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

FORM 10-Q

(MARK ONE)

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2003

or

[   ]

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 000-19720

ABAXIS, INC. (Exact name of registrant as specified in its charter)

California	77-0213001
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification Number)

3240 Whipple Road Union City, California 94587 (Address of principal executive offices including zip code)

(510) 675-6500 (Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes [X]      No [   ].

At February 10, 2004, 19,442,824 shares of Common Stock were outstanding.

This Report on Form 10-Q consists of 32 pages. The exhibit index is on page 27.

ABAXIS, INC. Report On Form 10-Q for the Quarter Ended December 31, 2003

INDEX

Item	Page
Facing Sheet	1
Table of Contents	2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Statements of Operations -
Three and nine months ended December 31, 2003 and 2002	3
Condensed Balance Sheets - December 31, 2003 and March 31, 2003	4
Condensed Statements of Cash Flows -
Nine months ended December 31, 2003 and 2002	5
Notes to Condensed Financial Statements	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3. Quantitative and Qualitative Disclosures About Market Risk	26
Item 4. Controls and Procedures	26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	26
Item 2. Changes in Securities and Use of Proceeds	26
Item 3. Defaults Upon Senior Securities	26
Item 4. Submission of Matters to a Vote of Security Holders	27
Item 5. Other Information	27
Item 6. Exhibits and Reports on Form 8-K	27
Signatures	28

 

2

PART I -- FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Abaxis, Inc. Condensed Statements of Operations (Unaudited)

			Three Months Ended December 31,						Nine Months Ended December 31,
			2003			2002			2003			2002
Revenues:
Product sales, net		$	12,245,000		$	8,453,000		$	33,966,000		$	24,453,000
Development and licensing revenue			35,000			35,000			163,000			151,000
Total revenues			12,280,000			8,488,000			34,129,000			24,604,000
Costs and operating expenses:
Cost of product sales			6,155,000			4,391,000			17,016,000			12,763,000
Selling, general and administrative			3,680,000			2,875,000			10,464,000			8,291,000
Research and development			1,218,000			870,000			3,468,000			2,810,000
Total costs and operating expenses			11,053,000			8,136,000			30,948,000			23,864,000
Income from operations			1,227,000			352,000			3,181,000			740,000
Interest and other income			39,000			48,000			124,000			168,000
Interest and other expense			(2,000)			(24,000)			(50,000)			(113,000)
Net income before income taxes			1,264,000			376,000			3,255,000			795,000
Income tax provision			91,000			11,000			153,000			24,000
Net income			1,173,000			365,000			3,102,000			771,000
Preferred dividends and accretion (a)			(28,000)			(204,000)			(419,000)			(1,031,000)
Net income (loss) attributable to common shareholders		$	1,145,000		$	161,000		$	2,683,000		$	(260,000)
Basic net income (loss) per share		$	0.06		$	0.01		$	0.15		$	(0.02)
Diluted net income (loss) per share		$	0.05		$	0.01		$	0.14		$	(0.02)
Weighted average common shares outstanding – basic			18,957,000			16,799,000			17,678,000			16,576,000
Weighted average common shares outstanding – diluted			21,534,000			17,148,000			19,728,000			16,576,000

(a)

For the three and nine months ended December 31, 2003, includes dividends of $28,000 and $419,000, respectively. For the three months ended December 31, 2002, includes dividends of $204,000. For the nine months ended December 31, 2002, includes dividends of $661,000 and a non-cash dividend charge of $370,000 related to the beneficial conversion feature contained in the Company’s Series E Preferred Stock issued in April 2002.

See notes to condensed financial statements.

 

3

Abaxis, Inc. Condensed Balance Sheets (Unaudited)

			December 31, 2003			March 31, 2003
ASSETS
Current assets:
Cash and cash equivalents		$	16,048,000		$	10,430,000
Trade receivables (net of allowances of $286,000 at December 31, 2003
and $267,000 at March 31, 2003			7,690,000			7,482,000
Inventories			5,441,000			4,982,000
Prepaid expenses			262,000			667,000
Total current assets			29,441,000			23,561,000
Property and equipment - net			8,136,000			8,580,000
Deposits and other assets			869,000			227,000
Total assets		$	38,446,000		$	32,368,000
LIABILITIES, CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable		$	2,385,000		$	2,084,000
Dividends payable			28,000			408,000
Accrued payroll and related expenses			2,404,000			1,811,000
Other accrued liabilities			289,000			377,000
Warranty reserve			228,000			123,000
Deferred revenue			268,000			378,000
Current portion of capital lease obligations			27,000			58,000
Current portion of long-term debt			467,000			467,000
Total current liabilities			6,096,000			5,706,000
Capital lease obligations, less current portion			22,000			38,000
Long-term debt, less current portion			117,000			466,000
Deferred rent			394,000			321,000
Deferred revenue, less current portion			392,000			318,000
Commission obligation, less current portion			52,000			75,000
Total non-current liabilities			977,000			1,218,000
Commitments and contingencies
Redeemable convertible preferred stock, Series E, no par value:
issued and outstanding shares - none at December 31, 2003 and 5,570
at March 31, 2003 (liquidation preference of $0 at December 31, 2003
and $5,570,000 at March 31, 2003			-			3,176,000
Shareholders’ equity:
Convertible preferred stock, Series D, no par value:
authorized shares - 5,000,000; issued and outstanding
shares - none at December 31, 2003 and 6,508 at March 31, 2003			-			3,143,000
Common stock, no par value: authorized shares -
35,000,000; issued and outstanding shares - 19,396,305
at December 31, 2003 and 16,816,095 at March 31, 2003			90,174,000			80,608,000
Accumulated deficit			(58,801,000)			(61,483,000)
Total shareholders’ equity			31,373,000			22,268,000
Total liabilities, convertible preferred stock and shareholders' equity		$	38,446,000		$	32,368,000

See notes to condensed financial statements.

 

4

Abaxis, Inc. Condensed Statements of Cash Flows (Unaudited)

			Nine Months Ended December 31,
			2003			2002
Operating activities:
Net income		$	3,102,000		$	771,000
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization			1,252,000			1,224,000
Common stock issued for employee benefit plans			73,000			172,000
Stock based compensation (reversal), including amortization
of deferred stock compensation			18,000			(14,000)
Changes in operating assets and liabilities:
Trade receivables			(208,000)			357,000
Inventories			(434,000)			(444,000)
Prepaid expenses			405,000			153,000
Deposits and other assets			52,000			(194,000)
Accounts payable			301,000			417,000
Accrued payroll and related expenses			593,000			170,000
Warranty reserve and other accrued liabilities			17,000			(211,000)
Deferred rent			73,000			98,000
Deferred revenue			(36,000)			(142,000)
Long-term commission obligation			(23,000)			(14,000)
Net cash provided by operating activities			5,185,000			2,343,000
Investing activities:
Purchase of property and equipment			(779,000)			(867,000)
Purchase of intangible asset			(750,000)			-
Net cash used in investing activities			(1,529,000)			(867,000)
Financing activities:
Borrowings under line of credit			-			1,000,000
Repayment of line of credit			-			(2,000,000)
Repayment of equipment financing			(349,000)			(350,000)
Repayment of capital lease obligations			(47,000)			(85,000)
Net cash proceeds from issuance of preferred stock			-			6,812,000
Exercise of warrants and common stock options			2,358,000			178,000
Dividends paid			-			(457,000)
Net cash provided by financing activities			1,962,000			5,098,000
Net increase in cash and cash equivalents			5,618,000			6,574,000
Cash and cash equivalents at beginning of period			10,430,000			4,098,000
Cash and cash equivalents at end of period		$	16,048,000		$	10,672,000
Supplemental disclosures of cash flow information:
Cash paid for interest		$	42,000		$	108,000
Cash paid for taxes		$	165,000		$	-
Noncash financing activities:
Preferred stock dividends and accretion		$	419,000		$	574,000
Issuance of common stock for conversion of preferred stock
and payment of dividends payable		$	12,877,000		$	2,080,000
Warrants and options issued for services and issuance costs		$	-		$	369,000

See notes to condensed financial statements.

 

5

ABAXIS, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited)

1. BASIS OF PRESENTATION

The condensed unaudited financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. These condensed unaudited financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K/A for the fiscal year ended March 31, 2003. The unaudited condensed financial statements included herein reflect all normal recurring adjustments, which are, in the opinion of management, necessary to state fairly the results of operations and financial position for the periods presented. Certain amounts as presented in the financial statements for the previous periods have been reclassified to conform to the fiscal year ending March 31, 2004 financial statement presentation. The results for the period ended December 31, 2003 are not necessarily indicative of the results to be expected for the entire fiscal year ending March 31, 2004 or for any future period.

2. SIGNIFICANT ACCOUNTING POLICIES

Comprehensive Income - Comprehensive income was the same as net income for the three and nine months ended December 31, 2003 and 2002.

New Accounting Pronouncements - In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure.” SFAS No. 148 amends FASB Statement No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements of the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company adopted the disclosure provisions of SFAS No. 148 on January 1, 2003. The Company did not change to using the fair value based method of accounting for stock-based employee compensation as permitted by the voluntary transition provisions of SFAS 148; and therefore, adoption of SFAS No. 148 did not have an impact on the financial position, results of operations or cash flows of the Company.

