UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K

 

 

Commission File Number 000-19720

ABAXIS, INC.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(510) 675-6500

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

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

 

 

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

 

The aggregate market value of the voting stock held by non-affiliates of Abaxis as of September 28, 2007, the last business day of the second fiscal quarter, was $325,742,000 based upon the closing sale price reported for such date on the NASDAQ Global Market. For purposes of this disclosure, 6,957,000 shares of common stock held by persons who hold more than 5% of the outstanding shares of registrant’s common stock and shares held by executive officers and directors of the registrant have been excluded because such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily conclusive for any other purpose and exclusion of such shares should not be construed to indicate that any such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the registrant or that such person is controlled by or under common control with the registrant.

 

As of June 9, 2008, there were 21,768,000 shares of the Registrant’s common stock outstanding.

 

 

Abaxis, Inc.

 

Annual Report on Form 10-K

For The Fiscal Year Ended March 31, 2008

 

TABLE OF CONTENTS

 

 

FORWARD-LOOKING STATEMENTS

 

This report contains forward-looking statements within the meaning of Sections 21E of the Securities Exchange Act of 1934, as amended that reflect Abaxis’ current view with respect to future events and financial performance. In this report, the words “will,” “anticipates,” “believes,” “expects,” “intends,” “plans,” “future,” “project,” “estimate,” “would,” “may,” “could,” “should,” “might,” and similar expressions identify forward-looking statements. These forward-looking statements are subject to certain risks and uncertainties, including but not limited to those discussed below, that could cause actual results to differ materially from historical results or those anticipated. Such risks and uncertainties include, but are not limited to, the market acceptance of our products and the continuing development of our products, regulatory clearance and approvals required by the U.S. Food and Drug Administration (“FDA”) and other government approvals, risks associated with manufacturing and distributing our products on a commercial scale, free of defects, risks related to the introduction of new instruments manufactured by third parties, risks associated with entering the human diagnostic market on a larger scale, risks associated with liquidity concerns related to our auction rate securities, risks related to the protection of Abaxis’ intellectual property or claims of infringement of intellectual property asserted by third parties, risks involved in carrying of inventory, risks associated with the ability to attract, train and retain competent sales personnel, general market conditions and competition.

 

Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Abaxis assumes no obligation to update any forward-looking statements as circumstances change. Readers are advised to read this Annual Report on Form 10-K in its entirety paying careful attention to the risk factors set forth in this and other reports or documents filed by Abaxis from time to time with the Securities and Exchange Commission (“SEC”), particularly the quarterly reports on Form 10-Q and any current reports on Form 8-K, copies of which may be obtained from Abaxis or from the SEC at its website at www.sec.gov.

 

 

GENERAL

 

Abaxis, Inc. (“Abaxis,” “us” or “we”) develops, manufactures, markets and sells portable blood analysis systems for use in any human or veterinary patient-care setting to provide clinicians with rapid blood constituent measurements. Abaxis was incorporated in California in 1989. Our principal offices are located at 3240 Whipple Road, Union City, California 94587. Our telephone number is (510) 675-6500 and our Internet address is www.abaxis.com. Our common stock trades on the NASDAQ Global Market under the symbol “ABAX.”

 

OUR INDUSTRY: IN VITRO DIAGNOSTIC TESTING

 

We believe that a key element of the patient-centered, cost-constrained health care system in the current year and beyond will be the availability of blood analysis systems in the patient care setting that are easily and reliably operated by caregivers and that provide accurate, real time results to enable rapid clinical decisions. The optimal system uses whole blood, has built-in calibration and quality control, provides quick turnaround time, is portable and is low cost. In addition, the optimal near-patient system should be easy to use by people with no special training and capable of transmitting test results instantly to caregivers and patient information management systems.

 

We have developed a blood analysis system incorporating all of these criteria into a 5.1 kilogram (11.2 pounds) portable analyzer and a series of menu-specific, multi-test single-use reagent discs. The system is essentially a compact portable laboratory that can be easily located near the patient. Each reagent disc is pre-configured with multiple analytes and contains all the reagents necessary to perform a fixed menu of tests. Taking the system to the patient care site instead of shipping the sample to a central laboratory makes blood testing and analysis as easy as measuring the patient’s blood pressure, temperature, and heart rate and eliminates the necessity of multiple visits to the doctor’s office. Additional advantages of near-patient testing include eliminating errors from sample handling, transcription and transportation. We have adapted this blood analysis system in both the human medical and veterinary markets in order to bring the same advantages to all health care professionals and patients.

ABAXIS PRODUCTS

 

We operate in two segments: (i) the medical market and (ii) the veterinary market. Revenues in the medical market accounted for 23%, 20% and 16% of our total revenues for fiscal 2008, 2007 and 2006, respectively. Revenues in the veterinary market accounted for 71%, 74% and 78% of our total revenues for fiscal 2008, 2007 and 2006, respectively.

 

Point-of-Care Blood Chemistry Analyzer

 

Our primary product is a blood analysis system, consisting of a compact portable analyzer and a series of single-use plastic discs, called reagent discs, containing all the chemicals required to perform a panel of up to 14 tests on human patients and 13 tests on veterinary patients. The system can be operated with minimal training and performs multiple routine tests on whole blood, serum or plasma samples. The system provides test results in approximately 12 minutes with the precision and accuracy equivalent to a clinical laboratory analyzer. We manufacture the system in our manufacturing facilities in Union City, California and we market the system in both the medical market and in the veterinary market, as described below.

 

 

Reagent Discs

 

The reagent discs used with the blood chemistry analyzers are designed to handle almost all technical steps of blood chemistry testing automatically. The discs first separate a whole blood sample into plasma and blood cells, meter the required quantity of plasma and diluent, mix the plasma and diluent, and deliver the mixture to the reagent chambers, called cuvettes, along the disc perimeter. The diluted plasma dissolves and mixes with the reagent beads initiating the chemical reactions, which are monitored by the analyzer. The discs are 8-cm diameter, single-use devices constructed from three ultrasonically welded injection-molded plastic parts. The base and the middle piece create the chambers, cuvettes and passageways for processing the whole blood and mixing plasma with diluent and reagents. The top piece, referred to as the bar code ring, is imprinted with bar codes that contain disc-specific calibration information. In the center of the disc is a plastic diluent container sealed with polyethylene-laminated foil. Spherical lyophilized reagent beads are placed in the cuvettes during disc manufacturing. Upon completion of the analysis, used discs may be placed back into their foil pouches to minimize human contact with blood prior to proper disposal.

 

To perform a panel of tests, the operator collects a blood sample, then transfers the sample into the reagent disc. The operator places the disc into the analyzer drawer, and enters patient, physician, and operator information. The analyzer spins the disc to separate cells from plasma, meters and mixes plasma with diluent, distributes diluted plasma to the cuvettes, and monitors chemical reactions. In approximately 12 minutes, results are printed or can be transmitted to a patient data management system for inclusion in the patient’s medical record. A computer port enables transmission of patient results to external computers for patient data management.

We offer our blood analysis system with a total of 27 diagnostic tests. Our test methods are as follows:

 

 

Twenty-one of these tests are marketed for both the medical and veterinary markets. The tests for BA and T₄ are marketed exclusively in the veterinary market. The tests for DBIL, HDL, LD and TRIG are marketed exclusively in the medical market. We market our reagent products by configuring these 27 test methods in panels that are designed to meet a variety of clinical diagnostic needs. We offer 13 multi-test reagent disc products in the medical market and 8 multi-test reagent disc products in the veterinary market.

 

The reagent discs offered with our Piccolo chemistry analyzers are as follows:

 

 

“CLIA waived” means the FDA has granted our application to classify the product as having waived status with respect to the Clinical Laboratory Improvement Amendments (“CLIA”) of 1988. See “Government Regulation” in this section for additional information on CLIA.

The reagent discs offered with our VetScan chemistry analyzers are as follows:

 

 

Hematology

 

In September 2007, we introduced a veterinary hematology instrument under the name VetScan HM5^tm. The VetScan HM5 offers a 22-parameter complete blood count (CBC) analysis, including a five-part differential cell counter specifically designed for veterinary applications. In May 2004, we introduced a veterinary hematology instrument that offers an 18-parameter CBC analysis, including a three-part white blood cell differential, marketed originally as the VetScan HMII, and is now referred to as the VetScan HM2^tm. We currently purchase the hematology instruments from Diatron MI Kft. of Budapest, Hungary. Through April 2004, we marketed a veterinary hematology instrument under the name VetScan HMT. We continue to support and service our current population of VetScan HM5, VetScan HM2, VetScan HMII and VetScan HMT hematology instruments.

 

Orbos Process

 

The dry reagents used in our reagent discs are produced using a proprietary technology called the Orbos^® Discrete Lyophilization Process (the “Orbos process”). This process allows the production of a precise amount of active chemical ingredient in the form of a soluble bead. The Orbos process involves flash-freezing a drop of liquid reagent to form a solid bead and then freeze-drying the bead to remove water. The Orbos beads are stable in dry form and dissolve rapidly in aqueous solutions. We believe that the Orbos process has broad applications in products where delivery of active ingredients in a stable, pre-metered format is desired. We have licensed the technology underlying the Orbos process to bioMerieux, Inc., Cepheid and GE Healthcare (formerly Amersham Bioscience Corp.). Additionally, we have a supply contract with Becton, Dickinson and Company for products using the Orbos process. Revenues from these arrangements, however, are unpredictable. We continue to explore potential applications with other companies, although there can be no assurance that we will be able to develop any new applications for the Orbos process.

 

Future Products

 

We continue to develop new products that we believe will provide further opportunities for growth in the human medical and veterinary markets. Development of tests for other disc products will be targeted at specific applications based on fulfilling clinical needs.

 

CUSTOMERS AND DISTRIBUTION

 

We market and sell our products worldwide by maintaining direct sales forces and through independent distributors. Our direct sales force is primarily located in the United States and we maintain one sales office outside of the United States in Germany. Sales and marketing expenses were $23.7 million, $20.6 million and $16.2 million, or 24%, 24% and 24% of our total revenues, in fiscal 2008, 2007 and 2006, respectively.

Customers

 

Depending on the needs of a customer segment, we sell our point-of-care blood analyzer products and reagent discs either directly or through distributors. In the delivery of human or veterinary care, there are many kinds of providers and a multitude of sites where Abaxis products could be used as an alternative to relying on a central laboratory for blood test information, as described below.

 

Medical Market

 

We believe that our Piccolo chemistry analyzer, consisting of a menu of 25 reagent test results, is suitable for a wide variety of the human medical market segments. These market segments include military installations (ships, field hospitals and mobile care units), physicians office practices across all specialties, urgent care and walk-in clinics (free-standing or hospital-connected), home care providers (national, regional or local), nursing homes, ambulance companies, oncology treatment clinics, hospital labs and draw stations.

 

Veterinary Market

 

We believe that our veterinary reagent product offerings meet a substantial part of the clinical diagnostic needs of veterinarians and the research marketplace. Potential customers for the VetScan chemistry analyzer and hematology analyzer are companion animal hospitals, animal clinics with mixed practices of small animals, birds and reptiles, equine and bovine practitioners, veterinary emergency clinics, veterinary referral hospitals, universities, government, pharmaceutical companies, biotechnology companies and private research laboratories.

 

Distribution Within North America

 

Medical Market

 

We sell our human-oriented products directly to those customers who serve large human patient populations with employed caregivers such as the military, hospitals and managed care organizations. As a result of health care reform, we anticipate a consolidation of providers with more centralized purchasing of medical products based on the standardization of care and the use of patient outcome studies to influence purchase decisions. We plan to achieve our direct sales objectives by employing highly skilled sales specialists and sales teams to work closely with providers in performing studies to show that the use of the Piccolo blood chemistry analyzer, rather than laboratory alternatives, can provide better outcomes at a lower cost.

 

Distribution alternatives in the human medical market can contribute to identifying potential customers and introducing the product, but often need the support of our personnel in completing the sale. Product distributors are generally of two types: (i) large companies that primarily serve hospitals, clinics and large health maintenance organizations (HMOs) nationwide using multiple warehouses and extensive transportation systems, and (ii) smaller companies that provide the daily supplies needed by office-based physicians. Large distributors with local and regional companies can service the office-based physicians market segment as well. In the human medical market, national firms sell thousands of products, including furniture, capital equipment, surgical instruments and a myriad of consumables. The smaller companies generally direct their product offerings to those items a physician uses daily in caring for primarily ambulatory patients. These firms also may sell lower priced equipment such as diagnostic instruments, which are used in conjunction with consumable reagents.

 

We are currently exploring distribution alternatives and may enter into arrangements, where appropriate. We entered into formal distribution agreements with the following distributors to sell and market Piccolo chemistry analyzers and medical reagent discs: National Distribution & Contracting, Inc. in our third quarter of fiscal 2008, McKesson Medical-Surgical Inc. in our first quarter of fiscal 2008, Cardinal Health in our fourth quarter of fiscal 2007, Henry Schein’s Medical Group in our first quarter of fiscal 2007 and PSS World Medical, Inc. in our third quarter of fiscal 2006. We are also currently pursuing direct medical sales, where appropriate.

