ABAXIS (ABAX)

 

 

x	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

o	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

Basis of Presentation>.  We have prepared the unaudited condensed consolidated financial statements included herein pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim periods.  The unaudited condensed consolidated financial statements included herein reflect all normal recurring adjustments, which are, in the opinion of our management, necessary to state fairly the results of operations and financial position for the periods presented.  The results for the three month period ended June 30, 2011 are not necessarily indicative of the results to be expected for the entire fiscal year ending March 31, 2012 or for any interim or future period.

 

These unaudited condensed consolidated financial statements should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2011.

 

Reclassifications.>  Certain reclassifications have been made to prior periods’ financial statements to conform to the current period presentation.  These reclassifications did not result in any change in previously reported net income, total assets or shareholders’ equity.

 

Use of Estimates.>  The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  Such management estimates include allowance for doubtful accounts, sales and other allowances, estimated selling price of our products, fair value of investments, valuation of inventory, fair value of intangible assets, useful lives of intangible assets, income taxes, valuation allowance for deferred tax assets, share-based compensation and warranty reserves.  Our management bases their estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.  Our actual results may differ materially from these estimates.

 

Significant Accounting Policies.  >The significant accounting policies used in preparation of these condensed consolidated financial statements are disclosed in our Annual Report on Form 10-K for the year ended March 31, 2011 filed with the SEC on June 13, 2011, and have not changed significantly as of June 30, 2011, except for the accounting standard on revenue recognition explained below.

 

Revenue Recognition:>  In October 2009, the Financial Accounting Standards Board (the “FASB”) amended the accounting standards for certain multiple deliverable revenue arrangements to:

 

·

provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the consideration should be allocated;

 

·

require an entity to allocate revenue in an arrangement using estimated selling price (“ESP”) of deliverables if a vendor does not first have vendor-specific objective evidence (“VSOE”) of selling price or secondly does not have third-party evidence (“TPE”) of selling price; and

 

·

eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.

 

Our multiple-element arrangement includes the sale of one or more tangible product offerings with one or more associated services offerings, each of which are individually considered separate units of accounting.  The determination of our units of accounting did not change with the adoption of the new revenue recognition guidance and as such we allocate revenue to each element in a multiple-element arrangement based upon the relative selling price of each deliverable.  When applying the relative selling price method, we determine the selling price for each deliverable using VSOE of selling price, if it exists, or TPE of selling price.  If neither VSOE nor TPE of selling price exist for a deliverable, we use our best estimate of selling price for that deliverable.  Revenue allocated to each element is then recognized when all revenue recognition criteria are met for each element.

 

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These amendments are effective for the Company beginning on April 1, 2011 and we elected to apply the amendment prospectively to new or materially modified revenue arrangements after its effective date.  The adoption of this amendment did not have a material impact on our consolidated financial position, results of operations and cash flows for the three months ended June 30, 2011.

 

NOTE 2.  RECENT ACCOUNTING PRONOUNCEMENTS

 

Disclosure of Supplementary Pro Forma Information for Business Combinations:>  In December 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations,” (Topic 805) - Business Combinations (ASU 2010-29), to improve consistency in how the pro forma disclosures are calculated.  The amendment enhances the disclosure requirements and requires description of the nature and amount of any material, nonrecurring pro forma adjustments directly attributable to a business combination.  The amendment became effective for the Company beginning on April 1, 2011 and is applied prospectively to business combinations for which the acquisition date is after the effective date.  The Company will assess the impact of the amendment if and when future business combinations occur.

 

NOTE 3.  INVESTMENTS

 

The following table summarizes short-term and long-term investments by major security type (in thousands):

 

		June 30, 2011				March 31, 2011
		Amortized Cost				Amortized Cost
Short-term investments
Held-to-maturity:
Certificates of deposits		$	7,410			$	11,834
Commercial paper			1,999				1,997
Corporate bonds			6,077				6,132
Municipal bonds			1,205				6,018
Total short-term investments in held-to-maturity		$	16,691			$	25,981
Long-term investments
Held-to-maturity:
Certificates of deposits		$	250			$	250
Corporate bonds			23,547				17,402
Municipal bonds			7,332				5,585
U.S. agency securities			16,000				13,000
Total long-term investments in held-to-maturity		$	47,129			$	36,237

 

For our short-term and long-term investments classified as held-to-maturity as of June 30, 2011, we had total gross unrecognized holding gains of $197,000 and total gross unrecognized losses of $83,000.  The amortized cost of our investments approximates their fair value.  As of June 30, 2011 and March 31, 2011, we did not have other-than-temporary impairment in the fair value of any individual security classified as held-to-maturity and we had no unrealized gain (loss) on investments.  Redemptions in accordance with the callable provisions of the U.S. agency securities during the three months ended June 30, 2011 and 2010, were $0 and $12.5 million, respectively.

 

The contractual maturities of short-term and long-term investments as of June 30, 2011 and March 31, 2011, are as follows (in thousands):

 

		June 30, 2011				March 31, 2011
Investments		Amortized Cost				Amortized Cost
Due in less than one year		$	16,691			$	25,981
Due in 1 to 4 years			47,129				36,237
Total investments		$	63,820			$	62,218

 

NOTE 4.  FAIR VALUE MEASUREMENTS

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (“exit price”) in an orderly transaction between market participants at the measurement date.  FASB Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures,” establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs).  The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).  The three levels of the fair value hierarchy are described below:

 

 

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Level 1:  Quoted prices (unadjusted) in active markets for identical assets or liabilities.

 

Level 2:  Directly or indirectly observable inputs as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in markets that are not active.  Level 2 also includes assets and liabilities that are valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates and volatility factors, are corroborated by readily observable data from actively quoted markets for substantially the full term of the financial instrument.

 

Level 3:  Unobservable inputs that are supported by little or no market data and require the use of significant management judgment.  These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.

 

The following table summarizes financial assets, measured at fair value on a recurring basis, by level within the fair value hierarchy as of June 30, 2011 and March 31, 2011 (in thousands):

 

		As of June 30, 2011
		Quoted Prices in Active Markets for Identical Assets				Significant Other Observable Inputs				Significant Unobservable Inputs
		Level 1				Level 2				Level 3				Total
Assets
Cash equivalents		$	7,303			$	-			$	-			$	7,303
Total assets at fair value		$	7,303			$	-			$	-			$	7,303

 

		As of March 31, 2011
		Quoted Prices in Active Markets for Identical Assets				Significant Other Observable Inputs				Significant Unobservable Inputs
		Level 1				Level 2				Level 3				Total
Assets
Cash equivalents		$	2,415			$	-			$	-			$	2,415
Total assets at fair value		$	2,415			$	-			$	-			$	2,415

 

Our Level 1 financial assets are cash equivalents, comprised of money market mutual funds, which are highly liquid instruments with original or remaining maturities of three months or less at the time of purchase that are readily convertible into cash.  The fair value of our Level 1 financial assets is based on quoted market prices of the underlying security.  As of June 30, 2011 and March 31, 2011, we did not have any Level 2 or Level 3 financial assets or liabilities measured at fair value on a recurring basis.  During the three months ended June 30, 2011 and 2010, we did not have any Level 3 financial assets or liabilities on a recurring basis.

 

NOTE 5.  INVENTORIES

 

Inventories include material, labor and overhead, and are stated at the lower of cost (first-in, first-out method) or market.  Components of inventories were as follows (in thousands):

 

		June 30,				March 31,
		2011				2011
Raw materials		$	8,577			$	9,950
Work-in-process			2,388				2,323
Finished goods			7,643				7,541
Inventories		$	18,608			$	19,814

 

NOTE 6.  INVESTMENT IN UNCONSOLIDATED AFFILIATE

 

Our investment in an unconsolidated affiliate consists of an investment in equity securities of Scandinavian Micro Biodevices APS (“SMB”).  In February 2011, we purchased a 15% equity ownership interest in SMB, for $2.8 million in cash.  SMB is a privately-held developer and manufacturer of point-of-care diagnostic products for veterinary use.  SMB, based in Farum, Denmark, has been the original equipment manufacturer of the Abaxis VetScan VSpro point-of-care coagulation and specialty analyzer since 2008.  Abaxis has had exclusive distribution rights for the analyzer and associated cartridges in North America since 2008.  Starting January 2011, Abaxis has non-exclusive rights in other areas of the world.  We accounted for our investment in SMB using the equity method due to our significant influence over SMB’s operations.  During the three months ended June 30, 2011, we recorded our allocated portion of SMB’s net loss of $38,000.

