the Company introduced its SmileForever program. Under this program, Center customers may, for an additional fee, receive a limited number of touch-up procedures over a specified term, typically one to two-years. The revenue associated with this program is deferred and recognized over the contractual term. Additionally, in cases where SmileForever revenue is bundled with procedure revenue and / or revenue from retail product sales, revenue is allocated to SmileForever using the fair values of the components of the bundle per the requirements of EITF 00-21 and any revenue so allocated is then deferred and recognized over the contractual term. At September 27, 2008, and December 29, 2007, the deferred revenue balances associated with the SmileForever program were $1,375,000 and $3,331,000, respectively.

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Inventories

Inventories are stated at the lower of average cost or market. The Company 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 market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

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 at Associated Centers, which the Company is disputing. Based upon the circumstances and the advice of its independent counsel and advisors, management has estimated and accrued approximately $1.2 million through September 27, 2008, for potential additional sales tax liability related to these assessments and related state sales tax matters.

The Company may further increase its tax reserve in 2008 in response to tax assessments received to date. The Company intends to vigorously challenge the imposition of these tax assessments, and believes it has substantial grounds for its position. Nonetheless, the Company may attempt to negotiate a resolution of such 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 some or all of these tax assessments discussions 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 the assessments, 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 disclaims any intention or 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-week period ended September 27, 2008 compared to the 13-week period ended September 29, 2007:

Total Revenues, Net declined 25%, to $4.3 million in our third quarter of 2008 compared to $5.7 million in the third quarter of 2007. Whitening revenues declined to $3.0 million in the third quarter of 2008 compared to $3.3 million in the third quarter of 2007. This decrease reflects difficulties in attempting to change the whitening procedure from one performed by dentists for an hour period to one that is self administered over a shorter period of time. Effective May 2008, the Company returned to its original procedure utilizing dentists. However the disruption to the business and confusion by the customer impacted the third quarter. Overall economic conditions affecting consumer spending also adversely impacted revenues.

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In addition, the price for the shorter procedure was lower than that which was charged for the longer procedure. In addition, SmileForever revenue decreased to $0.6 million in the third quarter of 2008 from $0.9 million in the third quarter of 2007, and revenue sold to QVC increased by $137 thousand.

Operating and occupancy costs decreased 3%, to $3.4 million in the third quarter of 2008 compared to $3.5 million in the third quarter of 2007, reflecting decrease in cost of goods sold relating to our lower retail sales and increase in QVC network sales and a decrease in our accrual for center closures. Our spa occupancy costs were nearly identical in the two periods.

Selling, General and Administrative expenses decreased to $1.1 million in the third quarter of 2008 from $2.8 million in the third quarter of 2007. This decrease was primarily due to our continued downsizing activities as well as a decrease in advertising and professional fees.

Depreciation and Amortization expense decreased to $341,000 in the third quarter of 2008 compared to $356,000 in the third quarter of 2007.

Other Income and expense, net. For the thirteen week periods ended September 27, 2008 and September 29, 2007, other income, net of expenses was $2,000 and $279,000, respectively, reflecting the decrease in interest earned as a result of the company's utilization of its cash.

The following are explanations of significant changes for the 39-week period ended September 27, 2008 compared to the 39-week period ended September 29, 2007:

Total Revenues, Net declined to $14.1 million from $19.6 million or 28%. This decline reflects the Company's attempt, beginning during the middle of the first quarter and into the second quarter, to change the whitening procedure from one performed by dentists for an hour period to one that is self administered over a shorter period of time. The Company had difficulties implementing this change and returned to its original procedure utilizing dentists during May 2008. QVC revenues increased by 25% reflecting strong sales. The SmileForever program revenue decreased 8% to $2.3 million.

Operating and occupancy costs decreased slightly to $10.6 million for 2008 from $10.7 for 2007.

Selling, General and Administrative expensesdecreased to $4.1 million from $10.2 million or 60%. This decrease was primarily due to downsizing activities and a decrease in advertising and professional fees.

Depreciation and Amortization expense was unchanged at $1.1 million for both 2008 and 2007.

Other Income and expense net decreased to $2 thousand as the cash available for investment purposes declined from 2007 to 2008.

Liquidity and Capital Resources

General

At September 27, 2008, the Company had approximately $73,000 in unrestricted cash. The Company expects that its principal uses of cash will be to provide working capital to meet corporate expenses and satisfy outstanding liabilities. The financial statements reflect a going concern basis of accounting. While the Company was able to pay its debts as of the date of this Report, and had a plan to generate positive cash flow from its Centers business operations, the Company has yet to achieve profitability from operations and may require additional funds to continue to operate. The Company's ongoing operations may be negatively impacted if it is unable to either generate internally or obtain such funds through new debt or equity issuance. There can be no assurance that such funds will be available and if so, at an acceptable cost.

Sources and Uses of Cash

Through the third quarter of 2008, the Company used $5.4 million in cash in operating activities. The Company's net loss for the thirty-nine weeks ended September 27, 2008 was $2.1 million. Changes in working capital accounts and other operating assets and liabilities were $1.1 million, while cash declined $3.4 million for the 39 weeks period ended September 27, 2008.

In the 39 week period ended September 27, 2008, the Company's investing activities were related to the release of previously restricted cash balances of $2.2 million and capital expenditures of $0.3 million.