 

Veterinary Market

 

Veterinarians are served typically by local distributors, some with national affiliations. We work with various independent distributors to sell our instruments and consumable products. In the United States, we have both

regional and national based distributors, which includes, among others, American Veterinary Supply Corp., DVM Resources, IVESCO LLC., Merritt Veterinary Supplies, Inc., Nelson Laboratories, Penn Veterinary Supply, Inc., TW Medical Veterinary Supply and Western Medical Supply, Inc. In addition to selling through distributors, we directly supply our VetScan products to Veterinary Centers of America (VCA), the nation’s largest veterinary hospital chain. In fiscal 2008, one distributor in the United States veterinary market, DVM Resources, accounted for 12% of our total worldwide revenues.

 

From April 2004 through May 2006, we had a distribution partnership with the veterinary division of Henry Schein, Inc. While we continue to enter into arrangements with other veterinary distributors, in May 2006, both Abaxis and Henry Schein determined that it was in the best interest of both companies to discontinue the distribution agreement due to Henry Schein’s acquisition of a regional distributor of a competing company in the veterinary market. To support those customers who were previously supplied products by Henry Schein, we have had our current distributors supply and service these sites, or depending on the customer’s needs and geographical location, we will continue to support and service these customers on a direct basis as well.

 

We also sell our veterinary products to distributors located in Canada. Our veterinary reagents are sold to various distributors in Canada, which includes Associated Veterinary Purchase, CDMV, Distribution Vie et Sante, Midwest Veterinary Distribution Cooperative Limited, Veterinary Purchasing Company Limited and Western Drug Distribution Center Limited. Currently, we sell our VetScan chemistry analyzers and hematology analyzers to one distributor in Canada, Vet Novations.

 

We intend to enter into arrangements with additional veterinary distributors within North America as well as pursue direct veterinary sales, where appropriate.

 

Distribution Outside of North America

 

Our international sales and marketing objectives include identifying and defining the market segments in each country by product and then focusing on specific objectives for each segment in each country. These specific objectives include modification and expansion of distribution and distributor training and monitoring to ensure the attainment of sales goals.

 

We currently have distributors for our products in the following foreign countries: Australia, Austria, Bahrain, Belgium, Czech Republic, Denmark, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, Korea, Macao, the Netherlands, New Zealand, the Philippines, Portugal, Romania, Russia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, Ukraine, United Arab Emirates and the United Kingdom. Our distributor in each of these countries is responsible for obtaining the necessary approvals to sell our new and existing products.

 

Revenues in Europe accounted for 13%, 12% and 11% of our total revenues for fiscal 2008, 2007 and 2006, respectively. Revenues in Asia Pacific and rest of the world accounted for 3%, 4% and 4% of our total revenues for fiscal 2008, 2007 and 2006, respectively.

 

We plan to continue to enter into additional distributor relationships to expand our international distribution base and solidify our international presence.

 

MANUFACTURING

 

We manufacture our Piccolo and VetScan chemistry analyzers from our facility located in Union City, California. The VetScan HM2 and HM5 are manufactured by Diatron in Budapest, Hungary and are purchased by us as a completed instrument.

 

Our Piccolo products are regulated under the 1976 Medical Device Amendments to the Food, Drug and Cosmetic Act, which is administered by the FDA. To produce and commercially ship Piccolo products, we must have a license to manufacture medical products in the State of California, where we conduct our principal manufacturing activities, and be registered by the FDA as a medical device manufacturer. Current Good Manufacturing Practice requirements are set forth in the 21 CFR 820 Quality System Regulation. These requirements regulate the methods used in, and the facilities and controls used for the design, manufacture, packaging, storage, installation and servicing of our medical devices intended for human use. Our manufacturing facility is subject to

periodic inspections. In addition, various state regulatory agencies may regulate the manufacture of our products. To date, we have complied with the following federal state, local and international regulatory requirements:

 

 

Although we are not required to comply with all of the government regulations applicable to the human medical market when manufacturing the VetScan products, we intend that all of our manufacturing operations will be compliant with the Quality System Regulation to help ensure product quality and integrity regardless of end use or patient.

 

In addition to the development of standardized manufacturing processes and quality control programs for the entire manufacturing process, our manufacturing activities are concentrated in the following three primary areas:

 

 

We generally operate with a limited order backlog because our products are typically shipped shortly after orders are received. As a result, product sales in any quarter are generally dependent on orders booked and shipped in that quarter.

 

MATERIAL RELATIONSHIPS WITH SUPPLIERS AND OTHER THIRD PARTIES

 

Diatron Messtechnik GmbH.  In our November 2003 original equipment manufacturing and supply manufacturing (“OEM”) agreement with Diatron Messtechnik GmbH (“Diatron”), we acquired the exclusive right to distribute Diatron’s veterinary hematology analyzers in Australia, Canada, Japan, New Zealand and the United States. The Diatron hematology instruments are currently supplied by Diatron MI Kft. The agreement had a five-year term and we were subject to certain minimum purchase quantities during the original contract term. In September 2006, the terms of the agreement, with respect to the purchase commitments, were revised and we completed all of the purchase commitments requirements in the quarter ended December 31, 2007. In February 2008, the terms of the OEM agreement, with respect to the purchase commitments, were again revised. Under the amended OEM agreement currently in effect, we are committed to purchase a minimum number of hematology instruments through fiscal 2009. See Note 8 “Commitments and Contingencies” of the Notes to Financial Statements for additional information.

 

DVM Resources.  DVM Resources, one of our distributors of veterinary products in the United States, accounted for 12% and 15% of our total worldwide revenue in fiscal 2008 and 2007, respectively.

 

COMPETITION

 

Competition in the human and veterinary diagnostic markets is intense. Blood analysis is a well-established field in which there are a number of competitors that have substantially greater financial resources and larger, more established marketing, sales and service organizations than we do. We compete primarily with the following organizations: commercial clinical laboratories, hospitals’ clinical laboratories and manufacturers of bench top multi-test blood analyzers and other testing systems that health care providers can use “on-site.”

 

Historically, hospitals and commercial laboratories perform most of the human medical testing, and veterinary specialized commercial laboratories perform most of the veterinary medical testing. We have identified five principal factors that we believe customers typically use to evaluate our products and those of our competitors. These factors are as follows: (i) range of tests offered; (ii) the immediacy of results; (iii) cost effectiveness; (iv) ease of use and (v) reliability of results. We believe that we compete effectively on each of these factors except for the range of tests offered. Clinical laboratories are effective at processing both a wide range and high volumes of discrete tests using skilled technicians and complex equipment. While our current offering of reagent discs cannot provide the same broad range of tests, we believe that in our targeted market segments, our products provide a sufficient breadth of test menus to compete successfully with clinical laboratories given the advantages of our products with respect to the other four factors.

 

Our principal competitors in the human diagnostic market are Alfa Wassermann S.P.A., i-STAT Corporation (which was purchased by Abbott Laboratories), Johnson & Johnson (including its subsidiary, Ortho-Clinical Diagnostics, Inc.), Kodak (DT60 analyzer), Polymedco, Inc. and F. Hoffmann-La Roche Ltd. (Reflotron system). Our principal competitors in the veterinary diagnostic market are Idexx Laboratories, Inc. and Heska Corporation. Most of our competitors have significantly greater financial, marketing, sales and technical and other resources than we do. In particular, many of our competitors have large sales forces and well-established distribution channels.

Consequently, we are developing our distribution network and expanding our direct sales force in order to compete in these markets.

 

GOVERNMENT REGULATION

 

U.S. Food and Drug Administration Clearance

 

Our Piccolo products are regulated under the 1976 Medical Device Amendment to the Food, Drug and Cosmetic Act, which is administered by the FDA. The FDA has classified our Piccolo products as “Class I” and “Class II” devices. These classifications require us to submit to the FDA a pre-market notification form, or 510(k). The FDA uses the 510(k) to substantiate product claims that are made by medical device manufacturers prior to marketing. In our 510(k) notification, we must, among other things, establish that the product we plan to market is “substantially equivalent” to (1) a product that was on the market prior to the adoption of the 1976 Medical Device Amendment or (2) a product that the FDA has previously cleared under the 510(k) process.

 

The FDA review process of a 510(k) notification can last anywhere from three to six months, and the FDA must issue a written order finding “substantial equivalence” before a company can market a medical device. As of March 31, 2008, we have received market clearance from the FDA for our Piccolo system and 25 reagent tests that we have on 13 reagent discs. We are currently developing additional tests that we will have to clear with the FDA through the 510(k) notification procedures. These new test products are crucial for our success in the human medical market. If we do not receive 510(k) clearance for a particular product or any of these additional tests, we will not be able to market that product in the United States, which could harm our future sales.

 

Clinical Laboratory Improvements Act Regulations

 

Our Piccolo products are also affected by the CLIA of 1988. The CLIA are intended to insure the quality and reliability of all medical testing in the United States regardless of where the tests are performed. The current CLIA regulations divide laboratory tests into three categories: “waived,” “moderately complex” and “highly complex.” Many of the tests performed using the Piccolo system are in the “moderately complex” category. This category requires that any location in which testing is performed be certified as a laboratory. Hence, we can only sell some Piccolo products to customers who meet the standards of a laboratory. To receive “laboratory” certification, a testing facility must be certified by the Centers for Medicare and Medicaid Services. After the testing facility receives a “laboratory” certification, it must then meet the CLIA regulations. Because we can only sell some Piccolo products to testing facilities that are certified “laboratories,” the market for some products is correspondingly constrained.

 

In October 2007, the FDA granted waived status under CLIA regulations for the following analytes when used in conjunction with the Piccolo xpress and Piccolo Classic chemistry analyzers for the medical market: chloride (CL-), potassium (K+), sodium (NA+) and total carbon dioxide (tCO₂).

 

Prior to the end of fiscal 2007, the FDA granted waived status under CLIA regulations for the following tests when used in conjunction with our Piccolo chemistry analyzer: alanine aminotransferase (ALT), albumin (ALB), alkaline phosphatase (ALP), amylase (AMY), aspartate aminotransferase (AST), calcium (CA), creatinine (CRE), gamma glutamyltransferase (GGT), glucose (GLU), high-density lipoprotein cholesterol (HDL), total bilirubin (TBIL), total protein (TP), triglycerides (TRIG), total cholesterol (CHOL), urea nitrogen (BUN) and uric acid (UA). Accordingly, we can offer the following Piccolo reagent discs as waived tests to the medical market: Basic Metabolic Panel, Comprehensive Metabolic Panel, Electrolyte Panel, General Chemistry 6, General Chemistry 13, Kidney Check, Lipid Panel, Lipid Panel Plus and Liver Panel Plus. Waived status permits untrained personnel to run the Piccolo chemistry analyzer using these tests; thus, extending the sites (doctors’ offices and other point-of-care environments) that can use the Piccolo chemistry analyzer.

 

We cannot assure you that we will successfully receive CLIA waived status from the FDA for other products. Consequently, for the reagent discs that have not received CLIA waived status, the market for our Piccolo products may be confined to those testing facilities that are certified as “laboratories” and our growth can be limited accordingly. However, we are engaged in an active program to test and apply for CLIA waivers for additional analytes.

Other Regulations

 

We are subject to a variety of federal, state, local and international regulations regarding the manufacture and sale of our products. In addition, as we continue to sell in foreign markets, we may have to obtain additional governmental clearances in those markets. Foreign certifications that we have received include the following, among others:

 

 

As we continue to sell in foreign markets, we may have to obtain additional governmental clearances in those markets. The government regulations for our medical and veterinary products vary. We cannot predict what impact, if any, such current or future regulatory changes would have on our business.

 

RESEARCH AND DEVELOPMENT

 

Research and development activities are focused on the following: developing new immunoassay tests, clinical trials, preparation of submission for CLIA waived status on new test methods and product improvements and enhancement of existing products. Our research and development expenses, which consist of salaries and benefits, consulting expenses and materials were $7.0 million, $6.2 million and $6.1 million, or 7%, 7% and 9% of our total revenues, in fiscal 2008, 2007 and 2006, respectively.

 

PATENTS AND PROPRIETARY TECHNOLOGIES

 

We have pursued the development of a patent portfolio to protect our proprietary technology. As of March 31, 2008, 36 patent applications have been filed on our behalf with the United States Patent and Trademark Office, of which the following 29 have been issued and are active:

 

 

Our policy is to file patent applications to protect technology, inventions and improvements that are important to the development of our business. We also rely upon trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain competitive position. Fourteen international applications have been filed on our behalf under the Patent Cooperation Treaty (PCT) and we are selectively filing patent applications in countries where we anticipate to market our products. Eighty-four national foreign applications were filed on our behalf in various countries and 74 of them have been granted. Of these 74, a total of 39 have been abandoned; and 1 patent was opposed by bioMerieux, which was settled during fiscal 2006, granting bioMerieux a license under certain of our patents.