Had compensation cost been recognized based on the fair value at the date of grant for options during the three and nine months ended December 31, 2003 and 2002, the pro forma amounts of the Company’s net income and basic and diluted net income (loss) per share would have been as follows:

			Three Months Ended December 31,						Nine Months Ended December 31,
			2003			2002			2003			2002
Net income:
As reported		$	1,173,000		$	365,000		$	3,102,000		$	771,000
Less stock-based compensation expense
determined under the fair value method for
all awards, net of related tax effects			(422,000)			(354,000)			(1,126,000)			(877,000)
Pro forma net income (loss)		$	751,000		$	11,000		$	1,976,000		$	(106,000)
Net income (loss) per share:
As reported - basic		$	0.06		$	0.01		$	0.15		$	(0.02)
Pro forma - basic		$	0.04		$	0.00		$	0.11		$	(0.01)
As reported - diluted		$	0.05		$	0.01		$	0.14		$	(0.02)
Pro forma - diluted		$	0.03		$	0.00		$	0.10		$	(0.01)

The Company’s calculations were made using the Black-Scholes option pricing model, based on a multiple option valuation approach, and forfeitures were recognized as they occurred. The following are the weighted average assumptions:

 

6

		Three Months Ended December 31,						Nine Months Ended December 31,
		2003			2002			2003			2002
Expected life of option		6 years			6 years			6 years			6 years
Risk-free interest rate		3.53	%		3.17	%		2.78-3.53	%		3.17	%
Dividend yield		0.00	%		0.00	%		0.00	%		0.00	%
Volatility		61	%		62	%		58-61	%		62	%

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities. “ This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities. “ This statement is effective for contracts entered into or modified after June 30, 2003. The adoption of this statement did not have an impact on the Company’s financial position, results of operations or cash flows.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. “ This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This statement is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this statement did not have an impact on the Company’s financial position, results of operations or cash flows.

The Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46 (“FIN 46“), “Consolidation of Variable Interest Entities,” in January 2003, and a revised interpretation of FIN 46 (“FIN 46-R”) in December 2003. FIN 46 requires certain variable interest entities (“VIEs”) to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of FIN 46 are effective immediately for all arrangements entered into after January 31, 2003. Since January 31, 2003, the Company has not invested in any entities it believes are variable interest entities for which the Company is the primary beneficiary. For all arrangements entered into after January 31, 2003, the Company is required to continue to apply FIN 46 through the end of the fourth quarter of fiscal 2004. The Company is required to adopt the provisions of FIN 46-R for those arrangements in the first quarter of fiscal 2005. For arrangements entered into prior to February 1, 2003, the Company is required to adopt the provisions of FIN 46-R in the first quarter of fiscal 2005. The Company does not expect the adoption of FIN 46-R to have an impact on the financial position, results of operations or cash flows of the Company.

3. NET INCOME (LOSS) PER SHARE INFORMATION

Basic net income (loss) per share is computed by dividing the net income (loss) attributable to common shareholders by the weighted average number of shares of common stock outstanding. Diluted net income (loss) per share is computed by dividing net income (loss) attributable to common shareholders by the weighted average number of common shares that would have been outstanding during the period assuming the issuance of common shares for all potential dilutive common shares outstanding.

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

 

7

		Three Months Ended December 31,					Nine Months Ended December 31,
		2003		2002			2003		2002
Weighted average number of common
shares outstanding used in calculating
basic net income (loss) per share		18,957,000		16,799,000			17,678,000		16,576,000
Weighted average number of dilutive stock
options and warrants outstanding using
the treasury stock method		2,577,000		349,000			2,050,000		-
Weighted average number of shares
outstanding used in calculating
diluted net income (loss) per share		21,534,000		17,148,000			19,728,000		16,576,000

Diluted net income (loss) per share does not include the effect of the following common equivalent shares related to outstanding options and warrants, using the treasury stock method and related to preferred shares issuable upon conversion of preferred stock, as their effect would be antidilutive for the three and nine months ended December 31, 2003 and 2002:

		Three Months Ended December 31,					Nine Months Ended December 31,
		2003		2002			2003		2002
		(number of shares)					(number of shares)
Series D convertible preferred stock		173,000		930,000			647,000		931,000
Series E convertible preferred stock		75,000		857,000			573,000		986,000
Options to purchase common stock		728,000		487,000			1,184,000		502,000
Warrants to purchase common stock		301,000		1,277,000			709,000		1,267,000
		1,277,000		3,551,000			3,113,000		3,686,000

4. INVENTORY

Inventories are stated at the lower of cost (first-in, first-out method) or market and consist of the following:

			December 31, 2003			March 31, 2003
Raw materials		$	2,706,000		$	2,317,000
Work-in-process			1,711,000			2,071,000
Finished goods			1,024,000			594,000
		$	5,441,000		$	4,982,000

5. WARRANTY RESERVES

The Company provides for the estimated future costs to be incurred under the Company’s standard warranty obligations of one year. Estimated contractual warranty obligations are recorded when related sales are recognized and any additional amounts are recorded when such costs are probable and can be reasonably estimated.

The warranty reserve activity is summarized as follows for the three- and nine-month periods ended December 31, 2003 and 2002:

 

8

			Three Months Ended December 31,						Nine Months Ended December 31,
			2003			2002			2003			2002
Balance Beginning of Period		$	169,000		$	178,000		$	123,000		$	192,000
Provision for warranty expense			224,000			169,000			568,000			346,000
Warranty costs incurred			(165,000)			(128,000)			(463,000)			(319,000)
Balance End of Period		$	228,000		$	219,000		$	228,000		$	219,000

6. LINE OF CREDIT AND LONG-TERM DEBT

In September 2003, the Company terminated its existing line of credit with Comerica Bank-California and entered into a new line of credit with Comerica Bank-California which provides for borrowings of up to $2,000,000, bears interest at the bank’s prime rate minus 0.25%, which totaled 3.75% at December 31, 2003, and is payable monthly. Of the $2,000,000 available, $820,000 was committed to secure a letter of credit for the Company’s facilities lease. The letter of credit will be reduced to $97,000 when the Company meets certain requirements as outlined in the terms of the Company’s facilities lease agreement, which among other stipulations, includes a minimum cumulative net income requirement of $2,000,000 for four consecutive quarters. The new line of credit terminates upon notification by either party and the outstanding balance is payable upon demand. At December 31, 2003, there was no amount outstanding under the Company’s line of credit. At December 31, 2002, the amount outstanding under the Company’s prior line of credit was $1,000,000. The weighted average interest rate on the line of credit during the three months ended December 31, 2003 and 2002 was 3.75% and 4.45%, respectively. In September 2003, the Company’s foreign line of credit expired.

The Company also has an equipment financing loan, which at December 31, 2003 had an outstanding balance of $584,000. The equipment loan bears interest at the prime rate plus 1.00%, which totaled 5.00% at December 31, 2003 and is payable in monthly installments of principal and interest totaling $42,000 over a period of two years. The weighted average interest rate on equipment financing loans during the three months ended December 31, 2003 and 2002 was 5.00% and 5.45%, respectively.

The line of credit and equipment financing agreements contain certain financial covenants, which are evaluated on a quarterly basis. Included in these financial covenants, among other stipulations, is a requirement that the Company have a minimum net income of $25,000 before preferred stock dividends and accretion in any three quarters of a fiscal year, provided that any loss before preferred stock dividends and accretion incurred in the remaining quarter is not to exceed $250,000. The Company is also required to be profitable, as defined, on a fiscal year to date basis beginning with the six month period ending September 30, 2003 and to have net income before preferred stock dividends and accretion on preferred stock of $1,150,000 for the fiscal year ending March 31, 2004. In addition, the Company is required to have a quick ratio, as defined, of not less than 1.00 to 1.00, cash flow coverage, as defined, of not less than 1.25 to 1.00, debt to net worth ratio, as defined, not greater than 1.00 to 1.00 and to maintain a tangible effective net worth, as defined, of not less than $25,731,000. At December 31, 2003, the Company was in compliance with these covenants.

Borrowings under the line of credit and equipment financing loans are secured by a pledge of the Company’s net book value of assets of $31.4 million at December 31, 2003 including its intellectual property.

