News Column

ABAXIS INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

May 30, 2014

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



BUSINESS OVERVIEW

Abaxis, Inc. is a worldwide developer, manufacturer and marketer of portable blood analysis systems that are used in a broad range of medical specialties in human or veterinary patient care to provide clinicians with rapid blood constituent measurements. Since October 2011, Abaxis also has been providing veterinary reference laboratory diagnostic and consulting services for veterinarians through AVRL. 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 primarily through independent distributors, supplemented by our direct sales force. Our sales force is primarily located in the United States. Abaxis Europe GmbH, our wholly-owned subsidiary, markets and distributes diagnostic systems for medical and veterinary uses in the European market.



We manage our business in two operating segments, the medical market and veterinary market, as described below. See "Segment Results" in this section for a detailed discussion of financial results.

Medical Market. We serve a worldwide customer group in the medical market consisting of physicians' office practices across multiple 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, hospital laboratories, military installations (ships, field hospitals and mobile care units), pharmaceutical clinical trials and cruise ship lines. For our products in the human medical market, we employ primarily independent distributors to market our products. Starting in January 2013, we transitioned the majority of our medical product sales to Abbott as our exclusive distributor in the medical market. Pursuant to our Abbott Agreement, Abbott obtained the exclusive right to sell and distribute our Piccolo Xpress chemistry analyzers and associated consumables in the professionally-attended human healthcare market in the United States and China (including Hong Kong). Effective September 2013, we amended the Abbott Agreement to limit Abbott's territory under such agreement to the United States. Under the Abbott Agreement, we have certain responsibilities for providing technical support and warranty services to Abbott in support of its marketing and sales efforts. The initial term of the Abbott Agreement ends on December 31, 2017, and after the initial term, the Abbott Agreement renews automatically for successive one-year periods unless terminated by either party based upon a notice of non-renewal six months prior to the then-current expiration date. We will continue to sell and distribute these medical products outside of the market segments as to which Abbott has exclusive rights. Under our Abbott Agreement, we will continue to sell and distribute to Catapult Health LLC and specified customer segments in the United States, including pharmacy and retail store clinics, shopping malls, CROs and cruise ship lines. Veterinary Market. Our VetScan products serve a worldwide customer group in the veterinary market 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. We depend on a number of distributors in North America that distribute our VetScan products. In September 2012, we entered into a distribution agreement with MWI to purchase, market and sell the full line of Abaxis veterinary products throughout the United States. In the United States veterinary market segment, we also rely on various independent regional distributors. We depend on our distributors to assist us in promoting our VetScan products, and accordingly, if one or more of our distributors were to stop selling our products in the future, we may experience a temporary sharp decline or delay in our sales revenues until our customers identify another distributor or purchase products directly from us. 27 -------------------------------------------------------------------------------- Table of Contents Overview of Financial Results In fiscal 2014, total revenues were $171.9 million, a decrease of 8% from fiscal 2013. The net decrease in revenues was primarily due to a net decrease in medical and veterinary instrument and veterinary reagent disc sales, partially offset by an increase in service revenues from veterinary reference laboratory diagnostic and consulting services. Gross profit in fiscal 2014 was $83.1 million, a decrease of 15% from fiscal 2013, primarily attributable to lower unit sales of instruments and reagent discs in our veterinary market. Total operating expenses in fiscal 2014 were $62.3 million, an increase of $6.2 million, or 11%, from $56.1 million in fiscal 2013, primarily attributable to a gain from our legal settlement with Cepheid of $17.3 million in the second quarter of fiscal 2013, partially offset by a decrease in sales and marketing expenses in fiscal 2014. Sales and marketing expenses were $37.3 million during fiscal 2014 and $46.9 million for fiscal 2013, a decrease of $9.6 million, or 20%, primarily due to (a) a decrease in personnel-related expenses and a decrease in sales and marketing spending as a result of restructuring our sales and marketing organization within the medical market due to our distribution agreement with Abbott which we entered into in October 2012, as described below under "Products and Services - Medical Market" and (b) a decrease in personnel-related expenses from lower veterinary business headcount. General and administrative expenses were $11.3 million for fiscal 2014 and $12.8 million for fiscal 2013, a decrease of $1.5 million, or 12%, from fiscal 2013 to fiscal 2014. The decrease was primarily due to a decrease in legal expenses due to the settlement of our Cepheid patent infringement case in the second quarter of fiscal 2013. Net income for fiscal 2014 was $14.2 million, a decrease of 48% from $27.5 million in fiscal 2013, due primarily to (a) the decreased revenues described above and (b) a gain from our legal settlement with Cepheid of $17.3 million in the second quarter of fiscal 2013 and a decrease in our income tax provision of $5.8 million over the second quarter of fiscal 2013, resulting from such settlement, and offset in part by the decreased sales and marketing expenses described above. Our diluted earnings per share decreased to $0.63 in fiscal 2014 from $1.23 in fiscal 2013. Cash, cash equivalents and investments increased by $25.9 million during fiscal 2014 to a total of $121.2 million at March 31, 2014. The primary source of cash and cash equivalents during fiscal 2014 was operating cash flows of $35.6 million. Key non-operating uses of cash during fiscal 2014 included $4.7 million for payments made for tax withholdings related to net share settlements of restricted stock units and $3.0 million for repurchases of our common stock under our share repurchase program. During fiscal 2014, we spent a total of $3.0 million of cash to repurchase and retire 86,000 shares of our common stock at an average purchase price of $34.58 per share, including commission expense.



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. During fiscal 2014, our medical market and veterinary market businesses in the United States were impacted by our continuing transition to new distribution partners, as described below. During the fourth quarter of fiscal 2013, we transitioned the majority of our medical sales to Abbott as our exclusive distributor in the medical market in the United States. As such, we rely on Abbott and we no longer have control over the marketing and sale of our primary medical products into most of the U.S. medical market and we are dependent upon the efforts and priorities of Abbott in promoting and creating a demand for such products in such market. During fiscal 2014, we were impacted by the timing of purchases of our medical products sold to Abbott as it continued to integrate our products into its sales process and work through its inventory. In the United States veterinary market, we rely on MWI, a national distributor, and on various independent regional distributors. During 2014, our strategy of increasing demand for our veterinary products through the expansion of our distribution partners, did not lead to the increased demand for our products in the veterinary clinics that we had anticipated. During the second half of fiscal 2014, as compared to the same period in fiscal 2013, our sales orders from our largest distributors in the veterinary market decreased resulting from excess channel inventory created during the second half of fiscal 2013 and first half of fiscal 2014. Such excess inventory was the result of our distributors not selling our products to end customers at the same rate as they were purchasing products from us. Although demand for instrument sales from our distributors' end customers continued to grow during the third and fourth quarters of fiscal 2014, it was less than the demand forecasted earlier in the year by our largest distributors and the distributors' ordering rates. In the second half of fiscal 2014, we took additional steps to more closely monitor and manage channel inventory in an effort to normalize the veterinary product inventories at our distribution partners in the United States. As a result of these efforts, we believe that purchases by our distributors will be more in line with in-clinic sales starting in the first quarter of our fiscal 2015. 28 -------------------------------------------------------------------------------- Table of Contents We are dependent upon the efforts and priorities of our distributors in promoting and creating a demand for our products and as such, we do not have control over the marketing and sale of our products into these markets. Should these efforts be unsuccessful, or should we fail to maintain these relationships, our business, financial condition and results of operations are likely to be adversely affected. 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 revenues 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 products, to achieve profitability in AVRL, the sales performances of our products by our independent distributors, 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 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. For a more detailed discussion on the application of these and other accounting policies, see the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K. Revenue Recognition. Our primary customers are distributors and direct customers in both the medical and veterinary markets. Service revenues are primarily generated from veterinary reference laboratory diagnostic and consulting services for veterinarians. Revenues from product sales and services, net of estimated sales allowances, discounts and rebates, are recognized when (i) evidence of an arrangement exists, (ii) upon shipment of the products or rendering of services 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. From time to time, we offer discounts on AVRL services for a specified period as incentives. Discounts are reductions to invoiced amounts within a specified period and are recorded at the time services are performed. Net service revenues are recognized at the time services are performed. Amounts collected in advance of revenue recognition are recorded as a current or non-current deferred revenue liability based on the time from the balance sheet date to the future date of revenue recognition. We recognize revenues associated with extended maintenance agreements ratably over the life of the contract. Multiple Element Revenue Arrangements. Our sales arrangements may contain 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. We participate in selling arrangements in the veterinary market that include multiple deliverables, such as instruments, consumables and service agreements associated with our veterinary reference laboratory. Judgments as to the allocation of consideration from an arrangement to the multiple elements of the arrangement, and the appropriate timing of revenue recognition are critical with respect to these arrangements. A 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. We allocate revenues 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 vendor-specific objective evidence ("VSOE") of selling price, if it exists, or third-party evidence ("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. 29 -------------------------------------------------------------------------------- Table of Contents Revenues from our multiple element arrangements are allocated separately to the instruments, consumables, extended maintenance agreements and incentives based on the relative selling price method. Amounts allocated to each element are based on its objectively determined fair value, such as the sales price for the product or service when it is sold separately. Revenues allocated to each element are then recognized when the basic revenue recognition criteria, as described above, are met for each element. Revenues associated with incentives in the form of free goods are deferred until the goods are shipped to the customer. Revenues associated with incentives in the form of extended maintenance agreements are deferred and recognized ratably over the life of the extended maintenance contract, generally one to three years. Incentives in the form of extended maintenance agreements are our most significant multiple element arrangement. For our selling arrangements in the veterinary market that include multiple deliverables, such as instruments, consumables and service agreements associated with our veterinary reference laboratory, revenue is recognized upon delivery of the product or performance of the service during the term of the service contract when the basic revenue recognition criteria, as described above, are met for each element. We allocate revenues to each element based on the relative selling price of each deliverable. Amounts allocated to each element are based on its objectively determined fair value, such as the sales price for the product or service when it is sold separately. From time to time, we offer customer incentives consisting of arrangements with customers to include discounts on future sales of services associated with our veterinary reference laboratory. We apply judgment in determining whether future discounts are significant and incremental. When the future discount offered is not considered significant and incremental, we do not account for the discount as an element of the original arrangement. To determine whether a discount is significant and incremental, we look to the discount provided in comparison to standalone sales of the same product to similar customers, the level of discount provided on other elements in the arrangement, and the significance of the discount to the overall arrangement. If the discount in the multiple element arrangement approximates the discount typically provided in standalone sales, that discount is not considered incremental. During fiscal 2014, 2013 and 2012, our customer incentive programs with future discounts were not significant. At March 31, 2014 and 2013, the current portion of deferred revenue balances was $1.2 million and $1.4 million, respectively, and the non-current portion of deferred revenue balances was $4.0 million and $3.8 million, respectively. During fiscal 2014, changes in deferred revenue balances were primarily attributable to extended maintenance contracts offered to customers in the form of free services in connection with the sale of our instruments primarily in the first six months of fiscal 2014, partially offset by deferred revenue recognized ratably over the life of the maintenance contracts. In October 2013, we changed the standard warranty period on certain instruments from three to five years, which resulted in a decrease in maintenance contracts offered to customers in the form of free services during the second half of fiscal 2014.