 

EMPLOYEES

 

As of March 31, 2008, we had 321 full-time employees distributed across the following divisions:

 

 

We also use temporary help to assist in performing certain operational duties. As of March 31, 2008, we had 25 temporary employees with most of them assisting in manufacturing operations. None of our employees is covered by a collective bargaining agreement and we consider our relations with our employees to be good.

INFORMATION AVAILABLE TO INVESTORS

 

We make available, free of charge on or through our Internet address located at www.abaxis.com our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. In addition, copies of our reports, proxy statements and other information filed electronically with the SEC may be accessed at http://www.sec.gov. The public may also read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. This information may also be obtained by calling the SEC at 1-800-SEC-0330, by sending an electronic message to the SEC at publicinfo@sec.gov or by sending a fax to the SEC at 1-202-777-1027.

 

 

RISK FACTORS THAT MAY AFFECT OUR PERFORMANCE

 

Our future performance is subject to a number of risks. If any of the following risks actually occur, our business could be harmed and the trading price of our common stock could decline. In evaluating our business, you should carefully consider the following risks in addition to the other information in this Annual Report on Form 10-K. We note these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995. It is not possible to predict or identify all such factors and, therefore, you should not consider the following risks to be a complete statement of all the potential risks or uncertainties that we face.

 

We are not able to predict sales in future quarters and a number of factors affect our periodic results, which makes our quarterly operating results less predictable.

 

We are not able to accurately predict our sales in future quarters. Our revenue in the medical and veterinary markets is derived primarily by selling to distributors who resell our products to the ultimate user. While we are better able to predict sales of our reagent discs, as we sell these discs primarily for use with blood chemistry analyzers that we sold in prior periods, we generally are unable to predict with much certainty sales of our blood chemistry analyzers, as we typically sell our blood chemistry analyzers to new users. Accordingly, our sales in any one quarter are not indicative of our sales in any future period.

 

We generally operate with a limited order backlog, because we ship our products shortly after we receive the orders from our customers. As a result, our product sales in any quarter are generally dependent on orders that we receive and ship in that quarter. We base our expense levels, which are to a large extent fixed, in part on our expectations as to future revenues. We may be unable to reduce our spending in a timely manner to compensate for any unexpected revenue shortfall. As a result, any such shortfall would immediately materially and adversely impact our operating results and financial condition.

 

The sales cycle for our products can fluctuate, which may cause revenue and operating results to vary significantly from period to period. We believe this fluctuation is due primarily to (i) seasonal patterns in the decision making processes by our independent distributors and direct customers, (ii) inventory or timing considerations by our distributors and (iii) on the purchasing requirements of the U.S. Military to acquire our products. Accordingly, we believe that period to period comparisons of our results of operations are not necessarily meaningful.

 

In the future, our periodic operating results may vary significantly depending on, but not limited to, a number of factors, including:

 

 

 

We would fail to achieve anticipated revenue if the market does not accept our products.

 

We believe that our core compact blood chemistry analyzer product differs substantially from current blood chemistry analyzers on the market. Our primary competition is from centralized laboratories that offer a greater number of tests than our products, but do so at a greater overall cost and require more time. We also compete with other point-of-care analyzers that cost more, require more maintenance and offer a narrower range of tests. However, these point-of-care analyzers are generally marketed by larger companies which have greater resources for sales and marketing, in addition to a recognized brand name and established distribution relationships.

 

In the human medical market, we have relatively limited experience in large-scale sales of our Piccolo blood chemistry analyzers. Although we believe that our blood chemistry analyzers offer consumers many advantages, including substantial cost savings according to our analyses, in terms of implementation of the actual product, these advantages involve changes to current standard practices, such as using large clinical laboratories that will require changes in both the procedures and mindset of care providers. The human medical market in particular is highly regulated, structured, difficult to penetrate and often slow to adopt new product offerings. If we are unable to convince large numbers of medical clinics, hospitals and other point-of-care environments of the benefits of our Piccolo blood chemistry analyzers and our other products, we will suffer lost sales and could fail to achieve anticipated revenue.

 

Historically, in the veterinary market, we have marketed our VetScan systems through both direct sales and distribution channels to veterinarians. We continue to develop new animal blood tests to expand and we cannot be assured that these tests will be accepted by the veterinary market.

 

We could fail to achieve anticipated revenue if problems related to the manufacture of our new blood chemistry analyzers are not resolved.

 

We manufacture our blood chemistry analyzers at our manufacturing facility in Union City, California. We are currently experiencing problems related to the manufacture of our new blood chemistry analyzer, which are primarily related to difficulties and delays in obtaining certain key components that we purchase from various suppliers. These manufacturing problems may be potentially related to quality control issues for key components that we obtain from our suppliers or to design issues of the key components required in our blood chemistry analyzer. Our difficulties in obtaining an adequate amount of quality components for the manufacture of our blood chemistry analyzer had a materially adverse impact on our sales of Vetscan chemistry analyzers in fiscal 2008. If we are unable to resolve these manufacturing problems on our new blood chemistry analyzer, we will not be able to manufacture sufficient quantities to meet anticipated demand and, therefore, will not be able to effectively market and sell our new blood chemistry analyzer; accordingly, our revenue and business would be materially adversely affected.

 

We have invested a significant portion of our cash in auction rate securities, the market for which is currently illiquid. Funds associated with certain of our auction rate securities may not be accessible for an undetermined period of time and our auction rate securities may experience an other than temporary decline in value, which would adversely affect our statement of operations.

 

Our marketable securities portfolio includes auction rate securities that are structured with short-term interest rate reset dates of generally less than 30 days, but with contractual maturities that can be well in excess of ten years or may never mature. At the end of each reset period, which occurs ranging from every seven to 28 days, depending on the security, investors can sell or continue to hold the securities at par. This mechanism has historically provided a liquid market for these securities. However, the recent negative conditions in the global credit markets have prevented some investors from liquidating their holdings of auction rate securities because the amount of securities submitted for sale has exceeded the amount of purchase orders for such securities. At March 31, 2008, we held $37.0 million par value of our investments in auction rate securities for which the auctions had been unsuccessful. An auction failure, which is not a default in the underlying debt instrument, occurs when there are more sellers than

buyers at a scheduled interest rate auction date and parties desiring to sell their securities are unable to do so. If the credit market does not improve, auctions for our invested amounts may continue to fail. If an auction fails for securities in which we have invested, we may be unable to liquidate some or all of our auction rate securities at par, should we need or desire to access the funds invested in those securities. In the event we need or desire to access these funds, we will not be able to do so until a future auction on these investments is successful or a buyer is found outside the auction process. If a buyer is found but is unwilling to purchase the investments at par, we may incur a loss. Furthermore, if the issuers of the auction rate securities are unable to successfully complete future auctions and their credit ratings deteriorate, we may be required to adjust the carrying value of these investments by recording an impairment charge.

 

There is no assurance as to when the market for auction rate securities will stabilize. The fair value of our auction rate securities could change significantly based on market conditions and continued uncertainties in the credit markets. If conditions in the credit markets deteriorate further causing additional auctions to fail, the funds associated with these auction rate securities may also not be accessible for an undetermined period of time, and we may be required to record losses or an impairment charge on our auction rate securities portfolio in future quarters, which would harm our financial condition.

 

We rely on patents and other proprietary information, the loss of which would negatively affect our business.

 

As of March 31, 2008, 36 patent applications have been filed on our behalf with the United States Patent and Trademark Office (“USPTO”), of which 30 patents have been issued and 29 patents are currently active. Additionally, we have filed several international patent applications covering the same subject matter as our domestic applications. The patent position of any medical device manufacturer, including us, is uncertain and may involve complex legal and factual issues. Consequently, we may not be issued any additional patents, either domestically or internationally. Furthermore, our patents may not provide significant proprietary protection because there is a chance that they will be circumvented or invalidated. We cannot be certain that we were the first creator of the inventions covered by our issued patents or pending patent applications, or that we were the first to file patent applications for these inventions, because (1) the USPTO maintains all patent applications that are not filed in any foreign jurisdictions in secrecy until it issues the patents (unless a patent application owner files a request for publication) and (2) publications of discoveries in the scientific or patent literature tend to lag behind actual discoveries by several months. We may have to participate in interference proceedings, which are proceedings in front of the USPTO, to determine who will be issued a patent. These proceedings could be costly and could be decided against us.

 

We also rely upon copyrights, trademarks and unpatented trade secrets. Others may independently develop substantially equivalent proprietary information and techniques that would undermine our proprietary technologies. Further, others may gain access to our trade secrets or disclose such technology. Although we require our employees, consultants and advisors to execute agreements that require that our corporate information be kept confidential and that any inventions by these individuals are property of Abaxis, there can be no assurance that these agreements will provide meaningful protection or adequate remedies for our trade secrets in the event of unauthorized use or disclosure of such information. The unauthorized dissemination of our confidential information would negatively impact our business.

 

We must continue to develop our sales, marketing and distribution experience in the human diagnostic market or our business will not grow.

 

Although we have gained experience marketing our VetScan products in the veterinary diagnostic market, we have limited sales, marketing and distribution experience with our Piccolo chemistry analyzers in the human diagnostic market. Accordingly, we cannot assure you that:

 

 

Should we fail to effectively develop our sales, marketing and distribution efforts, our growth will be limited and our results of operations will be adversely affected.

 

We must increase sales of our Piccolo and VetScan products or we may not be able to maintain profitability.

 

As of March 31, 2008, we had cumulative net losses of $3.0 million. Our ability to continue to be consistently profitable will depend, in part, on our ability to increase our sales volumes of our Piccolo and VetScan products. Increasing the sales volume of our products will depend upon, among other things, our ability to:

 

 

We cannot assure you that we will be able to successfully increase our sales volumes of our products to sustain profitability.

 

We may inadvertently produce defective products, which may subject us to significant warranty liabilities or product liability claims and we may have insufficient product liability insurance to pay material uninsured claims.

 

Our business exposes us to potential warranty and product liability risks which are inherent in the testing, manufacturing and marketing of human and veterinary medical products. We strive to apply sophisticated methods to raw materials and produce defect-free medical test equipment. Although we have established procedures for quality control on both the raw materials that we receive from suppliers and our manufactured final products, these procedures may prove inadequate to detect a defect that occurs in limited quantities, that we have not anticipated or otherwise. Our Piccolo and VetScan chemistry analyzers may be unable to detect all errors which could result in the misdiagnosis of human or veterinary patients.

 

Should we inadvertently manufacture and ship defective products, we may be subject to substantial claims under our warranty policy or product liability laws. In addition, our policy is to credit medical providers for any defective product that we produce, including those reagent discs that are rejected by our Piccolo and VetScan chemistry analyzers. Therefore, even if a mass defect within a lot or lots of reagent discs were detected by our Piccolo and VetScan chemistry analyzers, the replacement of such reagent discs free of charge would be costly and could materially harm our financial condition. Further, in the event that a product defect is not detected in our Piccolo chemistry analyzer, our relatively recent expansion into the human medical market greatly increases the risk that the amount of damages involved with just one product defect would be material to our operations. We currently maintain limited product liability insurance that we believe is adequate for our current needs, taking into account the risks involved and cost of coverage. However, our product liability insurance and cash may be insufficient to cover potential liabilities. In addition, in the future the coverage that we require may be unavailable on commercially reasonable terms, if at all. Even with our current insurance coverage, a mass product defect, product liability claim or recall could subject us to claims above the amount of our coverage and would materially adversely affect our business and our financial condition.

 

We must effectively train and integrate the members of our sales team in order to achieve our anticipated revenue or expand our business.

 

As of March 31, 2008, we had 72 full-time sales personnel directly involved in our sales and marketing activities, many of whom have been employed by us for a limited period of time. In addition, we experience significant turnover in our sales and marketing personnel. If we are to increase our direct sales, we will need to train new sales personnel and supervise them closely. We also will continue hiring additional sales personnel. If we are unable to retain our existing personnel, or attract and train additional qualified personnel, our growth may be limited due to our lack of resources to market our products.

We need to successfully manufacture and market additional reagent discs for the human diagnostic market if we are to compete in that market.

 

We have developed a blood analysis system that consists of a portable blood analyzer and single-use reagent discs. Each reagent disc performs a series of standard blood tests. We believe that it is necessary to develop additional series of reagent discs with various tests for use with the Piccolo and VetScan chemistry analyzers. Historically, we have developed reagent discs suitable for the human medical and veterinary diagnostic markets. We have received 510(k) clearances from the U.S. Food and Drug Administration (“FDA”) for 25 test methods in the human medical market. These tests are included in standard tests for which the medical community receives reimbursements from third-party payors such as HMOs and Medicare. We may not be able to successfully manufacture or market these reagent discs. Our failure to meet these challenges will materially adversely affect our operating results and financial condition.

 

We rely primarily on distributors to sell our products and we rely on sole distributor arrangements in a number of countries. Our failure to successfully develop and maintain these relationships could adversely affect our business.

