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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-K

(Mark One) |X|

Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended March 31, 2004

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)

3240 Whipple Road
Union City, CA 94587
(Address of principal executive offices)

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

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, No par value
(Title of Class)

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

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

        Indicate by check mark whether the registrant is an accelerated filer as defined in Rule 12b-2 of the Act. Yes |X| No |_|

        The aggregate market value of the voting stock held by non-affiliates of Abaxis, as of June 7, 2004 was $343,084,646 based upon the closing sale price reported for such date on the NASDAQ National Market. For purposes of this disclosure, shares of common stock held by persons who hold more than 5% of the outstanding shares of common stock and shares held by officers and directors of the registrant have been excluded because such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily conclusive for any other purpose.

        We had 19,597,815 shares of Common Stock outstanding on June 7, 2004.

Abaxis, Inc.
Annual Report on Form 10-K
For The Fiscal Year Ended March 31, 2004
TABLE OF CONTENTS

 

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PART I

This report contains forward-looking statements within the meaning of Sections 21E of the Securities Exchange Act of 1934 that reflect Abaxis’ current view with respect to future events and financial performance. In this report, the words “will,” “anticipates,” “believes,” “expects,” “intends,” “plans,” “future,” 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, required United States Food and Drug Administration (“FDA”) clearance and other government approvals, risks associated with manufacturing and distributing our products on a commercial scale, free of defects, risk related to the introduction of new instruments manufactured by third parties, risks associated with entering the human diagnostic market on a larger scale, risks related to the protection of the our intellectual property or claims of infringement of intellectual property asserted by third parties, risks involved in carrying of inventory, risks associated with the ability to attract, train and retain competent sales personnel, general market conditions and competition.

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

ITEM 1.   BUSINESS

General

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. Our Internet address is www.abaxis.com. We make available free of charge on or through our Internet website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. Our common stock trades on the Nasdaq National Market under the symbol “ABAX.”

Our primary product is a blood analysis system, consisting of a compact 6.9 kilogram (15 pounds) 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®.

Through April 2004, we marketed a veterinary hematology analyzer under the name VetScan HMT, which provided a complete blood count including three-part white blood cell differential in less than 2 minutes and required only 12 µL (microliter) of whole blood. It provided results for eight selectable species, plus two user configurable programs. We marketed one type of reagent kit with this analyzer. We purchased the hematology analyzer and reagent kits from Melet Schloesing Laboratoires of France. We will continue to support and service our current population of VetScan HMT hematology customers.

In May 2004, we introduced a hematology instrument (“VetScan HMII”) that offers an 18-parameter CBC (complete blood count) analysis, including a three-part white blood cell differential for the diagnostic assessment of patients by the veterinarian in their clinic. We entered into an original equipment manufacturing (“OEM”) agreement with Diatron Messtechnik GmbH (DIATRON) of Austria to purchase the DIATRON hematology instruments commencing in the fiscal quarter that the instruments were qualified, which was the first quarter of fiscal 2005. We market the combination of the VetScan and the VetScan HMII under the name VetScan DXS.

We offer our point-of-care blood chemistry analyzer system with a total of 25 diagnostic tests. Our repertoire of tests includes alanine aminotransferase (ALT), albumin (ALB), alkaline phosphatase (ALP), amylase (AMY), aspartate aminotransferase (AST), calcium (CA++), creatine kinase (CK), chloride (CL-), creatinine (CRE), direct bilirubin (DBIL), gamma glutamyl

 

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transferase (GGT), glucose (GLU), high-density lipoprotein cholesterol (HDL), magnesium (MG), phosphorous (PHOS), potassium (K+), sodium (NA+), thyroxine (T4), total bilirubin (TBIL), total carbon dioxide (TCO2), total cholesterol (CHOL), total protein (TP), triglycerides (TRIG), urea nitrogen (BUN) and uric acid (UA). Nineteen of these tests are marketed for both human and veterinary markets. Tests for MG and T4 are currently marketed exclusively in the veterinary market. The tests for CL-, DBIL, HDL and TRIG are marketed exclusively in the human market. We market our reagent products by configuring these 25 test methods in panels that are designed to meet a variety of clinical diagnostic needs. We currently offer 11 multi-test reagent disc products in the human medical market and 8 multi-test reagent disc products in the veterinary market.

Our focus in fiscal 2005 will be continued growth in the veterinary market where we believe we can receive immediate economic rewards, while at the same time expanding our presence in the human in vitro diagnostic point of care market. We intend to continue our marketing efforts of our Piccolo systems to the U.S. military. Internationally, we will continue to focus our sales efforts in Asia, Europe and Latin America.

Our Industry: In Vitro Diagnostic Testing

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

Abaxis has developed a blood analysis system incorporating all of these criteria into a 6.9 kilogram (15 pounds) analyzer and a series of menu-specific, multi-test single-use reagent discs. The system is essentially a compact portable laboratory that can be easily located near the patient. Each reagent disc is pre-configured with multiple analytes and contains all the reagents necessary to perform a fixed menu of tests. Taking the system to the patient care site instead of shipping the sample to a central laboratory makes blood testing and analysis as easy as measuring the patient’s blood pressure, temperature, and heart rate and eliminates the necessity of multiple visits to the doctor’s office. Additional advantages of near-patient testing include eliminating errors from sample handling, transcription and transportation. We have adapted this blood analysis system in both the veterinary and human medical markets in order to bring the same advantages to all healthcare professionals and patients.

Abaxis Products

Point-of-Care Blood Chemistry Analyzers

We currently manufacture and market our point-of-care blood chemistry analyzers for veterinary use under the name VetScan® and in the human medical market under the name Piccolo®. The blood analysis system is a portable spectrophotometer, which is a device that measures the absorption of light at various wavelengths. A variable speed motor is used to spin a reagent disc for sample processing. The chemical reactions in the disc’s cuvettes are measured optically by detecting the light absorbance of the solutions in the cuvettes at pre-determined wavelengths. The absorbances are converted to clinically relevant units by a measurement microprocessor. Results are stored by the analyzer’s interface microprocessor, sent to an RS232 port and printed on result cards by an internal thermal printer or transmitted to a patient data management system. The features of the analyzer include a small required sample size (100 µL) of whole blood, serum or plasma, an intelligent quality control system that includes many self-test functions to ensure quality results, a built-in instrument self calibration, a built-in printer, a quick turn-around time of less than 14 minutes, minimal operational training and ease of information transmission using a computer port on the analyzer.