Customer Programs. From time to time, we offer customer marketing and incentive programs. Our most significant customer programs are described as follows:

Instrument Trade-In Programs. 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. Instrument Rental Programs. 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. Sales Incentive Programs. We periodically offer customer sales incentive programs and we record reductions to revenue related to these programs. Incentives may be provided in the form of volume-based incentives, end-user rebates and discounts. A summary of our revenue reductions is described below. Other rebate programs offered to distributors or customers vary from period to period in the medical and veterinary markets and were not significant.



· Volume-based Incentives. Volume-based incentives, in the form of rebates, are

offered from time to time to distributors and group purchasing organizations

upon meeting the sales volume requirements during a qualifying period and are

recorded as a reduction to gross revenues during a qualifying period. The

pricing rebate program is primarily offered to distributors in the North

America veterinary market, upon meeting the sales volume requirements of

veterinary products during the qualifying period. Factors used in the rebate

calculations include the identification of products sold subject to a rebate

during the qualifying period and which rebate percentage applies. Based on

these factors and using historical trends, adjusted for current changes, we

estimate the amount of the rebate that will be paid and record the liability as

a reduction to gross revenues when we record the sale of the product.

Settlement of the rebate accruals from the date of sale ranges from one to nine

months after sale. Changes in the rebate accrual at each fiscal year end are

based upon distributors and group purchasing organizations meeting the purchase

requirements during the quarter.

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Table of Contents · End-User Rebates and Discounts. From time to time, cash rebates are offered to

end-users who purchase certain products or instruments during a promotional

period and are recorded as a reduction to gross revenues. Additionally, we

periodically offer sales incentives to end-users, in the form of sales

discounts, to purchase consumables for a specified promotional period,

typically over five years from the sale of our instrument, and we reimburse

resellers for the value of the sales discount provided to the end-user. We

estimate the amount of the incentive earned by end-users during a quarter and

record a liability to the reseller as a reduction to gross revenues. Factors

used in the liability calculation of incentives earned by end-users include the

identification of qualified end-users under the sales program during the period

and using historical trends. Settlement of the liability to the reseller

ranges from one to twelve months from the date an end-user earns the incentive.

The following table summarizes the change in total accrued sales incentive programs (in thousands): Balance at Beginning Balance at of Year Provisions Payments End of Year Year Ended March 31, 2014 $ 1,043$ 1,872$ (2,215 ) $ 700 Year Ended March 31, 2013 $ 696$ 2,058$ (1,711 )$ 1,043 Year Ended March 31, 2012 $ 411$ 1,626$ (1,341 ) $ 696 Royalty Revenues. 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. Allowance for Doubtful Accounts. We recognize revenue when collection from the customer is reasonably assured. We maintain an allowance for doubtful accounts based on our assessment of the collectibility of the amounts owed to us by our customers. We regularly review the allowance and consider the following factors in determining the level of allowance required: the customer's payment history, the age of the receivable balance, the credit quality of our customers, the general financial condition of our customer base and other factors that may affect the customers' ability to pay. An additional allowance is recorded based on certain percentages of our aged receivables, using historical experience to estimate the potential uncollectible. Account balances are charged off against the allowance when we believe it is probable the receivable will not be recovered. If our actual collections experience changes, revisions to our allowances may be required, which could adversely affect our operating income. Fair Value Measurements. We apply fair value accounting for all financial assets and liabilities and non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining fair value, we consider the principal or most advantageous market in which we would transact and consider assumptions that market participants would use when pricing the asset or liability. The fair value hierarchy 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 March 31, 2014, our investments in cash equivalents, which we classified as available-for-sale, totaled $5.0 million, using Level 1 inputs since these investments 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 March 31, 2014, our available-for-sale investments in certificates of deposit and corporate bonds, totaled $10.9 million, using Level 2 inputs, based on market pricing and other observable market inputs for similar securities obtained from various third party data providers.

31 -------------------------------------------------------------------------------- Table of Contents 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 March 31, 2014, we did not have any Level 3 financial assets or liabilities measured at fair value on a recurring basis. 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 March 31, 2014, we also had $36.7 million in investments 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 SMB for $2.8 million in cash. We use the equity method to account for our investment in this entity because we do not control it, but have the ability to exercise significant influence over it. 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 our consolidated statements of income. At March 31, 2014 and 2013, our investment in unconsolidated affiliate totaled $2.6 million. 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. To date, since our investment in SMB, we have not recorded an impairment charge on this investment. 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 five years, depending on the type of product. 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. Effective October 2013, we prospectively changed our standard warranty obligations on certain instruments sold from three to five years. The increase in the standard warranty obligation did not result in a material impact on our cost of revenues or our accrued warranty costs during fiscal 2014. We also provide for the estimated future costs to be incurred under our standard warranty obligation on our reagent discs. A provision for defective reagent discs is recorded and classified as a current liability 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 March 31, 2014, our current portion of warranty reserves for instruments and reagent discs totaled $1.0 million and our non­current portion of warranty reserves for instruments totaled $821,000, 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. Total accrued warranty reserve increased by $484,000, from March 31, 2013 to March 31, 2014, primarily due to an increase in the number of instruments in standard warranty. For fiscal 2014, 2013 and 2012, the provision for warranty expense related to instruments was $1.6 million, $859,000 and $1.2 million, respectively. The provision related to instruments increased in fiscal 2014, as compared to fiscal 2013, primarily due to an increase in the number of instruments under standard warranty. The provision related to instruments decreased during fiscal 2013, as compared to fiscal 2012, primarily attributable to our quarterly evaluation of service experience on our chemistry analyzers based on estimated product failure rates. Additionally, during fiscal 2013, we recorded an adjustment to pre-existing warranties of $290,000, which reduced our warranty reserves and our cost of revenues, based on both historical and projected product performance rates of instruments. Management periodically 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 such revision, as well as in following quarters. 32 -------------------------------------------------------------------------------- Table of Contents 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 manufacturing overhead. We establish provisions for excess, obsolete and unusable inventories after evaluation of future demand of our products 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. 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. We did not recognize any impairment charges on long-lived assets during fiscal 2014, 2013 and 2012. Intangible Assets. Intangible assets, consisting of licenses and other rights acquired from third parties, are presented at cost, net of accumulated amortization. The intangible assets are amortized using the straight-line method over their estimated useful life, which approximates the economic benefit. If our underlying assumptions regarding the estimated useful life of an intangible asset change, then the amortization period, amortization expense and the carrying value for such asset would be adjusted accordingly, and could result in a material change in the amortization expense and the carrying value for such asset. During fiscal 2014, 2013 and 2012, our changes in estimated useful life of intangible assets were not significant. 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 March 31, 2014 and 2013, we had no significant uncertain tax positions. Our policy is to include interest and penalties related to gross unrecognized tax benefits within our provision for income taxes. For fiscal 2014, 2013 and 2012, we did not recognize any interest or penalties related to uncertain tax positions in the consolidated statements of income, and at March 31, 2014 and 2013, we had no accrued interest or penalties. Share-Based Compensation Expense. We account for share-based compensation arrangements using the fair value method. We recognize share-based compensation expense, net of an estimated forfeiture rate, over the requisite service period of the award to employees and directors. 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. Prior to fiscal 2007, we granted stock option awards to employees and directors as part of our share-based compensation program. We have not granted any stock options since the beginning of fiscal 2007. We have recognized compensation expense for stock options granted during the requisite service period of the stock option. As of March 31, 2014, we had no unrecognized compensation expense related to stock options granted. 33 -------------------------------------------------------------------------------- Table of Contents Since fiscal 2007, we have granted restricted stock unit awards to employees and directors as part of our share-based compensation program. Restricted stock unit awards to consultants have been insignificant. Awards of restricted stock units are issued at no cost to the recipient and may have time-based vesting criteria, or a combination of time-based and performance-based vesting criteria, as described below. The fair value of restricted stock unit awards with only time-based vesting terms, which we refer to as restricted stock unit awards (time vesting), 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. Share-based compensation expense is recognized net of an estimated forfeiture rate, over the requisite service period of the award. The forfeiture estimate is based on historical data and other factors, and compensation expense is adjusted for actual results. As a result, if factors change and we use different assumptions, our share-based compensation expense could be materially different in the future. We also began granting restricted stock unit awards subject to performance vesting criteria, which we refer to as restricted stock unit awards (performance vesting), to our executive officers starting in fiscal 2013. Restricted stock unit awards (performance vesting) consist of the right to receive shares of common stock, subject to achievement of time-based criteria and certain corporate performance-related goals over a specified period, as established by the Compensation Committee of our Board of Directors (the "Compensation Committee"). For restricted stock units subject to performance vesting, we recognize any related share-based compensation expense ratably over the service period based on the most probable outcome of the performance condition. The fair value of our restricted stock unit awards (performance vesting) used in our expense recognition method is measured based on the number of shares granted, the closing market price of our common stock on the date of grant and an estimate of the probability of the achievement of the performance goals. The amount of share-based compensation expense recognized in any one period can vary based on the attainment or expected attainment of the performance goals. If such performance goals are not ultimately met, no compensation expense is recognized and any previously recognized compensation expense is reversed. Fiscal 2013 Performance RSUs. In April 2012, the Compensation Committee approved the grant of restricted stock unit awards (performance vesting) for 84,000 shares of common stock to our executive officers that contained both time-based and performance-based vesting terms (the "FY2013 Performance RSUs"). The FY2013 Performance RSUs were subject to vesting in four equal annual increments based upon: (1) achievement of certain pre-established corporate annual performance-related goals, as established by the Compensation Committee; and (2) the grantee's satisfaction of service requirements through the vesting period. The annual financial performance goals were established at the beginning of each performance period and, accordingly, the portion (or "tranche") of the FY2013 Performance RSU subject to each goal is treated as a separate grant for accounting purposes. The number of vested restricted stock unit awards (performance vesting) is determined at the end of each annual performance period. The fiscal 2013 performance target for the FY2013 Performance RSUs was established at the grant date following ASC 718-10-55-95 and the aggregate estimated grant date fair value of the FY2013 Performance RSUs was $752,000, or $35.62 per share, based on the closing market price of our common stock on the date of grant. Only the target for fiscal 2013 performance for the first tranche was set in April 2012, and accordingly, only 25% of the FY2013 Performance RSUs were deemed granted in fiscal 2013 in accordance with ASC 718-10-55-95. In April 2013, in consideration of the grant of the FY2014 Performance RSUs described below, the remaining 75% of the FY2013 Performance RSUs, which consisted of the second, third and fourth tranches, were cancelled. As a result, these restricted stock units are no longer outstanding. The remaining 75% of the FY2013 Performance RSUs were not deemed granted for accounting purposes because each annual performance target was to be set at the start of each respective single-fiscal year performance period in accordance with ASC 718-10-55-95. On April 29, 2013, 21,000 shares subject to the FY2013 Performance RSUs were issued to our executive officers as a result of achieving performance-related goals for the fiscal year ended March 31, 2013. We fully recognized compensation expense for the FY2013 Performance RSUs during the requisite service period in fiscal 2013. As of March 31, 2014, we had no unrecognized compensation expenses related to FY2013 Performance RSUs. Fiscal 2014 Performance RSUs. In April 2013, the Compensation Committee approved the grant of restricted stock unit awards (performance vesting) for 129,000 shares of common stock to our executive officers that also contained both time-based and performance-based vesting terms (the "FY2014 Performance RSUs"). The aggregate estimated grant date fair value of the FY2014 Performance RSUs was $5.5 million, or $42.43 per share, based on the closing market price of our common stock on the date of grant. The FY2014 Performance RSUs vest only if both of the following criteria are satisfied: (1) our consolidated income from operations for the fiscal year ending March 31, 2014, as certified by the Compensation Committee, is in excess of the applicable target amount described below; and (2) the recipient remains in the Service of the Company (as defined in our Equity Incentive Plan) until the applicable vesting date set forth as follows: 34