 

We sell our medical and veterinary products primarily through a limited number of distributors. As a result, we are dependent upon these distributors to sell our products and to assist us in promoting and creating a demand for our products. We operate on a purchase order basis with the distributors and the distributors are under no contractual obligation to continue carrying our products. Further, many of our distributors may carry our competitors’ products, and may promote our competitors’ products over our own products.

 

We depend on a number of distributors in the United States who distribute our VetScan products. Our largest distributor in the United States, DVM Resources, accounted for 12% and 15% of our total worldwide revenues for fiscal 2008 and 2007, respectively. While we continue to enter into arrangements with veterinary distributors, we have also terminated our distribution relationship with the veterinary division of Henry Schein in May 2006. While we have in the past, and expect to in the future, support those customers who were previously supplied products by Henry Schein through our current distributor base and direct service, the loss of these customers or other distributors may negatively affect our future revenues. Accordingly, if one or more of our distributors were to stop selling our products in the future, we may experience a sharp decline or delay in our sales revenue.

 

In the United States medical market, we depend on a few distributors for our Piccolo products. We entered into formal distribution agreements with the following distributors to sell and market Piccolo chemistry analyzers and medical reagent discs: National Distribution & Contracting, Inc. in our third quarter of fiscal 2008, McKesson Medical-Surgical Inc. in our first quarter of fiscal 2008, Cardinal Health in our fourth quarter of fiscal 2007, Henry Schein’s Medical Group in our first quarter of fiscal 2007 and PSS World Medical, Inc. in our third quarter of fiscal 2006. We depend on these distributors to assist us in promoting market acceptance of our Piccolo chemistry analyzers.

 

Internationally, we rely on only a few distributors for our products in both the medical and veterinary diagnostic markets. We terminated our distributor agreement with T. Chatani & Co., Ltd. in Japan in the first quarter of fiscal 2008 and, although T. Chatani & Co., Ltd has agreed to continue to service Abaxis customers, which includes selling our reagent discs and hematology reagent kits, for a limited period, our total product sales to T. Chatani & Co., Ltd. under the arrangement have significantly decreased and, as a result, our quarterly revenues has been adversely impacted. In October 2007, we signed an exclusive distribution agreement with Central Scientific Commerce, Inc. (“CSC”) to distribute the complete line of our medical and veterinary products in Japan. In the third quarter of fiscal 2008, CSC began the process of registering our new instruments, the VetScan VS2, VetScan HM5 and Piccolo xpress in Japan. The registration process was completed in the first quarter of fiscal 2009, and consequently, CSC can begin to import and market our instruments along with our reagent discs and kits. However, we cannot assure you that our new distribution relationship with CSC will be as successful as our prior distribution arrangement, or at all. Furthermore, an inability of, or any delays by, our distributor in receiving the necessary approvals for our new or other products can adversely impact our revenues in Japan.

 

We currently rely on distributors that carry either our medical or veterinary products in the following countries: Australia, Austria, Bahrain, Belgium, Canada, Czech Republic, Denmark, France, Germany, Hong Kong, Ireland,

Israel, Italy, Japan, Korea, Macao, the Netherlands, New Zealand, the Philippines, Portugal, Romania, Russia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, Ukraine, United Arab Emirates, the United Kingdom and the United States. Our distributors in each of these countries are responsible for obtaining the necessary approvals to sell our new and existing products. These distributors may not be successful in obtaining proper approvals for our new and existing products in their respective countries, and they may not be successful in marketing our products. We plan to continue to enter into additional distributor relationships to expand our international distribution base and solidify our international presence. However, we may not be successful in entering into additional distributor relationships on favorable terms, or at all. In addition, our distributors may terminate their relationship with us at any time. Historically, we have experienced a high degree of turnover among our international distributors. This turnover makes it difficult for us to establish a steady distribution network overseas. Consequently, we may not be successful in marketing our Piccolo and VetScan products internationally.

 

We depend on sole suppliers for several key components in our products, many of whom we have not entered into contractual relationships with and failure of our suppliers to provide the components to us could harm our business.

 

We use several key components that are currently available from limited or sole sources as discussed below:

 

 

We operate on a purchase order basis with all of the suppliers of our molded plastic reagent discs, reagent chemicals, blood chemistry analyzer components and hematology instruments and hematology reagents and, therefore, these suppliers are under no contractual obligation to supply us with their products or to do so at specified prices. Although we believe that there may be potential alternate suppliers available for these critical components, to date we have not qualified additional vendors beyond those referenced above and cannot assure you we would be able to enter into arrangements with additional vendors on favorable terms, or at all.

 

Because we are dependent on a limited number of suppliers and manufacturers for critical components to our products, we are particularly susceptible to any interruption in the supply of these products or the viability of our assembly arrangements. The loss of any one of these suppliers or a disruption in our manufacturing arrangements could materially adversely affect our business and financial condition.

We may not be able to compete effectively with larger, more established entities or their products, or with future organizations or future products, which could cause our sales to decline.

 

Blood analysis is a well-established field in which there are a number of competitors that have substantially greater financial resources and larger, more established marketing, sales and service organizations than we do. We compete with the following organizations:

 

 

Historically, hospitals and commercial laboratories performed most human diagnostic testing, and commercial laboratories performed most veterinary medical testing. We have identified five principal factors that we believe customers typically use to evaluate our products and those of our competitors. These factors include:

 

 

We believe that we compete effectively on each of these factors except for the range of tests offered. Clinical laboratories are effective at processing large panels of tests using skilled technicians and complex equipment. While our current offering of reagent discs cannot provide the same broad range of tests, we believe that in certain markets our products provide a sufficient breadth of test menus to compete successfully with clinical laboratories given the advantages of our products with respect to the other four factors. In addition, we cannot assure you that we will continue to be able to compete effectively on cost effectiveness, ease of use, immediacy of results or reliability of results. We also cannot assure you that we will ever be able to compete effectively on the basis of range of tests offered.

 

Competition in the human and veterinary diagnostic markets is intense. Our principal competitors in the human diagnostic market are Alfa Wassermann S.P.A., i-STAT Corporation (which was purchased by Abbott Laboratories), Johnson & Johnson (including its subsidiary, Ortho-Clinical Diagnostics, Inc.), Kodak (DT60 analyzer), Polymedco, Inc. and F. Hoffman-La Roche (Reflotron system). Our principal competitors in the veterinary diagnostic market are Idexx Laboratories, Inc. and Heska Corporation. Most of our competitors have significantly greater financial and other resources than we do. In particular, many of our competitors have large sales forces and well-established distribution channels. Consequently, we must develop our distribution channels and significantly improve our direct sales force in order to compete in these markets.

 

Changes in third-party payor reimbursement regulations can negatively affect our business.

 

By regulating the maximum amount of reimbursement they will provide for blood testing services, third-party payors, such as HMOs, pay-per-service insurance plans, Medicare and Medicaid, can indirectly affect the pricing or the relative attractiveness of our human testing products. For example, the Centers for Medicare and Medicaid Services (the “CMS”) set the level of reimbursement of fees for blood testing services for Medicare beneficiaries. If third-party payors decrease the reimbursement amounts for blood testing services, it may decrease the amount that physicians and hospitals are able to charge patients for such services. Consequently, we would need to charge less for our products. If the government and third-party payors do not provide for adequate coverage and reimbursement levels to allow health care providers to use our products, the demand for our products will decrease.

We are subject to numerous governmental regulations and regulatory changes are difficult to predict and may be damaging to our business.

 

Need for FDA Certification for Our Medical Device Products

 

Our Piccolo products are regulated under the 1976 Medical Device Amendments to the Food, Drug and Cosmetic Act, which is administered by the FDA. The FDA has classified our Piccolo products as “Class I” and “Class II” devices. These classifications require us to submit to the FDA a pre-market notification form or 510(k). The FDA uses the 510(k) to substantiate product claims that are made by medical device manufacturers prior to marketing. In our 510(k) notification, we must, among other things, establish that the product we plan to market is “substantially equivalent” to (1) a product that was on the market prior to the adoption of the 1976 Medical Device Amendment or (2) a product that the FDA has previously cleared under the 510(k) process.

 

The FDA review process of a 510(k) notification can last anywhere from three to six months, and the FDA must issue a written order finding “substantial equivalence” before a company can market a medical device. As of March 31, 2008, we have received market clearance from the FDA for our Piccolo chemistry analyzer and 25 reagent tests that we have on 13 reagent discs. We are currently developing additional tests that we will have to clear with the FDA through the 510(k) notification procedures. These new test products are crucial for our success in the human medical market. If we do not receive 510(k) clearance for a particular product, we will not be able to market that product in the United States, which could harm our future sales.

 

Need to Comply with Manufacturing Regulations

 

The 1976 Medical Device Amendment also requires us to manufacture our Piccolo products in accordance with Good Manufacturing Practices guidelines. Current Good Manufacturing Practice requirements are set forth in the 21 CFR 820 Quality System Regulation. These requirements regulate the methods used in, and the facilities and controls used for the design, manufacture, packaging, storage, installation and servicing of our medical devices intended for human use. Our manufacturing facility is subject to periodic inspections. In addition, various state regulatory agencies may regulate the manufacture of our products. To date, we have complied with the following federal, state, local and international regulatory requirements:

 

 

We cannot assure you that we will successfully pass any re-inspection by the FDA or the State of California. In addition, we cannot assure you that we can comply with all current or future government manufacturing requirements and regulations. If we are unable to comply with the regulations, or if we do not pass routine inspections, our business and results of operations will be materially adversely affected.

 

Effects of the Clinical Laboratory Improvement Amendments on Our Products

 

Our Piccolo products are also affected by the Clinical Laboratory Improvement Amendments (the “CLIA”) of 1988. The CLIA are intended to insure the quality and reliability of all medical testing in the United States

regardless of where the tests are performed. The current CLIA regulations divide laboratory tests into the following three categories:

 

 

Many of the tests performed using the Piccolo chemistry analyzer are in the “moderately complex” category. This category requires that any location in which testing is performed be certified as a laboratory. Hence, we can only sell some Piccolo products to customers who meet the standards of a laboratory. To receive “laboratory” certification, a testing facility must be certified by the CMS. After the testing facility receives a “laboratory” certification, it must then meet the CLIA regulations. Because we can only sell some Piccolo products to testing facilities that are certified “laboratories,” the market for some products is correspondingly constrained.

 

In October 2007, the FDA granted waived status under CLIA regulations for the following analytes when used in conjunction with the Piccolo xpress and Piccolo Classic chemistry analyzers for the medical market: chloride (CL-), potassium (K+), sodium (NA+) and total carbon dioxide (tCO₂).

 

Prior to the end of fiscal 2007, the FDA granted waived status under CLIA regulations for the following tests when used in conjunction with our Piccolo chemistry analyzer: alanine aminotransferase (ALT), albumin (ALB), alkaline phosphatase (ALP), amylase (AMY), aspartate aminotransferase (AST), calcium (CA), creatinine (CRE), gamma glutamyltransferase (GGT), glucose (GLU), high-density lipoprotein cholesterol (HDL), total bilirubin (TBIL), total protein (TP), triglycerides (TRIG), total cholesterol (CHOL), urea nitrogen (BUN) and uric acid (UA). Accordingly, we can offer the following Piccolo reagent discs as waived tests to the medical market: Basic Metabolic Panel, Comprehensive Metabolic Panel, Electrolyte Panel, General Chemistry 6, General Chemistry 13, Kidney Check, Lipid Panel, Lipid Panel Plus and Liver Panel Plus. Waived status permits untrained personnel to run the Piccolo chemistry analyzer using these tests; thus, extending the sites (doctors’ offices and other point-of-care environments) that can use the Piccolo chemistry analyzer.

 

Although we are engaged in an active program to test and apply for CLIA waivers for additional analytes, we cannot assure you that we will successfully receive CLIA waived status from the FDA for other products. Consequently, for the reagent discs that have not received CLIA waived status, the market for our Piccolo products may be confined to those testing facilities that are certified as “laboratories” and our growth can be limited accordingly.

 

Need to Comply with Various Federal, State, Local and International Regulations

 

Federal, state, local and international regulations regarding the manufacture and sale of health care products and diagnostic devices may change. In addition, as we continue to sell in foreign markets, we may have to obtain additional governmental clearances in those markets. Foreign certifications that we have received include the following, among others:

 

 

We cannot predict what impact, if any, such current or future regulatory changes would have on our business. We may not be able to obtain regulatory clearances for our products in the United States or in foreign markets, and the failure to obtain these regulatory clearances will materially adversely affect our business and results of operations.

 

Although we believe that we will be able to comply with all applicable regulations of the FDA and of the State of California, including the Quality System Regulation, current regulations depend on administrative interpretations. Future interpretations made by the FDA, CMS or other regulatory bodies may adversely affect our business.

 

We have incurred and may continue to incur, in future periods, significant share-based compensation charges under SFAS No. 123(R), which may adversely affect our reported financial results.