 

 

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NOTE 7.  WARRANTY RESERVES

 

We provide for the estimated future costs to be incurred under our standard warranty obligation on our instruments and reagent discs.

 

Instruments.>  Our standard warranty obligation on instruments ranges from one to three 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.  Cost of revenues reflects estimated warranty expense for instruments sold in the current period and any adjustments in estimated warranty expense for the installed base under our standard warranty obligation based on our quarterly evaluation of service experience.  The estimated accrual for warranty exposure is based on historical experience as to product failures, estimated product failure rates, estimated repair costs, material usage and freight incurred in repairing the instrument after failure and known design changes under the warranty plan.

 

During the three months ended June 30, 2011, we recorded an additional accrual to pre-existing warranties of $257,000, which increased our warranty reserves and our cost of revenues, based on both historical and projected product performance rates.  Management continually evaluates the sufficiency of the warranty provisions and makes adjustments when necessary.  If an unusual performance rate related to warranty claims is noted, an additional warranty accrual may be assessed and recorded when a failure event is probable and the cost can be reasonably estimated.

 

During the three months ended June 30, 2010, we recorded an adjustment to pre-existing warranties of $307,000, which reduced our warranty reserves and our cost of revenues, based on both a decrease in our historical experience as to product failures and our judgment of a decrease in estimated product failure rates of blood chemistry analyzers.

 

Reagent Discs.>  We record a provision for defective reagent discs when the related sale is recognized and any additional amount is recorded when such cost is probable and can be reasonably estimated.  The warranty cost includes the replacement costs and freight of a defective reagent disc.  During the three months ended June 30, 2011 and 2010, the provision for warranty expense related to replacement of defective reagent discs was $91,000 and $97,000, respectively.  The balance of accrued warranty reserve related to replacement of defective reagent discs at June 30, 2011 and 2010 was $523,000 and $360,000, respectively, which was classified as a current liability on the condensed consolidated balance sheets.

 

We evaluate our estimates for warranty reserves on an ongoing basis and believe we have the ability to reasonably estimate warranty costs.  However, unforeseeable changes in factors may impact the estimate for warranty and such changes could cause a material change in our warranty reserve accrual in the period in which the change was identified.

 

The change in our accrued warranty reserve during the three months ended June 30, 2011 and 2010 is summarized as follows (in thousands):

 

		Three Months Ended
		June 30,
		2011				2010
Balance at beginning of period		$	1,222			$	1,343
Provision for warranty expense			343				125
Warranty costs incurred			(352	)			(147	)
Adjustment to pre-existing warranties			257				(307	)
Balance at end of period			1,470				1,014
Non-current portion of warranty reserve			275				72
Current portion of warranty reserve		$	1,195			$	942

 

NOTE 8.  BORROWINGS

 

Notes Payable.  >Effective January 2011, we have a ten year loan agreement with the Community Redevelopment Agency of the City of Union City (“the Agency”) whereby the Agency will provide us with an unsecured loan of up to $1.0 million, primarily to purchase capital equipment.  The loan bears interest at 5.0% and is payable quarterly.  As of June 30, 2011, our short-term and long-term notes payable balances were $85,000 and $725,000, respectively, and we recorded the short-term balance in other accrued liabilities on the condensed consolidated balance sheets.  The entire outstanding balance of the note shall be payable in full on the earlier of:  (i) December 2020, or (ii) the date Abaxis ceases operations in Union City, California.  The Agency also has the right to accelerate the maturity date and declare all balances immediately due and payable upon the event of default as defined in the loan agreement.  We evaluate covenants in our loan agreement on a quarterly basis, and we were in compliance with such covenants as of June 30, 2011.

 

In accordance with the terms of the loan agreement, the Agency will provide Abaxis with an annual credit that can be applied against the accrued interest and outstanding principal balance on a quarterly basis.  The Agency determines the annual credit based on certain taxes paid by Abaxis to the City of Union City, California for a specified period, as defined in the loan agreement.  We anticipate that our annual credits from the Agency will be used to fully repay our notes payable due to the Agency.  We may carry forward unused quarterly credits to apply against our outstanding balance in a future period.  Credits applied to repay our notes payable and accrued interest are recorded in “Interest and other income (expense), net” on the condensed consolidated statements of income.

 

 

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NOTE 9.  COMMITMENTS AND CONTINGENCIES

 

Purchase Commitments.>  In October 2008, we entered into an original equipment manufacturing (“OEM”) agreement with SMB of Denmark to purchase coagulation and specialty analyzers and related cartridges.  Effective January 2011, we amended and restated our OEM agreement, including the terms of our minimum purchase commitments.  Under the amended agreement, we committed to purchase a minimum number of coagulation and specialty analyzers and related cartridges on an annual basis during each calendar year 2011 through 2015.  Our purchase obligations in the future may be adjusted if our minimum purchase commitments are not met during a calendar year period.  At June 30, 2011, our total remaining outstanding commitment due is approximately $12.6 million.

 

In July 2010, we entered into a development and supply equipment agreement with Diatron MI PLC (“Diatron”) of Hungary to purchase Diatron hematology instruments.  Under the agreement, we committed to purchase a minimum number of hematology instruments on an annual basis during the calendar years 2010 and 2011.  At June 30, 2011, we have completed the outstanding purchase commitment in our agreement with Diatron.

 

Patent License Agreement.>  Effective January 2009, we entered into a license agreement with Inverness Medical Switzerland GmbH, now known as Alere Switzerland GmbH (“Alere”).  Under our license agreement, we licensed co-exclusively certain worldwide patent rights related to lateral flow immunoassay technology in the field of animal health diagnostics in the professional marketplace.  The license agreement provides that Alere shall not grant any future rights to any third parties under its current lateral flow patent rights in the animal health diagnostics field in the professional marketplace.  The license agreement enables us to develop and market products under rights from Alere to address animal health and laboratory animal research markets.

 

In exchange for the license rights, we (i) paid an up-front license fee of $5.0 million to Alere in January 2009, (ii) agreed to pay royalties during the term of the agreement, based solely on sales of products in a jurisdiction country covered by valid and unexpired claims in that jurisdiction under the licensed Alere patent rights, and (iii) agreed to pay a yearly minimum license fee of between $500,000 to $1.0 million per year, which fee will be creditable against any royalties due during such calendar year.  The royalties, if any, are payable through the date of the expiration of the last valid patent licensed under the agreement that includes at least one claim in a jurisdiction covering products we sell in that jurisdiction.  The yearly minimum fees became payable starting in fiscal 2011 for so long as we desire to maintain exclusivity under the agreement.

 

Litigation.> On June 28, 2010, we filed a patent infringement lawsuit against Cepheid with respect to Cepheid’s Methicillin-resistant Staphylococcus aureus (MRSA) product, on which Cepheid has ceased paying license royalties.  On December 17, 2010, Cepheid filed its amended answer and certain counterclaims seeking findings of no breach of contract, non-infringement, unenforceability and invalidity of the asserted patents, and a declaration regarding the patent term of one of the patents.  We believe the counterclaims raised by Cepheid are without merit and intend to contest them vigorously.  Because of the cost involved in pursuing patent infringement cases, we believe the cost of this litigation could have a material adverse effect on Abaxis, our consolidated financial position and results of operations.  As of June 30, 2011, we had not recorded future litigation and related expenses to pursuing the patent infringement case and an estimate of such costs cannot be made at this time.  A claims construction hearing was held in June 2011 and the court has issued its claims construction order.  The parties must complete a mandatory mediation in August 2011.  A trial date has not been set.

 

We are involved from time to time in various litigation matters in the normal course of business.  Other than as described above, we believe that the ultimate resolution of these matters will not have a material effect on our consolidated financial position or results of operations.  There can be no assurance that existing or future legal proceedings arising in the ordinary course of business or otherwise will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flows.