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Table of Contents · 25% shares issuable upon settlement of FY2014 Performance RSUs upon satisfying

90% of target of consolidated income from operations for the year ending March

31, 2014 and time-based vesting on April 29, 2016;

· 25% shares issuable upon settlement of FY2014 Performance RSUs upon satisfying

90% of target of consolidated income from operations for the year ending March

31, 2014 and time-based vesting on April 29, 2017;

· 25% shares issuable upon settlement of FY2014 Performance RSUs upon satisfying

100% of target of consolidated income from operations for the year ending March

31, 2014 and time-based vesting on April 29, 2016; and

· 25% shares issuable upon settlement of FY2014 Performance RSUs upon satisfying

100% of target of consolidated income from operations for the year ending March

31, 2014 and time-based vesting on April 29, 2017.

As of March 31, 2014, we reviewed each of the underlying performance targets related to the outstanding FY2014 Performance RSUs and determined that it was not probable that the FY2014 Performance RSUs will vest and did not record share-based compensation related to these awards during fiscal 2014. On April 23, 2014, the Compensation Committee determined that the Company's consolidated income from operations for fiscal 2014 was below 90% of target and, accordingly, the FY2014 Performance RSUs did not vest and were cancelled. Fiscal 2015 Performance RSUs. In April 2014, the Compensation Committee approved the grant of restricted stock unit awards (performance vesting) for 172,000 shares of common stock to our executive officers that also contained both time-based and performance-based vesting terms (the "FY2015 Performance RSUs"). The aggregate estimated grant date fair value of the FY2015 Performance RSUs was $7.0 million, or $40.82 per share, based on the closing market price of our common stock on the date of grant. The FY2015 Performance RSUs vest only if both of the following criteria are satisfied: (1) our consolidated income from operations for the fiscal year ending March 31, 2015, as certified by the Compensation Committee, is in excess of the applicable target amount described below; and (2) the recipient remains in the Service of the Company (as defined in our Equity Incentive Plan) until the applicable vesting date set forth as follows:



· 25% shares issuable upon settlement of FY2015 Performance RSUs upon satisfying

90% of target of consolidated income from operations for the year ending March

31, 2015 and time-based vesting on April 28, 2017;

· 25% shares issuable upon settlement of FY2015 Performance RSUs upon satisfying

90% of target of consolidated income from operations for the year ending March

31, 2015 and time-based vesting on April 28, 2018;

· 25% shares issuable upon settlement of FY2015 Performance RSUs upon satisfying

100% of target of consolidated income from operations for the year ending March

31, 2015 and time-based vesting on April 28, 2017; and

· 25% shares issuable upon settlement of FY2015 Performance RSUs upon satisfying

100% of target of consolidated income from operations for the year ending March

31, 2015 and time-based vesting on April 28, 2018.

Share-based compensation expense has had a material impact on our earnings per share and on our consolidated financial statements for fiscal 2014, 2013 and 2012. The impact of share-based compensation expense on our consolidated financial results is disclosed in Note 12, "Equity Compensation Plans and Share-Based Compensation" in the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K. As of March 31, 2014, our unrecognized compensation expense related to restricted stock unit awards (time vesting) granted to employees and directors totaled $17.3 million, which expense is expected to be recognized over a weighted average service period of 1.5 years. We expect that share-based compensation will materially impact our consolidated financial statements in the foreseeable future. Excluding forfeitures, we estimate expense recognition of restricted stock units with time-based vesting criteria over the requisite service period of the award, for awards granted and unvested as of March 31, 2014 as follows: $9.0 million in fiscal 2015, $6.1 million in fiscal 2016, $4.6 million in fiscal 2017 and $995,000 in fiscal 2018. 35 --------------------------------------------------------------------------------

Table of Contents RESULTS OF OPERATIONS Total Revenues Revenues by Geographic Region and by Product and Service Category. Revenues by geographic region based on customer location and revenues by product and service category during fiscal 2014, 2013 and 2012 were as follows (in thousands, except percentages): Year Ended March 31, Change 2013 to 2014 Change 2012 to 2013 Revenues by Dollar Percent Dollar Percent Geographic Region 2014 2013 2012 Change Change Change Change North America $ 136,607$ 152,774$ 128,969$ (16,167 ) (11 )% $ 23,805 18 % Percentage of total revenues 79 % 82 % 82 % Europe 27,161 26,086 21,926 1,075 4 % 4,160 19 % Percentage of total revenues 16 % 14 % 14 % Asia Pacific and rest of the world 8,102 7,165 5,701 937 13 % 1,464 26 % Percentage of total revenues 5 % 4 % 4 % Total revenues $ 171,870$ 186,025$ 156,596$ (14,155 ) (8 )% $ 29,429 19 % Year Ended March 31, Change 2013 to 2014 Change 2012 to 2013 Revenues by Product and Dollar Percent Dollar Percent Service Category 2014 2013 2012 Change Change Change Change Instruments(1) $ 37,539$ 46,034$ 35,150$ (8,495 ) (18 )% $ 10,884 31 % Percentage of total revenues 22 % 25 % 22 % Consumables(2) 117,533 127,481 113,810 (9,948 ) (8 )% 13,671 12 % Percentage of total revenues 68 % 68 % 73 % Other products and services(3) 16,648 12,360 7,472 4,288 35 % 4,888 65 % Percentage of total revenues 10 % 7 % 5 % Product and service revenues, net 171,720 185,875 156,432 (14,155 ) (8 )% 29,443 19 % Percentage of total revenues 100 % 100 % 100 % Development and licensing revenue 150 150 164 - - % (14 ) (9 )% Percentage of total revenues <1% <1% <1 % Total revenues $ 171,870$ 186,025$ 156,596$ (14,155 ) (8 )% $ 29,429 19 %



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(1) Instruments include chemistry analyzers, hematology instruments, VSpro

specialty analyzers and i-STAT analyzers.

(2) Consumables include reagent discs, hematology reagent kits, VSpro specialty

cartridges, i-STAT cartridges and rapid tests.

(3) Other products and services include veterinary reference laboratory

diagnostic and consulting service.