 

On April 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”), issued by the Financial Accounting Standards Board, which requires the measurement of all share-based payments to employees, using a fair-value-based method and the recording of such expense in our results of operations. The fair value of restricted stock unit awards used in our expense recognition method is measured based on the number of shares granted and the closing market price of the Company’s common stock on the date of grant. Such value is recognized as an expense, net of an estimated forfeiture rate, for those shares expected to vest over the corresponding requisite service period. Our policy is to recognize the expense of restricted stock unit grants based on the vested portions of the awards. During fiscal 2007 and 2008, we granted restricted stock unit awards to employees based on the following time-based vesting schedule over a four-year period: five percent vesting after the first year; additional ten percent after the second year; additional 15 percent after the third year; and the remaining 70 percent after the fourth year of continuous employment. During fiscal 2007 and 2008, share-based compensation expense related to restricted stock units had a material impact on our earnings per share and on our financial statements and we expect that it will continue to adversely impact our reported results of operations, particularly in the fourth year of vesting for the restricted stock unit awarded to employees. As of March 31, 2008, our total unrecognized compensation expense related to restricted stock unit awards granted to employees and directors to date totaled $9.5 million.

 

We depend on key members of our management and scientific staff and, if we fail to retain and recruit qualified individuals, our ability to execute our business strategy and generate sales would be harmed.

 

We are highly dependent on the principal members of our management and scientific staff. The loss of any of these key personnel, including in particular Clinton H. Severson, our President, Chief Executive Officer and Chairman of our Board of Directors, might impede the achievement of our business objectives. We may not be able to continue to attract and retain skilled and experienced marketing, sales and manufacturing personnel on acceptable terms in the future because numerous medical products and other high technology companies compete for the services of these qualified individuals. We currently do not maintain key man life insurance on any of our employees.

 

We are subject to increasingly complex requirements from recent legislation requiring companies to evaluate internal control over financial reporting.

 

Rules adopted by the Securities and Exchange Commission pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require an assessment of internal control over financial reporting by our management and an attestation of the effectiveness of our internal controls over financial reporting by an independent registered public accounting firm. We have an ongoing program to perform the assessment, testing and evaluation to comply with these requirements and we expect to continue to incur significant expenses to Section 404 compliance on an ongoing basis.

 

Our management assessed the effectiveness of our internal control over financial reporting as of our fiscal years ended March 31, 2008 and 2007. Although we received an unqualified opinion on our financial statements for the fiscal years ended March 31, 2008 and 2007, and on the effectiveness of our internal control over financial reporting as of March 31, 2008 and 2007, we cannot predict the outcome of our testing in future periods. In the event that our internal controls over financial reporting are not effective as defined under Section 404, or any failure to

implement required new or improved controls, or difficulties encountered in implementation could harm operating results or prevent us from accurately reporting financial results or cause a failure to meet our reporting obligations in the future. If management cannot assess internal control over financial reporting is effective, or our independent registered public accounting firm is unable to provide an unqualified attestation report on such assessment, investor confidence and our share value may be negatively impacted.

 

We may need additional funding in the future and these funds may not be available to us.

 

We believe that our existing capital resources, available line of credit and anticipated revenue from the sales of our products will be adequate to satisfy our currently planned operating and financial requirements through the next 12 months, although no assurances can be given. The terms of our line of credit contain a number of covenants concerning financial tests that we must meet, and these tests are more fully explained under the subheading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K.

 

Further, we expect to incur incremental additional costs to support our future operations, including:

 

 

To the extent that our existing resources and anticipated revenue from the sale of our products are insufficient to fund our activities or if we are unable to meet the financial covenants of our line of credit, we may have to raise additional funds from the issuance of public or private securities. In the event that we cannot maintain compliance with these financial covenants, we may also be subject to increased interest rate expenses. We may not be able to raise additional funding, or if we are able to, we may not be able to raise funding on acceptable terms. We may also dilute then-existing shareholders if we raise additional funds by issuing new equity securities. Alternately, we may have to relinquish rights to certain of our technologies, products and/or sales territories if we are required to obtain funds through arrangements with collaborative partners. If we are unable to raise needed funds, we may be required to curtail our operations significantly. This would materially adversely affect our operating results and financial condition.

 

We must comply with strict and potentially costly environmental regulations or we could pay significant fines.

 

We are subject to stringent federal, state and local laws, rules, regulations and policies that govern the use, generation, manufacture, storage, air emission, effluent discharge, handling and disposal of certain materials and wastes. In particular, we are subject to laws, rules and regulations governing the handling and disposal of biohazardous materials used in the development and testing of our products. We handle and dispose of human and veterinary blood samples for testing (whole blood, plasma, serum), which cost approximately $90,000 in fiscal 2008, and includes other environmental health and safety expenses to comply with applicable environmental regulations. Although we believe that we have complied with applicable laws and regulations in all material respects and have not been required to take any action to correct any noncompliance, we may have to incur significant costs to comply with environmental regulations if our manufacturing to commercial levels continues to increase. In addition, if a government agency determines that we have not complied with these laws, rules and regulations, we may have to pay significant fines and/or take remedial action that would be expensive and we do not carry environmental-related insurance coverage.

Our facilities and manufacturing operations are vulnerable to natural disasters and other unexpected losses; system failures or delays may harm our business.

 

Our success depends on the efficient and uninterrupted operation of our manufacturing operations, which are co-located with our corporate headquarters in Union City, California. A failure of manufacturing operations, be it in the development and manufacturing of our Piccolo or VetScan blood chemistry analyzers or the reagent discs used in the blood chemistry analyzers, could result in our inability to supply customer demand.

 

We do not have a backup facility to provide redundant manufacturing capacity in the event of a system failure. Accordingly, if our location in Union City, California experienced a system failure or regulatory problem that temporarily shuts down our manufacturing facility, our manufacturing ability would become unavailable until we were able to bring an alternative facility online, a process which could take several weeks or even months. These manufacturing operations are also vulnerable to damage from earthquakes, fire, floods, power loss, telecommunications failures, break-ins and similar events. Although we carry property and business interruption insurance, our coverage may not be adequate to compensate us for all losses that may occur. Additionally, our computer servers may be vulnerable to computer viruses, physical or electronic break-ins and similar disruptions.

 

Fluctuations in foreign exchange rates and the possible lack of financial stability in foreign countries could prevent overseas sales growth.

 

Our international sales are currently primarily U.S. dollar-denominated. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products less competitive in international markets. For the limited amount of our sales denominated in local currencies, we are subject to fluctuations in exchange rates between the U.S. dollar and the particular local currency. Our operating results could also be adversely affected by the seasonality of international sales and the economic conditions of our overseas markets.

 

Our operating results could be materially affected by unanticipated changes in our tax provisions or exposure to additional income tax liabilities.

 

Our determination of our tax liability (like any company’s determination of its tax liability) is subject to review by applicable tax authorities. Any adverse outcome of such a review could have an adverse effect on our operating results and financial condition. In addition, the determination of our provision for income taxes and other tax liabilities requires significant judgment including our determination of whether a valuation allowance against deferred tax assets is required. Although we believe our estimates and judgments are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made.

 

Our stock price is highly volatile and investing in our stock involves a high degree of risk, which could result in substantial losses for investors.

 

The market price of our common stock, like the securities of many other medical products companies, fluctuates over a wide range, and will continue to be highly volatile in the future. During the quarter ended March 31, 2008, the closing sale prices of our common stock on the NASDAQ Global Market ranged from $20.89 to $37.88 per share and the closing sale price for our quarter ended March 31, 2008 was $23.17 per share. During the last eight fiscal quarters ended March 31, 2008, our stock price closed at a high of $39.74 on December 24, 2007 and a low of $16.82 on May 24, 2006 and May 30, 2006. Many factors may affect the market price of our common stock, including:

 

 

 

Because our stock price is so volatile, investing in our common stock is highly risky. A potential investor must be able to withstand the loss of his entire investment in our common stock.

 

Our shareholders rights plan and our ability to issue preferred stock may delay or prevent a change of control of Abaxis.

 

Our shareholder rights plan, adopted by our board of directors on April 22, 2003, may make it more difficult for a third party to acquire, or discourage a third party from attempting to acquire control of, Abaxis. The shareholder rights plan could limit the price that investors might be willing to pay in the future for shares of our common stock.

 

In addition, our board of directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the shareholders, except to the extent required by NASDAQ rules. The issuance of preferred stock, while providing flexibility in connection with possible financings or acquisitions or other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock.

 

 

Not applicable.

 

 

We occupy approximately 91,124 square feet of office, research and development and manufacturing space in a building in Union City, California. The lease agreement is for ten years and commenced in January 2001. We have an option to extend the lease for five additional years. Additionally, starting in September 2007, we lease approximately 5,800 square feet of office space in Darmstadt, Germany, expiring in fiscal 2013. We believe that our current facilities are suitable and adequate to meet our needs for the foreseeable future.

 

 

We are from time to time involved in various litigation matters in the normal course of business. While the outcome of these proceedings and claims cannot be predicted with certainty, we believe that the ultimate resolution of these matters will not have a material effect on our financial position or results of operations.

 

 

No matters were submitted to a vote of our security holders during the quarter ended March 31, 2008.

 

 

Market Information for Common Stock

 

Our common stock is traded on the NASDAQ Global Market under the symbol “ABAX.” The following table sets forth the quarterly high and low intra-day per share sales prices for the common stock from April 1, 2006 through March 31, 2008 as reported on the NASDAQ Global Market:

 

 

As of June 9, 2008, there were 21,768,000 shares of our common stock outstanding, held by 147 shareholders of record.

 

We did not repurchase any of our equity securities during the fourth quarter of fiscal 2008.

 

Dividends

 

Under our debt agreements, we are restricted from paying aggregate cash dividends on our capital stock in excess of 50% of our net income on an annual basis. We have not paid cash dividends on our common stock and do not anticipate paying cash dividends in the foreseeable future.

Stock Performance Graph(1)

 

The graph below compares the cumulative total shareholder return on an investment in our common stock, the Russell 2000 Index and the NASDAQ Medical Equipment Index over the past five year period ended March 31, 2008. The shareholder return shown on the graph below is not necessarily indicative of future performance, and we do not make or endorse any predictions as to future shareholder returns.

 

The graph assumes the investment of $100 on March 31, 2003 in our common stock, the Russell 2000 Index and the NASDAQ Medical Equipment Index and assumes dividends, if any, are reinvested. No dividends have been declared on our common stock to date.

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN

Among Abaxis, Inc., the Russell 2000 Index

and the NASDAQ Medical Equipment Index

 

 

 

 

 

The following selected financial data is qualified by reference to and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and with the financial statements, related notes thereto and other financial information included elsewhere in this Annual Report on Form 10-K.

 

 

 

 

 

The following discussion and analysis should be read in conjunction with our financial statements and related notes thereto included elsewhere in this Annual Report on Form 10-K. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of several factors, including those set forth under Item 1A. “Risk Factors” and elsewhere in this Annual Report on Form 10-K.

 

BUSINESS OVERVIEW

 

Abaxis, Inc. (“Abaxis,” “us,” or “we”) develops, manufactures, markets and sells portable blood analysis systems for use in any human or veterinary patient-care setting to provide clinicians with rapid blood constituent measurements. Our primary product is a blood analysis system, consisting of a compact portable analyzer and a series of single-use plastic discs, called reagent discs, containing all the chemicals required to perform a panel of up to 14 tests on human patients and 13 tests on veterinary patients. We manufacture the system in our manufacturing facilities in Union City, California and we market our blood chemistry analyzers in both the medical market and in the veterinary market, as described below.

 

 

In September 2007, we introduced a veterinary hematology instrument under the name VetScan HM5^tm. The VetScan HM5 offers a 22-parameter complete blood count (CBC) analysis, including a five-part differential cell counter specifically designed for veterinary applications. In May 2004, we introduced a veterinary hematology instrument that offers an 18-parameter CBC analysis, including a three-part white blood cell differential, marketed originally as the VetScan HMII, and is now referred to as the VetScan HM2^tm. We currently purchase the hematology instruments from Diatron MI Kft. of Budapest, Hungary. Through April 2004, we marketed a veterinary hematology instrument under the name VetScan HMT. We continue to support and service our current population of VetScan HM5, VetScan HM2, VetScan HMII and VetScan HMT hematology instruments.

 

Our sales for any future periods are not predictable with a significant degree of certainty, and may depend on a number of factors outside of our control, including inventory or timing considerations by our distributors. We generally operate with a limited order backlog because our products are typically shipped shortly after orders are received. As a result, product sales in any quarter are generally dependent on orders booked and shipped in that quarter. Our expense levels, which are to a large extent fixed, are based in part on our expectations of future revenues. Accordingly, we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. As a result, any such shortfall would negatively affect our operating results and financial condition. In addition, our sales may be adversely impacted by pricing pressure from competitors. Our ability to be consistently profitable will depend, in part, on our ability to increase the sales volumes of our Piccolo and VetScan products and to successfully compete with other competitors. We believe that period to period comparisons of our results of operations are not necessarily meaningful indicators of future results.