 

 

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NOTE 10.  SHARE-BASED COMPENSATION

 

In accordance with ASC 718, “Compensation-Stock Compensation,” we recognize share-based compensation expense, net of an estimated forfeiture rate, over the requisite service period of the award to employees and directors.  The following table summarizes total share-based compensation expense, net of tax, related to restricted stock units during the three months ended June 30, 2011 and 2010, which is included in our condensed consolidated statements of income (in thousands, except per share data):

 

		Three Months Ended
		June 30,
		2011				2010
Cost of revenues		$	195			$	145
Research and development			212				339
Sales and marketing			498				494
General and administrative			215				156
Share-based compensation expense before income taxes			1,120				1,134
Income tax benefit			(389	)			(432	)
Total share-based compensation expense after income taxes		$	731			$	702
Net impact of share-based compensation on:
Basic net income per share		$	0.03			$	0.03
Diluted net income per share		$	0.03			$	0.03

 

Share-based compensation has been classified in the condensed consolidated statements of income or capitalized on the condensed consolidated balance sheets in the same manner as cash compensation paid to employees.  Capitalized share-based compensation costs at June 30, 2011 and March 31, 2011 were $154,000 and $107,000, respectively, which were included in inventories on our condensed consolidated balance sheets.

 

Cash Flow Impact

 

The accounting standard with respect to share-based payment requires cash flows resulting from excess tax benefits to be classified as a part of cash flows from financing activities.  Excess tax benefits are realized tax benefits from tax deductions for exercised stock options and vested restricted stock units in excess of the deferred tax asset attributable to share-based compensation expense for such share-based awards.  Excess tax benefits are considered realized when the tax deductions reduce taxes that otherwise would be payable.  Excess tax benefits classified as a financing cash inflow for the three months ended June 30, 2011 and 2010 were $435,000 and $409,000, respectively.

 

Equity Compensation Plans

 

Our share-based compensation plans are described below.

 

2005 Equity Incentive Plan.  >Our 2005 Equity Incentive Plan (the “Equity Incentive Plan”) restated and amended our 1998 Stock Option Plan.  The Equity Incentive Plan allows for the awards of stock options, stock appreciation rights, restricted stock awards, restricted stock units, performance cash awards, performance shares, performance units, deferred compensation awards or other share-based awards to employees, directors and consultants.  On October 27, 2010, our shareholders approved an amendment to the Equity Incentive Plan to (i) increase the aggregate number of shares of common stock reserved for issuance under the Equity Incentive Plan by 500,000 shares, (ii) clarify that we may continue to grant performance cash awards under the Equity Incentive Plan and (iii) reapprove the Internal Revenue Code Section 162(m) performance criteria and award limits of the Equity Incentive Plan to permit us to continue to grant awards to key officers that qualify as performance-based compensation under Section 162(m) of the Internal Revenue Code.  As of June 30, 2011, the Equity Incentive Plan provides for the issuance of a maximum of 5,886,000 shares, of which 422,000 shares of common stock were then available for future issuance.  Shares that are canceled or forfeited from an award and shares withheld in satisfaction of tax withholding obligations are again available for issue under the Equity Incentive Plan.

 

Options granted to employees and directors generally expire ten years from the grant date.  Options granted to employees generally become exercisable over a period of four years based on cliff-vesting terms and continuous employment.  Options granted to non-employee directors generally become exercisable over a period of one year based on monthly vesting terms and continuous service.  See the “Stock Options” section in this Note for additional information.

 

Restricted stock units awarded to employees generally vest over a period of four years and the awards may also be subject to accelerated vesting upon achieving certain performance-based milestones and continuous employment during the vesting period.  Restricted stock units awarded to non-employee directors generally vest in full one year after the grant date based on continuous service.  See the “Restricted Stock Units” section in this Note for additional information.

 

1992 Outside Directors’ Stock Option Plan.  >Under our 1992 Outside Directors’ Stock Option Plan (the “Directors Plan”), options to purchase shares of common stock were automatically granted, annually, to non-employee directors.  Options under the Directors Plan were nonqualified stock options and were granted at the fair market value on the date of grant and expired ten years from the date of grant.  Options granted to non-employee directors generally become exercisable over a period of one year based on monthly vesting terms and continuous service.  The Directors Plan provided for the issuance of a maximum of 250,000 shares.  As of June 30, 2011, all outstanding options under the Directors Plan were fully vested and fully exercisable and no shares of common stock were available for future issuance because the time period for granting options expired in June 2002 in accordance with the terms of the Directors Plan.

 

Our current practice is to issue new shares of common stock from our authorized shares for share-based awards upon the exercise of stock options or vesting of restricted stock units.

 

 

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Stock Options

 

Prior to April 1, 2006, we granted stock options to employees, with an exercise price equal to the closing market price of our common stock on the date of grant and with cliff-vesting terms over four years, conditional on continuous employment with the Company.  In addition, prior to April 1, 2006, we granted stock options to non-employee directors with an exercise price equal to the closing market price of our common stock on the date of grant and became exercisable over a period of one year based on monthly vesting terms, conditional on continuous service to the Company.  There were no stock options granted since the beginning of fiscal 2007 and we did not grant stock options during the three months ended June 30, 2011.  We have recognized compensation expense during the requisite service period of the stock option.  As of June 30, 2011, we had no unrecognized compensation expense related to stock options granted.

 

Stock Option Activity

 

The following table summarizes information regarding options outstanding and options exercisable at June 30, 2011 and the changes during the three-month period then ended:

 

						Weighted				Weighted
						Average				Average				Aggregate
						Exercise				Remaining				Intrinsic
		Number of				Price				Contractual				Value
		Shares				Per Share				Life (Years)				(In thousands)
Outstanding at March 31, 2011			406,000			$	12.10
Granted			-				-
Exercised			(40,000	)			5.75
Canceled or forfeited			-				-
Outstanding at June 30, 2011			366,000			$	12.79				2.33			$	5,301
Vested and expected to vest at June 30, 2011			366,000			$	12.79				2.33			$	5,301
Exercisable at June 30, 2011			366,000			$	12.79				2.33			$	5,301

 

The aggregate intrinsic value in the table above represents the pre-tax intrinsic value, based on our closing stock price as of June 30, 2011, that would have been received by the option holders had all option holders exercised their stock options as of that date.  Total intrinsic value of stock options exercised during the three months ended June 30, 2011 and 2010 was $900,000 and $932,000, respectively.  Cash proceeds from stock options exercised during the three months ended June 30, 2011 and 2010 were $228,000 and $324,000, respectively.

 

Restricted Stock Units

 

We grant restricted stock unit awards to employees and directors as part of our share-based compensation program which began in fiscal 2007.  The restricted stock unit awards entitle holders to receive shares of common stock at the end of a specified period of time.  Vesting for restricted stock unit awards is based on continuous employment or service of the holder.  Upon vesting, the equivalent number of common shares are typically issued net of tax withholdings.  If the vesting conditions are not met, unvested restricted stock unit awards will be forfeited.  Generally, the restricted stock unit awards vest according to one of the following time-based vesting schedules:

 

·

Restricted stock unit awards to employees:  Four-year time-based vesting as follows:  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 with the Company.

 

·	Restricted stock unit awards to non-employee directors:  100 percent vesting after one year of continuous service to the Company.

 

Certain restricted stock unit awards granted to employees in fiscal 2007 were subject to accelerated vesting upon achieving certain performance-based milestones.  To date, none of the performance-based milestones required for acceleration, related to the fiscal 2007 grants, has been achieved and the related restricted stock unit grants have been fully vested based on time-based vesting.  Additionally, the Compensation Committee of our Board of Directors (the “Compensation Committee”), in its discretion, may provide in the event of a change in control for the acceleration of vesting and/or settlement of the restricted stock unit held by a participant upon such conditions and to such extent as determined by the Compensation Committee.  Our Board of Directors has adopted an executive change in control severance plan, which it may terminate or amend at any time, that provides that awards granted to executive officers will accelerate fully on a change of control.  The vesting of non-employee director awards granted under the Equity Incentive Plan automatically will also accelerate in full upon a change in control.

 

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 our common stock on the date of grant.  Such value is recognized as an expense over the corresponding requisite service period.  The share-based compensation expense is reduced for an estimate of the restricted stock unit awards that are expected to be forfeited.  The forfeiture estimate is based on historical data and other factors, and compensation expense is adjusted for actual results.  As of June 30, 2011, the total unrecognized compensation expense related to restricted stock unit awards granted amounted to $20.4 million, which is expected to be recognized over a weighted average service period of 2.50 years.

