News Column

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

August 11, 2014

FORWARD-LOOKING STATEMENTS

This Management's Discussion and Analysis of Financial Condition and Results of Operations includes a number of forward-looking statements, which reflect our current views with respect to future events and financial performance. In this report, the words "will," "anticipates," "believes," "expects," "intends," "plans," "future," "projects," "estimates," "would," "may," "could," "should," "might," and similar expressions identify forward-looking statements. These forward-looking statements are subject to certain risks and uncertainties, including but not limited to those discussed below, in Part II, Item 1A of this report and in Part I, Item 1A of our most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission (the "SEC"), that could cause actual results to differ materially from historical results or those anticipated. Such risks and uncertainties relate to our manufacturing operations, including the vulnerability of our manufacturing operations to potential interruptions and delays and our ability to manufacture products free of defects, fluctuations in our quarterly results of operations and difficulty in predicting future results, the transition of our U.S. medical sales to Abbott Point of Care, Inc., the performance of our independent distributors, our ability to manage the inventory levels of our distributors effectively, our dependence on certain sole or limited source suppliers, market acceptance of our products and services, expansion of our sales, marketing and distribution efforts, dependence on key personnel, the ability of AVRL to compete effectively, the protection of our intellectual property and claims of infringement of intellectual property asserted by third parties, and other risks detailed under "Risk Factors" in this Quarterly Report on Form 10-Q. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We assume no obligation to update any forward-looking statements as circumstances change.



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, promotes 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. The products manufactured and sold in this segment primarily consist of Piccolo chemistry analyzers and medical reagent discs. 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 those market segments 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, clinical research organizations 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. Our veterinary market product offerings include VetScan chemistry analyzers and veterinary reagent discs, VetScan hematology instruments and related reagent kits, VetScan VSpro specialty analyzers and related consumables, VetScan i-STAT analyzers and related consumables and VetScan rapid tests. Since October 2011, our veterinary market services consist of veterinary reference laboratory diagnostic and consulting services for veterinarians in the United States through Abaxis Veterinary Reference Laboratories ("AVRL"). 19



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Table of Contents 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 Veterinary Supply, Inc. ("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.



Overview of Financial Results

In the first quarter of fiscal 2015, total revenues were $47.5 million, an increase of 10% over last year's comparable quarter. The net increase in revenues was primarily due to an increase in Piccolo and VetScan chemistry analyzers and related reagent disc sales and an increase in service revenues from veterinary reference laboratory diagnostic and consulting services. Gross profit in the first quarter of fiscal 2015 was $23.9 million, an increase of 14% over last year's comparable quarter, primarily attributable to higher unit sales of reagent discs in our veterinary market. Total operating expenses in the first quarter of fiscal 2015 were $16.4 million, an increase of $177,000, compared to the same period last year. Research and development expenses increased by $774,000, or 24%, over last year's comparable quarter, primarily attributable to higher expenses related to new product development and enhancement of existing products in both the medical and veterinary markets. These expenses were partially offset by a decrease in sales and marketing expenses of $450,000, or 4%, from last year's comparable quarter, primarily due to a decrease in personnel-related expenses from lower veterinary business headcount and decreased costs related to promotional and marketing spending. Net income in the first quarter of fiscal 2015 was $4.7 million, an increase of $1.5 million, compared to the same period last year, due primarily to the increased revenues described above, partially offset by an increase in our income tax provision of $960,000. Our diluted earnings per share increased to $0.21 in the first quarter of fiscal 2015 from $0.14 for the same period last year. Cash, cash equivalents and investments increased by $4.5 million during the three months ended June 30, 2014 to a total of $125.7 million at June 30, 2014. The primary source of cash and cash equivalents during the three months ended June 30, 2014 was operating cash flows of $10.0 million. Key non-operating uses of cash during the three months ended June 30, 2014 included capital expenditures of $1.7 million, payments made for tax withholdings related to net share settlements of restricted stock units of $1.6 million and payment of a cash dividend of $0.10 per share, totaling $2.2 million to shareholders of record on June 3, 2014.