Fiscal 2014 Compared to Fiscal 2013

North America. During fiscal 2014, total revenues in North America decreased by 11%, or $16.2 million, as compared to fiscal 2013. The change in total revenues in North America was primarily attributable to the following:



· Total revenues from our Piccolo chemistry analyzers and medical reagent discs

in North America (including sales to the U.S. government) decreased by 14%, or

$3.1 million, primarily due to a lower average selling pricing of Piccolo

chemistry analyzers and medical reagent discs sold to our distributor, Abbott,

partially offset by an increase in the sales volume of medical reagent discs

sold to Abbott during the fourth quarter of fiscal 2014.

· Total revenues from our VetScan chemistry analyzers and veterinary reagent

discs in North America decreased by 18%, or $13.2 million, primarily due to a

decrease in the unit volume of VetScan chemistry analyzers and veterinary

reagent discs sold during the second half of fiscal 2014 in order to balance

the inventory level in the distribution channel.

· Total revenues from our VetScan hematology instruments and hematology reagent

kits in North America decreased by 15%, or $3.1 million, primarily due to a

decrease in the unit volume of VetScan hematology instruments and hematology

reagent kits sold during the second half of fiscal 2014 in order to balance the

inventory level in the distribution channel.

· Total revenues from our VetScan VSpro specialty analyzers and related

consumables, VetScan i­STAT analyzers and related consumables and VetScan rapid

tests in North America decreased by 4%, or $1.0 million, primarily due to a

decrease in the unit volume of VetScan VSpro specialty analyzers, VetScan

i­STAT analyzers and VetScan rapid tests sold during the second half of fiscal

2014 in order to balance the inventory level in the distribution channel,

partially offset by a higher unit volume of VetScan i­STAT analyzers and

VetScan rapid tests sold during the first half of fiscal 2014, resulting from

our addition of MWI as a nationwide distributor in September 2012.

36



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Table of Contents · Other product and service revenues in North America increased by 37%, or $4.2

million, primarily due to (a) an increase in service revenues from veterinary

reference laboratory diagnostic and consulting services provided by AVRL to new

customers and increased business with current customers and (b) a decrease in

extended maintenance contracts offered to customers as incentives in the form

of free services in connection with the sale of our instruments during fiscal

2014, for which revenue is deferred and recognized ratably over the life of the

maintenance contract. The increase in other product and service revenues was

partially offset by a decrease in unit volume of products sold using our Orbos

process. Europe. During fiscal 2014, total revenues in Europe increased by 4%, or $1.1 million, as compared to fiscal 2013. The change in total revenues in Europe was primarily attributable to the following:



· Revenues from Piccolo chemistry analyzers and medical reagent discs decreased

by 12%, or $913,000, primarily due to higher sales of Piccolo chemistry

analyzers during fiscal 2013 to an international medical supplies sourcing and

support company to support a pharmaceutical clinical trial conducted by a

biotechnology company, partially offset by an increase in the unit volume of

medical reagent discs sold to various distributors.

· Total VetScan chemistry analyzers and veterinary reagent disc sales increased

by 10%, or $1.6 million. Revenues from veterinary reagent discs increased by

22%, or $2.6 million, primarily attributable to (a) an increase in the unit

volume of veterinary reagent discs sold to a distributor and (b) higher average

selling prices of veterinary reagent discs. The increase was partially offset

by a decrease in revenues from VetScan chemistry analyzers of 27%, or $1.0

million, primarily attributable to (a) a decrease in the unit volume of VetScan

chemistry analyzers sold to various distributors and (b) lower average selling

prices of VetScan chemistry analyzers.

· Revenues from VetScan hematology instruments and hematology reagent kits

increased by 16%, or $202,000, primarily attributable to an increase in the

unit volume of VetScan hematology instruments sold to various distributors.

Asia Pacific and rest of the world. During fiscal 2014, total revenues in Asia Pacific and rest of the world increased by 13%, or $937,000, as compared to fiscal 2013. The change in total revenues in Asia Pacific and rest of the world was primarily attributable to the following:



· Revenues from medical instruments and medical reagent discs increased by 32%,

or $246,000, primarily attributable to a higher unit volume of medical reagent

discs sold to a distributor.

· Revenues from veterinary instruments increased by 29%, or $673,000, primarily

attributable to (a) a higher unit volume of VetScan chemistry analyzers and

VetScan hematology instruments sold to a distributor and (b) a higher unit

volume of VetScan i­STAT analyzers sold to a distributor.

Significant concentrations. Two distributors in the United States, MWI and Abbott, accounted for 18% and 10%, respectively, of our total worldwide revenues during fiscal 2014. For a discussion of inventories held by our distributors, see "Factors that May Affect Future Performance" above.



Fiscal 2013 Compared to Fiscal 2012

North America. During fiscal 2013, total revenues in North America increased by 18%, or $23.8 million, as compared to fiscal 2012. The change in total revenues in North America was primarily attributable to the following:



· Total revenues from our Piccolo chemistry analyzers and medical reagent discs

in North America (excluding sales to the U.S. government) decreased by 2%, or

$298,000, primarily due to a decrease in average selling prices of Piccolo

chemistry analyzers and medical reagent discs sold to our distributor, Abbott,

partially offset by an increase in the sales volume of Piccolo chemistry to

Abbott. In October 2012, we entered into the Abbott Agreement.



· Total sales of our Piccolo chemistry analyzers and medical reagent discs to the

U.S. government decreased by 38%, or $1.2 million, primarily due to a decrease

in the U.S. Military's needs for our products as a result of U.S. troops leaving Iraq in 2011.



· Total revenues from our VetScan chemistry analyzers and veterinary reagent

discs in North America increased by 20%, or $12.6 million, primarily due to (a)

an increase in the sales volume of VetScan chemistry analyzers due in part to

additional sales personnel and sales to various distributors, including MWI,

since we entered into a distribution agreement in September 2012, (b) an

increase in the sales volume of veterinary reagent discs resulting from an

expanded installed base of our VetScan chemistry analyzers and (c) higher

average selling prices of VetScan chemistry analyzers and veterinary reagent

discs.



· Total revenues from our VetScan hematology instruments and hematology reagent

kits in North America increased by 28%, or $4.5 million, primarily due to an

increase in the sales volume of VetScan hematology instruments due in part to

additional sales personnel and sales to various distributors, including MWI.

37 -------------------------------------------------------------------------------- Table of Contents · Total revenues from our VetScan VSpro specialty analyzers and related



consumables, VetScan i-STAT analyzers and related consumables and VetScan rapid

tests in North America increased by 18%, or $3.7 million, primarily due to an

increase in the sales volume of VetScan VSpro specialty analyzers, VetScan

i-STAT analyzers and VetScan rapid tests, due in part to additional sales personnel and sales to various distributors, including MWI.



· Other product and service revenues in North America increased by 66%, or $4.6

million, primarily due to an increase in service revenues from veterinary

reference laboratory diagnostic and consulting services to new customers and

increased business with current customers. Veterinary reference laboratory

diagnostic and consulting services provided by AVRL started in the third quarter of fiscal 2012. Europe. During fiscal 2013, total revenues in Europe increased by 19%, or $4.2 million, as compared to fiscal 2012. Revenues from Piccolo chemistry analyzers and medical reagent discs increased by 47%, or $2.4 million, primarily due to (a) sales of Piccolo chemistry analyzers to an international medical supplies sourcing and support company to support a pharmaceutical clinical trial conducted by a biotechnology company and (b) an increase in the sales volume of medical reagent discs to various distributors. Total VetScan chemistry analyzers and veterinary reagent discs sales increased by 8%, or $1.2 million, primarily attributable to an increase in revenues from veterinary reagent discs of 14%, or $1.4 million due to higher sales volume to a distributor. Asia Pacific and rest of the world. During fiscal 2013, total revenues in Asia Pacific and rest of the world increased by 26%, or $1.5 million, as compared to fiscal 2012. Revenues from veterinary instruments increased by 33%, or $565,000, primarily due to an increase in the sales volume of VetScan chemistry analyzers to various distributors. Revenues from veterinary consumables increased by 27%, or $867,000, primarily due to an increase in the sales volume of veterinary reagent discs to various distributors. Significant concentrations. One distributor in the United States, Animal Health International, accounted for 11% of our total worldwide revenues during fiscal 2013. Segment Results Total Revenues, Cost of Revenues and Gross Profit by Segment. 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 and services provided by market and customer group. During fiscal 2013, certain reclassifications were made to prior fiscal year financial statements, primarily related to segment categories. In the fourth quarter of fiscal 2013, we reclassified certain revenues related to extended maintenance contracts and costs related to instrument repair and support, from our unallocated category to its respective business segment, either medical market or veterinary market. The Company reclassified the historically presented reportable segments to reflect changes in the way its decision maker evaluates the performance of its operations and allocates resources. These reclassifications did not result in any change in previously reported consolidated revenues, cost of revenues or gross profit. 38 -------------------------------------------------------------------------------- Table of Contents Fiscal 2014 Compared to Fiscal 2013



The following table presents revenues, cost of revenues, gross profit and percentage of revenues by operating segments and from certain unallocated items for fiscal 2014 and 2013 (in thousands, except percentages):

Year Ended March 31, Change Percent of Percent of Dollar Percent 2014 Revenues(1) 2013 Revenues(1) Change Change Revenues: Medical Market $ 28,134 100 % $ 31,643 100 % $ (3,509 ) (11 )% Percentage of total revenues 16 % 17 % Veterinary Market 140,698 100 % 150,510 100 % (9,812 ) (7 )% Percentage of total revenues 82 % 81 % Other(2) 3,038 3,872 (834 ) (22 )% Percentage of total revenues 2 % 2 % Total revenues 171,870 186,025 (14,155 ) (8 )% Cost of revenues: Medical Market 15,623 56 % 15,179 48 % 444 3 % Veterinary Market 73,030 52 % 72,477 48 % 553 1 % Other(2) 108 138 (30 ) (22 )% Total cost of revenues 88,761 87,794 967 1 % Gross profit: Medical Market 12,511 44 % 16,464 52 % (3,953 ) (24 )% Veterinary Market 67,668 48 % 78,033 52 % (10,365 ) (13 )% Other(2) 2,930 3,734 (804 ) (22 )% Gross profit $ 83,109$ 98,231$ (15,122 ) (15 )%



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(1) The percentage reported is based on revenues by operating segment.