 

 

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Restricted Stock Unit Activity

 

The following table summarizes restricted stock unit activity for the three months ended June 30, 2011:

 

						Weighted
						Average
		Number of				Grant Date
		Shares				Fair Value(1)
Unvested at March 31, 2011			940,000			$	22.09
Granted			279,000				28.60
Vested(2)			(188,000	)			21.48
Canceled or forfeited			(1,000	)			25.76
Unvested at June 30, 2011			1,030,000			$	23.96

 

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(1)	The weighted average grant date fair value of restricted stock units is based on the number of shares and the closing market price of our common stock on the date of grant.

(2)	The number of restricted stock units vested includes shares that we withheld on behalf of our employees to satisfy the statutory tax withholding requirements.

 

Total intrinsic value of restricted stock units vested during the three months ended June 30, 2011 and 2010 was $5.4 million and $4.7 million, respectively.  The total grant date fair value of restricted stock units vested during the three months ended June 30, 2011 and 2010 was $4.0 million and $4.3 million, respectively.

 

NOTE 11.  NET INCOME PER SHARE

 

Basic net income per share is computed by dividing the net income attributable to common shareholders by the weighted average number of common shares outstanding during the period.  Diluted net income per share is computed by dividing the net income attributable to common shareholders by the weighted average number of common shares that would have been outstanding during the period assuming the issuance of common shares for all potential dilutive common shares outstanding using the treasury stock method.  Dilutive potential common shares outstanding include outstanding stock options, restricted stock units and warrants.

 

The following is a reconciliation of the weighted average number of common shares outstanding used in calculating basic and diluted net income per share (in thousands, except share and per share data):

 

		Three Months Ended
		June 30,
		2011				2010
Numerator:
Net income		$	2,214			$	3,580
Denominator:
Weighted average common shares outstanding - basic			22,681,000				22,211,000
Weighted average effect of dilutive securities:
Stock options			189,000				349,000
Restricted stock units			216,000				190,000
Warrants			9,000				-
Weighted average common shares outstanding - diluted			23,095,000				22,750,000
Net income per share:
Basic net income per share		$	0.10			$	0.16
Diluted net income per share		$	0.10			$	0.16

 

Stock options and warrants are excluded from the computation of diluted weighted average shares outstanding if the exercise price of the stock options and warrants is greater than the average market price of our common stock during the period because the inclusion of these stock options and warrants would be antidilutive to net income per share.  During the three months ended June 30, 2011 and 2010, there were no stock options and warrants excluded from the computation of diluted weighted average shares outstanding.

 

We excluded the following restricted stock units from the computation of diluted weighted average shares outstanding because the inclusion of these awards would be antidilutive to net income per share:

 

	Three Months Ended
	June 30,
	2011	2010
Weighted average number of shares underlying antidilutive restricted stock units	-	234,000

 

 

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NOTE 12.  INCOME TAXES

 

During the three months ended June 30, 2011 and 2010, our income tax provision was $1.3 million, based on an effective tax rate of 37%, and $2.3 million, based on an effective tax rate of 39%, respectively.  The decrease in the effective tax rate during the three months ended June 30, 2011, as compared to the three months ended June 30, 2010, was primarily due to lower state tax expenses resulting from the change in California to a single factor apportionment and an increase in federal research and development tax credits during the three months ended June 30, 2011.

 

We did not have any unrecognized tax benefits as of June 30, 2011 or June 30, 2010.  During the three months ended June 30, 2011 and 2010, we did not recognize any interest or penalties related to unrecognized tax benefits.

 

NOTE 13.  SEGMENT REPORTING INFORMATION

 

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by our chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance.

 

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 identify our reportable segments as those customer groups that represent more than 10% of our combined revenue or gross profit or loss of all reported operating segments.  We manage our business on the basis of the following two reportable segments:  (i) the medical market and (ii) the veterinary market, which are based on the products sold by market and customer group.  Each reportable segment has similar manufacturing processes, technology and shared infrastructures.  The accounting policies for segment reporting are the same as for the Company as a whole.  We do not segregate assets by segments since our chief operating decision maker, or decision making group, does not use assets as a basis to evaluate a segment’s performance.

 

Medical Market

 

In the medical market reportable segment, we serve a worldwide customer group consisting of military installations (ships, field hospitals and mobile care units), physicians’ office practices across all specialties, urgent care, outpatient and walk-in clinics (free-standing or hospital-connected), health screening operations, home care providers (national, regional or local), nursing homes, ambulance companies, oncology treatment clinics, dialysis centers, pharmacies and hospital labs.  The products manufactured and sold in this segment primarily consist of Piccolo chemistry analyzers and medical reagent discs.

 

Veterinary Market

 

In the veterinary market reportable segment, we serve a worldwide customer group consisting of 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.  The products manufactured and sold in this segment primarily consist of VetScan chemistry analyzers and veterinary reagent discs.  We also sell OEM supplied products in this segment consisting of VetScan hematology instruments and related reagent kits, VetScan VSpro coagulation and specialty analyzers and related consumables, VetScan i-STAT analyzers and related VetScan i-STAT consumables and rapid tests.

 

The table below summarizes revenues, cost of revenues and gross profit from our two operating segments and from certain unallocated items for the three months ended June 30, 2011 and 2010 (in thousands):

 

		Three Months Ended
		June 30,
		2011				2010
Revenues:
Medical Market		$	7,156			$	6,438
Veterinary Market			27,669				26,818
Other(1)			1,178				1,697
Total revenues			36,003				34,953
Cost of revenues:
Medical Market			3,343				2,969
Veterinary Market			12,404				10,913
Other(1)			1,033				1,287
Total cost of revenues			16,780				15,169
Gross profit:
Medical Market			3,813				3,469
Veterinary Market			15,265				15,905
Other(1)			145				410
Gross profit		$	19,223			$	19,784

 

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(1)	Represents unallocated items, not specifically identified to any particular business segment.

 

 

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NOTE 14.  REVENUES BY PRODUCT CATEGORY AND GEOGRAPHIC REGION AND SIGNIFICANT CONCENTRATIONS

 

Revenue Information

 

The following is a summary of our revenues by product category (in thousands):

 

		Three Months Ended
		June 30,
Revenues by Product Category		2011				2010
Instruments(1)		$	7,529			$	7,325
Consumables(2)			26,707				25,318
Other products			1,729				1,869
Product sales, net			35,965				34,512
Development and licensing revenue			38				441
Total revenues		$	36,003			$	34,953

 

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(1)	Instruments include chemistry analyzers, hematology instruments, VSpro coagulation and specialty analyzers and i-STAT analyzers.

(2)	Consumables include reagent discs, hematology reagent kits, VSpro coagulation and specialty cartridges, i-STAT cartridges and rapid tests.

 

The following is a summary of revenues by geographic region based on customer location (in thousands):

 

		Three Months Ended
		June 30,
Revenues by Geographic Region		2011				2010
North America		$	29,708			$	27,789
Europe			5,182				5,627
Asia Pacific and rest of the world			1,113				1,537
Total revenues		$	36,003			$	34,953

 

Significant Concentrations

 

Revenues from significant customers as a percentage of total revenues were as follows:

 

		Three Months Ended
	Geographical	June 30,
Distributor	Location	2011	2010
Walco International, Inc., d/b/a DVM Resources	United States	11%	<10%

 

At June 30, 2011 and 2010, one distributor in the United States accounted for 14% and 12%, respectively, of our total receivables balance.

 

NOTE 15.  SUBSEQUENT EVENTS

 

On August 5, 2011, the Board of Directors of Abaxis, Inc. approved the repurchase of up to an aggregate of $40,000,000 of its Common Stock.  The repurchases will be made from time to time on the open market at prevailing market prices or in negotiated transactions off the market.