Hematology

From March 1999 to April 2004, we entered into an original equipment manufacturing (OEM) and distribution agreement with MELET SCHLOESING Laboratoires (MELET) under which we marketed and sold the MELET hematology instrument and reagents and MELET marketed and sold the VetScan and Piccolo products. We marketed the MELET hematology instrument as the VetScan® HMT in the veterinary market.

In May 2004, we introduced the VetScan HMII, a hematology instrument that offers an 18-parameter CBC (complete blood count) analysis, including a three-part white blood cell differential for the diagnostic assessment of patients by the veterinarian in their clinic. We entered into an original equipment manufacturing (“OEM”) agreement with Diatron Messtechnik GmbH (DIATRON) of Austria to purchase the DIATRON hematology instruments commencing in the fiscal quarter that the

instruments were qualified, which was the first quarter of fiscal 2005. We market the combination of the VetScan and the VetScan HMII under the name VetScan DXS.

Reagent Discs

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

To perform a panel of tests, the operator collects a blood sample. The operator then transfers the sample into the reagent disc. The operator places the disc into the analyzer drawer, and enters patient, physician, and operator identification numbers. The analyzer spins the disc to separate cells from plasma, meters and mixes plasma with diluent, distributes diluted plasma to the cuvettes, and monitors chemical reactions. In less than 14 minutes, results are printed out on a result card with an adhesive backing or can be transmitted to a patient data management system for inclusion in the patient’s medical record. A computer port enables transmission of patient results to external computers for patient data management.

The VetScan system was introduced in the U.S. veterinary market in July 1994. We initially launched the system with the Diagnostic Profile, a nine-test reagent product. Since then, we have added new test methods and new reagent disc products targeted to fulfill different veterinary diagnostic needs. The following is a list of the current VetScan reagents offered:

We introduced our Piccolo system to the human medical market in November 1995 with two reagent discs, General Health Panel 8 and General Health Panel 11. Since that time we have introduced new panels to aid conventional disease diagnosis or monitor disease treatment. The following is a list of the current Piccolo reagents offered:

 

General Chemistry 6	ALT, AST, BUN, CRE, GGT, GLU.
Electrolyte Panel	CL- ,K+, Na+, tCO2.
MetLyte 8	BUN, CK, CL-, CRE, GLU, K+, Na+, tCO2.
Basic Metabolic Panel	BUN, CA++, CL-, CRE, GLU, K+, NA+, tCO2.
Lipid Panel	TOTAL CHOL, TOTAL CHOL/HDL RATIO, HDL, LDL, TRIG, VLDL.
Renal Panel	ALB, BUN, CA++, CL-, CRE, GLU, K+, NA+, PHOS, tCO2.
Comprehensive Metabolic	ALB, ALP, ALT, AST, BUN, CA++, CL-, CRE, GLU, K+, NA+, TBIL, tCO2, TP.
Hepatic Panel	ALB, ALP, ALT, AST, DBIL, TBIL, TP.

Orbos Process

The dry reagents used in our 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 with other companies, although there can be no assurance that we will be able to develop any new applications for the Orbos process.

VetScan Canine Heartworm Antigen Test

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.

Future Products

We continue to develop new products that we believe will provide further opportunities for growth in the human and veterinary markets. For the human medical market, we completed and released the developments of the Renal Function, Hepatic Function and Comprehensive Metabolic Panels during fiscal 2004. Additionally, we have begun working on the feasibility of a second generation Lipid Panel Disc that would add liver function and glucose tests to the lipid panel. Development of tests for other disc products will be targeted at specific applications based on fulfilling clinical needs. Our current focus of test methods development is in general clinical chemistry. In addition to general clinical chemistry, we have demonstrated our ability to perform immunoassay tests on our blood analysis system by successfully developing the Thyroxine (T4) test in the veterinary market. We believe other immunoassay methods can be performed with our discs to measure a wide assortment of blood analytes, including cardiac markers. Although there can be no assurance that we will be able to develop any of these potential products, we believe that our technology and expertise will allow us to develop reagent disc products in the future to provide a variety of additional blood tests.

Customers and Distribution

Customers

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

We believe that our current Piccolo system menu of 24 reagent test results is suitable for a wide variety of the human medical market segments. These market segments include military installations (ships, field hospitals and mobile care units), physicians office practices, urgent care and walk-in clinics (free-standing or hospital-connected), home care providers (national, regional or local), nursing homes, ambulance companies, dialysis centers, hospital labs and draw stations.

We believe that our current veterinary reagent product offerings meet a substantial part of the clinical diagnostic needs of veterinarians. Potential customers for the VetScan DXS are primarily companion animal hospitals, animal clinics with mixed practices of small animals, birds and reptiles, equine practitioners, veterinary referral hospitals, private toxicology laboratories and university and government toxicology research laboratories.

Distribution Within North America

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

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

Veterinarians are served typically by local distributors, some with national affiliations. Our largest volume purchaser is Vedco, Inc., which is a national network of independent distributors through which six member distributors represent our products. We also work with ten additional independent distributors of which DVM Resources is our fastest growing partner in instrument and consumable sales. In addition to selling through distributors, we directly supply our VetScan products to Veterinary Centers of America (VCA), the nation’s largest veterinary hospital chain. In April 2004, we signed a distributor agreement with the Veterinary Division of Henry Schein, Inc., a distributor of animal healthcare products and services to veterinary practitioners to sell and distribute the VetScan DXS, along with the associated reagent discs and kits. We intend to enter into arrangements with additional veterinary distributors as well as pursue direct veterinary sales where appropriate.