 

CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS

 

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. On an on-going basis, we evaluate our estimates and the

sensitivity of these estimates to deviations in the assumptions used in making them. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. However, there can be no assurance that our actual results will not differ from these estimates.

 

We have identified the policies below as critical because they are not only important to understanding our financial condition and results of operations, but also because application and interpretation of these policies requires both judgment and estimates of matters that are inherently uncertain and unknown. Accordingly, actual results may differ materially from our estimates. The impact and any associated risks related to these policies on our business operations are discussed below. For a more detailed discussion on the application of these and other accounting policies, see the Notes to Financial Statements included in this Annual Report on Form 10-K.

 

Revenue Recognition and Deferred Revenue.  Our primary customers are distributors and direct customers in both the medical and veterinary markets. Revenues from product sales, net of estimated sales allowances and rebates, are recognized when (i) evidence of an arrangement exists, (ii) upon shipment of the products to the customer, (iii) the sales price is fixed or determinable and (iv) collection of the resulting receivable is reasonably assured. Rights of return are not provided.

 

We recognize revenue associated with extended maintenance agreements ratably over the life of the contract. Amounts collected in advance of revenue recognition are recorded as a current or non-current liability based on the time from the balance sheet date to the future date of revenue recognition. We provide incentives in the form of free goods or extended maintenance agreements to customers in connection with the sale of our instruments. Revenues from such sales is allocated separately to the instruments and incentives based on the relative fair value of each element. Revenues allocated to incentives is deferred until the goods are shipped to the customer or is recognized ratably over the life of the maintenance contract. At March 31, 2008, 2007 and 2006, the current portion of deferred revenue balances was $807,000, $917,000 and $939,000, respectively, and the non-current portion of deferred revenue balances was $1.1 million, $1.2 million and $938,000, respectively. The fluctuation in balances is due to the types of customer incentives programs offered during the period, depends on when the free goods are shipped to the customer and the maintenance period of the maintenance agreements.

 

We periodically offer trade-in programs to customers for trading in an existing instrument to purchase a new instrument and we will either provide incentives in the form of free goods or reduce the sales price of the instrument. These incentives in the form of free goods are recorded according to the policies described above.

 

Distributor and Customer Rebates.  We offer distributor pricing rebates and customer incentives from time to time. The distributor pricing rebates are offered to distributors upon meeting the sales volume requirements during a qualifying period. The distributor pricing rebates are recorded as a reduction to gross revenues during the qualifying period. Cash rebates are offered to customers who purchase specific instruments during a promotional period. Cash rebates are recorded as a reduction to gross revenues.

 

The distributor pricing rebate program, which started in fiscal 2005, is offered to distributors in the North America veterinary market, upon meeting the sales volume requirements of reagent discs during the qualifying period. Factors used in the rebate calculations include the identification of products sold subject to a rebate during the qualifying period and which rebate percentage applies. Based on these factors and using historical trends, adjusted for current changes, we estimate the amount of the rebate that will be paid and record the liability as a reduction to gross revenues when we record the sale of the product. Settlement of the rebate accruals from the date of sale ranges from one to three months after sale. At March 31, 2008, 2007 and 2006, the accrual balances related to distributor pricing rebates were $140,000, $229,000 and $90,000, respectively. The changes in the rebate accrual at each fiscal year end are based upon distributors meeting the purchase requirements during the quarter.

 

Rebate programs offered to customers vary from period to period in the medical and veterinary markets. Generally, the customer rebate program relates to the sale of certain products or instruments during a specified promotional period. As part of the rebate program, a customer receives a cash rebate upon purchasing certain instruments in the North America market during a promotional period. Factors used in the rebate calculations include the identification of instruments sold subject to a rebate during the qualifying period and the estimated lag time between the sale and payment of a rebate. We estimate the amount of the rebate that will be paid and record the liability as a reduction of gross revenues when we record the sale of the product. Settlement of the rebate accruals

from the date of sale ranges from one to six months after sale. At March 31, 2008, 2007 and 2006, the accrual balances related to customer rebates were $0, $168,000 and $36,000, respectively. The changes in the rebate accrual were due to the type of marketing promotions offered during the fiscal year and timing of the rebate obligations paid to customers.

 

The following table is an analysis of the roll forward activities for the distributor and customer rebate accruals (in thousands):

 

 

Sales and Other Allowances.  We estimate a provision for defective reagent discs as part of sales allowances when we issue credits to customers for defective reagent discs. We also establish, upon shipment of our products to distributors, a provision for potentially defective reagent discs, based on estimates derived from historical experience. The provision for potentially defective reagent discs was recorded in sales allowances, using internal data available to estimate the level of inventory in the distribution channel, the lag time for customers to report defective reagent discs and the historical rates of defective reagent discs. The balances related to sales allowance for defective reagent discs at March 31, 2008, 2007 and 2006 were $27,000, $368,000 and $234,000, respectively. Starting on July 1, 2007, the provision for potentially defective reagent discs is recorded as part of warranty reserves, instead of sales allowances, since we replace defective reagent discs rather than issue a credit to customers. Changes in our estimates for accruals related to provisions for defective reagent discs have not been material to our financial position or results of operations. In the future, the actual defective reagent discs may exceed our estimates, which could adversely affect our financial results.

 

Allowance for Doubtful Accounts.  We maintain an allowance for doubtful accounts based on our assessment of the collectibility of the amounts owed to us by our customers. In determining the amount of the allowance, we make judgments about the creditworthiness of customers which is mostly determined by the customer’s payment history and the outstanding period of accounts. We specifically identify amounts that we believe to be uncollectible and the allowance for doubtful accounts is adjusted accordingly. An additional allowance is recorded based on certain percentages of our aged receivables, using historical experience to estimate the potential uncollectible and our assessment of the general financial condition of our customer base. If our actual collections experience changes, revisions to our allowances may be required, which could adversely affect our operating income.

 

Fair Value of Investments.  Various assumptions are used in the valuation models to estimate the fair value of our investments in auction rate securities, including a security’s expected future cash flows, market rate of return and its term. These assumptions, assessments and the interpretations of relevant market data are subject to uncertainties, are difficult to predict and require significant judgment. The use of different assumptions, applying different judgment to inherently subjective matters and changes in future market conditions could result in significantly different estimates of fair value.

Warranty Reserves.  We provide for the estimated future costs to be incurred under our standard warranty obligation on our instruments. Our standard warranty obligation on instruments is two years. The estimated contractual warranty obligation is recorded when the related revenue is recognized and any additional amount is recorded when such cost is probable and can be reasonably estimated. While we engage in product quality programs and processes, including monitoring and evaluating the quality of our suppliers, our estimated accrual for warranty exposure is based on historical experience, estimated product failure rates, material usage and freight incurred in repairing the instrument after failure and known design changes.

 

A provision for defective reagent discs is recorded when related sales are recognized and any additional amounts are recorded when such costs are probable and can be reasonably estimated, at which time they are included in cost of revenues. Prior to July 1, 2007, we primarily issued a credit to customers for defective reagent discs and, therefore, the provision for estimated costs for defective reagent discs, which includes the replacement costs and freight of a defective reagent disc, was recorded as part of sales and other allowances. Starting on July 1, 2007, the provision for defective reagent discs is recorded as part of warranty reserves, since we replace defective reagent discs rather than issue a credit to customers.

 

We analyze the adequacy of the ending accrual balance of warranty reserves each quarter. The determination of warranty reserves requires us to make estimates of the expected costs to repair or replace the instruments and to replace defective reagent discs under warranty. If actual repair or replacement costs of instruments or replacement costs of reagent discs differ significantly from our estimates, adjustments to cost of revenues may be required.

 

Inventories.  We state inventories at the lower of cost or market, cost being determined using standard costs which approximates the first-in, first-out (FIFO) method. Inventories include material, labor and overhead. We establish provisions for excess, obsolete and unusable inventories after evaluation of future demand and market conditions. If future demand or actual market conditions are less favorable than those estimated by management or if a significant amount of the material were to become unusable, additional inventory write-downs may be required, which would have a negative effect on our operating income.

 

Long-Lived Assets.  The carrying value of our long-lived assets is reviewed for impairment, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We look to current and future profitability, as well as current and future undiscounted cash flows, excluding financing costs, as primary indicators of recoverability. An impairment loss would be recognized when the sum of the undiscounted future net cash flows expected to result from the use of the asset and its eventual disposal is less than the carrying amount. If impairment is determined to exist, any related impairment loss is calculated based on fair value.

 

Income Taxes.  We account for income taxes under the provisions of SFAS No. 109, “Accounting for Income Taxes.” Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amounts to be recovered.

 

Share-Based Compensation Expense.  On April 1, 2006, we adopted SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”) using the modified prospective method and therefore have not restated prior periods’ results. Under the fair value provisions of SFAS No. 123(R), we recognize share-based compensation expense, net of an estimated forfeiture rate, for those shares expected to vest over the requisite service period of the award to employees and directors. Prior to April 1, 2006, we accounted for share-based awards to employees and directors using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and other related guidance and therefore, no employee compensation cost had been recognized for share-based awards in financial statements prior to April 1, 2006 because we issued stock options with an exercise price equal to the market value at the date of grant.

 

We use the Black-Scholes option pricing model to determine the fair value of stock options granted prior to March 31, 2006. Determining the appropriate fair value model and calculating the fair value of share-based awards requires highly subjective assumptions, as described below.

 

For restricted stock units, the assumptions to calculate compensation expense is based on the fair value of our stock at the grant date. As a result, if factors change and we use different assumptions, our share-based compensation expense could be materially different in the future.

 

As required by SFAS No. 123(R), employee share-based compensation expense recognized is calculated based on the awards expected to vest and reduced for estimated forfeitures. The forfeiture rate is estimated based on historical data of our share-based awards that are granted and cancelled prior to vesting and upon historical experience of employee turnover. Changes in estimated forfeiture rates and differences between estimated forfeiture rates and actual experience may result in significant, unanticipated increases or decreases in share-based compensation expense from period to period. To the extent we revise our estimate of the forfeiture rate in the future, our share-based compensation expense could be materially impacted in the quarter of revision, as well as in following quarters.

 

The adoption of SFAS No. 123(R) at the beginning of fiscal 2007 had a material impact on our earnings per share and on our financial statements for fiscal 2008 and 2007, and we expect that it will materially impact our financial statements in the foreseeable future. The impact of SFAS No. 123(R) on our financial results is disclosed in Note 10 “Share-Based Compensation” in the Notes to Financial Statement in this Annual Report on Form 10-K.

 

RESULTS OF OPERATIONS

 

Abaxis develops, manufactures, markets and sells portable blood analysis systems for use in the human or veterinary patient-care setting to provide clinicians with rapid blood constituent measurements. We operate in two segments: (i) the medical market and (ii) the veterinary market. See “Segment Results” in this section for a detailed discussion.

 

Total Revenues

 

Revenues by Geographic Region and by Product Category.  Revenues by geographic region based on customer location and revenues by product category during fiscal 2008, 2007 and 2006 were as follows (in thousands, except percentages):

 

 

 

Fiscal 2008 Compared to Fiscal 2007

 

North America.  During fiscal 2008, total revenues in North America increased 16%, or $11.8 million, as compared to fiscal 2007. Components of the change in North America were as follows:

 

Instruments.  During fiscal 2008, total revenues from instruments sold in North America increased 5%, or $1.1 million, as compared to fiscal 2007. The primary factors of the change were as follows:

 

(i) Sales of our Piccolo chemistry analyzers in North America (excluding the U.S. government) increased 24%, or $1.4 million, primarily due to increased sales to distributors. Sales of our Piccolo chemistry analyzers to the U.S. government increased 60%, or $469,000, primarily due to an increase in the U.S. Military’s needs for our products in the fourth quarter of fiscal 2008, which were not predictable.

 

(ii) Sales of our VetScan chemistry analyzers in North America decreased 22%, or $2.1 million, primarily due to a shift in our sales and marketing focus from an instrument only emphasis to a focus on both instrument and reagent discs as a result of the manufacturing issues that we experienced in previous quarters.

 

(iii) Sales of our hematology systems in North America increased 19%, or $1.3 million, primarily due to the release of our VetScan HM5 in September 2007.

 

Reagent discs and kits.  During fiscal 2008, total revenues from reagent discs and kits sold in North America increased 20%, or $8.7 million, as compared to fiscal 2007. The primary factors of the change were as follows:

 

(i) Medical reagent discs sales in North America (excluding the U.S. government) increased 37%, or $2.3 million, primarily due to the expanded installed base of our Piccolo chemistry analyzers. Medical reagent discs sold to the U.S. government decreased 10%, or $239,000.

 

(ii) Veterinary reagent discs sales in North America increased 21%, or $6.5 million, primarily due to the expanded installed base of our VetScan chemistry analyzers.

 

(iii) Sales of hematology reagent kits in North America increased 5%, or $161,000.

 

Other products.  During fiscal 2008, total revenues from other products sold in North America increased 38%, or $1.8 million, as compared to fiscal 2007. The net increase in other products was primarily due to an increase in demand from Becton, Dickinson and Company for products using the Orbos Discrete Lyophilization Process (the “Orbos Process”), which is based on seasonal demands.