 

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

 

FORWARD-LOOKING STATEMENTS

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes a number of forward-looking statements, which reflect our current views with respect to future events and financial performance.  In this report, the words “will,” “anticipates,” “believes,” “expects,” “intends,” “plans,” “future,” “projects,” “estimates,” “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, in Part II, Item 1A of this report and in Part I, Item 1A of our most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”), 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 vulnerability of our manufacturing operations to potential interruptions and delays, fluctuations in our quarterly results of operations and difficulty in predicting future results, our dependence on certain sole or limited source suppliers, market acceptance of our products and the continuing development of our products, protection of Abaxis’ intellectual property or claims of infringement of intellectual property asserted by third parties, risks involved in carrying of inventory, development of our sales, marketing and distribution experience, and our ability to attract, train and retain competent sales personnel, general market conditions and competition and other risks detailed under “Risk Factors” in this Quarterly Report on Form 10-Q.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.  We assume no obligation to update any forward-looking statements as circumstances change.

 

 

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BUSINESS OVERVIEW

 

Company Description

 

Abaxis, Inc. 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.

 

Abaxis, Inc. (“Abaxis,” “the Company,” “us” or “we”) 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.  We make available free of charge on or through our Internet website 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.  Our common stock trades on the NASDAQ Global Market under the symbol “ABAX.”

 

Our corporate headquarters are located in Union City, California, from which we conduct our manufacturing, warehousing, research and development, regulatory, sales and marketing and administrative activities.  We market and sell our products worldwide by maintaining direct sales forces and through independent distributors.  Our sales force is primarily located in the United States.  Abaxis Europe GmbH, our wholly-owned subsidiary in Germany since July 2008, markets and distributes diagnostic systems for medical and veterinary uses in the European market.

 

Products and Services.  >We manage our business in two operating segments, based on the products sold by market and customer group in the medical market and veterinary market.

 

Point-of-Care Blood Chemistry Analyzers>. 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 market our blood chemistry analyzers in both the medical market and the veterinary market, as described below.

 

·

Medical Market:  We currently market the blood analysis system in the medical market under the name Piccolo® Xpress.  Through October 2006, we marketed the blood analysis system in the medical market as the Piccolo, now referred to as the Piccolo Classic.  We continue to support and service our current population of Piccolo Xpress and Piccolo Classic chemistry analyzers.

 

·

Veterinary Market:  We currently market the blood analysis system in the veterinary market under the name VetScan VS2.  Through March 2006, we marketed the blood analysis system in the veterinary market as the VetScan, now referred to as the VetScan Classic.  We continue to support and service our current population of VetScan VS2 and VetScan Classic chemistry analyzers.

 

In the veterinary market, we also offer the following products and services:

 

Hematology>. We have marketed a veterinary hematology instrument under the name VetScan HM5 since September 2007.  The VetScan HM5 offers a 22-parameter complete blood count (“CBC”) analysis, including a five-part differential cell counter specifically designed for veterinary applications.  We also market the VetScan HM2, 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.  We currently purchase these hematology instruments from Diatron MI PLC (“Diatron”) 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.  We also market reagent kits to be used with our hematology instruments which we currently purchase from two suppliers:  Clinical Diagnostic Solutions, Inc. and Diatron.

 

Coagulation and Specialty>. We have marketed a veterinary coagulation and specialty analyzer under the name VetScan VSpro since January 2009.  The VetScan VSpro assists in the diagnosis and evaluation of suspected bleeding disorders, toxicity/poisoning, evaluation of disseminated intravascular coagulation, hepatic disease and in monitoring therapy and the progression of disease states.  The point-of-care coagulation and specialty analyzer is offered with a combination assay (PT/aPTT test cartridge) for canine and feline testing.  In December 2010, we introduced the VetScan VSpro Fibrinogen Test, to provide quantitative in-vitro determination of fibrinogen levels in equine platelet poor plasma from a citrated stabilized whole blood sample.  The VetScan VSpro Fibrinogen Test is designed for use with the VSpro coagulation and specialty analyzer.  We currently purchase the coagulation and specialty analyzers and related cartridges from Scandinavian Micro Biodevices APS of Farum, Denmark (“SMB”).  Additionally, in February 2011, we purchased a 15% equity ownership interest in SMB.  See the “Investment in Unconsolidated Affiliate” section in Critical Accounting Policies, Estimates and Judgments for additional information.

 

i-STAT>.  We have marketed i-STAT instruments and related cartridges in the veterinary market since fiscal 2010.  The VetScan i-STAT 1 delivers blood gas, electrolyte, basic blood chemistry and hematology results in minutes from two drops of whole blood.  In May 2009, we entered into an exclusive agreement with Abbott Point of Care Inc. (“Abbott”), granting us the right to sell and distribute Abbott’s i-STAT® 1 handheld instrument and associated consumables for blood gas, electrolyte, basic blood chemistry and immunoassay testing in the animal health care market worldwide.  Our right to sell and distribute these products was initially non-exclusive, but became exclusive in all countries of the world, except for Japan, in November 2009.  Our rights in Japan remain non-exclusive for the term of the agreement.  The initial term of the agreement ends on December 31, 2014, and after this initial term, our agreement continues automatically for successive one-year periods unless terminated by either party.

 

 

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Rapid Tests>. In the veterinary market, we offer the following three VetScan Rapid Tests, which deliver easy to read results in approximately ten minutes, as described below.

 

·

Canine Heartworm Rapid Test:  In January 2009, we introduced the VetScan Canine Heartworm Rapid Test, a highly sensitive and specific test for the detection of Dirofilaria immitis in canine whole blood, serum or plasma.  The lateral flow immunoassay technology in the canine heartworm rapid tests provides immediate results.

 

·

Canine Parvovirus Rapid Test:  In March 2011, we introduced the VetScan Canine Parvovirus Rapid Test Kit, a qualitative test for the detection of canine parvovirus antigen in feces.  The VetScan Canine Parvovirus Rapid Test Kit uses a unique combination of monoclonal antibodies that provides the detection of parvovirus antigen, allowing the veterinarian to screen for and diagnose the infection.

 

·	VetScan Giardia Rapid Test:  In May 2011, we introduced the VetScan Giardia Rapid Test, which detects giardiasis, a gastrointestinal infection caused by the protozoan parasite Giardia.  Symptoms of Giardia infection include diarrhea and weight loss and infection is also more common in younger pets.

 

Abaxis Veterinary Reference Laboratories>.  During fiscal 2011, we began developing a full-service laboratory testing facility, Abaxis Veterinary Reference Laboratories (“AVRL”), which will be located in Olathe, Kansas.  AVRL will provide veterinary reference laboratory diagnostic and consulting services for veterinarians in the United States.  AVRL will also focus on providing specialty and esoteric testing and analysis.  Additionally, in January 2011, we formed a strategic alliance with Kansas State University, K-State Veterinary Diagnostic Lab and a commercial affiliate of Kansas State University, the National Institute for Strategic Technology Acquisition and Commercialization, to enable AVRL to provide a full service commercial laboratory for veterinarians.

 

Factors that May Impact Future Performance

 

Our industry is impacted by numerous competitive, regulatory and other significant factors.  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 but not limited to 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.  Product sales in any quarter are generally dependent on orders booked and shipped in that quarter.  As a result, any such revenue 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 condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and pursuant to the rules and regulations of the Securities and Exchange Commission.  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.  A more detailed discussion on the application of these and other accounting policies are included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2011.

 

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.  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 recognize revenue associated with extended maintenance agreements ratably over the life of the contract.

 

 

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We occasionally enter into multiple element revenue arrangements in which a customer may purchase a combination of instruments, consumables or extended maintenance agreements.  Additionally, 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 are allocated separately to the instruments and incentives based on the relative selling price method.  Revenue allocated to each element is then recognized when the basic revenue recognition criteria, as described above, is met for each element.  Revenues allocated to incentives are deferred until the goods are shipped to the customer or are recognized ratably over the life of the maintenance contract.

 

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 based on the relative selling price method according to the policies described above.

 

We periodically offer programs to customers whereby certain instruments are made available to customers for rent or on an evaluation basis.  These programs typically require customers to purchase a minimum quantity of consumables during a specified period for which we recognize revenue on the related consumables according to the policies described above.  Depending on the program offered, customers may purchase the instrument during the rental or evaluation period.  Proceeds from such sale are recorded as revenue according to the policies described above.  Rental income, if any, are also recorded as revenue according to the policies described above.