Distribution Outside of North America

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

We currently have distribution agreements in the following countries: Argentina, Australia, Austria, Bahrain, Belgium, France, Germany, Greece, Israel, Italy, Japan, Korea, Kuwait, Mexico, New Zealand, Nigeria, Norway, Poland, Portugal, South Africa, Spain, Switzerland, United Arab Emirates, the United Kingdom and Venezuela. Each distributor agreement contains a number of requirements that must be met to retain exclusivity, including minimum order quantity commitments, trade show and promotion requirements and a specified number of demonstration analyzer requirements. In most cases, the foreign distributors need to either go through a FDA-equivalent approval process with national regulators or clinical trials/market evaluations with

their local opinion leaders in the medical field. Each distributor is responsible for obtaining the required approvals. There can be no assurance that any of our distributors will be successful in obtaining proper approvals for Abaxis products in their respective countries or that these distributors will be successful in marketing Abaxis products. In August 2001, we signed a non-exclusive agreement with Scil Animal Care Company GmbH of Germany, a leading supplier of veterinary technology and supplies, to distribute the VetScan in defined European countries. In August 2002, we entered into an exclusive distribution agreement to distribute our VetScan products in Japan with T. Chatani & Co. We plan to continue to enter into additional distribution agreements to enhance our international distribution base and solidify our international presence.

Competition

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

Historically, hospitals and commercial laboratories perform most of the human medical testing, and 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 as follows: 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 both a wide range and high volumes of discrete tests using skilled technicians and complex equipment. While our current offering of reagent discs cannot provide the same broad range of tests, we believe that in our targeted market segments, our products provide a sufficient breadth of test menus to compete successfully with clinical laboratories given the advantages of our products with respect to the other four factors.

Our principal competitors in the human 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 are developing our distribution network and expanding our direct sales force in order to compete in these markets.

Manufacturing

We manufacture our Piccolo and VetScan products from our facilities located in Union City, California. The VetScan HMII is manufactured by DIATRON in Austria and is purchased by us as a completed instrument.

Our Piccolo products are regulated under the 1976 Medical Device Amendments to the Food, Drug and Cosmetic Act, which is administered by the Food and Drug Administration. To produce and commercially ship Piccolo products, we must have a license to manufacture medical products in the State of California, where we conduct our principal manufacturing activities, and have approval from the FDA as a medical device manufacturer. The 1976 Medical Device Amendment requires us to manufacture our Piccolo products in accordance with current Good Manufacturing Practices (“cGMP”) guidelines. Current Good Manufacturing Practice requirements are set forth in the 21 CFR820 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. 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 Union City facility. In May 2002, we received our ISO 9001 certification, expanding our compliance with international quality standards. In March 2003 the U.S. FDA conducted a facilities inspection and verified our compliance with the 21 CFR 820 Regulation. Although we are not required to comply with all of the government regulations applicable to the human market when manufacturing the VetScan DXS products, we have established all of our manufacturing operations to be compliant with the Quality System Regulation as this ensures product quality and integrity regardless of end use or patient.

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

Material Relationships with Suppliers and Other Third Parties

Amersham Biosciences Corp. (formerly Pharmacia Biotech, Inc.)

Under our 1994 agreement with Amersham Biosciences Corp. (formerly Pharmacia Biotech), we licensed our Orbos bead technology to Amersham Biosciences Corp. (formerly Pharmacia Biotech) for use in various medical tests. This agreement was amended in June 1997 to include DNA/RN and Human Leukocyte Antigen testing. We receive royalty payments equal to 5% of net sales, as defined in the agreement, of Amersham’s products that use our technology.

Becton Dickinson

Under our 1994 agreement with Becton Dickinson, Becton Dickinson has agreed to purchase from us certain minimum quantities of our Orbos chemical beads in return for compensation and our agreeing not to license or otherwise use the Orbos bead process with any other party. In June 1997, Becton Dickinson failed to purchase the minimum quantities specified in the agreement and thus the exclusivity terms of the agreement have lapsed. The contract with Becton Dickinson will expire in

September 2009 and, in the event that prior to that date we decide to cease manufacturing Orbos beads, we must give Becton Dickinson at least one year’s notice.

Diatron Messtechnik GmbH

Under our agreement with DIATRON, we acquired the exclusive right to distribute DIATRON’s veterinary hematology analyzers in Australia, Canada, Japan, New Zealand and the United States. The agreement has a five year term, but is also subject to certain minimum purchase quantities during the first five years of the contract term.

DVM Resources

We do not have any contractual relationship with DVM Resources, one of our distributors that accounted for 16% of our revenue in fiscal 2004. Consequently, DVM Resources may at any time cease to purchase our products without any penalty.

S.A. Scientific, Inc.

In November 2001, we signed a term sheet with S.A. Scientific, Inc. of San Antonio, Texas, under which S.A. Scientific agreed to provide us with canine heartworm antigen tests that we would distribute and sell using the Abaxis brand. The term sheet did not include any reference to indemnification by S.A. Scientific in the event that Abaxis was sued for patent infringement with respect to the canine heartworm antigen test. In March 2002, Idexx Laboratories, Inc. sued both Abaxis and S.A. Scientific for infringement upon patents issued to Idexx. The case was settled under the terms of an out-of-court agreement on December 6, 2002. Among other terms, Abaxis agreed to pay Idexx $249,500 in cash damages and to cease 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.

Scil Animal Care Gmbh

In September 2001, we entered into a five-year non-exclusive distribution agreement with Scil Animal Care Company GmbH of Germany, under which Scil will distribute our VetScan products in Belgium, Denmark, Finland, Germany, Norway, Sweden and the Netherlands.

Vedco, Inc.

We do not have any contractual relationship with Vedco, Inc., one of our distributors that accounted for 27% of our revenue in fiscal 2004. Consequently, Vedco may at any time cease to purchase our products without any penalty.

Government Regulation

Piccolo System

Food and Drug Administration Clearance

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.

Clinical Laboratory Improvements Act Regulations

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.