 

Development and licensing.  In fiscal 2008, total revenues from development and licensing in North America increased 12%, or $223,000, as compared to fiscal 2007. The increase from development and licensing revenue is primarily due to a licensing agreement to Cepheid, related to our proprietary technology, the Orbos Process.

Significant concentration.  One distributor in the United States, DVM Resources, accounted for 12% of our total worldwide revenues during fiscal 2008.

 

Europe.  During fiscal 2008, total revenues in Europe increased 30%, or $3.1 million, as compared to fiscal 2007. Components of the change in Europe were as follows:

 

Instruments.  During fiscal 2008, total revenues from instruments sold in Europe increased 20%, or $796,000, as compared to fiscal 2007. The primary factors of the change were as follows:

 

(i) Sales of our Piccolo chemistry analyzers in Europe increased 83%, or $642,000, primarily due to increased sales to distributors.

 

(ii) Sales of our VetScan chemistry analyzers in Europe decreased 4%, or $123,000.

 

(iii) Sales of our hematology systems in Europe increased 79%, or $277,000.

 

Reagent discs and kits.  During fiscal 2008, total revenues from reagent discs and kits sold in Europe increased 36%, or $2.3 million, as compared to fiscal 2007. The primary factors of the change were as follows:

 

(i) Medical reagent discs sales in Europe increased 54%, or $428,000, primarily due to the expanded installed base of our Piccolo chemistry analyzers.

 

(ii) Veterinary reagent discs sales in Europe increased 35%, or $1.9 million, primarily due to the expanded installed base of our VetScan chemistry analyzers.

 

(iii) Sales of hematology reagent kits in Europe were substantially the same as in the prior year.

 

Other products.  During fiscal 2008, total revenues from other products sold in Europe increased 38%, or $19,000, as compared to fiscal 2007.

 

Asia Pacific and rest of the world.   During fiscal 2008, total revenues in Asia Pacific and rest of the world decreased 15%, or $587,000, as compared to fiscal 2007. Components of the change in Asia Pacific and rest of the world were as follows:

 

Instruments.  During fiscal 2008, total revenues from instruments sold in Asia Pacific and rest of the world decreased 41%, or $779,000, as compared to fiscal 2007. The primary factors of the change were as follows:

 

(i) Sales of our Piccolo chemistry analyzers in Asia Pacific and rest of the world increased 105%, or $84,000.

 

(ii) Sales of our VetScan chemistry analyzers in Asia Pacific and rest of the world decreased 60%, or $729,000. The decrease in veterinary chemistry analyzers was primarily in Japan due to the termination of a distribution arrangement during the first quarter of fiscal 2008.

 

(iii) Sales of our hematology systems in Asia Pacific and rest of the world decreased 22%, or $134,000. The decrease in hematology instruments was primarily in Japan due to the termination of a distribution arrangement during the first quarter of fiscal 2008.

 

Reagent discs and kits.  During fiscal 2008, total revenues from reagent discs and kits sold in Asia Pacific and rest of the world increased 11%, or $208,000, as compared to fiscal 2007. The primary factors of the change were as follows:

 

(i) Medical reagent discs sales in Asia Pacific and rest of the world increased 43%, or $45,000.

 

(ii) Veterinary reagent discs sales in Asia Pacific and rest of the world increased 15%, or $236,000, primarily due to the expanded installed base of our VetScan chemistry analyzers.

 

(iii) Sales of hematology reagent kits in Asia Pacific and rest of the world decreased 35%, or $73,000.

 

Other products.  During fiscal 2008, total revenues from other products sold in Asia Pacific and rest of the world decreased 55%, or $16,000, as compared to fiscal 2007.

Fiscal 2007 Compared to Fiscal 2006

 

North America.  During fiscal 2007, total revenues in North America increased 23%, or $13.3 million, as compared to fiscal 2006. Components of the change in North America were as follows:

 

Instruments.  During fiscal 2007, total revenues from instruments sold in North America increased 30%, or $5.3 million, as compared to fiscal 2006. The primary factors of the change were as follows:

 

(i) Sales of our Piccolo chemistry analyzers in North America (excluding the U.S. government) increased 66%, or $2.3 million, partially due to marketing programs with two of our national distributors in fiscal 2007, offset by a decrease in the average selling price of Piccolo chemistry analyzers in North America (excluding the U.S. government). Sales of our Piccolo chemistry analyzers to the U.S. government decreased 16%, or $144,000, primarily due to a decrease in the U.S. Military’s needs for our products in the second quarter of fiscal 2007, which were not predictable.

 

(ii) Sales of our VetScan chemistry analyzers in North America increased 29%, or $2.2 million, primarily due to (a) an increase in sales personnel to promote our products and (b) an increase in the average selling price of our VetScan chemistry analyzers.

 

(iii) Sales of our hematology systems in North America increased 16%, or $944,000, attributed primarily to a slower market acceptance of the hematology systems in the prior fiscal year.

 

Reagent discs and kits.  During fiscal 2007, total revenues from reagent discs and kits sold in North America increased 19%, or $6.9 million, as compared to fiscal 2006. The primary factors of the change were as follows:

 

(i) Medical reagent discs sales in North America (excluding the U.S. government) increased 89%, or $2.9 million, primarily due to the expanded installed base of our Piccolo chemistry analyzers. Medical reagent discs sold to the U.S. government increased 23%, or $423,000, due to an increase in the U.S. Military’s needs for our products during the first and third quarters of fiscal 2007, which were not predictable.

 

(ii) Veterinary reagent discs sales in North America increased 9%, or $2.6 million, partially due to the expanded installed base of our VetScan chemistry analyzers, offset by a realignment of inventory in the distribution channel primarily during the first two quarters of fiscal 2007.

 

(iii) Sales of hematology reagent kits in North America increased 43%, or $968,000, primarily due to the expanded installed base of our hematology systems.

 

Other products.  During fiscal 2007, total revenues from other products sold in North America increased 16%, or $643,000, as compared to fiscal 2006. The increase was primarily due to an increase in demand from Becton, Dickinson and Company for products using the Orbos Process, which is based on seasonal demands, partially offset by an increase in maintenance contracts offered to customers from time to time as part of incentives in the form of free goods in connection with the sale of our products.

 

Development and licensing.  During fiscal 2007, total revenues from development and licensing in North America increased 32%, or $434,000, as compared to fiscal 2006. The increase from development and licensing revenue is primarily due to a licensing agreement to Cepheid, related to our proprietary technology, the Orbos Process.

 

Significant concentration.  One distributor in the United States, DVM Resources, accounted for 15% of our total worldwide revenues during fiscal 2007.

 

We had a distribution partnership with the veterinary division of Henry Schein, Inc. from April 2004 through May 2006. In May 2006, both Abaxis and Henry Schein determined that it was in the best interest of both companies to discontinue the distribution agreement due to Henry Schein’s acquisition of a regional distributor of a competing company in the veterinary market. To support those customers who were previously supplied products by Henry Schein, we have had our current distributors supply and service these sites, or depending on the customer’s needs and geographical location, we continue to support and service these customers on a direct basis as well.

Europe.  During fiscal 2007, total revenues in Europe increased 41%, or $3.0 million, as compared to fiscal 2006. Components of the change in Europe were as follows:

 

Instruments.  During fiscal 2007, total revenues from instruments sold in Europe increased 40%, or $1.1 million, as compared to fiscal 2006. The primary factors of the change were as follows:

 

(i) Sales of our Piccolo chemistry analyzers in Europe increased 121%, or $424,000, primarily due to (a) the fluctuation of the sales cycle of our Piccolo chemistry analyzers and (b) an increase in demand from distributors.

 

(ii) Sales of our VetScan chemistry analyzers in Europe increased 33%, or $702,000. The increase was partially offset by a decrease in sales in the second quarter of fiscal 2007 due to manufacturing issues associated with the introduction of the new VetScan VS2 product line.

 

(iii) Sales of our hematology systems in Europe increased 4%, or $13,000.

 

Reagent discs and kits.  During fiscal 2007, total revenues from reagent discs and kits sold in Europe increased 41%, or $1.8 million, as compared to fiscal 2006. The primary factors of the change were as follows:

 

(i) Medical reagent discs sales in Europe increased 127%, or $445,000, primarily due to the expanded installed base of our Piccolo chemistry analyzers.

 

(ii) Veterinary reagent discs sales in Europe increased 33%, or $1.3 million, primarily due to the expanded installed base of our VetScan chemistry analyzers.

 

(iii) Sales of hematology reagent kits in Europe increased 69%, or $83,000.

 

Other products.  In fiscal 2007, total revenues from other products sold in Europe increased 138%, or $29,000, as compared to fiscal 2006.

 

Asia Pacific and rest of the world.  During fiscal 2007, total revenues in Asia Pacific and rest of the world increased 36%, or $1.0 million, as compared to fiscal 2006. Components of the change in Asia Pacific and rest of the world were as follows:

 

Instruments.  During fiscal 2007, total revenues from instruments sold in Asia Pacific and rest of the world increased 50%, or $631,000, as compared to fiscal 2006. The primary factors of the change were as follows:

 

(i) Sales of our Piccolo chemistry analyzers in Asia Pacific and rest of the world were substantially the same as in the prior year.

 

(ii) Sales of our VetScan chemistry analyzers in Asia Pacific and rest of the world increased 146%, or $725,000, primarily due to increased sales by our distribution partner in Japan. In the second quarter of fiscal 2006, our distributor in Japan received clearance from the Japanese regulatory agency to import and market our Piccolo and VetScan chemistry analyzers.

 

(iii) Sales of our hematology systems in Asia Pacific and rest of the world decreased 14%, or $94,000.

 

Reagent discs and kits.  During fiscal 2007, total revenues from reagent discs and kits sold in Asia Pacific and rest of the world increased 23%, or $361,000, as compared to fiscal 2006. The primary factors of the change were as follows:

 

(i) Medical reagent discs sales in Asia Pacific and rest of the world decreased 9%, or $10,000.

 

(ii) Veterinary reagent discs sales in Asia Pacific and rest of the world increased 22%, or $287,000, primarily due to the expanded installed base of our VetScan chemistry analyzers.

 

(iii) Sales of hematology reagent kits in Asia Pacific and rest of the world increased 67%, or $84,000.

 

Other products.  During fiscal 2007, total revenues from other products sold in Asia Pacific and rest of the world increased 142%, or $17,000, as compared to fiscal 2006.

Segment Results

 

Fiscal 2008 Compared to Fiscal 2007

 

The following table presents revenues, cost of revenues, gross profit and percentage of revenues by operating segments for fiscal 2008 and 2007 (in thousands, except percentages):

 

 

 

 

Medical Market

 

Revenues for Medical Market Segment

 

During fiscal 2008, total revenues in the medical market increased 30%, or $5.3 million, as compared to fiscal 2007. Components of the change were as follows:

 

Instruments.  Total revenues from our Piccolo chemistry analyzers increased 35%, or $2.6 million, during fiscal 2008, as compared to fiscal 2007. We sold a total of 811 Piccolo chemistry analyzers during fiscal 2008, as compared to 644 Piccolo chemistry analyzers sold during fiscal 2007. The changes in revenues were attributed to (a) an increase in revenues in North America (excluding the U.S. government) of 24%, or $1.4 million, primarily due to increased sales to distributors; (b) an increase in Piccolo chemistry analyzers sold to the U.S. government of 60%, or $469,000, primarily due to an increase in the U.S. Military’s needs for our products in the fourth quarter of fiscal 2008, which were not predictable; (c) an increase in revenues in Europe of 83%, or $642,000, primarily due to increased sales to distributors; and (d) an increase in revenues in Asia Pacific and rest of the world of 105%, or $84,000.

 

Reagent discs.  Total revenues from reagent discs sold in the medical market increased 27%, or $2.5 million, during fiscal 2008, as compared to fiscal 2007. We sold 1.3 million medical reagent discs during fiscal 2008, as compared to 1.0 million medical reagent discs sold during fiscal 2007. The total increase in revenues from medical

reagent discs was primarily attributed to the expanded installed base of our Piccolo chemistry analyzers and was comprised of (a) an increase in revenues in North America (excluding the U.S. government) of 37%, or $2.3 million; (b) an increase in revenues in Europe of 54%, or $428,000; and (c) an increase in revenues in Asia Pacific and rest of the world of 43%, or $45,000. The increase in revenues was partially offset by a decrease in medical reagent discs sold to the U.S. government of 10%, or $239,000.

 

Gross Profit for Medical Market Segment

 

Gross profit for the medical market segment increased 28%, or $2.5 million, during fiscal 2008, as compared to fiscal 2007. Gross profit percentages for the medical market segment during fiscal 2008 and 2007 were 50% and 51%, respectively. In absolute dollars, the increase in gross profit for the medical market segment was primarily due to (a) an increase in Piccolo chemistry analyzers and medical reagent discs sold during fiscal 2008 and (b) higher average selling prices of Piccolo chemistry analyzers sold during fiscal 2008, partially offset by (c) higher manufacturing costs on the Piccolo xpress chemistry analyzers during fiscal 2008.