 

Royalties are typically based on licensees’ net sales of products that utilize our technology and are recognized as earned in accordance with the contract terms when royalties from licensees can be reliably measured and collectibility is reasonably assured, such as upon the receipt of a royalty statement from the licensee.  Our royalty revenue depends on the licensees’ use of our technology, and therefore, may vary from period to period and impact our revenues during a quarter.  On June 28, 2010, we notified Cepheid that Cepheid breached its license agreement with us due to Cepheid’s discontinuation of license royalty payments.  On October 1, 2010, we informed Cepheid that the breach had not been cured, and we terminated the entire license, as to all or any Cepheid products.  As a result of the license termination, our development and licensing revenue was adversely and materially impacted in our consolidated financial statements during fiscal 2011.  Also, we expect the license termination will adversely and materially impact development and licensing revenue in our consolidated financial statements in the foreseeable future.

 

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

 

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 Measurements.>  Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (“exit price”) in an orderly transaction between market participants at the measurement date.  The Financial Accounting Standards Board (the “FASB”) Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures,” establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs).  The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).  The three levels of the fair value hierarchy are described below:

 

Level 1:  Quoted prices (unadjusted) in active markets for identical assets or liabilities.  As of June 30, 2011, we used Level 1 assumptions for our cash equivalents, which are traded in an active market.  The valuations are based on quoted prices of the underlying security that are readily and regularly available in an active market, and accordingly, a significant degree of judgment is not required.

 

Level 2:  Directly or indirectly observable inputs as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in markets that are not active.  Level 2 also includes assets and liabilities that are valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates and volatility factors, are corroborated by readily observable data from actively quoted markets for substantially the full term of the financial instrument.  As of June 30, 2011, we did not have any Level 2 financial assets or liabilities measured at fair value on a recurring basis.

 

Level 3:  Unobservable inputs that are supported by little or no market data and require the use of significant management judgment.  These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.  As of June 30, 2011, we did not have any Level 3 financial assets or liabilities measured at fair value on a recurring basis.

 

 

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Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measure.  Therefore, even when market assumptions are not readily available, our own assumptions are developed to reflect those that market participants would use in pricing the asset or liability at the measurement date.  At June 30, 2011, our short-term investments totaled $16.7 million and our long-term investments totaled $47.1 million, which were classified as held-to-maturity and carried at amortized cost.

 

Investment in Unconsolidated Affiliate>.  In February 2011, we purchased a 15% equity ownership interest in Scandinavian Micro Biodevices APS (“SMB”), for $2.8 million in cash.  We use the equity method to account for our investment in this entity that we do not control, but where we have the ability to exercise significant influence.  Equity method investments are recorded at original cost and adjusted periodically to recognize (1) our proportionate share of the investees’ net income or losses after the date of investment, (2) additional contributions made and dividends or distributions received, and (3) impairment losses resulting from adjustments to net realizable value.  We eliminate all intercompany transactions in accounting for our equity method investments.  We record our proportionate share of the investees’ net income or losses in “Interest and other income (expense), net” on the consolidated statements of income.

 

We assess the potential impairment of our equity method investments when indicators such as a history of operating losses, a negative earnings and cash flow outlook, and the financial condition and prospects for the investee’s business segment might indicate a loss in value.  We did not recognize any impairment loss on investment in unconsolidated affiliate during the three months ended June 30, 2011.

 

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 ranges from one to three 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.  Cost of revenues reflects estimated warranty expense for instruments sold in the current period and any adjustments in estimated warranty expense for the installed base under our standard warranty obligation based on our quarterly evaluation of service experience.  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 our historical experience as to product failures, estimated product failure rates, estimated repair costs, material usage and freight incurred in repairing the instrument after failure and known design changes under the warranty plan.

 

A provision for defective reagent discs is recorded when the related sale is recognized and any additional amount is recorded when such cost is probable and can be reasonably estimated, at which time they are included in cost of revenues.  The warranty cost includes the replacement costs and freight of a defective reagent disc.

 

As of June 30, 2011, our current portion of warranty reserves for instruments and reagent discs totaled $1.2 million and our non-current portion of warranty reserves for instruments totaled $275,000, which reflects our estimate of warranty obligations based on the estimated product failure rates, the number of instruments in standard warranty, estimated repair and related costs of instruments, and an estimate of defective reagent discs and replacement and related costs of a defective reagent disc.

 

Each quarter, we reevaluate our estimate of warranty reserves, including our assumptions.  During the three months ended June 30, 2011, we recorded an additional accrual to pre-existing warranties of $257,000, which increased our warranty reserves and our cost of revenues, based on both historical and projected product performance rates.

 

Management continually evaluates the sufficiency of the warranty provisions and makes adjustments when necessary.  If an unusual performance rate related to warranty claims is noted, an additional warranty accrual may be assessed and recorded when a failure event is probable and the cost can be reasonably estimated.  We review the historical warranty cost trends and 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 estimated product failure rate, 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.  Additionally, if factors change and we revise our assumptions on the product failure rate of instruments or reagent discs, then our warranty reserves and cost of revenues could be materially impacted in the quarter of revision, as well as in following quarters.

 

Inventories.>  We state inventories at the lower of cost or market, cost being determined using standard costs which approximate actual costs using 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.

 

 

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Valuation of Long-Lived Assets.>  We evaluate the carrying value of our long-lived assets, such as property and equipment and amortized intangible assets, whenever events or changes in business circumstances or our planned use of long-lived assets indicate that the carrying amount of an asset may not be fully recoverable or their useful lives are no longer appropriate.  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 and long-lived assets are written down to their respective fair values.

 

Income Taxes.>  We account for income taxes using the liability method under which 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 expected to be recovered.

 

We recognize and measure benefits for uncertain tax positions using a two-step approach.  The first step is to evaluate the tax position taken or expected to be taken in a tax return by determining if the weight of evidence indicates that it is more likely than not that the tax position will be sustained upon audit, including resolution of any related appeals or litigation processes.  For tax positions that are more likely than not to be sustained upon audit, the second step is to measure the tax benefit as the largest amount that is more than 50 percent likely to be realized upon settlement.  Significant judgment is required to evaluate uncertain tax positions.  At June 30, 2011 and 2010, we had no uncertain tax positions.  Our policy is to include interest and penalties related to gross unrecognized tax benefits within our provision for income taxes.  During the three months ended June 30, 2011 and 2010, we did not recognize any interest or penalties related to uncertain tax positions in the condensed consolidated statements of income, and at June 30, 2011 and 2010, we had no accrued interest or penalties.

 

Share-Based Compensation Expense>.  We recognize share-based compensation expense, net of an estimated forfeiture rate, over the requisite service period of the award to employees and directors.

 

There were no stock options granted since the beginning of fiscal 2007 and we did not grant stock options during the three months ended June 30, 2011.  For restricted stock units, share-based compensation expense is based on the fair value of our stock at the grant date and recognized net of an estimated forfeiture rate, over the requisite service period of the award.  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 fair value provisions of share-based compensation, employee share-based compensation expense recognized is calculated over the requisite service period of the awards and reduced for estimated forfeitures.  The forfeiture rate is estimated based on historical data of our share-based compensation 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.

 

Share-based compensation expense resulted in a material impact on our earnings per share and on our condensed consolidated financial statements for fiscal 2011 and during the three months ended June 30, 2011.  The impact of share-based compensation expense on our condensed consolidated financial results is disclosed in Note 10, “Share-Based Compensation” in the Notes to Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.  We expect that share-based compensation will materially impact our consolidated financial statements in the foreseeable future.

 

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.