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 business in the United States was impacted by our continuing transition to a new distribution partner, as described below. Additionally, during fiscal 2014 and the first quarter of fiscal 2015, our veterinary market business in the United States was impacted by our continuing transition to a new distribution partner, 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 fiscal 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. Beginning in the second half of fiscal 2014, we have been taking 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 our distributors' purchases of our chemistry analyzers and related reagent discs were more in line with in-clinic sales starting in the first quarter of our fiscal 2015. We will continue to closely monitor and manage channel inventory at our veterinary distribution partners in the United States. 20



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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 condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and pursuant to the rules and regulations of the Securities and Exchange Commission. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. On an on-going basis, we evaluate our estimates and the sensitivity of these estimates to deviations in the assumptions used in making them. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. However, there can be no assurance that our actual results will not differ from these estimates. We have identified the policies below as critical because they are not only important to understanding our financial condition and results of operations, but also because application and interpretation of these policies requires both judgment and estimates of matters that are inherently uncertain and unknown. Accordingly, actual results may differ materially from our estimates. The impact and any associated risks related to these policies on our business operations are discussed below. A more detailed discussion on the application of these and other accounting policies are included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2014. 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. 21



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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 the three months ended June 30, 2014 and 2013, our customer incentive programs with future discounts were not significant.



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 and group

purchasing organizations 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.



· 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.

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Table of Contents 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 (a) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (b) an entity's own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below. Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities. As of June 30, 2014, our investments in cash equivalents, which we classified as available-for-sale, totaled $13.9 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 June 30, 2014, our available-for-sale investments in corporate bonds, totaled $10.4 million, using Level 2 inputs, based on market pricing and other observable market inputs for similar securities obtained from various third party data providers. Level 3: Unobservable inputs that are supported by little or no market data and require the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management's estimates of market participant assumptions. As of June 30, 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 June 30, 2014, we also had $28.2 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 June 30, 2014, our investment in unconsolidated affiliate totaled $2.6 million. 23



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Table of Contents 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 specific 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 period did not result in a material impact on our cost of revenues or our accrued warranty costs during fiscal 2014 or during the three months ended June 30, 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 June 30, 2014, our current portion of warranty reserves for instruments and reagent discs totaled $961,000 and our non­current portion of warranty reserves for instruments totaled $912,000, 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. As of March 31, 2014, our current portion of warranty reserves for instruments and reagent discs totaled $1.0 million and our non-current portion of warranty reserves for instruments totaled $821,000. The change in total accrued warranty reserve from March 31, 2014 to June 30, 2014 was not significant. 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. 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 the three months ended June 30, 2014 and 2013. 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. 24



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Table of Contents Income Taxes. We account for income taxes using the liability method under which deferred tax assets and liabilities are determined based on the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amounts expected to be recovered. We recognize and measure benefits for uncertain tax positions using a two-step approach. The first step is to evaluate the tax position taken or expected to be taken in a tax return by determining if the weight of evidence indicates that it is more likely than not that the tax position will be sustained upon audit, including resolution of any related appeals or litigation processes. For tax positions that are more likely than not to be sustained upon audit, the second step is to measure the tax benefit as the largest amount that is more than 50 percent likely to be realized upon settlement. Significant judgment is required to evaluate uncertain tax positions. At June 30, 2014 and March 31, 2014, 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. During the three months ended June 30, 2014 and 2013, we did not recognize any interest or penalties related to uncertain tax positions in the consolidated statements of income, and at June 30, 2014 and March 31, 2014, 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 June 30, 2014, we had no unrecognized compensation expense related to stock options granted. 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. The share-based compensation expense is reduced for an estimate of the restricted stock unit awards that are expected to be forfeited. The forfeiture estimate is based on historical data and other factors. In subsequent periods, if actual forfeitures differ from those estimates, an adjustment to share-based compensation expense will be recognized at that time. 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. 25



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Table of Contents 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 would have vested only if both of the following criteria were satisfied: (1) our consolidated income from operations for the fiscal year ended March 31, 2014, as certified by the Compensation Committee, was in excess of the applicable target amount described below; and (2) the recipient remained in the service of the Company until the applicable vesting date set forth as follows:



· 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 would vest and as a result 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 will 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 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.