7. CUSTOMER AND GEOGRAPHIC INFORMATION

The Company currently operates in one segment and develops, manufactures and markets portable blood analysis systems for use in any veterinary or human patient-care setting to clinicians with rapid blood constituent measurements. The following is a summary of revenues from external customers for each group of products and services provided by the Company:

 

9

			Three Months Ended December 31,						Nine Months Ended December 31,
			2003			2002			2003			2002
Blood chemistry analyzers		$	4,488,000		$	2,643,000		$	11,769,000		$	7,213,000
Reagent discs and kits			7,219,000			5,574,000			20,422,000			15,836,000
Other			538,000			236,000			1,775,000			1,404,000
Product sales, net			12,245,000			8,453,000			33,966,000			24,453,000
Development and licensing revenue			35,000			35,000			163,000			151,000
Total revenues		$	12,280,000		$	8,488,000		$	34,129,000		$	24,604,000

The following is a summary of revenues by customer group:

			Three Months Ended December 31,						Nine Months Ended December 31,
			2003			2002			2003			2002
Medical Market		$	2,080,000		$	495,000		$	5,294,000		$	1,869,000
Veterinary Market			9,789,000			7,735,000			27,305,000			21,574,000
Other			411,000			258,000			1,530,000			1,161,000
Total revenues		$	12,280,000		$	8,488,000		$	34,129,000		$	24,604,000

Two distributors, Vedco Inc. and DVM Resources accounted for 28% and 16%, respectively, of total revenues for the three-month period ended December 31, 2003, and 40% and 10%, respectively, of total revenues for the three-month period ended December 31, 2002. Vedco Inc. and DVM Resources accounted for 36% and 20%, respectively, of total revenues for the nine-month period ended December 31, 2003, and 37% and 10%, respectively, of total revenues for the nine-month period ended December 31, 2002. The following is a summary of revenues by geographic region based on customer location:

			Three Months Ended December 31,						Nine Months Ended December 31,
			2003			2002			2003			2002
United States		$	10,433,000		$	7,096,000		$	29,184,000		$	20,849,000
Europe			1,221,000			977,000			3,644,000			2,789,000
Asia and Latin America			626,000			415,000			1,301,000			966,000
Total revenues		$	12,280,000		$	8,488,000		$	34,129,000		$	24,604,000

Substantially all of the Company’s long-lived assets are located in the United States.

8. Redeemable Convertible Preferred Stock -- Series E

Redeemable Convertible Preferred Stock - Series E - In October 2003, under the terms of the Company’s Certificate of Determination with respect to the Series E Preferred Stock (the “Series E Preferred”), the Series E convertible preferred stock automatically converted into shares of common stock after twenty consecutive trading days where the per share closing price of the Company’s common stock as reported on the Nasdaq National Market exceeded $12.00. Elective conversions between October 1-15, 2003, coupled with the automatic conversion of all remaining outstanding Series E Preferred Stock, resulted in the conversion of 4,450 shares of Series E Preferred Stock into 684,615 shares of common stock during the three months ended December 31, 2003.

 

10

9. SHAREHOLDERS’ EQUITY

Stock Purchase Rights - On April 22, 2003, the Board of Directors of the Company approved the adoption of a Shareholder Rights Plan. Under the terms of the plan, shareholders of record on May 8, 2003, received one preferred stock purchase right for each outstanding share of Common Stock held. Each right entitles the registered holder to purchase from the Company one one-thousandth of a share of the Company’s Series RP Preferred Stock, $0.001 par value, at a price of $24.00 per share and becomes exercisable when a person or group acquires 15% or more of the Company’s Common Stock without prior approval by the Board of Directors.

Convertible Preferred Stock - Series D - In October 2003, under the terms of the Company’s Certificate of Determination with respect to the Series D Preferred Stock (the “Series D Preferred”), the Series D convertible preferred stock automatically converted into shares of common stock after twenty consecutive trading days where the per share closing price of the Company’s common stock as reported on the Nasdaq National Market exceeded $14.00. Elective conversions between October 1-28, 2003, coupled with the automatic conversion of all remaining outstanding Series D Preferred Stock, resulted in the conversion of 5,328 shares of Series D Preferred Stock into 761,142 shares of common stock during the three months ended December 31, 2003.

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

This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes a number of forward-looking statements which reflect Abaxis’ current views with respect to future events and financial performance. In this report, the words “will”, “anticipates”, “believes”, “expects”, “future”, “intends”, “plans”, and similar expressions identify forward-looking statements. These forward-looking statements are subject to certain risks and uncertainties, including but not limited to those discussed below, that could cause actual results to differ materially from historical results or those anticipated. Such risks and uncertainties include the market acceptance of our products and the continuing development of our products, risks associated with manufacturing and distributing our products on a commercial scale, free of defects, risks associated with entering the human diagnostic market on a larger scale, risks related to the protection of the Company’s intellectual property or claims of infringement of intellectual property asserted by third parties, risks involved in carrying of inventory, risks associated with the ability to attract, train and retain competent sales personnel, general market conditions and competition. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Abaxis assumes no obligation to update any forward-looking statements as circumstances change.

Overview

Abaxis, Inc. (“us” or “we”), incorporated in California in 1989, develops, manufactures and markets portable blood analysis systems for use in any veterinary or human patient-care setting to provide clinicians with rapid blood constituent measurements. Our principal offices are located at 3240 Whipple Road, Union City, California 94587, and our telephone number at that location is (510) 675-6500. We maintain a website at www.abaxis.com. Investors can obtain copies of our filings with the Securities and Exchange Commission from this site free of charge, as well as from the Securities and Exchange Commission website at www.sec.gov.

Our primary product is a system consisting of a compact 6.9 kilogram analyzer and a series of single-use plastic discs, called reagent discs, containing all the chemicals required to perform a panel of up to 13 tests on veterinary patients and 14 tests on human patients. The system can be operated with minimal training and performs multiple routine tests on whole blood, serum or plasma samples. The system provides test results in less than 14 minutes with the precision and accuracy equivalent to a clinical laboratory analyzer. We currently market this system for veterinary use under the name VetScan® and in the human medical market under the name Piccolo®. We also market a veterinary hematology analyzer under the name VetScan HMT, which provides a complete blood count (“CBC”) including three-part white blood cell (“WBC”) differential in less than 2 minutes and requires only 12 uL (microliter) of whole blood. It provides results for eight selectable species, plus two user configurable programs. We market one type of reagent kit with this analyzer. We purchase the hematology analyzer and reagent kits from Melet Schloesing Laboratories of France. We are not obligated to purchase a minimum amount of analyzers or reagent kits. We market the combination of the VetScan and the VetScan HMT under the name VetScan DXS. During the first quarter of the fiscal year ending March 31, 2005, we are planning to introduce an additional hematology product worldwide. We have entered into an OEM agreement with Diatron Messtechnik GmbH (DIATRON) of Austria to purchase the DIATRON hematology instruments, which are currently subject to further customization to meet our technical specifications. We plan to market this new instrument as the Vetscan HMII in

 

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the veterinary market. We are currently in the process of qualifying a supplier to produce the reagents for the new hematology instruments.

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

In December 2001, we introduced and launched the VetScan Canine Heartworm Antigen Test. We purchased the VetScan Canine Heartworm Antigen Test from S.A. Scientific, Inc., of San Antonio, Texas, a privately-held leader in the development and manufacturing of a wide-range of one-step rapid tests for various diseases. In March 2002, Idexx Laboratories, Inc. sued both Abaxis and S.A. Scientific for infringement upon patents issued to Idexx. On December 6, 2002, the case was settled under the terms of an out-of-court agreement between the parties. Among other terms, Abaxis paid Idexx $249,500 in cash damages and ceased the selling of the particular canine heartworm antigen test referenced in the complaint. Although we subsequently sold a limited number of redesigned canine heartworm tests manufactured by S.A. Scientific, we have subsequently terminated our relationship with S.A. Scientific. We are exploring whether or not we will introduce another canine heartworm antigen test in the near future, although there can be no assurance that we would be successful in any such efforts or that any party will not claim patent infringement on us or file suit upon other grounds.

Sales for any future periods are not predictable with a significant degree of certainty. We generally operate with limited order backlog because our products typically are shipped shortly after orders are received. As a result, product sales in any quarter are generally dependent on orders booked and shipped in that quarter. Our expense levels, which are to a large extent fixed, are based in part on our expectations of future revenues. Accordingly, we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. As a result, any such shortfall would negatively affect our operating results and financial condition. 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 our sales volumes of our VetScan DXS and Piccolo products and to compete with other competitors successfully. We believe that period to period comparisons of our results of operations are not necessarily meaningful.

Results of Operations

Total Revenues

The following is a summary of revenues by geographic region based on customer location for the three and nine months ended December 31, 2003 and 2002:

		Three Months Ended December 31,									Nine Months Ended December 31,
		2003			2002		Change				2003			2002		Change
United States	$	10,433,000		$	7,096,000		47	%		$	29,184,000		$	20,849,000		40	%
Europe		1,221,000			977,000		25	%			3,644,000			2,789,000		31	%
Asia and Latin America		626,000			415,000		51	%			1,301,000			966,000		35	%
Total revenues	$	12,280,000		$	8,488,000		45	%		$	34,129,000		$	24,604,000		39	%

Total revenues in the U.S. increased by 47% or $3,337,000 and increased by 40% or $8,335,000 for the three and nine months ended December 31, 2003 and 2002, respectively. The increase in the U.S. in the three months ended December 31, 2003 was primarily due to increases of $1,166,000 in instrument placements to all domestic customers excluding the U.S. military, $1,190,000 of reagent discs sold to all domestic customers excluding the U.S. military, $742,000 in total instrument placements and reagent discs sold to the U.S. military, and $239,000 in other sales. The increase in the U.S. in the nine months ended December 31, 2003 was primarily due to increases of $2,974,000 in instrument placements to all domestic customers excluding the U.S. military, $3,293,000 of reagent

 

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discs sold to all domestic customers excluding the U.S. military, $1,782,000 in total instrument placements and reagent discs sold to the U.S. military, and $286,000 in other sales. The dollar increases in revenues are due to increased productivity in both veterinary and medical sales and increased sales of our reagent discs and kits due to a higher consumption rate of institutional users and to the expanded installed base of Vetscan and Piccolo systems.