 

 

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Total Revenues

 

Revenues by Geographic Region and by Product Category.  >Revenues by geographic region based on customer location and revenues by product category during the three months ended June 30, 2011 and 2010 were as follows (in thousands, except percentages):

 

		Three Months Ended
		June 30,								Change
										Increase/				Percent
Revenues by Geographic Region		2011				2010				(Decrease)				Change
North America		$	29,708			$	27,789			$	1,919				7	%
Percentage of total revenues			83	%			80	%
Europe			5,182				5,627				(445	)			(8	)%
Percentage of total revenues			14	%			16	%
Asia Pacific and rest of the world			1,113				1,537				(424	)			(28	)%
Percentage of total revenues			3	%			4	%
Total revenues		$	36,003			$	34,953			$	1,050				3	%

 

		Three Months Ended
		June 30,								Change
										Increase/				Percent
Revenues by Product Category			2011				2010			(Decrease)				Change
Instruments(1)		$	7,529			$	7,325			$	204				3	%
Percentage of total revenues			21	%			21	%
Consumables(2)			26,707				25,318				1,389				5	%
Percentage of total revenues			74	%			73	%
Other products			1,729				1,869				(140	)			(7	)%
Percentage of total revenues			5	%			5	%
Product sales, net			35,965				34,512				1,453				4	%
Percentage of total revenues			100	%			99	%
Development and licensing revenue			38				441				(403	)			(91	)%
Percentage of total revenues		<1		%			1	%
Total revenues		$	36,003			$	34,953			$	1,050				3	%

 

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(1)	Instruments include chemistry analyzers, hematology instruments, VSpro coagulation and specialty analyzers and i-STAT analyzers.

(2)	Consumables include reagent discs, hematology reagent kits, VSpro coagulation and specialty cartridges, i-STAT cartridges and rapid tests.

 

Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010

 

North America>.  During the three months ended June 30, 2011, total revenues in North America increased by 7%, or $1.9 million, as compared to the three months ended June 30, 2010.  The change in total revenues in North America was primarily attributed to the following:

 

·

Total sales of our Piccolo chemistry analyzers and medical reagent discs in North America (excluding the U.S. government) increased by 13%, or $550,000, primarily due to (a) an increase in the sales volume of Piccolo chemistry analyzers to a distributor resulting from higher sales to end users and (b) an increase in the sales volume of medical reagent discs to a distributor resulting from higher sales to end users.

 

·	Total sales of our Piccolo chemistry analyzers and medical reagent discs to the U.S. government increased by 59%, or $367,000, primarily due to an increase in the sales volume of medical reagent discs based on an increase in the needs for our products, which were not predictable.

 

·

Total sales of our VetScan chemistry analyzers and veterinary reagent discs sales in North America increased by 4%, or $494,000, primarily due to an increase in the sales volume of veterinary reagent discs, resulting from an expanded installed base of our VetScan chemistry analyzers and higher average selling prices.

 

·	Total sales of our VetScan hematology instruments and hematology reagent kits in North America increased by 22%, or $608,000, primarily due to an increase in the sales volume of VetScan hematology and hematology reagent kits.

 

·	Total sales from our VSpro coagulation and specialty analyzers and related consumables, i-STAT analyzers and related consumables and rapid tests in North America increased by 10%, or $422,000, primarily due to an increase in the sales volume of rapid tests.

 

·

Total revenues from development and licensing in North America decreased by 91%, or $403,000, primarily based on a licensees’ decreased use of our technology.  On June 28, 2010, we notified Cepheid that Cepheid breached its license agreement with us due to Cepheid’s discontinuation of license royalty payments.  On October 1, 2010, we informed Cepheid that the breach had not been cured, and we terminated the entire license, as to all or any Cepheid products.  For further information, see Note 9 of the Notes to Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q.

 

 

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Europe>.  During the three months ended June 30, 2011, total revenues in Europe decreased by 8%, or $445,000, as compared to the three months ended June 30, 2010.  The change in total revenues in Europe was primarily attributed to a net decrease in total revenues of VetScan chemistry analyzers and veterinary reagent disc sales by 8%, or $295,000, due to a decrease in revenues from veterinary reagent discs of 17%, or $518,000, partially offset by an increase in revenues from VetScan chemistry analyzers of 32%, or $223,000, which were both primarily due to the timing of inventory purchases by various distributors.

 

Asia Pacific and rest of the world>.  During the three months ended June 30, 2011, total revenues in Asia Pacific and rest of the world decreased by 28%, or $424,000, as compared to the three months ended June 30, 2010, primarily attributed to a net decrease in revenues from veterinary instruments of 54%, or $369,000, resulting from higher sales volume of VetScan hematology instruments to a distributor in the first quarter of fiscal 2011.

 

Significant concentration>.  One distributor in the United States, DVM Resources, accounted for 11% of our total worldwide revenues during the three months ended June 30, 2011.  There were no distributors or direct customers that accounted for 10% or more of our total worldwide revenues during the three months ended June 30, 2010.

 

Segment Results

 

Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010

 

The following table presents revenues, cost of revenues, gross profit and percentage of revenues by operating segments and from certain unallocated items for the three months ended June 30, 2011 and 2010 (in thousands, except percentages):

 

		Three Months Ended
		June 30,																Change
						Percent of								Percent of				Increase/				Percent
		2011				Revenues(1)				2010				Revenues(1)				(Decrease)				Change
Revenues:
Medical Market		$	7,156				100	%		$	6,438				100	%		$	718				11	%
Percentage of total revenues			20	%							18	%
Veterinary Market			27,669				100	%			26,818				100	%			851				3	%
Percentage of total revenues			77	%							77	%
Other(2)			1,178								1,697								(519	)			(31	)%
Percentage of total revenues			3	%							5	%
Total revenues			36,003								34,953								1,050				3	%
Cost of revenues:
Medical Market			3,343				47	%			2,969				46	%			374				13	%
Veterinary Market			12,404				45	%			10,913				41	%			1,491				14	%
Other(2)			1,033								1,287								(254	)			(20	)%
Total cost of revenues			16,780								15,169								1,611				11	%
Gross profit:
Medical Market			3,813				53	%			3,469				54	%			344				10	%
Veterinary Market			15,265				55	%			15,905				59	%			(640	)			(4	)%
Other(2)			145								410								(265	)			(65	)%
Gross profit		$	19,223							$	19,784							$	(561	)			(3	)%

 

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(1)	The percentages reported are based on our revenues by operating segment.

(2)	Represents unallocated items, not specifically identified to any particular business segment.

 

Medical Market

 

Revenues for Medical Market Segment

 

During the three months ended June 30, 2011, total revenues in the medical market increased by 11%, or $718,000, as compared to the three months ended June 30, 2010.  Total revenues from Piccolo chemistry analyzers increased by 12%, or $203,000, during the three months ended June 30, 2011, as compared to the same period in fiscal 2011, primarily in North America due to an increase in the sales volume to a distributor resulting from higher sales to end users.  Total revenues from medical reagent discs increased by 12%, or $547,000, during the three months ended June 30, 2011, as compared to the same period in fiscal 2011, primarily due to (a) an increase in the sales volume to a distributor in North America resulting from higher sales to end users and (b) an increase in the sales volume to the U.S. government based on an increase in the needs for our products, which were not predictable.

 

 

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Gross Profit for Medical Market Segment

 

Gross profit for the medical market segment increased by 10%, or $344,000, during the three months ended June 30, 2011, as compared to the three months ended June 30, 2010.  Gross profit percentages for the medical market segment during the three months ended June 30, 2011 and 2010 were 53% and 54%, respectively.  In absolute dollars, the increase in gross profit for the medical market segment was primarily due to (a) an increase in the sales volume of medical reagent discs during the three months ended June 30, 2011 and (b) higher average selling prices of Piccolo chemistry analyzers and medical reagent discs.  The net increase in gross profit was partially offset by higher manufacturing and repair costs on Piccolo chemistry analyzers during the three months ended June 30, 2011.  As a percentage, the decrease in gross margin was primarily due to higher manufacturing and repair costs on Piccolo chemistry analyzers.

 

Veterinary Market

 

Revenues for Veterinary Market Segment

 

During the three months ended June 30, 2011, total revenues in the veterinary market increased by 3%, or $851,000, as compared to the three months ended June 30, 2010.  The change in total revenues from veterinary instruments was flat, as compared to the same period in fiscal 2011.  Veterinary instrument revenues decreased in Asia Pacific and rest of the world by 54%, or $369,000, resulting from higher sales volume of VetScan hematology instruments to a distributor in the first quarter of fiscal 2011, partially offset by (a) an increase in the sales volume of VetScan hematology instruments in North America and (b) an increase in revenues of VetScan chemistry analyzers in Europe, primarily due to the timing of inventory purchases by various distributors.