During the three months ended June 30, 2014, we recorded share-based compensation expense related to the portion of the FY2015 Performance RSUs, as we determined that it was probable that the performance targets would be met. We will assess the probability of the performance targets at the end of each quarter. Share-based compensation expense resulted in a material impact on our earnings per share and on our condensed consolidated financial statements for fiscal 2014 and during the three months ended June 30, 2014. The impact of share-based compensation expense on our condensed consolidated financial results is disclosed in Note 10, "Equity Compensation Plans and Share-Based Compensation" in the Notes to Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q. We expect that share-based compensation will materially impact our consolidated financial statements in the foreseeable future. 26



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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 the three months ended June 30, 2014 and 2013 were as follows (in thousands, except percentages): Three Months Ended June 30, Dollar Percent Revenues by Geographic Region 2014 2013 Change Change North America $ 38,340$ 34,652$ 3,688 11 % Percentage of total revenues 81 % 80 % Europe 7,284 6,552 732 11 % Percentage of total revenues 15 % 15 % Asia Pacific and rest of the world 1,853 1,965 (112 ) (6 )% Percentage of total revenues 4 % 5 % Total revenues $ 47,477$ 43,169$ 4,308 10 % Three Months Ended June 30, Dollar Percent Revenues by Product and Service Category 2014 2013 Change Change Instruments(1) $ 7,594$ 8,675$ (1,081 ) (12 )% Percentage of total revenues 16 % 20 % Consumables(2) 34,286 30,599 3,687 12 % Percentage of total revenues 72 % 71 % Other products and services(3) 5,560 3,858 1,702 44 % Percentage of total revenues 12 % 9 % Product and service revenues, net 47,440 43,132 4,308 10 % Percentage of total revenues 100 % 100 % Development and licensing revenue 37 37 - - % Percentage of total revenues <1% <1% Total revenues $ 47,477$ 43,169$ 4,308 10 %



______________________________________________________________________________________

(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 services.

Three Months Ended June 30, 2014 Compared to Three Months Ended June 30, 2013

North America. During the three months ended June 30, 2014, total revenues in North America increased by 11%, or $3.7 million, as compared to the same period in fiscal 2014. 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 increased by 30%, or $1.1 million, primarily due to an

increase in the sales volume of Piccolo chemistry analyzers and medical reagent

discs sold to Abbott.



· Total sales of our VetScan chemistry analyzers and veterinary reagent discs in

North America increased by 18%, or $3.1 million, primarily due to sales of

VetScan chemistry analyzers to the U.S. government and an increase in the sales

volume of veterinary reagent discs sold due to an expanded installed base.

· Total sales of our VetScan hematology instruments and hematology reagent kits

in North America decreased by 17%, or $692,000, primarily due to a decrease in

the unit volume of VetScan hematology instruments sold during the first quarter

of fiscal 2015 to balance the inventory level in the distribution channel and

higher incentives offered to customers as part of selling arrangements with

multiple deliverables during the first quarter of fiscal 2014, partially offset

by an increase in the sales volume of hematology reagent kits.

· Total sales of our VetScan VSpro specialty analyzers and related consumables,

VetScan i­STAT analyzers and related consumables and VetScan rapid tests in

North America decreased by 24%, or $1.5 million, primarily due to a decrease in

the unit volume of VetScan VSpro specialty analyzers, VetScan i-STAT analyzers

and rapid tests sold during the first quarter of fiscal 2015 to balance the

inventory level in the distribution channel and higher incentives offered to

customers as part of selling arrangements with multiple deliverables during the

first quarter of fiscal 2014.

27



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Table of Contents · Other products and services revenue in North America increased by 48%, or $1.7

million, primarily attributable to 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.