Total revenues in Europe increased by 25% or $244,000 and increased by 31% or $855,000 for the three and nine months ended December 31, 2003 and 2002, respectively. The increase in Europe in the three months ended December 31, 2003 was primarily due to increases in instrument sales of $63,000 and reagent disc sales of $180,000. The increase in Europe in the nine months ended December 31, 2003 was primarily due to increases in instrument sales of $307,000 and reagent disc sales of $546,000.

Total revenues in Asia and Latin America increased by 51% or $211,000 and increased by 35% or $335,000 for the three and nine months ended December 31, 2003 and 2002, respectively. The increase in Asia and Latin America in the three months ended December 31, 2003 was primarily due to increases in instrument sales of $126,000 and reagent disc sales of $78,000. The increase in Asia and Latin America in the nine months ended December 31, 2003 primarily reflects an increase in instrument sales of $257,000 and an increase in reagent disc sales of $68,000. One distributor, T. Chatani and Co. Ltd. accounted for 36% and 52% of total revenues in Asia and Latin America for the three and nine months ended December 31, 2003, respectively. The distribution partnership with T. Chatani and Co. started in the fourth quarter of fiscal 2003.

Our U.S. revenues accounted for 85% and 84% of our total revenues in the three months ended December 31, 2003 and 2002, respectively, and accounted for 86% and 85% of our total revenues in the nine months ended December 31 2003 and 2002, respectively. Our international revenues accounted for 15% and 16% of our total revenues in the three months ended December 31, 2003 and 2002, respectively, and accounted for 14% and 15% of our total revenues in the nine months ended December 31, 2003 and 2002, respectively. In spite of our increase in total revenues from prior periods, our growth rate worldwide has remained consistent in both the U.S. and international markets during the three and nine months ended December 31, 2003 and 2002.

Revenue from the human medical market accounted for 17% and 6% of total revenues for the three months ended December 31, 2003 and 2002, respectively, and accounted for 16% and 8% of total revenues for the nine months ended December 31, 2003 and 2002, respectively. Sales to the U.S. military accounted for 43% of revenue in the human medical market in the three months ended December 31, 2003, as compared to 31% of revenue in the human medical market in the three months ended December 31, 2002. Sales to the U.S. military accounted for 51% of revenue in the human medical market in the nine months ended December 31, 2003, as compared to 50% of revenue in the human medical market in the nine months ended December 31, 2002.

During the three months ended December 31, 2003, we sold 521 instruments worldwide, which includes both blood chemistry and hematology analyzers, a 56% increase from 335 instruments sold worldwide in the three months ended December 31, 2002. During the nine months ended December 31, 2003, we sold 1,358 instruments worldwide, a 54% increase from 881 instruments sold worldwide in the nine months ended December 31, 2002. The increases in instrument sales were in both the medical and veterinary markets.

Reagent discs and kits sold worldwide during the three months ended December 31, 2003 were 594,000, an increase of 27% or 128,000 from 466,000 reagent discs and kits sold worldwide during the three months ended December 31, 2002. During the nine months ended December 31, 2003, we sold 1,682,000 reagent discs and kits worldwide, an increase of 26% or 352,000 from 1,330,000 reagent discs and kits sold worldwide in the nine months ended December 31, 2002. The increase in reagent discs and kits sold is consistent with our belief that there will be increasing recurring reagent disc revenue as our product lines achieve greater market penetration and more consistent utilization. This growth is mainly attributable to the expanded installed base of VetScan DXS and Piccolo systems and higher consumption rates of institutional users. In September 2003, we released three key Piccolo medical panels which, together with existing panels, completes the full array of the Center for Medicare and Medicaid Services reimbursement panels.

We receive royalty payments from Amersham Biosciences (formerly Pharmacia Biotech) equal to 5% of net sales, as defined in our agreement, of Amersham’s products that use our technology. The related development and licensing revenues were $35,000 during both the three months ended December 31, 2003 and 2002. Development and licensing revenues increased by 8% or $12,000 in the nine months ended December 31, 2003 as compared to the nine months ended December 31, 2002. The fluctuations in development and licensing revenue are due to unforeseeable fluctuations in our customers’ use of our Orbos technology.

 

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Cost of Product Sales

Cost of product sales was $6,155,000 or 50% of product sales for the three months ended December 31, 2003, as compared to $4,391,000 or 52% of product sales for the three months ended December 31, 2002. Cost of product sales was $17,016,000 or 50% of product sales for the nine months ended December 31, 2003, as compared to $12,763,000 or 52% of product sales for the nine months ended December 31, 2002. The dollar increase in cost of product sales was primarily attributable to continued increases in sales volume of instruments and reagent discs. The decrease as a percentage of cost of product sales is due to both increased instrument sales resulting in higher margins and better efficiency achieved in our rotor production.

Selling, General and Administrative Expense

Selling, general and administrative expenses increased by 28%, or $805,000 and increased by 26%, or $2,173,000 in the three and nine months ended December 31, 2003 and 2002, respectively. As a percentage of total revenues, selling, general and administrative expenses were 30% and 34% for the three and nine months ended December 31, 2003, respectively, as compared to 31% and 34% for the three and nine months ended December 31, 2002, respectively. The dollar increase in selling, general and administrative expenses was primarily due to our expanded sales and marketing efforts in the human medical market.

Research and Development Expense

Research and development expenses increased by 40% or $348,000 and increased by 23%, or $658,000 in the three and nine months ended December 31, 2003 and 2002, respectively. As a percentage of total revenues, research and development expense were 10% and 10% for the three and nine months ended December 31, 2003, respectively, as compared to 10% and 11% for the three and nine months ended December 31, 2002, respectively. The dollar increase in research and development expenses is due to the development and clinical trials of new test methods to expand our test menus and to the development of our next generation blood chemistry analyzer.

Interest and Other Income

Interest and other income was $39,000 and $48,000 for the three months ended December 31, 2003 and 2002, respectively. Interest and other income was $124,000 and $168,000 for the nine months ended December 31, 2003 and 2002, respectively. Interest and other income primarily consists of interest earned on cash and cash equivalents.

Interest and Other (Expense)

Interest and other expense was $2,000 and $24,000 for the three months ended December 31, 2003 and 2002, respectively. For the three months ended December 31, 2003 and 2002, we incurred interest expense of $10,000 and $24,000, respectively, on our capital equipment loan, capital leases for equipment, and line of credit. For the three months ended December 31, 2003, other expense of ($8,000) related to a net gain on foreign currency transactions.

Interest and other expense was $50,000 and $113,000 for the nine months ended December 31, 2003 and 2002, respectively. For the nine months ended December 31, 2003 and 2002, we incurred interest expense of $36,000 and $109,000, respectively, on our capital equipment loan, capital leases for equipment, and line of credit. For the nine months ended December 31, 2003, other expense of $9,000 related to a net loss on foreign currency transactions. No interest was capitalized during the periods.

Income Taxes

Income tax expense totaled $91,000 and $11,000 for the three months ended December 31, 2003 and 2002, respectively. Income tax expense totaled $153,000 and $24,000 for the nine months ended December 31, 2003 and 2002, respectively. Income tax expense primarily relates to taxes for various state tax jurisdictions and an increase in the valuation allowance with respect to federal alternative minimum tax.

Liquidity and Capital Resources

As of December 31, 2003, we had $16,048,000 in cash and cash equivalents. We anticipate to incur incremental additional costs to support our future operations, including further commercialization of our products and development of new test methods that will allow us to expand our veterinary market and further penetrate the human medical market; acquisition of capital equipment for our manufacturing facility, which includes the ongoing costs related to continuing development of our current and future products; and additional pre-clinical testing and clinical trials for our current and future products; and the design and production of our next generation blood chemistry analyzers.

 

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We anticipate that our existing capital resources, debt financing, and anticipated revenue from the sales of our products will be adequate to satisfy our currently planned operating and financial requirements through at least the next twelve months. Our future capital requirements will largely depend upon the increased market acceptance of our point-of-care blood analyzer products. 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 leverage our internal expansion into the human medical market or pursue strategic acquisition opportunities.

Operating Activities - For the nine months ended December 31, 2003, net cash provided by operating activities was $5,185,000 primarily due to net income of $3,102,000 plus depreciation and amortization of $1,252,000, $18,000 of stock based compensation and $73,000 of common stock issued for employee benefit plans, a decrease of $398,000 in prepaid expenses, deposits and other assets, deferred revenue, and long-term commission obligation, and increases of $776,000 in trade receivables, accounts payable, accrued payroll and related expenses, warranty reserve and other accrued liabilities, and deferred rent. Uses of cash from operating activities included an increase of $434,000 in inventories.

Investing Activities - Net cash used in investing activities for the nine months ended December 31, 2003 was $1,529,000 as compared to net cash used of $867,000 for the nine months ended December 31, 2002. The increase for the nine months ended December 31, 2003 related to the purchase of $779,000 of property and equipment and $750,000 of intellectual property relating to patents which will be amortized over 10 years.