 

Total revenues from consumables in the veterinary market increased by 4%, or $842,000, during the three months ended June 30, 2011, as compared to the same period in fiscal 2011, primarily attributed to (a) an increase in the sales volume of veterinary reagent discs in North America, resulting from an expanded installed base of our VetScan chemistry analyzers and higher average selling prices, (b) an increase in the sales volume of hematology reagent kits in North America and (c) an increase in the sales volume of rapid tests in North America.  The increase in consumable revenues was partially offset by a decrease in revenues of veterinary reagent discs in Europe, primarily due to the timing of inventory purchases by various distributors.

 

Gross Profit for Veterinary Market Segment

 

Gross profit for the veterinary market segment decreased by 4%, or $640,000, during the three months ended June 30, 2011, as compared to the three months ended June 30, 2010.  Gross profit percentages for the veterinary market segment during the three months ended June 30, 2011 and 2010 were 55% and 59%, respectively.  In absolute dollars, the decrease in gross profit for the veterinary market segment was primarily due to (a) an increase in freight costs to ship products, (b) higher manufacturing and repair costs on VetScan chemistry analyzers, (c) higher repair costs on hematology instruments and (d) higher costs on hematology instruments due to the Euro exchange rate.  The decrease in gross profit was partially offset by an increase in the sales volume of hematology reagent kits during the three months ended June 30, 2011.  As a percentage, the decrease in gross profit was primarily due to (a) an increase in freight costs to ship products and (b) higher costs on VetScan chemistry analyzers and hematology instruments.

 

Cost of Revenues

 

The following sets forth our cost of revenues for the periods indicated (in thousands, except percentages):

 

		Three Months Ended
		June 30,								Change
										Increase/				Percent
		2011				2010				(Decrease)				Change
Cost of revenues		$	16,780			$	15,169			$	1,611				11	%
Percentage of total revenues			47	%			43	%

 

Cost of revenues includes material, costs associated with manufacturing, assembly, packaging, warranty repairs, test and quality assurance for our instruments and consumables and manufacturing overhead, including costs of personnel and equipment associated with manufacturing support.

 

Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010

 

The increase in cost of revenues, in absolute dollars, during the three months ended June 30, 2011, as compared to the three months ended June 30, 2010, was primarily due to (a) higher manufacturing and repair costs on chemistry analyzers, (b) higher repair costs on hematology instruments, (c) higher costs on hematology instruments due to the Euro exchange rate and (d) an increase in the sales volume of rapid tests.  As a percentage of total revenues, the increase in cost of revenues was primarily due to higher costs on chemistry analyzers and hematology instruments.

 

 

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Gross Profit

 

The following sets forth our gross profit for the periods indicated (in thousands, except percentages):

 

		Three Months Ended
		June 30,								Change
										Increase/				Percent
		2011				2010				(Decrease)				Change
Total gross profit		$	19,223			$	19,784			$	(561	)			(3	)%
Total gross margin			53	%			57	%

 

Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010

 

Gross profit during the three months ended June 30, 2011 decreased 3%, or $561,000, as compared to the three months ended June 30, 2010, primarily due to the following:  (a) an increase in freight costs to ship products, (b) higher manufacturing and repair costs on chemistry analyzers, (c) higher repair costs on hematology instruments and (d) higher costs on hematology instruments due to the Euro exchange rate.  The decrease in gross profit was partially offset by an increase in the sales volume of medical reagent discs and hematology reagent kits and higher average selling prices of Piccolo chemistry analyzers and medical reagent discs.  As a percentage, the decrease in gross margin was primarily due to (a) an increase in freight costs to ship products and (b) higher costs on chemistry analyzers and hematology instruments.

 

Research and Development

 

The following sets forth our research and development expenses for the periods indicated (in thousands, except percentages):

 

		Three Months Ended
		June 30,								Change
										Increase/				Percent
		2011				2010				(Decrease)				Change
Research and development expenses		$	3,454			$	3,078			$	376				12	%
Percentage of total revenues			10	%			9	%

 

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 optimization and enhancement of existing products.

 

Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010

 

The increase in research and development expenses, in absolute dollars, during the three months ended June 30, 2011, as compared to the three months ended June 30, 2010, was primarily due to new product development and enhancement of existing products and clinical trials.  Research and development expenses are based on the project activities planned and the level of spending depends on budgeted expenditures.  The projects primarily relate 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 the three months ended June 30, 2011 and 2010 was $212,000 and $339,000, respectively.

 

We anticipate the absolute dollar amount of research and development expenses for fiscal 2012 to increase from fiscal 2011 but remain consistent as a percentage of total revenues, as we develop 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 or cost effective.

 

Sales and Marketing

 

The following sets forth our sales and marketing expenses for the periods indicated (in thousands, except percentages):

 

		Three Months Ended
		June 30,								Change
										Increase/				Percent
		2011				2010				(Decrease)				Change
Sales and marketing expenses		$	9,152			$	8,633			$	519				6	%
Percentage of total revenues			25	%			25	%

 

Sales and marketing expenses consist of personnel costs (including salaries, benefits and share-based compensation expense), commissions and travel-related expenses for personnel engaged in selling, costs associated with advertising, lead generation, marketing programs, trade shows and services related to customer and technical support.

 

 

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Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010

 

The increase in sales and marketing expenses, in absolute dollars, during the three months ended June 30, 2011, as compared to the three months ended June 30, 2010, was primarily due to personnel-related costs resulting from an increase in headcount to support the growth in our veterinary markets in North America and Europe.  Share-based compensation expense during the three months ended June 30, 2011 and 2010 was $498,000 and $494,000, respectively.

 

General and Administrative

 

The following sets forth our general and administrative expenses for the periods indicated (in thousands, except percentages):

 

		Three Months Ended
		June 30,								Change
										Increase/				Percent
		2011				2010				(Decrease)				Change
General and administrative expenses		$	3,419			$	2,124			$	1,295				61	%
Percentage of total revenues			9	%			6	%

 

General and administrative expenses consist of personnel costs (including salaries, benefits and share-based compensation expense), and expenses for outside professional services related to general corporate functions, including accounting and legal, and other general and administrative expenses.

 

Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010

 

The increase in general and administrative expenses, in absolute dollars, during the three months ended June 30, 2011, as compared to the three months ended June 30, 2010, was primarily due to (a) an increase of $750,000 in legal expenses related to pursuing a patent infringement case (see Note 9, “Commitments and Contingencies,” of the Notes to Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q for further information) and compliance in an investigation by the United States Federal Trade Commission of a competitor and (b) an increase of $522,000 related to start-up costs to develop our full service commercial laboratory for veterinarians, AVRL.  Share-based compensation expense during the three months ended June 30, 2011 and 2010 was $215,000 and $156,000, respectively.

 

Interest and Other Income (Expense), Net

 

The following sets forth our interest and other income (expense), net, for the periods indicated (in thousands):

 

		Three Months Ended
		June 30,								Change
										Increase/
		2011				2010				(Decrease)
Interest and other income (expense), net		$	294			$	(105	)		$	399

 

Interest and other income (expense), net consists primarily of interest earned on cash and cash equivalents and investments, foreign currency exchange gains and losses and our equity in net income and loss of an unconsolidated affiliate.

 

Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010

 

The increase in interest and other income (expense), net, during the three months ended June 30, 2011, as compared to the three months ended June 30, 2010, was primarily attributed to net favorable foreign currency exchange rates during the three months ended June 30, 2011.

 

Income Tax Provision

 

The following sets forth our income tax provision for the periods indicated (in thousands, except percentages):

 

		Three Months Ended
		June 30,
		2011				2010
Income tax provision		$	1,278			$	2,264
Effective tax rate			37	%			39	%

 

Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010

 

During the three months ended June 30, 2011 and 2010, our income tax provision was $1.3 million, based on an effective tax rate of 37%, and $2.3 million, based on an effective tax rate of 39%, respectively.  The decrease in the effective tax rate during the three months ended June 30, 2011, as compared to the three months ended June 30, 2010, was primarily due to lower state tax expenses resulting from the change in California to a single factor apportionment and an increase in federal research and development tax credits during the three months ended June 30, 2011.

 

 

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LIQUIDITY AND CAPITAL RESOURCES

 

Total cash, cash equivalents and short-term and long-term investments at June 30, 2011 and March 31, 2011 were as follows (in thousands, except percentages):

 

		June 30,				March 31,
		2011				2011
Cash and cash equivalents		$	45,073			$	43,471
Short-term investments			16,691				25,981
Long-term investments