Europe. During the three months ended June 30, 2014, total revenues in Europe increased by 11%, or $732,000, as compared to the same period in fiscal 2014. The change in revenues from Piccolo chemistry analyzers and medical reagent discs was not significant. Revenues from VetScan chemistry analyzers and veterinary reagent discs increased by 18%, or $738,000, primarily due to an increase in the sales volume of veterinary reagent discs to a distributor, partially offset by lower average selling prices of VetScan chemistry analyzers sold.



Asia Pacific and rest of the world. During the three months ended June 30, 2014, the change in total revenues in Asia Pacific and rest of the world was not significant, as compared to the same period in fiscal 2014.

Significant concentrations. During the three months ended June 30, 2014 and 2013, one distributor in the United States, MWI, accounted for 15% and 23%, respectively, of our total worldwide revenues.

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.



Three Months Ended June 30, 2014 Compared to Three Months Ended June 30, 2013

The following table presents revenues, cost of revenues, gross profit and percentage of revenues by operating segments and from certain unallocated items for the three months ended June 30, 2014 and 2013 (in thousands, except percentages): Three Months Ended June 30, Change Percent of Percent of Dollar Percent 2014 Revenues(1) 2013 Revenues(1) Change Change Revenues: Medical Market $ 7,245 100 % $ 6,038 100 % $ 1,207 20 % Percentage of total revenues 15 % 14 % Veterinary Market 39,367 100 % 36,371 100 % 2,996 8 % Percentage of total revenues 83 % 84 % Other(2) 865 760 105 14 % Percentage of total revenues 2 % 2 % Total revenues 47,477 43,169 4,308 10 % Cost of revenues: Medical Market 3,844 53 % 3,294 55 % 550 17 % Veterinary Market 19,724 50 % 18,948 52 % 776 4 % Other(2) 37 35 2 6 % Total cost of revenues 23,605 22,277 1,328 6 % Gross profit: Medical Market 3,401 47 % 2,744 45 % 657 24 % Veterinary Market 19,643 50 % 17,423 48 % 2,220 13 % Other(2) 828 725 103 14 % Gross profit $ 23,872$ 20,892$ 2,980 14 %



______________________________________________________________________________________

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

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

business segment. 28



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Table of Contents Medical Market



Revenues for Medical Market Segment

During the three months ended June 30, 2014, total revenues in the medical market increased by 20%, or $1.2 million, as compared to the same period in fiscal 2014. The change in the medical market segment was primarily attributable to the following:

· Total revenues from Piccolo chemistry analyzers increased by 16%, or $178,000,

during the three months ended June 30, 2014, as compared to the same period in

fiscal 2014, primarily attributable to an increase in the sales volume of Piccolo chemistry analyzers sold in North America to Abbott.



· Total revenues from medical reagent discs increased by 21%, or $970,000, during

the three months ended June 30, 2014, as compared to the same period in fiscal

2014, primarily attributable to an increase in the sales volume of medical

reagent discs sold in North America to Abbott.

Gross Profit for Medical Market Segment

Gross profit for the medical market segment increased by 24%, or $657,000, during the three months ended June 30, 2014, as compared to the same period in fiscal 2014. Gross profit percentages for the medical market segment during the three months ended June 30, 2014, and 2013 were 47% and 45%, respectively. In absolute dollars and as a percentage of total revenues, the increase in gross profit was primarily due to a higher unit volume of medical reagent discs sold.



Veterinary Market

Revenues for Veterinary Market Segment

During the three months ended June 30, 2014, total revenues in the veterinary market increased by 8%, or $3.0 million, as compared to the same period in fiscal 2014. The change in the veterinary market segment was primarily attributable to the following:

· Total revenues from veterinary instruments decreased by 17%, or $1.3 million,

during the three months ended June 30, 2014, as compared to the same period in

fiscal 2014, primarily attributable to (a) a decrease in the unit volume of our

VetScan hematology instruments, VetScan VSpro specialty analyzers and VetScan

i-STAT analyzers sold in North America during the first quarter of fiscal 2015

to balance the inventory level in the distribution channel and higher

incentives offered to customers in North America as part of selling

arrangements with multiple deliverables during the first quarter of fiscal 2014

and (b) lower average selling prices of VetScan chemistry analyzers sold in

Europe during the first quarter of fiscal 2015. These decreases were partially

offset by sales of VetScan chemistry analyzers to the U.S. government during

the first quarter of fiscal 2015.