 

Veterinary Market

 

Revenues for Veterinary Market Segment

 

During fiscal 2008, total revenues in the veterinary market increased 11%, or $7.2 million, as compared to fiscal 2007. Components of the change were as follows:

 

Instruments.  Total revenues from our veterinary instruments sold decreased 7%, or $1.5 million, during fiscal 2008, as compared to fiscal 2007. We sold a total of 2,332 VetScan chemistry analyzers and hematology instruments during fiscal 2008, as compared to 2,485 veterinary instruments sold during 2007. The primary factors of the change were as follows:

 

(i) Sales of our VetScan chemistry analyzers decreased 22%, or $3.0 million, comprised of (a) a decrease in revenues in North America of 22%, or $2.1 million, primarily due to a shift in our sales and marketing focus from an instrument only emphasis to a focus on both instrument and reagent discs as a result of the manufacturing issues that we experienced in previous quarters; (b) a decrease in revenues in Europe of 4%, or $123,000; and (c) a decrease in revenues in Asia Pacific and rest of the world of 60%, or $729,000, primarily in Japan due to the termination of a distribution arrangement during the first quarter of fiscal 2008.

 

(ii) Sales of our hematology instruments increased 19%, or $1.5 million, comprised of (a) an increase in revenues in North America of 19%, or $1.3 million, primarily due to the release of the VetScan HM5 in September 2007 and (b) an increase in revenues in Europe of 79%, or $277,000. The increase in revenues was partially offset by a decrease in revenues in Asia Pacific and rest of the world of 22%, or $134,000.

 

Reagent discs and kits.  Total revenues from reagent discs and hematology reagent kits sold in the veterinary market increased 21%, or $8.6 million, during fiscal 2008, as compared to fiscal 2007. The primary factors of the change were as follows:

 

(i) Total revenues from reagent discs sold in the veterinary market increased 23%, or $8.6 million, during fiscal 2008, as compared to fiscal 2007. We sold 3.6 million veterinary reagent discs during fiscal 2008, as compared to 3.1 million veterinary reagent discs sold during fiscal 2007. The increase in revenues from veterinary reagent discs was primarily attributed to the expanded installed base of our VetScan chemistry analyzers and was comprised of (a) an increase in revenues in North America of 21%, or $6.5 million; (b) an increase in revenues in Europe of 35%, or $1.9 million; and (c) an increase in revenues in Asia Pacific and rest of the world of 15%, or $236,000.

 

(ii) Total revenues from hematology reagent kits sold in the veterinary market increased 2%, or $89,000, during fiscal 2008, as compared to fiscal 2007. The increase in revenues from hematology reagent kits was attributed to (a) an increase in revenues in North America of 5%, or $161,000, partially offset by (b) a decrease in revenues in Asia Pacific and rest of the world of 35%, or $73,000. Revenues from hematology reagent kits in Europe were substantially the same as in the prior year.

Gross Profit for Veterinary Market Segment

 

Gross profit for the veterinary market segment increased 13%, or $4.4 million, during fiscal 2008, as compared to fiscal 2007. Gross profit percentages for the veterinary market segment during fiscal 2008 and 2007 were 55%. In absolute dollars, the increase in gross profit for the veterinary market segment was primarily due to (a) an increase in veterinary reagent discs sold during fiscal 2008, partially offset by (b) a decrease in VetScan chemistry analyzers sold during fiscal 2008; (c) higher manufacturing costs on the VetScan VS2 chemistry analyzers during fiscal 2008; and (d) weaker U.S. dollar relative to the Euro currency.

 

Fiscal 2007 Compared to Fiscal 2006

 

The following table presents revenues, cost of revenues, gross profit and percentage of revenues by operating segments for fiscal 2007 and 2006 (in thousands, except percentages):

 

 

 

 

Medical Market

 

Revenues for Medical Market Segment

 

During fiscal 2007, total revenues in the medical market increased 60%, or $6.6 million, as compared to fiscal 2006. Components of the change were as follows:

 

Instruments.  Total revenues from our Piccolo chemistry analyzers increased 53%, or $2.6 million, during fiscal 2007, as compared to fiscal 2006. We sold a total of 644 Piccolo chemistry analyzers in fiscal 2007, as compared to 391 Piccolo chemistry analyzers sold in fiscal 2006. The change in revenues was attributed to (a) an increase in North America (excluding the U.S. government) of 66%, or $2.3 million, primarily due to marketing programs with two of our national distributors; (b) an increase in Europe of 121%, or $424,000; partially offset by (c) a decrease in the average selling price of Piccolo chemistry analyzers in North America (excluding the

U.S. government); and (d) a decrease in Piccolo chemistry analyzers sold to the U.S. government of 16%, or $144,000, primarily due to a decrease in the U.S. Military’s needs for our products in the second quarter of fiscal 2007, which were not predictable.

 

Reagent discs and kits.  Total revenues from reagent discs sold in the medical market increased 67%, or $3.8 million, during fiscal 2007, as compared to fiscal 2006. We sold 1.0 million reagent discs in fiscal 2007, as compared to 575,000 reagent discs sold in fiscal 2006. The change in revenues was attributed to (a) an increase in North America (excluding the U.S. government) of 89%, or $2.9 million, primarily due to the expanded installed base of our Piccolo chemistry analyzers; (b) an increase in reagent discs sold to the U.S. government of 23%, or $423,000, primarily due to an increase in the U.S. Military’s needs for our products during the first and third quarters of fiscal 2007, which were not predictable; and (c) an increase in Europe of 127%, or $445,000, primarily due to the expanded installed base of our Piccolo chemistry analyzers. The net increase was partially offset by a decrease in Asia Pacific and rest of the world of 9%, or $10,000.

 

Gross Profit for Medical Market Segment

 

Gross profit for the medical market segment increased 48%, or $2.9 million, during fiscal 2007, as compared to fiscal 2006. Gross profit percentages for the medical market segment during fiscal 2007 and 2006 were 51% and 55%, respectively. In absolute dollars, the increase in gross profit for the medical market segment was due to (a) an increase in Piccolo chemistry analyzers and medical reagent discs sold during fiscal 2007, partially offset by (b) an increase in costs associated with manufacturing the Piccolo xpress during fiscal 2007, resulting in a decrease in gross profit percentage during fiscal 2007.

 

Veterinary Market

 

Revenues for Veterinary Market Segment

 

During fiscal 2007, total revenues in the veterinary market increased 19%, or $10.0 million, as compared to fiscal 2006. Components of the change were as follows:

 

Instruments.  Total revenues from our veterinary instruments sold increased 26%, or $4.5 million, during fiscal 2007, as compared to fiscal 2006. We sold a total of 2,485 VetScan chemistry analyzers and hematology systems in fiscal 2007, as compared to 2,131 veterinary instruments sold in fiscal 2006. The primary factors of the change were as follows:

 

(i) Sales of our VetScan chemistry analyzers increased 36%, or $3.6 million, comprised of (a) an increase in North America of 29%, or $2.2 million; (b) an increase in Europe of 33%, or $702,000; and (c) an increase in Asia Pacific and rest of the world of 146%, or $725,000. The increase in VetScan chemistry analyzers was attributed primarily to the worldwide release of the VetScan VS2 system.

 

(ii) Sales of our hematology systems increased 12%, or $863,000, comprised of (a) an increase in North America of 16%, or $944,000; (b) an increase in Europe of 4%, or $13,000, partially offset by (c) a decrease in Asia Pacific and rest of the world of 14%, or $94,000. The net increase was attributed primarily to a slower market acceptance of the hematology systems in the prior period in North America.

 

Reagent discs and kits.  Total revenues from reagent discs and hematology reagent kits sold in the veterinary market increased 15%, or $5.4 million, in fiscal 2007, as compared to fiscal 2006. The primary factors of the change were as follows:

 

(i) Total revenues from reagent discs sold in the veterinary market increased 13%, or $4.2 million, during fiscal 2007, as compared to fiscal 2006. We sold 3.1 million reagent discs in fiscal 2007, as compared to 2.8 million reagent discs sold in fiscal 2006. The increase in revenue from reagent discs was attributed to the following: (a) an increase in North America of 9%, or $2.6 million, partially due to the expanded installed base of our VetScan chemistry analyzers, offset by a realignment of inventory in the distribution channel primarily during the first two quarters of fiscal 2007; (b) an increase in Europe of 33%, or $1.3 million, primarily due to the expanded installed

base of our VetScan chemistry analyzers; and (c) an increase in Asia Pacific and rest of the world of 22%, or $287,000, primarily due to the expanded installed base of our VetScan chemistry analyzers.

 

(ii) Total revenues from hematology reagent kits sold in the veterinary market increased 45%, or $1.1 million, during fiscal 2007, as compared to fiscal 2006. We sold 17,000 hematology reagent kits in fiscal 2007, as compared to 12,000 hematology reagent kits in fiscal 2006. The increase of hematology reagent kits sold was due to the expanded installed base of our hematology systems, comprised of (a) an increase in North America of 43%, or $968,000; (b) an increase in Europe of 69%, or $83,000; and (c) an increase in Asia Pacific and rest of the world of 67%, or $84,000.

 

Gross Profit for Veterinary Market Segment

 

Gross profit for the veterinary market segment increased 16%, or $4.8 million, during fiscal 2008, as compared to fiscal 2007. Gross profit percentages for the veterinary market segment during fiscal 2007 and 2006 were 55% and 56%, respectively. In absolute dollars, the increase in gross profit for the veterinary market segment was due to (a) an increase in VetScan chemistry analyzers, reagent discs and hematology reagent kits sold during fiscal 2007, partially offset by (b) higher manufacturing costs on the VetScan VS2 chemistry analyzers during fiscal 2007.

 

Cost of Revenues

 

The following sets forth, our cost of revenues for fiscal 2008, 2007 and 2006 (in thousands, except percentages):

 

 

Cost of revenues includes the costs associated with manufacturing, assembly, packaging, warranty repairs, test and quality assurance for our instruments, reagent discs and hematology reagent kits and manufacturing overhead, including costs of personnel and equipment associated with manufacturing support.

 

Fiscal 2008 Compared to Fiscal 2007

 

Cost of revenues in fiscal 2008 increased by 16%, or $6.1 million, as compared to fiscal 2007, primarily due to the following: (a) an increase in the sales volume of medical and veterinary reagent discs; (b) an increase in costs associated with manufacturing the VetScan VS2 and Piccolo xpress chemistry analyzers; and (c) the weaker U.S. dollar relative to the Euro currency.

 

Fiscal 2007 Compared to Fiscal 2006

 

Cost of revenues in fiscal 2007 increased by 31%, or $9.3 million, as compared to fiscal 2006, primarily due to the following: (a) an increase in the sales volume of medical and veterinary instruments and reagent discs and hematology reagent kits; (b) an increase in costs associated with manufacturing the VetScan VS2 and Piccolo xpress; and (c) the weaker U.S. dollar relative to the Euro currency. As a percentage of total revenues, cost of

revenues increased in fiscal 2007, as compared to fiscal 2006, primarily due to costs associated with manufacturing the VetScan VS2 and Piccolo xpress.

 

Operating Expenses

 

Research and Development

 

The following sets forth, our research and development expenses for fiscal 2008, 2007 and 2006 (in thousands, except percentages):

 

 

Research and development expenses consist of personnel costs (including salaries, benefits and share-based compensation expense), consulting expenses and materials and related expenses associated with the development of new tests and test methods, clinical trials, product improvements and enhancement of existing products.

 

Fiscal 2008 Compared to Fiscal 2007

 

Research and development expenses in fiscal 2008 increased by 13%, or $786,000, as compared to fiscal 2007. Research and development expenses in fiscal 2008 related primarily to new product development and enhancement of existing products and clinical trials. The investments in research and development were attributed primarily to new product development in both the medical and veterinary markets and costs related to compliance with FDA regulations and clinical trials. Share-based compensation expense during fiscal 2008 and 2007 was $153,000 and $117,000, respectively.

 

We anticipate the dollar amount of research and development expenses to increase in fiscal 2009 from fiscal 2008 but remain consistent as a percentage of total revenues, as we complete new products for both the medical and veterinary markets. There can be no assurance, however, that we will undertake such research and development activities in future periods or, if we do, that such activities will be successful.

 

Fiscal 2007 Compared to Fiscal 2006

 

Research and development expenses in fiscal 2007 increased by 1%, or $53,000, as compared to fiscal 2006. Research and development expenses during fiscal 2007 related primarily to new product development in both the medical and veterinary markets. The investments in research and development were attributed primarily to projects including clinical trials, developing new immunoassay tests and preparation of submission for CLIA waived status on new test methods. Share-based compensation expense incurred in connection with our adoption of SFAS No. 123(R) in fiscal 2007 was $117,000.

 

Sales and Marketing

 

The following sets forth, our sales and marketing expenses for fiscal 2008, 2007 and 2006 (in thousands, except percentages):