Other Regulations

We are subject to a variety of federal, state, local and international regulations regarding the manufacture and sale of our products. For example, in December 2003, 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. As we continue to sell in foreign markets, we may have to obtain additional governmental clearances in those markets. We cannot predict what impact, if any, such current or future regulatory changes would have on our business.

VetScan DXS

The government regulations discussed above generally do not apply to our VetScan DXS products in the U.S. Internationally, among the countries where we currently have established distribution arrangements, to our knowledge, Japan is the only market where VetScan DXS products are subject to government approvals. In Japan, the Ministry of Agriculture, Forestry and Fishery regulates veterinary diagnostic devices, and thus the DXS System must be approved by such Ministry prior to being marketed in Japan.

In order to maintain high quality standards for all products, we are using the same manufacturing facilities to manufacture all point-of-care blood chemistry analyzers whether they be for the Piccolo or VetScan system products and therefore is following the same manufacturing processes and procedures where practical.

Intellectual Property

We have pursued the development of a patent portfolio to protect our technology. As of June 14, 2004, 33 patent applications have been filed on behalf of Abaxis with the United States Patent and Trademark Office, of which the following 27 have been issued:

 

5,275,016	Cryogenic Apparatus	January 4, 1994	April 24, 2012
5,304,348	Reagent Container for Analytical Rotor	April 19, 1994	February 11, 2012
5,384,247	Determination of Sodium Ions in Fluids	January 24, 1995	January 24, 2012
5,403,415	Method and Device for Ultrasonic Welding	April 4, 1995	November 17, 2013
5,409,665	Simultaneous Cuvette Filling with Means to Isolate Cuvettes	April 25, 1995	September 1, 2013
5,409,814	Determination of Ions in Fluids	April 25, 1995	April 25, 2012
5,413,732	Reagent Compositions for Analytical Testing	May 9, 1995	May 9, 2012
5,457,053	Reagent Container for Analytical Rotor	October 10, 1995	October 10, 2012
5,472,603	Analytical Rotor with Dye Mixing Chamber	December 5, 1995	December 5, 2012
5,478,750	Methods for Photometric Analysis	December 26, 1995	March 31, 2013
5,501,958	Determination of Potassium Ions in Fluids	March 26, 1996	March 26, 2013
5,518,930	Simultaneous Cuvette Filling with Means to Isolate Cuvettes	May 21, 1996	September 1, 2013
5,590,052	Error Checking in Blood Analyzer	December 31, 1996	April 14, 2014
5,591,643	Simplified Inlet Channels	January 7, 1997	January 7, 2014
5,599,411	Method and Device for Ultrasonic Welding	February 4, 1997	November 17, 2013
5,624,597	Reagent Compositions for Analytical Testing	April 29, 1997	April 29, 2014
5,693,233	Methods of Transporting Fluids Within An Analytical Rotor	December 2, 1997	April 2, 2012
5,776,563	Dried Chemical Compositions	July 7, 1998	July 7, 2015
5,998,031	Dried Chemical Compositions	December 7, 1999	August 19, 2011
6,068,971	Process for Determination of Ions in Fluids by Masking of Interfering Ions	May 30, 2000	May 30, 2017
6,235,531	Modified Siphons for Improved Metering Precision	May 22, 2001	September 1, 2013
6,251,684	Dried Chemical Compositions	June 26, 2001	August 18, 2011

Our policy is to file patent applications to protect technology, inventions and improvements that are important to the development of our business. We also rely upon trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain competitive position. Fourteen international applications have been filed on behalf of Abaxis under the Patent Cooperation Treaty (PCT) and we are selectively filing patent applications in countries where we anticipate to market our products. Under the fourteen PCT applications, 72 national foreign applications were filed on behalf of Abaxis in various countries and forty-two of them have been granted. Of these forty-two, one is being opposed by the European Patent Office, and we are in the process of responding to their concerns.

Employees

As of March 31, 2004, we had 171 full-time employees distributed across the following divisions:

•

24 in research and development;

•

87 in manufacturing operations;

•

50 in sales and marketing (including customer support); and

•

10 in general and administrative.

We also use temporary help to assist in carrying out certain operational duties. As of March 31, 2004, we had 6 temporary employees with most of them assisting in manufacturing operations. None of our employees are covered by collective bargaining agreements and management considers its relations with employees to be good.

ITEM 2. PROPERTIES

We occupy approximately 91,124 square feet of office, research and development and manufacturing space in a building in Union City, California. The lease agreement is for ten years commencing January 2001 with an option to extend the lease for five additional years. Our Germany office consists of approximately 900 square feet located in Darmstadt, Germany. The lease agreement for the Germany office is terminable upon three months notice. We believe that our current facilities are suitable and adequate to meet our needs for the foreseeable future.

ITEM 3. 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No items were submitted to a vote of security holders during the quarter ended March 31, 2004.

PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our initial public offering of common stock was completed in January 1992. Since that date, our common stock has been traded on the NASDAQ National Market under the symbol “ABAX”.

The high and low prices for our common stock during each quarter since April 1, 2002 are exhibited in the table below, as represented by the high and low daily trade closing sales prices as reported by the NASDAQ National Market:

As of June 7, 2004, there were 19,597,815 shares of our Common Stock issued and outstanding and held by 224 shareholders of record.

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. We have never paid dividends on our common stock and do not anticipate paying cash dividends in the foreseeable future.

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 entitled 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.

Securities Authorized for Issuance Under Equity Compensation Plans

Abaxis has two equity incentive plans under which our equity securities are or have been authorized for issuance to our employees or directors: the 1989 Stock Option Plan, which was amended and restated as the 1998 Stock Option Plan, and the 1992 Outside Directors’ Stock Option Plan. Both the 1998 Stock Option Plan and the 1992 Outside Directors’ Stock Option Plan have been approved by our shareholders. In June 2002, the time period for granting options under the Directors’ Plan expired in accordance with the terms of the plan. From time to time we issue warrants to purchase shares of our common stock to non-employees, such as service providers and purchasers of our preferred stock.