· Total revenues from consumables in the veterinary market increased by 10%, or

$2.7 million, during the three months ended June 30, 2014, as compared to the

same period in fiscal 2014, primarily attributable to (a) an increase in the

sales volume of veterinary reagent discs sold in North America due to an

expanded installed base and (b) an increase in the sales volume of veterinary

reagent discs to a distributor in Europe. These increases were partially offset

by a decrease in the unit volume of rapid tests sold during the first quarter

of fiscal 2015 to balance the inventory level in the distribution channel in

North America and higher incentives offered to customers as part of selling

arrangements with multiple deliverables during the first quarter of fiscal

2014.



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

increased by 57%, or $1.5 million, during the three months ended June 30, 2014,

as compared to the same period in fiscal 2014, primarily attributable to an

increase in service revenues from veterinary reference laboratory diagnostic

and consulting services provided by AVRL in North America from sales to new

customers and increased business with current customers.

Gross Profit for Veterinary Market Segment

Gross profit for the veterinary market segment increased by 13%, or $2.2 million, during the three months ended June 30, 2014, as compared to the same period in fiscal 2014. Gross profit percentages for the veterinary market segment during the three months ended June 30, 2014 and 2013 were 50% and 48%, respectively. In absolute dollars, the net increase in gross profit was primarily attributable to (a) a higher unit volume of veterinary reagent discs sold and (b) higher service revenues provided by AVRL, partially offset by higher manufacturing costs on hematology instruments. The increase in gross profit percentage was primarily attributable to a higher unit volume of veterinary reagent discs sold.



Other

Gross profit in our other category increased by 14%, or $103,000, during the three months ended June 30, 2014, as compared to the same period in fiscal 2014, primarily attributable to an increase in unit volume of products sold using our patented Orbos Discrete Lyophilization Process. 29



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Table of Contents Three Months Ended June 30, 2014 Compared to Three Months Ended June 30, 2013

Cost of Revenues

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

Three Months Ended June 30, Dollar Percent 2014 2013 Change Change Cost of revenues $ 23,605$ 22,277$ 1,328 6 % Percentage of total revenues 50 % 52 % 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. The increase in cost of revenues, in absolute dollars, during the three months ended June 30, 2014, as compared to the same period in fiscal 2014, was primarily due to (a) an increase in the sales volume of VetScan chemistry analyzers and medical and veterinary reagent discs, (b) higher manufacturing costs on hematology instruments and (c) higher cost of services associated with the growth in service revenues provided by AVRL. The decrease in cost of revenues, as a percentage of total revenues, during the three months ended June 30, 2014, as compared to the same period in fiscal 2014, was primarily due to lower manufacturing costs of medical and veterinary reagent discs.



Gross Profit

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

Three Months Ended June 30, Dollar Percent 2014 2013 Change Change Total gross profit $ 23,872$ 20,892$ 2,980 14 % Total gross profit percentage 50 % 48 % Gross profit during the three months ended June 30, 2014 increased by 14%, or $3.0 million, as compared to the same period in fiscal 2014, primarily attributable to the following: (a) a higher unit volume of medical and veterinary reagent discs sold and (b) higher service revenues provided by AVRL, partially offset by higher manufacturing costs on hematology instruments. The increase in gross profit percentage was primarily attributable to (a) a higher unit volume of medical and veterinary reagent discs sold and (b) higher service revenues provided by AVRL. Research and Development