Financing Activities - Net cash provided by financing activities of $1,962,000 for the nine months ended December 31, 2003 included $2,358,000 from the exercise of common stock options and warrants offset by repayments totaling $396,000 on a capital equipment loan and capital lease obligations. Net cash provided by financing activities of $5,098,000 for the nine months ended December 31, 2002 included net cash proceeds of $6,812,000 from the issuance of Series E preferred stock, $178,000 from the exercise of common stock options, net borrowings of $1,000,000 from the line of credit, offset by dividends payable of $457,000 and $2,000,000 in repayments on the line of credit, and repayments totaling $435,000 on a capital equipment loan and capital lease obligations.

Preferred Stock - In October 2003, under the terms of our respective Certificate of Determination with respect to both the Series D Preferred Stock (the “Series D Preferred”) and Series E Preferred Stock (the “Series E Preferred”), the Series D Preferred and the Series E Preferred automatically converted into shares of common stock after twenty consecutive trading days where the per share closing price of our common stock as reported on the Nasdaq National Market exceeded $14.00 and $12.00, respectively. Elective conversions between October 1-15, 2003, coupled with the automatic conversion of all remaining outstanding Series E Preferred Stock, resulted in the conversion of 4,450 shares of Series E Preferred Stock into 684,615 shares of common stock during the three months ended December 31, 2003. Elective conversions between October 1-28, 2003, coupled with the automatic conversion of all remaining outstanding Series D Preferred Stock, resulted in the conversion of 5,328 shares of Series D Preferred Stock into 761,142 shares of common stock during the three months ended December 31, 2003. Consequently, we have eliminated our obligation to pay an ongoing annual aggregate amount of $662,000 that the holders of the Series D Preferred and Series E Preferred would have otherwise received in either cash or shares of our common stock.

Line of Credit and Long-Term Debt - In September 2003, we terminated our existing line of credit with Comerica Bank-California and entered into a new line of credit with Comerica Bank-California, which provides for borrowings of up to $2,000,000, bears interest at the bank’s prime rate minus 0.25%, which totaled 3.75% at September 30, 2003, and is payable monthly. Of the $2,000,000 available, $820,000 was committed to secure a letter of credit for our facilities lease. The letter of credit will be reduced to $97,000 when we meet certain requirements as outlined in the terms of our facilities lease agreement, which among other stipulations, includes a minimum cumulative net income requirement of $2,000,000 for four consecutive quarters. The new line of credit terminates upon notification by either party and the outstanding balance is payable upon demand. At December 31, 2003, there was no amount outstanding under our line of credit. At December 31, 2002, the amount outstanding under our prior line of credit was $1,000,000. The weighted average interest rate on the line of credit during the three months ended December 31, 2003 and 2002 was 3.75% and 4.45%, respectively. In September 2003, our foreign line of credit expired.

We also have an equipment financing loan, which at December 31, 2003 had an outstanding balance of $584,000. The equipment loan bears interest at the prime rate plus 1.00%, which totaled 5.00% at December 31, 2003 and is payable in monthly installments of principal and interest totaling $42,000 over a period of two years. The weighted average interest rate on equipment financing loans during the three months ended December 31, 2003 and 2002 was 5.00% and 5.45%, respectively.

 

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The line of credit and equipment financing agreements contain certain financial covenants, which are evaluated on a quarterly basis. Included in these financial covenants, among other stipulations, is a requirement that we have a minimum net income of $25,000 before preferred stock dividends and accretion in any three quarters of a fiscal year, provided that any loss before preferred stock dividends and accretion incurred in the remaining quarter is not to exceed $250,000. We are also required to be profitable, as defined, on a fiscal year to date basis beginning with the six month period ending September 30, 2003 and to have net income before preferred stock dividends and accretion on preferred stock of $1,150,000 for the fiscal year ending March 31, 2004. In addition, we are required to have a quick ratio, as defined, of not less than 1.00 to 1.00, cash flow coverage, as defined, of not less than 1.25 to 1.00, debt to net worth ratio, as defined, not greater than 1.00 to 1.00 and to maintain a tangible effective net worth, as defined, of not less than $25,731,000. At December 31, 2003, we were in compliance with these covenants.

Borrowings under the line of credit and equipment financing loans are secured by a pledge of our net book value of assets of $31.4 million at December 31, 2003 including our intellectual property.

Critical Accounting Policies - We have identified certain accounting policies as critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to the identified critical accounting policies on our business operations are discussed in our amended Annual Report on Form 10-K/A for the fiscal year ended March 31, 2003 filed with the Securities and Exchange Commission.

Contingencies - We are involved from time to time in various litigation matters in the normal course of business. We believe that the ultimate resolution of these matters will not have a material effect on our financial position or results of operations.

New Accounting Pronouncements - In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure.” SFAS No. 148 amends FASB Statement No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements of the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We adopted the disclosure provisions of SFAS No. 148 on January 1, 2003. We did not change to using the fair value based method of accounting for stock-based employee compensation as permitted by the voluntary transition provisions of SFAS 148; and therefore, adoption of SFAS No. 148 did not have an impact on our financial position, results of operations or cash flows in the financial statements.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities. “ This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities. “ This statement is effective for contracts entered into or modified after June 30, 2003. The adoption of this statement did not have an impact on our financial position, results of operations or cash flows.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. “ This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This statement is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this statement did not have an impact on our financial position, results of operations or cash flows.

The Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities,” in January 2003, and a revised interpretation of FIN 46 (“FIN 46-R”) in December 2003. FIN 46 requires certain variable interest entities (“VIEs”) to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The provisions of FIN 46 are effective immediately for all arrangements entered into after January 31, 2003. Since January 31, 2003, we have not invested in any entities that we believe are variable interest entities for which we are the primary beneficiary. For all arrangements entered into after January 31, 2003, we are required to continue to apply FIN 46 through the end of the fourth quarter of fiscal 2004. We are required to adopt the provisions of FIN 46-R for those arrangements in the first quarter of fiscal 2005. For arrangements entered into prior to February 1, 2003, we are required to adopt the provisions of FIN 46-R in the first quarter of fiscal 2005. We do not expect the adoption of FIN 46-R to have an impact on our financial position, results of operations or cash flows.

 

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RISK FACTORS THAT MAY AFFECT OUR PERFORMANCE

Our future performance is subject to a number of risks. If any of the following risks actually occur, our business could be harmed and the trading price of our common stock could decline. You should also refer to other information contained in our annual report for the fiscal year ended March 31, 2003, as filed on Form 10-K/A, including the financial statements included therein and the notes related thereto.

When used in these risk factors, the words “anticipates,” “believes,” “expects,” “intends,” “plans,” “future,” and similar expressions identify forward-looking statements. Our actual results could differ materially from those that we project in the forward-looking statements as a result of factors that we have set forth throughout this document as well as factors of which we are currently not aware.

We Have Not Been Consistently Profitable; We Must Increase Sales Of Our Piccolo And Vetscan DXS Products To Maintain Consistent Profitability

We recognized a net loss in one of the last twelve fiscal quarters ended December 31, 2003. After accounting for dividend charges associated with the issuance of our preferred stock and non-cash charges related to the beneficial conversion feature contained in the preferred stock, we recognized a net loss in five of those quarters. There can be no assurance that we will experience consistent profitability in the future. As of December 31, 2003, we have incurred cumulative net losses of approximately $59 million. Our ability to be consistently profitable will depend, in part, on our ability to increase our sales volumes of our VetScan DXS and Piccolo products. Increasing our sales volume of our products will depend upon our ability to:

•

continue to develop our products;

•

increase our sales and marketing activities;

•

effectively manage our manufacturing activities; and

•

effectively compete against current and future competitors.

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

We Are Not Able To Predict Sales In Future Quarters And A Number Of Factors Affect Our Periodic Results

We are not able to accurately predict our sales in future quarters. In any quarter, we derive almost half of our revenues from two distributors who resell our products to the ultimate user. While we are better able to predict sales of our reagent discs, as we sell these discs primarily for use with analyzers that we sold in prior periods, we generally are unable to predict with much certainty sales of our analyzers, as we typically sell our analyzers to new users. Accordingly, our sales in any one quarter are not indicative of our sales in any future period. In addition, we generally operate with limited order backlog, because we ship our products shortly after we receive the orders from our customers. As a result, our product sales in any quarter are generally dependent on orders that we receive and ship in that quarter. We base our expense levels, which are to a large extent fixed, in part on our expectations as to future revenues. We may be unable to reduce our spending in a timely manner to compensate for any unexpected revenue shortfall. As a result, any such shortfall would immediately materially and adversely impact our operating results and financial condition. In addition, we have historically experienced a decrease in our sales, especially in Europe, in our second and third quarters, ending in September and December of each year, which we believe is due to seasonal patterns in the decision making processes to acquire our products. Accordingly, we believe that period to period comparisons of our results of operations are not necessarily meaningful.