The following table provides aggregate information through March 31, 2004 regarding (i) grants under both of our equity incentive plans and (ii) outstanding warrants to purchase our common stock.

EQUITY COMPENSATION INFORMATION

⁽¹⁾     Consists of warrants that have a five year term in which they may be exercised. All warrants were issued to service providers, except for warrants to purchase an aggregate of 88,750 and 115,000 shares of our common stock at a per share exercise price of $7.00 issued to purchasers of our Series D and Series E convertible preferred stock, respectively.

ITEM 6. SELECTED FINANCIAL DATA

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

 

			Years Ended March 31,
			2004			2003			2002			2001			2000
Statement of Operations Data:
Product sales, net			$	46,599,000		$	34,532,000		$	30,418,000		$	29,536,000		$	23,236,000
Development and licensing revenue				275,000			248,000			213,000			237,000			140,000
Total revenues				46,874,000			34,780,000			30,631,000			29,773,000			23,376,000
Costs and operating expenses:
Cost of product sales				22,966,000			17,755,000			15,966,000			16,560,000			12,695,000
Selling, general and administrative				14,431,000			11,564,000			9,333,000			9,641,000			7,765,000
Research and development				4,757,000			3,888,000			3,834,000			3,458,000			3,534,000
Total costs and operating expenses				42,154,000			33,207,000			29,133,000			29,659,000			23,994,000
Income (loss) from operations				4,720,000			1,573,000			1,498,000			114,000			(618,000	)
Interest and other income				173,000			217,000			91,000			140,000			187,000
Interest and other expense				(68,000	)		(149,000	)		(269,000	)		(45,000	)		(170,000	)
Net income (loss) before income taxes				4,825,000			1,641,000			1,320,000			209,000			(601,000	)
Income tax provision (benefit)				(19,208,000	)		5,000			16,000			21,000			(24,000	)
Net income (loss)				24,033,000			1,636,000			1,304,000			188,000			(577,000	)
Preferred dividends and accretion (a)				(419,000	)		(1,235,000	)		(1,033,000	)		(1,648,000	)		(151,000	)
Net income (loss) attributable to common shareholders			$	23,614,000		$	401,000		$	271,000		$	(1,460,000	)	$	(728,000	)
Basic net income (loss) per share			$	1.30		$	0.02		$	0.02		$	(0.09	)	$	(0.05	)
Diluted net income (loss) per share			$	1.16		$	0.02		$	0.02		$	(0.09	)	$	(0.05	)
Shares used in computing basic per share amounts				18,128,181			16,634,447			16,264,153			15,994,438			14,295,748
Shares used in computing diluted per share amounts				20,387,167			17,014,313			16,811,326			15,994,438			14,295,748

(a)

For fiscal 2004, includes preferred dividends of $419,000. For fiscal 2003, includes preferred dividends of $865,000 and a non-cash preferred dividend charge of $370,000 related to the beneficial conversion feature contained in our Series E Preferred Stock issued in April 2002. For fiscal 2002, includes preferred dividends of $446,000 and a non-cash preferred dividend charge of $587,000 related to the beneficial conversion feature contained in our Series E Preferred Stock issued in March 2002. For fiscal 2001, includes preferred dividends of $230,000 and a non-cash preferred dividend charge of $1,418,000 related to the beneficial conversion feature contained in our Series D Preferred Stock issued in October 2000. For fiscal 2000, includes preferred dividends of $151,000.

15

 

			March 31,
			2004			2003			2002			2001			2000
Balance Sheet Data:
Cash, cash equivalents, and short-term investments			$	17,322,000		$	10,430,000		$	4,098,000		$	2,012,000		$	2,049,000
Working capital				25,865,000			17,855,000			13,282,000			7,811,000			4,019,000
Total assets				61,898,000			32,368,000			29,680,000			26,001,000			14,098,000
Long-term obligations, excluding current portion				938,000			1,218,000			1,747,000			2,191,000			878,000
Convertible preferred stock				--			3,176,000			2,561,000			--			--
Total shareholders' equity				54,572,000			22,268,000			18,152,000			15,495,000			7,237,000

ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 primary product is a system consisting of a compact 6.9 kilogram (15 pounds) 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.

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

Total revenues increased 35% from $34,780,000 in fiscal 2003 to $46,874,000 in fiscal 2004. The growth in revenue was primarily due to an increase in total instrument sales of 51% or $5,459,000 from fiscal 2003 to fiscal 2004 and an increase of reagent discs and kits of 29% or $6,251,000 from fiscal 2003 to fiscal 2004. Revenues from the medical market increased by $4,082,000 from $3,037,000 in fiscal 2003 to $7,119,000 in fiscal 2004. Revenues from the veterinary market increased by $7,562,000 from $30,313,000 in fiscal 2003 to $37,875,000 in fiscal 2004. Other sales of $2,261,000 in fiscal 2004 primarily consisted of $1,061,000 related to sales of our Orbos technology. Although we sold a limited number of redesigned canine heartworm tests manufactured by S.A. Scientific in fiscal 2004, we have subsequently terminated our relationship with S.A. Scientifc.

Total revenues increased 14% from $30,631,000 in fiscal 2002 to $34,780,000 in fiscal 2003. The growth in revenue was primarily due to an increase in total instrument sales of 8% or $840,000 from fiscal 2002 to fiscal 2003 and an increase of total reagent discs and kits of 20% or $3,687,000 from fiscal 2002 to fiscal 2003. Revenues from the medical market increased by $1,451,000 from $1,586,000 in fiscal 2002 to $3,037,000 in fiscal 2003. Revenues from the veterinary market increased by $3,001,000 from $27,312,000 in fiscal 2002 to $30,313,000 in fiscal 2003. Other sales decreased $413,000 from $2,317,000 in fiscal 2002 to $1,904,000 in fiscal 2003. Other sales included a decrease of $618,000 in Orbos sales and an increase of $16,000 in sales from the VetScan Canine Heartworm Test, which we ceased selling in December 2002 as a result of an out-of-court settlement.