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

Three Months Ended June 30, Dollar Percent 2014 2013 Change Change



Research and development expenses $ 3,947$ 3,173$ 774

24 % Percentage of total revenues 8 % 7 % 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. Research and development expenses increased during the three months ended June 30, 2014, as compared to the same period in fiscal 2014, primarily attributable to higher expenses related to new product development and enhancement of existing products in both the medical and veterinary markets, including costs associated with our research and development diagnostic agreement with LamdaGen Corporation, which we entered into in fiscal 2014, to integrate LamdaGen's high-sensitivity Plasmonic ELISA technology on the reagent discs used with our chemistry analyzers. Share-based compensation expense included in research and development expenses during the three months ended June 30, 2014 and 2013 was $441,000 and $367,000, respectively. 30



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Table of Contents 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 the periods indicated (in thousands, except percentages):

Three Months Ended June 30, Dollar Percent 2014 2013 Change Change Sales and marketing expenses $ 9,578$ 10,028$ (450 ) (4 )% Percentage of total revenues 20 % 23 % 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. Sales and marketing expenses decreased during the three months ended June 30, 2014, as compared to the same period in fiscal 2014, primarily due to (a) a decrease in personnel-related expenses primarily due to lower veterinary business headcount and (b) decreased costs related to promotional and marketing spending. Share-based compensation expense included in sales and marketing expenses during the three months ended June 30, 2014 and 2013 was $826,000 and $706,000, respectively. General and Administrative



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

Three Months Ended June 30, Dollar Percent 2014 2013 Change Change



General and administrative expenses $ 2,908$ 3,055$ (147 )

(5 )% Percentage of total revenues 6 % 7 %



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.

General and administrative expenses decreased during the three months ended June 30, 2014, as compared to the same period in fiscal 2014, primarily attributable to a decrease in share-based compensation related to adjustments for forfeiture estimates to reflect actual forfeitures when an award vested in the first quarter of fiscal 2015, partially offset by other expenses to support our ongoing growth. Share-based compensation expense included in general and administrative expenses during the three months ended June 30, 2014 and 2013 was $424,000 and $922,000, respectively.



Interest and Other Income (Expense), Net

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

Three Months Ended June 30, Dollar 2014 2013 Change



Interest and other income (expense), net $ 47$ 404$ (357 )

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.



Interest and other income (expense), net in the first quarter of fiscal 2015 decreased as compared to the first quarter of fiscal 2014, primarily attributable to foreign currency exchange rate fluctuations.

31



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Table of Contents Income Tax Provision



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

Three Months Ended June 30, 2014 2013 Income tax provision $ 2,771$ 1,811 Effective tax rate 37 % 36 % During the three months ended June 30, 2014 and 2013, our income tax provision was $2.8 million, based on an effective tax rate of 37%, and $1.8 million, based on an effective tax rate of 36%, respectively. The effective tax rate during the three months ended June 30, 2014, as compared to the three months ended June 30, 2013, increased primarily due to an elimination of federal research and development tax credits resulting from the expiration of the credit for expenses incurred after December 31, 2013. We did not have any unrecognized tax benefits as of June 30, 2014 and March 31, 2014. During the three months ended June 30, 2014 and 2013, 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 June 30, 2014 and March 31, 2014 (in thousands, except percentages): June 30, March 31, 2014 2014 Cash and cash equivalents $ 87,103$ 73,589 Short-term investments 20,139 29,102 Long-term investments 18,411 18,491



Total cash, cash equivalents and investments $ 125,653$ 121,182 Percentage of total assets

55 % 56 %



At June 30, 2014, we had net working capital of $151.5 million compared to $148.6 million at March 31, 2014.

Cash Flow Changes

Cash provided by (used in) operating, investing and financing activities for the three months ended June 30, 2014 and 2013 were as follows (in thousands):

Three



Months Ended June 30,

2014 2013 Net cash provided by operating activities $ 10,015$ 12,157 Net cash provided by investing activities 7,229 2,863 Net cash used in financing activities (3,665 ) (2,298 ) Effect of exchange rate changes on cash and cash equivalents (65 ) 154 Net increase in cash and cash equivalents $



13,514 $ 12,876

Cash and cash equivalents at June 30, 2014 were $87.1 million compared to $73.6 million at March 31, 2014. The increase in cash and cash equivalents during the three months ended June 30, 2014 was primarily due to net cash provided by operating activities of $10.0 million and proceeds from maturities and redemptions of investments of $13.7 million. The increase was partially offset by purchases of investments of $4.8 million, payments made for tax withholdings related to net share settlements of restricted stock units of $1.6 million, purchases of property and equipment of $1.7 million and payment of cash dividends totaling $2.2 million during the three months ended June 30, 2014.