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

business segment. Medical Market



Revenues for Medical Market Segment

During fiscal 2014, total revenues in the medical market decreased by 11%, or $3.5 million, as compared to fiscal 2013. The change in the medical market segment was primarily attributable to the following:

· Total revenues from Piccolo chemistry analyzers decreased by 39%, or $3.9

million, during fiscal 2014 as compared to fiscal 2013, primarily attributable

to (a) a lower average selling pricing of Piccolo chemistry analyzers sold to

Abbott and (b) higher sales of Piccolo chemistry analyzers during fiscal 2013

to an international medical supplies sourcing and support company in Europe to

support a pharmaceutical clinical trial conducted by a biotechnology company.

· Total revenues from medical reagent discs increased by 1%, or $158,000, during

fiscal 2014 as compared to fiscal 2013, primarily attributable to (a) an

increase in the sales volume of medical reagent discs sold to Abbott during the

fourth quarter of fiscal 2014, (b) an increase in the unit volume of medical

reagent discs sold to various distributors in Europe and (c) a higher unit

volume of medical reagent discs sold to a distributor in Asia Pacific and rest

of the world. The increase was partially offset by a lower average selling

pricing of medical reagent discs sold to Abbott.

· Total revenues from other products and services in the medical market increased

by 17%, or $248,000, during fiscal 2014 as compared to fiscal 2013, primarily

attributable to a decrease in extended maintenance contracts offered to

customers as incentives in the form of free services in connection with the

sale of our Piccolo chemistry analyzers in North America in fiscal 2014, for

which revenue is deferred and recognized ratably over the life of the maintenance contract.



Gross Profit for Medical Market Segment

Gross profit for the medical market segment decreased by 24%, or $4.0 million, during fiscal 2014 as compared to fiscal 2013. Gross profit percentages for the medical market segment during fiscal 2014 and 2013 were 44% and 52%, respectively. In absolute dollars, the decrease in gross profit was primarily due to (a) lower unit sales of Piccolo chemistry analyzers, (b) lower average selling prices of Piccolo chemistry analyzers and medical reagent discs and (c) higher manufacturing costs of Piccolo chemistry analyzers. These decreases were partially offset by higher unit sales of medical reagent discs. The decrease in gross profit percentage was primarily attributable to (a) lower unit sales of Piccolo chemistry analyzers and (b) lower average selling prices of Piccolo chemistry analyzers and medical reagent discs. 39 -------------------------------------------------------------------------------- Table of Contents Veterinary Market



Revenues for Veterinary Market Segment

During fiscal 2014, total revenues in the veterinary market decreased by 7%, or $9.8 million, as compared to fiscal 2013. The change in the veterinary market segment was primarily attributable to the following:



· Total revenues from veterinary instruments decreased by 13%, or $4.6 million,

during fiscal 2014 as compared to fiscal 2013, primarily attributable to (a) a

decrease in the unit volume of VetScan chemistry analyzers, VetScan hematology

instruments, VetScan VSpro specialty analyzers and VetScan i-STAT analyzers

sold in North America during the second half of fiscal 2014 in order to balance

the inventory level in the distribution channel and (b) a decrease in the unit

volume of VetScan chemistry analyzers sold to various distributors and lower

average selling prices of VetScan chemistry analyzers, both in Europe. These

decreases were partially offset by (a) an increase in the unit volume of

VetScan hematology instruments sold to various distributors in Europe, (b) an

increase in the unit volume of VetScan chemistry analyzers and VetScan

hematology instruments sold to a distributor in Asia Pacific and rest of the

world, (c) an increase in the unit volume of VetScan i­STAT analyzers sold

during the first half of fiscal 2014, resulting from our addition of MWI as a

nationwide distributor in September 2012 and (d) an increase in the unit volume

of VetScan i­STAT analyzers sold to a distributor in Asia Pacific and rest of

the world.



· Total revenues from consumables in the veterinary market decreased by 9%, or

$10.1 million, during fiscal 2014 as compared to fiscal 2013, primarily

attributable to a decrease in the unit volume of veterinary reagent discs,

hematology reagent kits and VetScan rapid tests sold in North America during

the second half of fiscal 2014 in order to balance the inventory level in the

distribution channel. The decrease was partially offset by (a) a higher unit

volume of VetScan rapid tests sold during the first half of fiscal 2014,

resulting from our addition of MWI as a nationwide distributor in September

2012, (b) an increase in the unit volume of veterinary reagent discs sold to a

distributor in Europe and (c) higher average selling prices of veterinary reagent discs sold in Europe.



· Total revenues from other products and services in the veterinary market

increased by 68%, or $4.9 million, during fiscal 2014 as compared to fiscal

2013, primarily attributable to (a) an increase in service revenues from

veterinary reference laboratory diagnostic and consulting services provided by

AVRL in North America to new customers and increased business with current

customers and (b) a decrease in extended maintenance contracts offered to

customers as incentives in the form of free services in connection with the

sale of our veterinary instruments in North America during fiscal 2014, for

which revenue is deferred and recognized ratably over the life of the

maintenance contract. In October 2013, we changed the standard warranty period

on certain instruments from three to five years, which resulted in a decrease

in maintenance contracts offered to customers in the form of free services

during the second half of fiscal 2014.

Gross Profit for Veterinary Market Segment

Gross profit for the veterinary market segment decreased by 13%, or $10.4 million, during fiscal 2014 as compared to fiscal 2013. Gross profit percentages for the veterinary market segment during fiscal 2014 and 2013 were 48% and 52%, respectively. In absolute dollars, the decrease in gross profit was due to (a) lower unit sales of veterinary reagent discs and (b) higher manufacturing costs of VetScan chemistry analyzers and veterinary reagent discs. These decreases in gross profit were partially offset by higher service revenues provided by AVRL. The decrease in gross profit percentage was primarily attributable to lower unit sales of VetScan chemistry analyzers and veterinary reagent discs. Other Gross profit in our other category decreased by 22%, or $804,000, during fiscal 2014, as compared to fiscal 2013, primarily attributable to a decrease in unit volume of products sold using our Orbos process. 40 -------------------------------------------------------------------------------- Table of Contents Fiscal 2013 Compared to Fiscal 2012



The following table presents revenues, cost of revenues, gross profit and percentage of revenues by operating segments and from certain unallocated items for fiscal 2013 and 2012 (in thousands, except percentages):

Year Ended March 31, Change Percent of Percent of Dollar Percent 2013 Revenues(1) 2012 Revenues(1) Change Change Revenues: Medical Market $ 31,643 100 % $ 30,404 100 % $ 1,239 4 % Percentage of total revenues 17 % 19 % Veterinary Market 150,510 100 % 122,253 100 % 28,257 23 % Percentage of total revenues 81 % 78 % Other(2) 3,872 3,939 (67 ) (2 )% Percentage of total revenues 2 % 3 % Total revenues 186,025 156,596 29,429 19 % Cost of revenues: Medical Market 15,179 48 % 14,323 47 % 856 6 % Veterinary Market 72,477 48 % 57,032 47 % 15,445 27 % Other(2) 138 138 - - % Total cost of revenues 87,794 71,493 16,301 23 % Gross profit: Medical Market 16,464 52 % 16,081 53 % 383 2 % Veterinary Market 78,033 52 % 65,221 53 % 12,812 20 % Other(2) 3,734 3,801 (67 ) (2 )% Gross profit $ 98,231$ 85,103$ 13,128 15 %



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(1) The percentage reported is based on revenues by operating segment.

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

business segment. Medical Market



Revenues for Medical Market Segment

During fiscal 2013, total revenues in the medical market increased by 4%, or $1.2 million, as compared to fiscal 2012. Total revenues from Piccolo chemistry analyzers increased by 19%, or $1.6 million, during fiscal 2013 as compared to fiscal 2012, primarily attributable to (a) an increase in the sales volume of Piccolo chemistry analyzers in North America to our distributor, Abbott, since we entered into the Abbott Agreement in October 2012 and (b) sales to an international medical supplies sourcing and support company in Europe to support a pharmaceutical clinical trial conducted by a biotechnology company. These increases were partially offset by (a) a decrease in average selling prices of Piccolo chemistry analyzers to Abbott and (b) a decrease in sales of Piccolo chemistry analyzers to the U.S. government due to a decrease in the U.S. Military's needs for our products as a result of U.S. troops leaving Iraq in 2011. Total revenues from medical reagent discs decreased by 3%, or $699,000, during fiscal 2013 as compared to fiscal 2012, primarily attributable to (a) a decrease in average selling prices of medical reagent discs to Abbott and (b) a decrease in sales of medical reagent discs to the U.S. government due to a decrease in the U.S. Military's needs for our products as a result of U.S. troops leaving Iraq in 2011. The decreases were partially offset by an increase in the sales volume of medical reagent discs to various distributors in Europe.