Our periodic operating results have varied in the past. In the future, we anticipate our periodic operating results to vary significantly depending on, but not limited to, a number of factors, including, in addition to those factors discussed elsewhere in this section:

•

new product announcements made by us or our competitors;

•

changes in our pricing structures or the pricing structures of our competitors;

 

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•

our ability to develop, introduce and market new products on a timely basis;

•

our manufacturing capacities and our ability to increase the scale of these capacities;

•

the mix of product sales between our analyzer and our reagent disc products;

•

the amount we spend on research and development; and

•

changes in our strategy.

We Could Fail to Achieve Anticipated Revenue If The Market Does Not Accept Our Products

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

Historically we have marketed our VetScan analyzer to veterinarians and we have relatively limited experience in large scale sales of our Piccolo analyzer into the human medical market. We continue to develop new animal blood tests that we cannot be assured will be accepted by the veterinary market. Although we believe that our blood analyzers offer consumers many advantages, including according to our analyses substantial cost savings, in terms of the actual product and implementation of it procedurally, these advantages involve changes to current standard practices, such as using large clinical laboratories, that will require changes in both the procedures and mindset of care providers. The human medical market in particular is highly regulated, structured and often slow to adopt new product offerings. If we are unable to convince large numbers of medical clinics, hospitals and other point-of-care environments of the benefits of our products, we will suffer lost sales and could fail to achieve anticipated revenue.

We are Dependent Upon Our Profitability, and If We Cannot Remain Profitable We May Need Additional Funding In The Future And These Funds May Not Be Available To Us

We believe that our existing capital resources, bank and equipment financing loans and anticipated revenue from the sales of our products will be adequate to satisfy our currently planned operating and financial requirements through March 31, 2004, although no assurances can be given. Our bank financing documents contain a number of covenants concerning financial tests that we must meet that are more fully detailed in the agreements that we have filed with the SEC as exhibits to our periodic reports. We may need additional funds if we are unable to meet requirements for continuing access to bank financing or if we do not achieve anticipated revenues from the sale of our Piccolo and VetScan DXS products.

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

•

further commercialization of our products and development of new test methods to allow us to further penetrate the human diagnostic market and the veterinary diagnostic market;

•

our need to acquire capital equipment for our manufacturing facilities, which includes the ongoing implementation of our semi-automated manufacturing lines to provide capacity for the production of commercial volumes of our products;

•

research and design costs related to the continuing development of our current and future products; and

•

additional pre-clinical testing and clinical trials for our current and future products.

To the extent that our existing resources and anticipated revenue from the sale of our products are insufficient to fund our activities or if we are unable to meet the financial tests contained in our bank financing documents, we may have to raise additional funds from the issuance of public or private securities. In the event that we cannot maintain compliance with the financial covenants of our bank financing agreements, we may also be subject to increased interest rate expenses. We may not be able to raise additional funding, or if we are able to, we may not be able to raise funding on acceptable terms. We may also dilute then-existing shareholders if we raise additional funds by issuing new equity securities. Alternately, we may have to relinquish rights to certain of our

 

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technologies, products and/or sales territories if we are required to obtain funds through arrangements with collaborative partners. If we are unable to raise needed funds, we may be required to curtail our operations significantly. This would materially adversely affect our operating results and financial condition.

We Recently Settled a Patent Infringement Lawsuit And We Could Be the Subject of Similar Legal Action in the Future

On March 28, 2002, Idexx Laboratories, Inc., our principal competitor in the veterinary diagnostic market, filed a complaint in the United States District Court for the District of Maine (Civil Action Docket No. 02-69-P-H) alleging that a canine heartworm test produced for us by a third party, S.A. Scientific, Inc., and sold using the Abaxis brand infringed on U.S. Patents Nos. 4,965,187 and 4,939,096 held by Idexx. On December 6, 2002, the parties entered into a settlement agreement under which, among other terms, we paid Idexx $249,500 in cash damages and we ceased the selling of the particular canine heartworm antigen test referenced in the complaint. Although we subsequently sold a limited number of redesigned canine heartworm tests manufactured by S.A. Scientific, we have subsequently terminated our relationship with S.A. Scientific. We are exploring whether we will introduce another canine heartworm antigen test in the near future and there can be no assurance that any party will not claim patent infringement or file suit upon other grounds. We would incur expenses in the defense of such claims and our attention could be diverted from our operations.

We Rely On Patents And Other Proprietary Information, The Loss Of Any Of Which Would Negatively Affect Our Business

As of December 31, 2003, we have filed 30 patent applications with the United States Patent and Trademark Office, of which 27 have been issued. Additionally, we have filed several international patent applications covering the same subject matter as our domestic applications. The patent position of any medical device manufacturer, including Abaxis, is uncertain and may involve complex legal and factual issues. Consequently, we may not be issued any additional patents, either domestically or internationally. Furthermore, our patents may not provide significant proprietary protection because there is a chance that they will be circumvented or invalidated. We cannot be certain that we were the first creator of the inventions covered by our issued patents or pending patent applications, or that we were the first to file patent applications for these inventions, because (1) the United States Patent and Trademark Office maintains all patent applications that are not filed in any foreign jurisdictions in secrecy until it issues the patents (unless a patent application owner files a request for publication) and (2) publications of discoveries in the scientific or patent literature tend to lag behind actual discoveries by several months. We may have to participate in interference proceedings, which are proceedings in front of the U.S. Patent and Trademark Office, to determine who will be issued a patent. These proceedings could be costly and could be decided against us.

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

We Continue to Develop Our Marketing And Distribution Experience In the Human Diagnostic Market And Have Limited Resources To Devote To Such Efforts

Although we have gained experience marketing our VetScan System products for the past seven years in the veterinary diagnostic market, we have much less experience in marketing the Piccolo System in the human diagnostic market. Accordingly, we have limited sales, marketing and distribution experience, especially in the human diagnostic market. We cannot assure you that:

•

we will be able to establish and maintain effective distribution arrangements in the human medical market;

•

any distribution arrangements that we are able to establish will be successful in marketing our products; or

•

the costs associated with marketing and distributing our products will not be excessive.

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

 

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We May Inadvertently Produce Defective Products, Which May Subject Us to Significant Warranty Liabilities or Product Liability Claims And We May Have Insufficient Product Liability Insurance

Our business exposes us to potential warranty and product liability risks which are inherent in the testing, manufacturing and marketing of human and veterinary medical products. We strive to apply sophisticated methods to raw materials and produce defect-free medical test equipment. Although we have established procedures for quality control on both the raw materials that we receive from suppliers and our manufactured final products, these procedures may prove inadequate to detect a defect that either occurs in limited quantities or that we have not anticipated. We believe that our VetScan and Piccolo systems detect the vast majority of errors that occur on our reagent discs and automatically reject such tests, prompting the medical provider to retest the patient. However, our VetScan and Piccolo systems may be unable to detect errors which could result in the misdiagnosis of veterinary or human patients.

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

Many of Our Sales Force Have Been Employed by Us for Less Than One Year And We Must Effectively Train And Integrate Our Sales Team In Order To Achieve Our Anticipated Revenue

We have thirty-one full-time sales personnel involved in our sales and marketing activities, many of whom have been employed by us for a limited period of time. While these individuals work with our distribution partners both domestically and internationally to extend our market reach, the primary selling activities are often done by these individuals. If we are to increase our sales, we will need to train our new salespeople and supervise them closely. We also will continue hiring additional sales personnel. If we are unable to retain our existing personnel, or attract and train additional qualified personnel, our growth may be limited due to our lack of capacity to market our products.

We Need to Successfully Manufacture and Market Additional, Recently Approved Reagent Discs For The Human Diagnostic Market If We Are To Compete In That Market

We have developed a blood analysis system that consists of a portable blood analyzer and single-use reagent discs. Each reagent disc performs a series of standard blood tests. We believe that it is necessary to develop additional series of reagent discs with various tests for use with the Piccolo and VetScan DXS. Historically, we primarily developed reagent discs suitable for the veterinary diagnostic market. We recently received approval from the U.S. Food and Drug Administration to begin selling additional tests, namely HDL and triglycerides, for the more lucrative human diagnostic market. These tests are included in standard tests for which the medical community receives reimbursements from third party payors such as HMOs and Medicare. We may not be able to successfully manufacture or market these newly developed reagent discs. Our failure to meet these challenges will materially adversely affect our operating results and financial condition.

We Rely On Distributors To Sell Our Products; We Rely On Sole Distributor Arrangements In A Number Of Countries

We distribute our products primarily through distributors. As a result, we are dependent upon these distributors to sell our products and to assist us in promoting and creating a demand for our products. We have a number of distributors in the United States who distribute our VetScan DXS products. Two distributors, Vedco Inc. and DVM Resources accounted for 28% and 16%, respectively, of total revenues for the three-month period ended December 31, 2003, and 40% and 10%, respectively, of total revenues for the three-month period ended December

 

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31, 2002. Vedco Inc. and DVM Resources accounted for 36% and 20%, respectively, of total revenues for the nine-month period ended December 31, 2003, and 37% and 10%, respectively, of total revenues for the nine-month period ended December 31, 2002. We believe that our future growth depends on the efforts of these distributors. If one of our distributors, particularly Vedco, Inc., were to stop selling our products we may not be able to replace such lost revenue. We operate on a purchase order basis with Vedco, Inc. and DVM Resources and each of these distributors is under no contractual obligation to continue carrying our products. Further, many of our distributors may carry our competitors’ products, and may promote our competitors’ products over our own products. Finally, we do not have at this time distribution partners in the United States who distribute our products for the human diagnostic market. Internationally, we have one distributor in Japan for our products in both the human and veterinary diagnostic markets.