Cash Flows from Operating Activities

During the three months ended June 30, 2014, we generated $10.0 million in cash from operating activities, compared to $12.2 million during the three months ended June 30, 2013. The cash provided by operating activities during the three months ended June 30, 2014 was primarily the result of net income of $4.7 million, adjusted for the effects of non-cash adjustments including depreciation and amortization of $2.1 million and share-based compensation expense of $2.0 million. Additionally, during the three months ended June 30, 2014, we had non-cash adjustments related to excess tax benefits from share-based awards of $100,000, a decrease of $1.3 million, compared to the same period last year, primarily due to lower tax deductions related to vested restricted stock units in excess of share-based compensation recognized for financial reporting. 32



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Table of Contents Other changes in operating activities during the three months ended June 30, 2014 were as follows:



· Receivables, net increased by $4.1 million, from $29.2 million at March 31,

2014 to $33.3 million as of June 30, 2014, primarily due to higher sales during

the first quarter of fiscal 2015.

· Inventories increased by $575,000, from $27.0 million at March 31, 2014 to

$27.6 million as of June 30, 2014, primarily based on our sales plan.

· Prepaid expenses and other current assets decreased by $733,000, from $2.5

million at March 31, 2014 to $1.7 million as of June 30, 2014, primarily

attributable to a decrease in prepaid taxes due to the timing of estimated

income tax payments.



· Net current deferred tax assets increased by $726,000, from $4.5 million at

March 31, 2014 to $5.2 million as of June 30, 2014, primarily as a result of

the timing for the deduction of share-based compensation, reserves, accruals,

depreciation and amortization.

· Accounts payable increased by $939,000, from $6.1 million at March 31, 2014 to

$7.1 million as of June 30, 2014, primarily due to the timing and payment of

services and inventory purchases.

· Accrued payroll and related expenses increased by $2.2 million, from $4.7

million at March 31, 2014 to $6.9 million as of June 30, 2014, primarily due to

an increase in accrued bonus at June 30, 2014 because qualifiers for bonus

payments were met in the first quarter of fiscal 2015.

· Accrued taxes increased by $2.4 million, from $1.1 million at March 31, 2014 to

$3.5 million as of June 30, 2014, primarily due to the timing of estimated

income tax payments.



· Other accrued liabilities increased by $754,000, from $3.1 million at March 31,

2014 to $3.8 million as of June 30, 2014, primarily due to higher accruals for

customer incentive programs during the quarter ended June 30, 2014.

· As of June 30, 2014 and March 31, 2014, the current portion of deferred revenue

was $1.2 million and $1.2 million, respectively, and the non-current portion of

deferred revenue was $3.8 million and $4.0 million, respectively. Net current

and non-current deferred revenue decreased by $222,000 from March 31, 2014 to

June 30, 2014, primarily attributable to deferred revenue recognized ratably

over the life of extended maintenance contracts offered to customers in the

form of free services in connection with the sale of our instruments. In

October 2013, we prospectively changed the standard warranty obligations on

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

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

connection with the sale of our instruments.

· As of June 30, 2014 and March 31, 2014, the current portion of warranty reserve

was $961,000 and $1.0 million, respectively, and the non-current portion of

warranty reserve was $912,000 and $821,000, respectively. The net change in

current and non-current warranty reserve from March 31, 2014 to June 30, 2014

was not significant. Warranty reserve is primarily based on (a) the number of

instruments in standard warranty, estimated product failure rates and estimated

repair costs and (b) an estimate of defective reagent discs and replacement

costs of reagent discs. In October 2013, we prospectively 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 or cost of revenues during the period.

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.