Gross Profit for Medical Market Segment

Gross profit for the medical market segment increased by 2%, or $383,000, during fiscal 2013 as compared to fiscal 2012. Gross profit percentages for the medical market segment during fiscal 2013 and 2012 were 52% and 53%, respectively. In absolute dollars, the increase in gross profit for the medical market segment was primarily attributable to (a) sales of Piccolo chemistry analyzers to an international medical supplies sourcing and support company to support a pharmaceutical clinical trial conducted by a biotechnology company and (b) an increase in the sales volume of Piccolo chemistry analyzers to Abbott, partially offset by lower average selling prices of Piccolo chemistry analyzers and medical reagent discs to Abbott. 41 -------------------------------------------------------------------------------- Table of Contents Veterinary Market



Revenues for Veterinary Market Segment

During fiscal 2013, total revenues in the veterinary market increased by 23%, or $28.3 million, as compared to fiscal 2012. Total revenues from veterinary instruments increased by 35%, or $9.3 million, during fiscal 2013 as compared to fiscal 2012, primarily attributable to (a) an increase in the sales volume of VetScan chemistry analyzers, VetScan hematology instruments, VetScan VSpro specialty analyzers and VetScan i-STAT analyzers in North America, due in part to additional sales personnel and sales to various distributors, including MWI, (b) higher average selling prices of VetScan chemistry analyzers in North America and (c) an increase in the sales volume of VetScan chemistry analyzers to various distributors in Asia Pacific and rest of the world. Total revenues from consumables in the veterinary market increased by 15%, or $14.4 million, during fiscal 2013 as compared to fiscal 2012, primarily attributable 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, (b) higher average selling prices of veterinary reagent discs in North America, (c) an increase in the sales volume of VetScan rapid tests, due in part to additional sales personnel and sales to various distributors, including MWI, (d) an increase in the sales volume of veterinary reagent discs to a distributor in Europe and (e) an increase in the sales volume of veterinary reagent discs to various distributors in Asia Pacific and rest of the world. Total revenues from other products and services in the veterinary market increased by $4.5 million, during fiscal 2013 as compared to fiscal 2012, primarily attributable to veterinary reference laboratory diagnostic and consulting services provided by AVRL in North America from sales to new customers and increased business with current customers. Veterinary reference laboratory diagnostic and consulting services provided by AVRL started in the third quarter of fiscal 2012.



Gross Profit for Veterinary Market Segment

Gross profit for the veterinary market segment increased by 20%, or $12.8 million, during fiscal 2013 as compared to fiscal 2012. Gross profit percentages for the veterinary market segment during fiscal 2013 and 2012 were 52% and 53%, respectively. In absolute dollars, the increase in gross profit for the veterinary market segment was primarily attributable to (a) an increase in the sales volume of VetScan chemistry analyzers, VetScan hematology instruments, and veterinary reagent discs and (b) higher average selling prices of veterinary reagent discs and hematology reagent kits. These increases in gross profit were partially offset by (a) an increase in freight costs to ship products and (b) cost of services for veterinary reference laboratory diagnostic and consulting services provided by AVRL beginning in the third quarter of fiscal 2012. As a percentage of total revenues, the decrease in gross profit margin was primarily due to (a) an increase in the sales volume of our original equipment manufacturer ("OEM") supplied products, which have a lower margin contribution and (b) cost of services for veterinary reference laboratory diagnostic and consulting services provided by AVRL beginning in the third quarter of fiscal 2012.



Cost of Revenues

The following sets forth our cost of revenues for fiscal 2014, 2013 and 2012 (in thousands, except percentages):

Year Ended March 31, Change 2013 to 2014 Change 2012 to 2013 Dollar Percent Dollar Percent 2014 2013 2012 Change Change Change Change Cost of revenues $ 88,761$ 87,794$ 71,493$ 967 1 % $ 16,301 23 % Percentage of total revenues 52 % 47 % 46 % Cost of revenues includes the cost of materials, direct labor costs, 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. Additionally, cost of revenues includes cost of services for veterinary reference laboratory diagnostic and consulting services provided by AVRL.



Fiscal 2014 Compared to Fiscal 2013

The increase in cost of revenues, in absolute dollars and as a percentage of total revenues, during fiscal 2014 as compared to fiscal 2013, was primarily attributable to (a) higher manufacturing costs of chemistry analyzers and veterinary reagent discs and (b) higher cost of services associated with the growth in service revenues provided by AVRL. These increases in cost of revenues were partially offset by lower unit sales of Piccolo chemistry analyzers and veterinary reagent discs.



Fiscal 2013 Compared to Fiscal 2012

The increase in cost of revenues, in absolute dollars, during fiscal 2013 as compared to fiscal 2012, was primarily due to (a) an increase in the sales volume of medical and veterinary instruments, (b) an increase in the sales volume of veterinary reagent discs, (c) an increase in freight costs to ship products, and (d) cost of services provided by AVRL beginning in the third quarter of fiscal 2012. 42 -------------------------------------------------------------------------------- Table of Contents While we have an ongoing cost improvement program to reduce material and component costs and are implementing design changes and process improvements, any cost reductions and design and process improvements may be partially offset by increases in other manufacturing costs in subsequent periods.



Gross Profit

The following sets forth our gross profit for fiscal 2014, 2013 and 2012 (in thousands, except percentages):

Year Ended March 31, Change 2013 to 2014 Change 2012 to 2013 Dollar Percent Dollar Percent 2014 2013 2012 Change Change Change Change Total gross profit $ 83,109$ 98,231$ 85,103$ (15,122 ) (15 )% $ 13,128 15 % Total gross margin 48 % 53 % 54 %



Fiscal 2014 Compared to Fiscal 2013

Gross profit in fiscal 2014 decreased by 15%, or $15.1 million, as compared to fiscal 2013, primarily attributable to the following: (a) lower unit sales of Piccolo chemistry analyzers and veterinary reagent discs, (b) lower average selling prices of Piccolo chemistry analyzers and medical reagent discs, (c) higher manufacturing costs of chemistry analyzers and veterinary reagent discs and (d) a decrease in unit volume of products sold using our Orbos process. These decreases in gross profit were partially offset by (a) higher unit sales of medical reagent discs and (b) higher service revenues provided by AVRL. The decrease in gross profit percentage was primarily attributable to (a) lower unit sales of chemistry analyzers and veterinary reagent discs and (b) lower average selling prices of Piccolo chemistry analyzers and medical reagent discs.



Fiscal 2013 Compared to Fiscal 2012

Gross profit in fiscal 2013 increased by 15%, or $13.1 million, as compared to fiscal 2012, primarily attributable to the following: (a) sales of Piccolo chemistry analyzers to an international medical supplies sourcing and support company to support a pharmaceutical clinical trial conducted by a biotechnology company, (b) Piccolo chemistry analyzers sold to Abbott, (c) an increase in the sales volume of VetScan chemistry analyzers, VetScan hematology instruments, and veterinary reagent discs, and (d) higher average selling prices of veterinary reagent discs and hematology reagent kits. These increases in gross profit were partially offset by (a) lower average selling prices of Piccolo chemistry analyzers and medical reagent discs sold to Abbott, (b) an increase in freight costs to ship products, and (c) cost of services for veterinary reference laboratory diagnostic and consulting services provided by AVRL beginning in the third quarter of fiscal 2012. As a percentage of total revenues, the decrease in gross profit margin was primarily due to (a) Piccolo chemistry analyzers and medical reagent discs sold to Abbott, (b) an increase in the sales volume of our OEM supplied products, which have a lower margin contribution and (c) cost of services for veterinary reference laboratory diagnostic and consulting services provided by AVRL beginning in the third quarter of fiscal 2012.



Research and Development

The following sets forth our research and development expenses for fiscal 2014, 2013 and 2012 (in thousands, except percentages):

Year Ended March 31, Change 2013 to 2014 Change 2012 to 2013 Dollar Percent Dollar Percent 2014 2013 2012 Change Change Change Change



Research and development expenses $ 13,647$ 13,577$ 12,246

$ 70 1 % $ 1,331 11 % Percentage of total revenues 8 % 7 % 8 % 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 and expenses related to regulatory and quality assurance. Research and development expenses are primarily based on the project activities planned and the level of spending depends on budgeted expenditures. Research and development expenses for the periods presented above are related primarily to new product development and enhancement of existing products in both the medical and veterinary markets.



Fiscal 2014 Compared to Fiscal 2013

Research and development expenses in fiscal 2014 was flat, as compared to fiscal 2013 primarily due to increased consulting expenses and materials associated with product development, partially offset by decreased personnel-related expenses. Share-based compensation expense included in research and development expenses during fiscal 2014 and 2013 was $1.1 million and $1.2 million, respectively. 43 -------------------------------------------------------------------------------- Table of Contents Fiscal 2013 Compared to Fiscal 2012



Research and development expenses in fiscal 2013 increased by 11%, or $1.3 million, as compared to fiscal 2012. Research and development expenses in fiscal 2013 related primarily to new product development and enhancement of existing products in both the medical and veterinary markets. Share-based compensation expense included in research and development expenses during fiscal 2013 and 2012 was $1.2 million and $866,000, respectively.

We anticipate the dollar amount of research and development expenses to increase in fiscal 2015 from fiscal 2014 but remain consistent as a percentage of total revenues, as we complete new products and enhance existing products for both the medical and veterinary markets.



Sales and Marketing

The following sets forth our sales and marketing expenses for fiscal 2014, 2013 and 2012 (in thousands, except percentages):

Year Ended March 31, Change 2013 to 2014 Change 2012 to 2013 Dollar Percent Dollar Percent 2014 2013 2012 Change Change Change Change



Sales and marketing expenses $ 37,330$ 46,943$ 39,618$ (9,613 )

(20 )% $ 7,325 18 % Percentage of total revenues 22 % 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, services related to customer and technical support and costs associated with advertising and marketing of AVRL.



Fiscal 2014 Compared to Fiscal 2013

Sales and marketing expenses in fiscal 2014 decreased by 20%, or $9.6 million, as compared to fiscal 2013. The decrease was primarily as a result of the restructuring of our sales and marketing organization within the medical market segment when we entered into a distribution partnership with Abbott in October 2012. The restructuring resulted in a decrease in personnel costs due to a sales force reduction and a decrease in sales and marketing spending in the United States medical market segment. Additionally, personnel-related expenses decreased primarily due to lower veterinary business headcount during fiscal 2014, as compared to fiscal 2013. Share-based compensation expense included in sales and marketing expenses during fiscal 2014 and 2013 was $2.1 million and $2.5 million, respectively.