The increase in revenues from fiscal 2003 to fiscal 2004 is attributable to increased worldwide demand in both the medical and veterinary markets and driven by increased unit sales of our reagent discs and kits due to a higher consumption rate of users and to the expanded installed base of our Piccolo and VetScan systems. In September 2003, we completed and released the developments of the Renal Function, Hepatic Function and Comprehensive Metabolic Panels, which are key Piccolo medical panels which, together with existing panels, completes the full array of the Center for Medicare and Medicaid Services reimbursement panels. In February 2004, we received Food and Drug Administration (FDA) market clearance for our magnesium assay for use in the Piccolo blood chemistry analyzers. In fiscal 2004, 2003 and 2002, sales in the United States represented 85%, 84% and 86%, respectively, of our total revenues. In spite of the increase of total revenues in absolute dollars from prior periods, our growth rate has remained consistent in both the United States and international markets during fiscal 2004, 2003 and 2002.

Development and licensing revenue consists of 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. Our development and licensing revenue during fiscal 2004, 2003 and 2002 are based on our customers’ use of the Orbos technology. The usage by our customer is unpredictable.

Revenues by Geographical Location

Total revenues in the United States increased by 38% or $10,971,000 from fiscal 2003 to fiscal 2004 and by 10% or $2,566,000 from fiscal 2002 to fiscal 2003. The increase in the United States in fiscal 2004 was primarily due to increases of instrument sales of $5,114,000 (including an increase in U.S. military sales of $1,123,000) and reagent discs of $5,477,000 (including an increase in U.S. military sales of $637,000).

Total revenues in the United States increased by 10% or $2,566,000 from fiscal 2002 to fiscal 2003. In fiscal 2003, total United States instrument sales decreased by $29,000 offset by an increase in instrument sales to the U.S. military of $219,000. In fiscal 2003, reagent disc sales in the United States increased by $3,010,000 (including an increase in U.S. military sales of $271,000).

In the United States, two distributors, Vedco Inc. and DVM Resources accounted for 27% and 16%, respectively, of total revenues for fiscal 2004, 36% and 11%, respectively, of total revenues for fiscal 2003, and 41% and 8%, respectively, of total revenues for fiscal 2002. In April 2004, we signed a distributor agreement with the Veterinary Division of Henry Schein, Inc., a distributor of animal healthcare products and services to veterinary practitioners to sell and distribute the VetScan DXS, along with the associated reagent discs and kits.

Total revenues in Europe increased by 29% or $1,139,000 from fiscal 2003 to fiscal 2004 and by 39% or $1,086,000 from fiscal 2002 to fiscal 2003. The increase in Europe in fiscal 2004 was primarily due to increases of instrument sales of $479,000 and reagent disc sales of $666,000. The increase in Europe in fiscal 2003 was primarily due to increases of instrument sales of $289,000 and reagent disc sales of $770,000.

Total revenues in Asia and Latin America decreased by 1% or $16,000 from fiscal 2003 to fiscal 2004 and increased by 36% or $497,000 from fiscal 2002 to fiscal 2003. The slight decrease in Asia and Latin America in fiscal 2004 was primarily due to a

decrease in instrument sales of $134,000 offset by an increase in reagent disc sales of $108,000. The increase in Asia and Latin America in fiscal 2003 was primarily due to increases of instrument sales of $580,000 offset by a decrease of reagent disc sales of $93,000.

Our goal for fiscal 2005 is to continue the increase in instrument sales by allocating resources to product selling and marketing. We intend to introduce marketing programs emphasizing instrument sales. We also plan to increase our sales force and offer incentive programs to retain highly skilled sales professionals. The increase of 29% or $6,251,000 in reagent disc sales during our fiscal 2004 compared to fiscal 2003 is consistent with our belief that there will be recurring reagent disc revenue as our product lines mature. This growth is mostly attributable to the expanded installed base of Piccolo and VetScan systems and higher consumption rates of users.

Cost of Product Sales

Cost of product sales includes the costs associated with manufacturing, assembly, package, warranty repairs, test and quality assurance for our instrument analyzers and reagent discs and manufacturing overhead, including costs of personnel and equipment associated with manufacturing support. The decrease in cost of product sales as a percent of revenue from fiscal 2002 to fiscal 2003 and from fiscal 2003 to fiscal 2004 were attributable to continued increases in sales volume of reagent discs and lower unit costs resulting from improved manufacturing processes and absorption of fixed costs of our current facilities. The increase in cost of product sales in absolute dollars from fiscal 2002 to fiscal 2003 and from fiscal 2003 to fiscal 2004 were primarily attributable to an increase in instrument sales of 51% or $5,459,000 from fiscal 2003 to fiscal 2004 and 8% or $840,000 from fiscal 2002 to fiscal 2003 and an increase of reagent discs of 29% or $6,251,000 from fiscal 2003 to fiscal 2004 and 20% or $3,687,000 from fiscal 2002 to fiscal 2003.

Selling, General and Administrative Expense

Selling, general and administrative expenses consist primarily of salaries and benefits, commissions and related expenses for personnel engaged in marketing, advertising, costs associated with promotional and other marketing expenses, customer service and technical service, general corporate functions, including accounting, human resources and legal. Selling, general and administrative expenses increased 25% or $2,867,000 in fiscal 2004 from fiscal 2003 primarily due to increased expenses of $841,000 devoted to sales and marketing resources in the medical market and $1,410,000 devoted to sales and marketing resources in the veterinary market. Selling, general and administrative expenses increased 24% or $2,231,000 in fiscal 2003 from fiscal 2002 primarily due to increased expenses of $1,024,000 devoted to sales and marketing resources in the medical market and $890,000 of costs related to legal action filed by Idexx, which resulted in an out-of-court settlement in December 2002.