Cash Flows from Investing Activities

Net cash provided by investing activities during the three months ended June 30, 2014 totaled $7.2 million, compared to net cash provided by investing activities of $2.9 million during the three months ended June 30, 2013. Changes in investing activities were as follows:



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

certificates of deposit, commercial paper and corporate bonds totaled $13.7

million during the three months ended June 30, 2014. Cash used to purchase

investments in certificates of deposit, commercial paper and corporate bonds

totaled $4.8 million during the three months ended June 30, 2014.

· Our capital expenditures totaled $1.7 million during the three months ended

June 30, 2014, primarily to increase our manufacturing capacity and support our

growth in our medical and veterinary business in North America. We expect to

continue to make significant capital expenditures as necessary in the normal

course of our business. 33



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Table of Contents Cash Flows from Financing Activities Net cash used in financing activities during the three months ended June 30, 2014 totaled $3.7 million, compared to net cash used in financing activities of $2.3 million during the three months ended June 30, 2013. The changes during the three months ended June 30, 2014 were primarily due to payments made for tax withholdings related to net share settlements of restricted stock units of $1.6 million and a cash dividend payment of $2.2 million. In April 2014, our Board of Directors declared a cash dividend of $0.10 per share on our outstanding common stock to all shareholders of record as of the close of business on June 3, 2014. This dividend, which totaled $2.2 million, was paid on June 17, 2014. Additionally, during the three months ended June 30, 2014, we did not purchase any shares pursuant to our share repurchase program described below.



Dividend

In April 2014, our Board of Directors declared a cash dividend of $0.10 per share on our outstanding common stock. This dividend, which totaled $2.2 million, was paid on June 17, 2014. In July 2014, our Board of Directors declared a cash dividend of $0.10 per share on our outstanding common stock to be paid on September 17, 2014 to all shareholders of record as of the close of business on September 3, 2014. We anticipate paying additional quarterly dividends during fiscal 2015 in December and March. However, such future declarations of quarterly dividends and the establishment of future record and payment dates are subject to the final determination of our Board of Directors.



Share Repurchase Program

Between August 2011 and January 2012, the Board of Directors authorized the repurchase of up to a total of $55.0 million of our common stock. In July 2013, the Board of Directors approved a $12.3 million increase to our existing share repurchase program to a total of $67.3 million. As of June 30, 2014, $37.0 million was available to purchase common stock under our share repurchase program. Since the share repurchase program began, through June 30, 2014, we have repurchased 1.3 million shares of our common stock at a total cost of $30.3 million, including commission expense. During the three months ended June 30, 2014 and 2013, we did not repurchase any shares of our common stock. 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

Purchase Commitments. We have purchase commitments, consisting of supply and inventory related agreements, totaling approximately $12.2 million as of June 30, 2014. These purchase order commitments include our purchase obligations to purchase VSpro specialty analyzers and related cartridges from SMB of Denmark through calendar year 2016 and obligations to purchase Diatron hematology instruments from Diatron of Hungary 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 June 30, 2014, our short-term and long-term notes payable balances were $100,000 and $556,000, respectively, and we recorded the short-term balance in "Other accrued liabilities" on the condensed consolidated balance sheets. The entire outstanding balance of the note 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 June 30, 2014. 34



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Table of Contents In accordance with the terms of the loan agreement, the Agency will provide Abaxis with an annual credit that can be applied against the accrued interest and outstanding principal balance on a quarterly basis. The Agency determines the annual credit based on certain taxes paid by Abaxis to the City of Union City, California for a specified period, as defined in the loan agreement. We anticipate that our annual credits from the Agency will be used to fully repay our notes payable due to the Agency. We may carry forward unused quarterly credits to apply against our outstanding balance in a future period. Credits applied to repay our notes payable and accrued interest are recorded in "Interest and other income (expense), net" on the condensed consolidated statements of income. 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 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. 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. A hearing on the motion for final approval of the settlement and plaintiff's petition for attorney's fees was held on June 17, 2014. The court has not yet issued a decision. 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 June 30, 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

A discussion of recent accounting pronouncements is included in Note 2 of the Notes to Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q. 35



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