Fiscal 2013 Compared to Fiscal 2012

Sales and marketing expenses in fiscal 2013 increased by 18%, or $7.3 million, as compared to fiscal 2012. The increase was primarily due to increased costs related to headcount and promotional and marketing spending to support AVRL and the ongoing growth of our veterinary business in North America. AVRL began providing services starting in the third quarter of fiscal 2012. Share-based compensation expense included in sales and marketing expenses during fiscal 2013 and 2012 was $2.5 million and $1.9 million, respectively.



General and Administrative

The following sets forth our general and administrative expenses for fiscal 2014, 2013 and 2012 (in thousands, except percentages):

Year Ended March 31, Change 2013 to 2014 Change 2012 to 2013 Dollar Percent Dollar Percent 2014 2013 2012 Change Change Change Change General and administrative expenses $ 11,333$ 12,825$ 13,782$ (1,492 ) (12 )% $ (957 ) (7 )% Percentage of total revenues 7 % 7 % 9 %



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.

44 -------------------------------------------------------------------------------- Table of Contents Fiscal 2014 Compared to Fiscal 2013 General and administrative expenses in fiscal 2014 decreased by 12%, or $1.5 million, as compared to fiscal 2013, primarily attributable to a decrease in legal expenses due to the settlement of our Cepheid patent infringement case in the second quarter of fiscal 2013. Share-based compensation expense included in general and administrative expenses during fiscal 2014 and 2013 was $3.3 million and $2.5 million, respectively.



Fiscal 2013 Compared to Fiscal 2012

General and administrative expenses in fiscal 2013 decreased by 7%, or $957,000, as compared to fiscal 2012. The decrease was primarily due to (a) $1.6 million related to start-up costs incurred to develop AVRL during the first and second quarters of fiscal 2012 and (b) a decrease in legal expenses during fiscal 2013, partially offset by an increase in share-based compensation expense during fiscal 2013. Share-based compensation expense included in general and administrative expenses during fiscal 2013 and 2012 was $2.5 million and $2.0 million, respectively. Gain from Legal Settlement



On September 24, 2012, we resolved our patent infringement litigation with Cepheid. As part of the settlement, the parties agreed to terminate all pending and future claims connected with the litigation in exchange for a one-time payment by Cepheid of $17.3 million, which we recognized as an offset to operating expenses during the second quarter of fiscal 2013.

Interest and Other Income (Expense), Net

The following sets forth our interest and other income (expense), net for fiscal 2014, 2013 and 2012 (in thousands, except percentages):

Year Ended March 31, Change 2014 2013 2012 2013-2014 2012-2013 Interest and other income (expense), net $ 1,144$ 253$ 710$ 891$ (457 ) 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 (loss) of an unconsolidated affiliate.



Fiscal 2014 Compared to Fiscal 2013

Interest and other income (expense), net in fiscal 2014 increased as compared to fiscal 2013, primarily attributable foreign currency exchange rate fluctuations.

Fiscal 2013 Compared to Fiscal 2012

Interest and other income (expense), net in fiscal 2013 decreased by 64%, or $457,000, as compared to fiscal 2012. The decrease was primarily due to net unfavorable foreign currency exchange rates.



Income Tax Provision

The following sets forth our income tax provision for fiscal 2014, 2013 and 2012 (in thousands, except percentages):

Year Ended March 31, 2014 2013 2012



Income tax provision $ 7,758$ 14,930$ 7,076 Effective tax rate 35 % 35 % 35 %

Fiscal 2014 Compared to Fiscal 2013

For fiscal 2014 and 2013, the income tax provisions were $7.8 million, based on an effective tax rate of 35%, and $14.9 million, based on an effective tax rate of 35%, respectively. The decrease in the income tax provision during fiscal 2014, as compared to fiscal 2013, was attributable to a reduction in pre-tax income and income tax resulting from a $17.3 million gain from a legal settlement in fiscal 2013, and partially offset by (a) an increase in non-deductible share-based compensation expenses and (b) a reduction in federal research and development tax credits resulting from the expiration of the credit for expenses incurred after December 31, 2013. 45 -------------------------------------------------------------------------------- Table of Contents Fiscal 2013 Compared to Fiscal 2012 For fiscal 2013 and 2012, the income tax provisions were $14.9 million, based on an effective tax rate of 35%, and $7.1 million, based on an effective tax rate of 35%, respectively. The increase in the income tax provision during fiscal 2013, as compared to fiscal 2012, was attributable to an increase in pre-tax income and income tax resulting from a $17.3 million gain from legal settlement, partially offset by (a) an increase in federal research and development tax credits, which was reinstated on January 2, 2013 and applied retroactively to January 1, 2012, (b) an increase in federal tax benefit for qualified production activities and (c) a reduction in non-deductible share-based compensation expenses. We expect our effective tax rate will be approximately 37% for federal, foreign and various state tax jurisdictions in fiscal 2015, compared to an effective tax rate of 35% in fiscal 2014. The expected effective tax rate of 37% in fiscal 2015 is primarily due to the expiration of the federal research and development tax credits for expenses incurred after December 31, 2013.



We did not have any unrecognized tax benefits as of March 31, 2014. During fiscal 2014, 2013 and 2012, we did not recognize any interest or penalties related to unrecognized tax benefits

LIQUIDITY AND CAPITAL RESOURCES

Cash, Cash Equivalents and Investments

The following table summarizes our cash, cash equivalents and short-term and long-term investments at March 31, 2014, 2013 and 2012 (in thousands, except percentages): March 31, 2014 2013 2012 Cash and cash equivalents $ 73,589$ 54,910$ 45,843 Short-term investments 29,102 23,354 21,689 Long-term investments 18,491 17,000 23,442



Total cash, cash equivalents and investments $ 121,182$ 95,264$ 90,974 Percentage of total assets

56 % 47 % 50 %



At March 31, 2014, we had net working capital of $148.6 million compared to $132.9 million at March 31, 2013.

Cash Flow Changes

Cash provided by (used in) operating, investing and financing activities during fiscal 2014, 2013 and 2012 were as follows (in thousands):

Year Ended



March 31,

2014 2013



2012

Net cash provided by operating activities $ 35,572$ 29,197$ 21,973 Net cash provided by (used in) investing activities (13,358 ) (1,657 ) 8,479 Net cash used in financing activities (4,045 ) (18,165 ) (27,915 ) Effect of exchange rate changes on cash and cash equivalents 510 (308 ) (165 ) Net increase in cash and cash equivalents $ 18,679 $



9,067 $ 2,372

Cash and cash equivalents at March 31, 2014 were $73.6 million compared to $54.9 million at March 31, 2013. The increase in cash and cash equivalents during fiscal 2014 was primarily due to net cash provided by operating activities of $35.6 million and proceeds from maturities and redemptions of investments of $24.3 million. The increase was partially offset by purchases of investments of $32.2 million, payments made for tax withholdings related to net share settlements of restricted stock units of $4.7 million, purchases of property and equipment of $5.6 million and repurchases of common stock of $3.0 million during fiscal 2014. Our consolidated statements of cash flows includes the effect of exchange rate changes on cash and cash equivalents and the net gains (losses) arising from transactions denominated in a currency other than the functional currency of a location and the remeasurement of assets and liabilities of our wholly-owned subsidiary, Abaxis Europe GmbH, using U.S. dollars as their functional currency. 46 -------------------------------------------------------------------------------- Table of Contents Cash Flows from Operating Activities During fiscal 2014, we generated $35.6 million in cash from operating activities, compared to $29.2 million in fiscal 2013. The cash provided by operating activities during fiscal 2014 was primarily the result of net income of $14.2 million during fiscal 2014, adjusted for the effects of non-cash adjustments including depreciation and amortization of $7.4 million and share-based compensation expense of $7.6 million, partially offset by a decrease of $2.2 million related to excess tax benefits from share-based awards.



Other changes in operating activities during fiscal 2014 were as follows:

· Receivables, net decreased by $11.2 million, from $40.0 million at March 31,

2013 to $28.8 million as of March 31, 2014, primarily due to lower sales in the

last month of the quarter ended March 31, 2014.

· Inventories remained flat from $26.8 million at March 31, 2013 to $27.0 million

as of March 31, 2014, primarily based on our sales plan.

· Prepaid expenses and other current assets decreased by $867,000, from $3.3

million at March 31, 2013 to $2.5 million as of March 31, 2014, primarily

attributable to (a) a prepayment to Diatron MI PLC at March 31, 2013 for

inventory purchases in the first quarter of fiscal 2014 and (b) a decrease in

prepaid taxes due to the timing of estimated income tax payments.

· Non-current net deferred tax assets increased by $914,000, from $643,000 at

March 31, 2013 to $1.6 million as of March 31, 2014, primarily as a result of

the timing for the deduction of reserves, accruals, depreciation and amortization.



· Accounts payable decreased by $2.0 million, from $8.1 million at March 31, 2013

to $6.1 million as of March 31, 2014, primarily due to the timing and payment

of services and inventory purchases.

· Accrued payroll and related expenses decreased by $1.6 million, from $6.3

million at March 31, 2013 to $4.7 million as of March 31, 2014, primarily due

to a reduction in accrued bonus at March 31, 2014 because qualifiers for bonus

payments were not met in the fourth quarter of fiscal 2014.

· Accrued taxes increased by $704,000, from $440,000 at March 31, 2013 to $1.1

million as of March 31, 2014, primarily due to the timing of estimated income

tax payments.



· As of March 31, 2014 and March 31, 2013, the current portion of deferred

revenue was $1.2 million and $1.4 million, respectively, and the non-current

portion of deferred revenue was $4.0 million and $3.8 million, respectively.