We currently have exclusive distribution agreements for our VetScan DXS products in Argentina, Australia, Austria, Bahrain, China, Greece, Japan, Korea, Mexico, New Zealand, Portugal, South Africa, Spain, Switzerland, United Arab Emirates and the United Kingdom. Our distributor in each of these countries is responsible for obtaining the necessary approvals to sell our products. These distributors may not be successful in obtaining proper approvals for our products in their respective countries, and they may not be successful in marketing our products. We plan to enter into additional distribution agreements to expand our international distribution base and solidify our international presence. However, we may not be successful in entering into additional distributor agreements. Our distributors may terminate their relationship with us at any time. Historically, we have experienced a high degree of turnover among our international distributors. This high degree of turnover makes it difficult for us to establish a steady distribution network overseas. Consequently, we may not be successful in marketing our Piccolo System and VetScan DXS products internationally.

We Depend On Sole Suppliers For Several Key Components To Our Products, Many of Whom We Have Not Entered Into Contractual Relationships With

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

•

Reagent Discs: Two injection molding manufacturers, C. Brewer & Co. and Nypro Oregon, Inc., currently make the molded plastic discs which, when loaded with reagents and welded together, form our reagent disc products. We believe that only a few manufacturers are capable of producing these discs to the narrow tolerances that we require; to date, we have only qualified these two manufacturers, with Nypro, Inc. being qualified at two separate facilities, to manufacture the molded plastic discs.

•

Reagent Chemicals: We currently depend on the following single source vendors for some of the chemicals that we use to produce the dry reagent chemistry beads that are either inserted in our reagent discs or sold as a stand-alone product: Amano Enzyme USA Co., Ltd., Genzyme Corporation, Kikkoman Corporation Biochemical Division, Microgenics Corporation, Roche Molecular Biochemicals of Roche Diagnostics Corporation, a division of F. Hoffmann-La Roche Ltd., Shinko American Inc., and Sigma Aldrich Inc.

•

Blood Analyzer Components: Our analyzer products use several technologically advanced components that we currently purchase from two single source vendors, PerkinElmer, Inc. and Electro Alliance, Inc. Our analyzers use a printer that is only made by Seiko North America Corporation. The loss of the supply of any of these components could force us to redesign our analyzers.

•

Hematology Instrument and Reagents: We currently purchase HMT instruments and reagents from MELET SCHLOESING Laboratories (MELET) of France. During the first quarter of the fiscal year ending March 31, 2005, we are planning to introduce an additional hematology product worldwide. We have entered into an OEM agreement with Diatron Messtechnik GmbH (DIATRON) of Austria to purchase the DIATRON hematology instruments, which are currently subject to further customization to meet our technical specifications. We plan to market this instrument as the Vetscan HMII in the veterinary market. We are currently in the process of qualifying a supplier to produce the reagents for the new hematology instruments.

We operate on a purchase order basis with all of the suppliers of our molded plastic reagent discs, reagent chemicals, and blood analyzer components and thus these suppliers are under no contractual obligation to supply us with their products or to do so at specified prices. Although we believe that there are potential alternate suppliers available for these critical components, to date we have not qualified additional vendors beyond those referenced above.

 

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

We Compete With Larger, Better Established Entities Such As Hospitals And Commercial Laboratories

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

•

commercial clinical laboratories;

•

hospitals’ clinical laboratories; and

•

manufacturers of bench top multi-test blood analyzers and other testing systems that health care providers can use “on-site.”

We May Not Be Able To Compete With These Organizations Or Their Products Or With Future Organizations Or Future Products

Historically, hospitals and commercial laboratories perform the most human medical testing, and commercial laboratories perform the most veterinary medical testing. We have identified five principal factors that customers typically use to evaluate our products and those of our competitors. These factors are:

•

range of tests offered;

•

the immediacy of results;

•

cost effectiveness;

•

ease of use; and

•

reliability of results.

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

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

Changes In Third Party Payor Reimbursement Regulations Can Negatively Affect Our Business

By regulating the maximum amount of reimbursement they will provide for blood testing services, third party payors, such as HMOs, pay-per-service insurance plans, Medicare and Medicaid, can indirectly affect the pricing or the relative attractiveness of our human testing products. For example, the Centers for Medicare and Medicaid Services (“CMS”) sets the level of reimbursement of fees for blood testing services for Medicare beneficiaries. If third party payors decrease the reimbursement amounts for blood testing services, it may decrease the amount that physicians and hospitals are able to charge patients for such services. Consequently, we will need to

 

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charge less for our products. If the government and third party payors do not provide for adequate coverage and reimbursement levels to allow health care providers to use our products, the demand for our products will decrease.

We Are Subject To Numerous Governmental Regulations

•

Need for FDA Certification for Our Medical Device Products

Our Piccolo products are regulated under the 1976 Medical Device Amendments to the Food, Drug and Cosmetic Act, which is administered by the Food and Drug Administration. The FDA has classified our Piccolo products as “Class I” and “Class II” devices. These classifications require us to submit to the FDA a pre-market notification form or 510(k). The FDA uses the 510(k) to substantiate product claims that are made by medical device manufacturers prior to marketing. In our 510(k) notification, we must, among other things, establish that the product we plan to market is “substantially equivalent” to (1) a product that was on the market prior to the adoption of the 1976 Medical Device Amendment or (2) to a product that the FDA has previously cleared under the 510(k) process. The FDA review process of a 510(k) notification can last anywhere from three to six months, and the FDA must issue a written order finding “substantial equivalence” before a company can market a medical device. To date, we have received market clearance from the FDA for our Piccolo System and 24 reagent tests that we have on eleven reagent discs. We are currently developing additional tests that the FDA will have to clear through the 510(k) notification procedures. These new test products are crucial for our success in the human diagnostic market. If we do not receive 510(k) clearance for a particular product, we will not be able to sell that product in the United States.

•

Need to Comply with Manufacturing Regulations

The 1976 Medical Device Amendment also requires us to manufacture our Piccolo products in accordance with Good Manufacturing Practices guidelines. Current Good Manufacturing Practice requirements are set forth in the quality system regulation. These requirements regulate the methods used in, and the facilities and controls used for, the design, manufacture, packaging, storage, installation and servicing of our medical devices intended for human use. Our manufacturing facility is subject to periodic audits. In addition, various state regulatory agencies may regulate the manufacture of our products. For example, we have obtained a license from the State of California to manufacture our products. In April 2001, the State of California Food and Drug Branch granted our manufacturing facility “in compliance” status, based on the regulations for Good Manufacturing Practices for medical devices. In May 2001, the State of California Food and Drug Branch granted licensing for our new Union City facility. The most recent inspection was in March 2003 when the FDA conducted a facilities inspection and verified our compliance with the 21 CFR 820 Regulation. We cannot assure you that we will successfully pass a re-inspection by the FDA or the State of California. In addition, we cannot assure you that we can comply with all current or future government manufacturing requirements and regulations. If we are unable to comply with the regulations, or if we do not pass routine inspections, our business and results of operations will be materially adversely affected.

•

Effects of the Clinical Laboratory Improvement Amendments on Our Products

Our Piccolo products are affected by the Clinical Laboratory Improvement Amendments of 1988. The Clinical Laboratory Improvement Amendments are intended to insure the quality and reliability of all medical testing in the United States regardless of where tests are performed. The current Clinical Laboratory Improvement Amendments divide laboratory tests into three categories: “simple,” “moderately complex” and “highly complex.” Tests performed using the Piccolo system are in the “moderately complex” category. This category requires that any location in which testing is performed be certified as a laboratory. Hence, we can only sell our Piccolo products to customers who meet the standards of a laboratory. To receive “laboratory” certification, a testing facility must be certified by the Centers for Medicare and Medicaid Services. After the testing facility receives a “laboratory” certification, it must then meet the Clinical Laboratory Improvement Amendments regulations. Because we can only sell our Piccolo products to testing facilities that are certified “laboratories,” the market for our products is correspondingly constrained. During the third quarter of fiscal 2004, we submitted a petition for “waived status” to the Food and Drug Administration (FDA) after we conducted clinical studies designed to demonstrate the ability of untrained personnel to use the Piccolo and obtain reliable results from the Piccolo Lipid Panel Reagent Disc (Total Cholesterol, HDL, and Triglycerides). Waived status would permit untrained personnel to run the Piccolo using the Lipid Panel and, thus, extending the sites (doctors’ offices and other point-of-care environments) that can use the Piccolo. Currently, this petition is under evaluation by the FDA. We cannot assure you that we will successfully receive the waived status from the FDA. Consequently, the market for our Piccolo products may be confined to those testing facilities that are certified as “laboratories” and our growth will be limited accordingly.