Selling, general and administrative activities accounted for 31%, 33% and 30% of total revenues during fiscal 2004, 2003 and 2002. We anticipate the dollar amount of selling, general and administrative expenses to increase in fiscal 2005 from fiscal 2004 but remain consistent as a percentage of total revenues due to our plan to increase our sales force and offer incentive programs to retain highly skilled sales professionals. In addition, we expect an increase in expenses due to accounting services relating to Sarbanes-Oxley compliance and an increase in premiums for our general business insurance.

Research and Development

Research and development expenses consist of salaries and benefits, related expenses associated with the development of clinical trials of new test methods and the enhancement of existing products. Research and development expenses increased by 22% or $869,000 in fiscal 2004 from fiscal 2003 primarily due to product development in the medical market. Research and development expenses increased by 1% or $54,000 in fiscal 2003 from fiscal 2002 primarily related to the completion of clinical trials and Food and Drug Administration (FDA) clearance on our Lipid Panel for use in the Piccolo diagnostic system and completion of the VetScan Comprehensive Diagnostic Profile rotor for use in the veterinary market.

Research and development activities accounted for 10%, 11% and 13% of total revenues during fiscal 2004, 2003 and 2002. We anticipate the dollar amount of research and development expenses to increase in fiscal 2005 from fiscal 2004 but remain consistent as a percentage of total revenues, as we complete new products for both the human medical and veterinary markets. There can be no assurance, however, that we will undertake such research and development activities in future periods or, if we do, that such activities will be successful.

Interest and Other, Net

The following table sets forth our interest and other income, net for fiscal 2004, 2003 and 2002:

Interest Income

Interest income was $173,000, $217,000 and $91,000 for fiscal 2004, 2003 and 2002, respectively. Interest and other income primarily consisted of interest earned on cash and cash equivalents. The decrease of 20% or $44,000, in fiscal 2004 from fiscal 2003, was primarily due to lower interest rates obtained on our cash, cash equivalents and short-term investments. The increase of $126,000 in fiscal 2003 from fiscal 2002 was primarily due to higher average invested balances.

Interest Expense and Other Income (Expense), Net

Interest and other expense for fiscal 2004, included a total of $43,000 of interest on our capital equipment loan and capital leases and $10,000 on our co-promotion agreement with Abbott Laboratories. In fiscal 2004, we recorded a net loss of $12,000 on foreign currency transactions. Interest and other expense for fiscal 2003, included a total of $107,000 of interest on our capital equipment loan and line of credit, $26,000 on our capital leases and $10,000 on our co-promotion agreement with Abbott Laboratories. Interest and other expense for fiscal 2002, included $210,000 on equipment and working capital loans and $87,000 on our building and capital leases, net of capitalized interest of $74,000 on the purchase and installation of our semi-automated disc production line. Also included in interest and other expense in fiscal 2002, was a cancellation fee of $32,000 related to the termination of our previous equipment and working capital loans when we signed our new agreements with Comerica Bank-California in March 2002. We incurred other expense of $6,000 for currency losses during fiscal 2002. These decreases in interest expense were primarily attributable to reduced balances on our equipment loan, capital leases and other outstanding debt.

Income Tax Provision (Benefit)

Income tax benefit totaled $19,208,000 in fiscal 2004, which included a one-time income tax benefit of $19,450,000 related to existing deferred tax assets (principally net operating loss carryforwards) because we concluded that it is more likely than not that these assets will be realized. Prior to the fourth quarter of fiscal 2004, these deferred tax assets had been fully reserved. The $19,450,000 income tax benefit is partially offset by a current tax provision of $242,000 related to taxes for various state tax jurisdictions and federal alternative minimum tax for fiscal 2004. For fiscal 2003 and 2002, income tax expense totaled $5,000 and $16,000, respectively, which primarily related to taxes for various state tax jurisdictions. We expect our effective tax rate will be approximately 39% for federal and various state tax jurisdictions in the near term.

Preferred Dividends and Accretion

In fiscal 2004, preferred dividends totaled $419,000. In fiscal 2003, we recorded preferred dividends and accretion related to the beneficial conversion feature of our preferred stock of $865,000 and $370,000, respectively, compared to $446,000 and $587,000, respectively, in fiscal 2002. In October 2003, under the terms of our respective Certificate of Determination with

respect to both the Series D Preferred Stock and Series E Preferred Stock, 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. Consequently, we have eliminated our obligation to pay an ongoing annual dividend to the holders of the Series D Preferred and Series E Preferred.

Liquidity and Capital Resources

As of March 31, 2004, we had $17,322,000 in cash, cash equivalents and short-term investments as compared to $10,430,000 at March 31, 2003.

Cash provided (used) in fiscal 2004, 2003 and 2002 was as follows:

Operating Activities — Net cash provided by operating activities in fiscal 2004 was $7,198,000. This was primarily the result of net income of $24,033,000 offset by the effects of non-cash expenses including depreciation and amortization of $1,708,000, common stock issued for employee benefits plan of $73,000, stock based compensation of $24,000, stock option income tax benefits of $1,902,000 and an increase in net deferred tax assets of $21,233,000. Additional cash was generated from a decrease of $355,000 in prepaid expenses, deposits and other assets, increases of $637,000 in accounts payable, $1,042,000 in accrued payroll and related expenses, $88,000 in deferred rent and $42,000 in deferred revenue. Uses of cash from operating activities included increases totaling $1,437,000 in trade receivables and in inventories and a decrease of long-term commission obligation of $36,000.

Net income in fiscal 2004 included a one-time income tax benefit of $19,450,000 related to existing deferred tax assets (principally net operating loss carryforwards) because we concluded that it is more likely than not that these assets will be realized. Prior to the fourth quarter of fiscal 2004, the net deferred tax assets had been fully reserved. The increase in trade receivable of $720,000 is primarily due to sales made in the last month of the quarter. The increase in inventory of $717,000, which mainly consists of finished reagent discs, is primarily due to higher sales forecast.