Net current and non-current deferred revenue was flat as of March 31, 2014 as

compared to March 31, 2013. During fiscal 2014, changes in deferred revenue

balances were primarily attributable to an increase in extended maintenance

contracts offered to customers in the form of free services in connection with

the sale of our instruments in the first half of fiscal 2014, partially offset

by deferred revenue recognized ratably over the life of the maintenance

contracts. In October 2013, we changed the standard warranty obligations on

certain instruments from three to five years, which resulted in a decrease in

maintenance contracts offered to customers in the form of free services during

the second half of fiscal 2014.

· As of March 31, 2014 and March 31, 2013, the current portion of warranty

reserve was $1.0 million and $995,000, respectively, and the non­current

portion of warranty reserve was $821,000 and $389,000, respectively. Net

current and non­current warranty reserve increased by $484,000. Warranty

reserve is primarily based on (a) the number of instruments in standard

warranty, estimated product failure rates and estimated repair costs of

instruments and (b) an estimate of defective reagent discs and replacement

costs of reagent discs. During fiscal 2014 we changed the standard warranty

obligations on certain instruments from three to five years. The increase in

the standard warranty obligation did not result in a material impact on our

warranty reserves during the period. The increase in accrued warranty reserve

from March 31, 2013 to March 31, 2014 was primarily attributable to an increase

in the number of instruments in standard warranty. Management periodically

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 anticipate that we will incur incremental additional costs to support our future operations, including further additional pre-clinical testing and clinical trials for our current and future products; research and design costs related to the continuing development of our current and future products; acquisition of capital equipment for our manufacturing facility and costs to operate AVRL. 47 -------------------------------------------------------------------------------- Table of Contents Cash Flows from Investing Activities Net cash used in investing activities during fiscal 2014 totaled $13.4 million, compared to net cash used in investing activities of $1.7 million during fiscal 2013. Changes in investing activities were as follows:



· Cash provided by proceeds from maturities and redemptions of investments in

certificates of deposit, corporate bonds and municipal bonds totaled $24.3

million during fiscal 2014. Cash used to purchase investments in certificates

of deposit, commercial paper and corporate bonds totaled $32.2 million during

fiscal 2014.



· Our capital expenditures totaled $5.6 million during each of fiscal 2014 and

2013, respectively, primarily to increase our manufacturing capacity and

support our AVRL operations and growth in our veterinary business in North

America. We expect to continue to make significant capital expenditures as

necessary in the normal course of our business.

Cash Flows from Financing Activities

Net cash used in financing activities during fiscal 2014 totaled $4.0 million, compared to net cash used in financing activities of $18.2 million during fiscal 2013. The changes in fiscal 2014 were primarily due to payments made for tax withholdings related to net share settlements of restricted stock units of $4.7 million and repurchases of common stock of $3.0 million, partially offset by proceeds from the exercise of stock options of $1.5 million and excess tax benefits from share-based awards of $2.2 million.



Share Repurchase Program

Between August 2011 and January 2012, our Board of Directors authorized the repurchase of up to a total of $55.0 million of our common stock. In July 2013, our Board of Directors approved a $12.3 million increase to our existing share repurchase program to a total of $67.3 million. As of March 31, 2014, $37.0 million was available to purchase common stock under our share repurchase program. Since the share repurchase program began, through March 31, 2014, we have repurchased 1.3 million shares of our common stock at a total cost of $30.3 million, including commission expense. During fiscal 2014, we repurchased 86,000 shares of our common stock for a total cost of $3.0 million and an average per share cost including commission expense of $34.58. During fiscal 2013, we did not repurchase any of our common stock. During fiscal 2012, we repurchased 1.2 million shares of our common stock at a total cost of $27.3 million and an average per share cost including commission expense of $23.41. The repurchases are made from time to time on the open market at prevailing market prices or in negotiated transactions off the market. Repurchased shares are retired. Financial Condition We believe that our cash and cash equivalents, investments and expected cash flows from operations will be sufficient to fund our operations, capital requirements, share repurchase program and anticipated quarterly dividends for at least the next twelve months. Our future capital requirements will largely depend upon the increased customer demand and market acceptance of our point-of-care blood analyzer products and of our Abaxis Veterinary Reference Laboratories. However, our sales for any future periods are not predictable with a significant degree of certainty. Regardless, we may seek to raise additional funds to pursue strategic opportunities.



Contractual Obligations

As of March 31, 2014, our contractual obligations for succeeding fiscal years are as follows (in thousands):

Payments Due by



Period

Total 2015 2016-2017 2018-2019 After 2019 Long-term debt obligations(1) $ 799$ 133$ 251$ 230$ 185 Operating lease obligations(2) 14,821 2,049 4,197 3,707 4,868 Purchase obligations(3) 11,652 3,299 5,878 1,920 555 $ 27,272$ 5,481$ 10,326$ 5,857$ 5,608



--------------------------------------------------------------------------------

(1) Long-term debt obligations include interest payments associated with notes

payable, which are described below in "Notes Payable."

(2) Operating lease obligations are described below in "Operating Leases."

(3) Purchase obligations are described below in "Purchase Commitments."

48 -------------------------------------------------------------------------------- Table of Contents Operating Leases. Operating lease obligations were comprised of our principal facility and various leased facilities and equipment under operating lease agreements, which expire on various dates from fiscal 2015 through fiscal 2025. Our principal facilities located in Union City, California is under a non-cancelable operating lease agreement, which expires in fiscal 2021. Purchase Commitments. Our purchase commitments comprise of supply and inventory related agreements. These purchase order commitments include our purchase obligations with SMB of Denmark to purchase VSpro specialty analyzers and related cartridges through calendar year 2016 under our amended agreement effective January 2014 and Diatron of Hungary to purchase Diatron hematology instruments under our current agreement through fiscal year 2015. Notes Payable. We have a ten year loan agreement with the Community Redevelopment Agency of the City of Union City ("the Agency") whereby the Agency provides us with an unsecured loan of up to $1.0 million, primarily to purchase capital equipment. The loan was effective January 2011, bears interest at 5.0% and is payable quarterly. As of March 31, 2014, our short-term and long-term notes payable balances were $100,000 and $581,000, respectively, and we recorded the short-term balance in "Other accrued liabilities" on the consolidated balance sheets. The entire outstanding balance of the note is 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 March 31, 2014. 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 consolidated statements of income. Patent Licensing Agreement. Effective January 2009, we entered into a license agreement with 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 are payable for so long as we desire to maintain exclusivity under the agreement.



Contingencies

On June 28, 2010, we filed a patent infringement lawsuit against Cepheid. On September 24, 2012, the parties agreed to terminate all pending and future claims connected with the litigation in exchange for a one-time payment by Cepheid of $17.3 million, which we recognized as an offset to operating expenses during the second quarter of fiscal 2013. On October 1, 2012, St. Louis Police Retirement System, a purported shareholder of Abaxis, filed a lawsuit against certain officers and each of the directors of the Company in the United States District Court for the Northern District of California alleging, among other things, that the directors violated Section 14(a) of the Securities Exchange Act of 1934 and breached their fiduciary duties by allegedly failing to disclose material information in our 2010 proxy statement, breached their fiduciary duties by allegedly violating the terms of our 2005 Equity Incentive Plan, and breached their fiduciary duties by failing to disclose alleged material information in our 2012 proxy statement regarding (1) the events leading up to our proposal to amend the 2005 Equity Incentive Plan to eliminate the limit on the number of shares that may be issued pursuant to restricted stock units, and (2) the effects of the proposed amendment on certain settled and outstanding restricted stock units. The plaintiff seeks, among other things, damages, disgorgement and attorney's fees. In addition, the plaintiff sought, and on October 23, 2012, the court issued, an order preliminarily enjoining our shareholder vote on Proposal 2 in our 2012 proxy statement, regarding an amendment to the 2005 Equity Incentive Plan, until such time as additional disclosures could be made. We filed with the SEC and mailed to shareholders supplemental proxy materials approved by the court, the injunction was lifted and our shareholders approved the proposal to amend our 2005 Equity Incentive Plan. A hearing on defendants' motion to dismiss the claims was held on May 7, 2013. 49 -------------------------------------------------------------------------------- Table of Contents On October 1, 2013, before the court ruled on the motions to dismiss, the parties notified the court that they had reached a settlement of the lawsuit. On January 16, 2014, the parties entered into a Stipulation of Settlement, and the following day, the plaintiff filed a motion for preliminary approval. On April 15, 2014, the court issued an order granting preliminary approval of the settlement. The parties have agreed, subject to court approval, that the claims against the defendants will be dismissed with prejudice and will be granted the release of certain known or unknown claims that have been or could have been brought later in the court arising out of the same allegations. We have agreed that if the proposed settlement terms are approved by the court, we will adopt certain corporate governance measures, such measures to be in effect for at least five years. The plaintiff has petitioned the court for an attorney's fee award of $1.7 million. The court has scheduled a hearing for June 17, 2014, at which time it will consider whether to grant final approval of the settlement and whether to grant plaintiff's petition for an attorney's fee award. The settlement is not contingent on the payment of any attorney's fee award. We believe that any attorney's fees that would be awarded to plaintiff's counsel would not have a material adverse effect on Abaxis, our consolidated financial position or our results of operations. We are involved from time to time in various litigation matters in the normal course of business. 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.



Off-Balance Sheet Arrangements

As of March 31, 2014, we did not have any off-balance sheet arrangements, as defined in Item 303 of Regulation S-K promulgated under the Securities Act of 1933. In addition, we identified no variable interests in any variable interest entities.



RECENT ACCOUNTING PRONOUNCEMENTS

For information with respect to recent accounting pronouncements and the impact of these pronouncements on our consolidated financial statements, see Note 1, "Description of Business and Summary of Significant Accounting Policies," of the Notes to Consolidated Financial Statements contained in this Annual Report on Form 10­K.


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Source: Edgar Glimpses


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