 

•

We Are Subject to Various Federal, State, Local, and International Regulations

Federal and state regulations regarding the manufacture and sale of health care products and diagnostic devices may change. In addition, as we continue to sell in foreign markets, we may have to obtain additional governmental clearances in those markets. For example, in January 2004, we received certification from the British Standards Institute to the ISO 13485:1996 quality system standard for medical devices. This quality system certification, along with successful completion of product testing to current European standards and the translation of Piccolo product documentation into the required languages, enabled us to meet the compliance requirements of the CE Mark and the current European In Vitro Device Directive. We cannot predict what impact, if any, such current or future regulatory changes would have on our business. We may not be able to obtain regulatory clearances for our products in the United States or in foreign markets, and the failure to obtain these regulatory clearances will materially adversely affect our business and results of operations.

Although we believe that we will be able to comply with all applicable regulations of the Food and Drug Administration and of the State of California, including Quality System Regulations, current regulations depend on administrative interpretations. Future interpretations made by the Food and Drug Administration, the Centers for Medicare and Medicaid Services (CMS) or other regulatory bodies may adversely affect our business.

We Depend On Key Members Of Our Management And Scientific Staff, And We Must Retain And Recruit Qualified Individuals If We Are To Be Competitive

We are highly dependent on the principal members of our management and scientific staff. The loss of any of these key personnel, including in particular Clinton H. Severson, our President, Chief Executive Officer and Chairman of our Board of Directors, might impede the achievement of our business objectives. Mr. Severson’s amended and restated employment agreement with us was filed with the SEC on August 14, 2001 as an exhibit to our quarterly report for the quarter ended June 30, 2001. We are not aware of any member of our executive management team who intends to retire within one year of the date of this filing. We currently do not maintain key man life insurance on any of our employees. Although historically we have been relatively successful both in retaining our current management and scientific staff and attracting and retaining skilled and experienced marketing, sales and manufacturing personnel, we may not be able to employ such personnel on acceptable terms in the future because numerous medical products and other high technology companies compete for the services of these qualified individuals.

Legislative Actions, Higher Insurance Cost And Potential New Accounting Pronouncements Are Likely To Cause Our General And Administrative Expenses To Increase And Impact Our Future Financial Position And Results Of Operations

In order to comply with the newly adopted Sarbanes-Oxley Act of 2002, as well as proposed changes to listing standards by Nasdaq, and proposed accounting changes by the Securities and Exchange Commission, we may be required to enhance our internal controls, hire additional personnel and utilize additional outside legal, accounting and advisory services, all of which will cause our general and administrative costs to increase. Insurers are also likely to increase premiums as a result of the high claims rates incurred over the past year, and so our premiums for our various insurance policies, including our directors’ and officers’ insurance policies, are likely to increase. Proposed changes in the accounting rules, including legislative and other proposals to account for employee stock options as a compensation expense among others, could materially increase the expenses that we report under generally accepted accounting principles and adversely affect our operating results.

We Must Comply With Strict And Costly Environmental Regulations

We are subject to stringent federal, state and local laws, rules, regulations and policies that govern the use, generation, manufacture, storage, air emission, effluent discharge, handling and disposal of certain materials and wastes. In particular, we are subject to laws, rules and regulations governing the handling and disposal of biohazardous materials used in the development and testing of our products. We handle and dispose of human and veterinary blood samples for testing (whole blood, plasma, serum) and we pay approximately $48,000 per year to comply with applicable environmental regulations. Although we believe that we have complied with applicable laws and regulations in all material respects and have not been required to take any action to correct any noncompliance, we may have to incur significant costs to comply with environmental regulations if our manufacturing to commercial levels continues to increase. In addition, if a government agency determines that we have not complied with these laws, rules and regulations, we may have to pay significant fines and/or take remedial action that would be expensive and we do not carry environmental-related insurance coverage.

 

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System Failures Or Delays May Harm Our Business And Our Facilities And Manufacturing Operations Are Vulnerable To Natural Disasters And Other Unexpected Losses

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

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

Fluctuations In Foreign Exchange Rates And The Possible Lack Of Financial Stability In Foreign Countries Could Prevent Overseas Sales Growth

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

Our Stock Price Is Highly Volatile And Investing In Our Stock Involves A High Degree Of Risk

The market price of our common stock, like the securities of many other medical products companies, fluctuates over a wide range, and will continue to be highly volatile in the future. During the last eight fiscal quarters ended December 31, 2003, our stock price traded at a high of $21.50 on December 5, 2003 and a low of $3.00 on August 19, 2002. The following factors may affect the market price of our common stock:

•

fluctuation in our operating results;

•

announcements of technological innovations or new commercial products by us or our competitors;

•

changes in governmental regulation;

•

prospects and proposals for health care reform;

•

governmental or third party payors’ controls on prices that our customers may pay for our products;

•

developments or disputes concerning patent or our other proprietary rights;

•

public concern as to the safety of our devices or similar devices developed by our competitors; and

•

general market conditions.

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

Our Recently Adopted Shareholders Rights Plan And Our Ability To Issue Preferred Stock May Delay Or Prevent A Change Of Control Of Abaxis

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

In addition, our board of directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without

 

25

any further vote or action by the stockholders, except to the extent required by NASDAQ rules. The issuance of preferred stock, while providing flexibility in connection with possible financings or acquisitions or other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to financial market risks with respect to interest rates on our line of credit, long-term debt and cash equivalent investments.

For our line of credit, the interest rate is equal to the prime rate minus 0.25%. Consequently, an increase in the prime rate would expose us to higher interest expenses. There was no outstanding balance on our line of credit at December 31, 2003.

For our equipment loan, the interest rate is equal to 1.00% over the prime rate. As with our line of credit, any increase in interest rates would expose us to higher interest expenses. The balance on our equipment loan was $584,000 as of December 31, 2003. Based on this balance, for each 1.00% increase in the prime rate, we would pay a total of $1,500 of additional interest each quarter.

All of our sales are denominated in U.S. dollars, except for sales under our OEM agreement to provide VetScan systems to Melet which are denominated in Euros. Sales to Melet during the three and nine months ended December 31, 2003 were 2% of our total revenues. At December 31, 2003, our net balance due to Melet was $27,000.

As a matter of management policy, we do not currently enter into transactions involving derivative financial instruments. In the event we do enter into such transactions in the future, such items will be accounted for in accordance with Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” in which case we will formally document all relationships between hedging instruments and hedged items, as well as our risk management objective and strategy for undertaking such hedge transactions.

Item 4. Controls and Procedures

(a) Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

(b) There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date of the evaluation referenced in paragraph (a) above.

PART II -- OTHER INFORMATION

Item 1. Legal Proceedings

We are from time to time involved in various litigation matters in the normal course of business. We believe that the ultimate resolution of these matters will not have a material effect on our financial position or results of operations.

Item 2. Changes in Securities and Use of Proceeds

Under our debt agreements, we are restricted from paying aggregate cash dividends on our stock in excess of 50% of our net income on an annual basis.

Item 3. Defaults Upon Senior Securities

None

 

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Item 4. Submission of Matters to a Vote of Security Holders

The Company’s annual meeting of shareholders was held on October 21, 2003 (the “Annual Meeting”). The following matters were voted upon and approved at the Annual Meeting:

(a)	To elect six (6) directors to hold office until the next annual meeting of shareholders. The votes cast and withheld for such nominees were as follows:

		Votes For		Votes Withheld
	Clinton H. Severson	13,661,735		1,415,635
	Richard J. Bastiani, Ph.D	14,408,828		668,542
	Henk J. Evenhuis	14,476,828		600,542
	Brenton G.A. Hanlon	14,408,828		668,542
	Prithipal Singh, Ph.D	14,478,028		599,342
	Ernest S. Tucker III, M.D	14,476,728		600,642

(b)	To ratify the appointment of Deloitte & Touche LLP as our independent public accountants for the fiscal year ending March 31, 2004.

	For	14,992,562
	Against	51,250
	Abstain	33,558

(c)	To approve an amendment to the Abaxis 1998 Stock Option Plan.

	For	7,700,475
	Against	1,086,092
	Abstain	75,101

Based on these voting results, each of the directors nominated was elected, the appointment of Deloitte & Touche LLP was approved, and the amendment to the Abaxis 1998 Stock Option Plan was approved.

Item 5. Other Information

None.

Item 6. Exhibits And Reports On Form 8-K

(a) Exhibits included herein

Exhibit Number	Description
31.1	Certification of President and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer and Vice President of Finance pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

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32.1	Certification of President and Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Chief Financial Officer and Vice President of Finance pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b) Reports on Form 8-K

On October 15, 2003, we filed a Current Report on Form 8-K regarding the automatic conversion of all outstanding Series E Preferred Stock.

On October 16, 2003, we submitted a Current Report on Form 8-K to release our quarterly earnings announcement.

On October 28, 2003, we filed a Current Report on Form 8-K regarding the automatic conversion of all outstanding Series D Preferred Stock.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		ABAXIS, INC. (Registrant)
Date: February 13, 2004		BY: /s/ Clinton H. Severson
		Clinton H. Severson President, Chief Executive Officer and Director (Principal Executive Officer)
Date: February 13, 2004		BY: /s/ Alberto R. Santa Ines
		Alberto R. Santa Ines Chief Financial Officer and Vice President of Finance (Principal Financial and Accounting Officer)

 

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