Net cash provided by operating activities in fiscal 2003 was $3,525,000. This was primarily the result of net income of $1,636,000 offset by the effects of non-cash expenses including depreciation and amortization of $1,634,000, common stock issued for employee benefits plan of $197,000 and stock based compensation of $16,000. Additional cash was generated from a decrease inventories of $600,000 and increases totaling $664,000 in accounts payable, accrued payroll and related expenses and deferred rent. The decrease in inventory was due to lower inventory levels as of March 31, 2003 resulting from better inventory management. The increase in accrued payroll and related expenses is primarily due to an increase in our headcount during fiscal 2003. Uses of cash from operating activities included increases totaling $869,000 in trade receivables, prepaid expenses, deposits and other assets and decreases totaling $314,000 in warranty reserve, other accrued liabilities, deferred revenue and long-term commission obligation.

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 diagnostic market; acquisition of capital equipment for our manufacturing facilities, which includes the ongoing costs related to continuing development of our current and future products; 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.

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 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.

Investing Activities — Net cash used in investing activities for fiscal 2004 was $10,029,000, and was primarily related to purchases of short-term investments of $7,998,000 and $1,281,000 of property and equipment and $750,000 of intellectual property relating to patents. Net cash used in investing activities for fiscal 2003 was $1,157,000, and was primarily related to $1,168,000 of purchases in property and equipment.

Our short-term investments consist of various certificate of deposits with maturities greater than three months at the balance sheet date and less than twelve months. Our short-term investment objective is to maximize yields without significantly increased risk.

We anticipate that we will continue to purchase property and equipment necessary in the normal course of our business.

Financing Activities – Net cash provided by financing activities of $1,725,000 included $2,716,000 of proceeds from the exercise of stock options and warrants, partially offset by repayments of $991,000 on our equipment loan finance and capital leases. During fiscal 2004, we paid off the outstanding balance of our equipment financing loan of $933,000.

Net cash provided by financing activities of $3,964,000 included $6,812,000 of net proceeds from the issuance of Series E preferred stock, net borrowings of $1,000,000 from our line of credit, offset by cash dividends of $457,000 and repayments on our line of credit, equipment financing loan and capital leases totaling $3,571,000.

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, coupled with the automatic conversion of all remaining outstanding Series E Preferred Stock, resulted in the conversion of 5,570 shares of Series E Preferred Stock into 856,907 shares of common stock during fiscal 2004. Elective conversions, coupled with the automatic conversion of all remaining outstanding Series D Preferred Stock, resulted in the conversion of 6,508 shares of Series D Preferred Stock into 929,699 shares of common stock during fiscal 2004. Consequently, we have eliminated our obligation to pay an ongoing annual dividend 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 March 31, 2004, 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 $410,000 if 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 March 31, 2004, there was no amount outstanding under our line of credit. The weighted average interest rate on the line of credit during 2004 and 2003 was 3.92% and 4.55%, respectively. In September 2003, our foreign line of credit expired.

We also had an equipment financing loan, which bore interest at the prime rate plus 1%, which totaled 5.00% at March 31, 2004, and is payable in monthly installments of $42,000 in principal and interest. In March 2004, we paid off the remaining outstanding balance of our equipment financing loan. Total repayments in fiscal 2004 were $933,000. At March 31, 2004, there was no amount outstanding under our equipment financing loan. At March 31, 2003, the outstanding balance on our equipment financing loan totaled $933,000. The weighted average interest rate on equipment financing loans during fiscal 2004 and 2003 was 5.00% and 5.55%, respectively.

The line of credit agreement 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 March 31, 2004, we were in compliance with these covenants.

Borrowings under the line of credit are collateralized by our net book value of assets of $54.6 million at March 31, 2004 including our intellectual property.

Critical Accounting Policies — We have identified the policies below as critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations are discussed below. For a more detailed discussion on the application of these and other accounting policies, see the Notes to Financial Statements included in this Annual Report on Form 10-K. The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates.

Revenue Recognition

Revenues from product sales, net of estimated sales allowances and rebates, are recognized upon shipment when a purchase order has been received, the sales price is fixed and determinable and collection of the resulting receivable is reasonably assured. Rights of return are not provided and provisions are made at the time the related revenue is recognized for the estimated future costs to be incurred under initial standard warranty obligations of one year. Revenues received for, or allocated to extended warranty arrangements are recognized ratably over the related warranty period. Instrument revenues under cross-distribution agreements (where we and another party purchase each other’s products for resale) are recognized upon sale of the products to the end user. Development and licensing revenue is recognized in accordance with the related contract terms.

We make estimates to adjust revenues for estimated sales allowances and rebates based on historical data and terms of current promotions, including cash rebates and trade-in programs in which we issue credit to customers as incentives for purchasing our products. Although we believe these estimates are reliable, it is possible that actual allowance or rebate amounts realized could vary from our estimates and that the amounts of such differences could affect our operating results.

Reserves and Accruals

We maintain allowances for doubtful accounts based on our assessment of the collectibility of amounts owed us by customers which is mostly determined by the customer’s payment history and the outstanding period of accounts. In addition, we provide provisions for the estimated future costs to be incurred under our standard warranty obligations of one year. Actual amounts realized could vary from our estimates and affect our operating results.

Income Taxes

As of March 31, 2004, we had net deferred tax assets of $21,233,000 primarily resulting from net operating loss carryforwards (“NOLs”), which consist of $48,468,000 of Federal NOLs that expire at various times through 2023, and $6,631,000 of state NOLs that expire at various times through 2007. At March 31, 2004, the Company eliminated the valuation allowance previously maintained against deferred tax assets to the extent that it is more likely than not that it will generate sufficient taxable income in the future to realize the deferred tax assets. We will continue to evaluate our deferred tax assets in the future to determine whether a deferred tax asset valuation allowance is required at some future point.

Contractual Obligations

As of March 31, 2004, we have the following outstanding contractual obligations:

In September 1999, we entered into a co-promotion agreement with Abbott Laboratories. The agreement was for an initial term of two years. As of September 30, 2000, the co-promotion agreement with Abbott Laboratories was terminated in accordance with its terms. While this agreement was in effect, we incurred commission obligations to Abbott Laboratories totaling $103,000 at March 31, 2004, payable over a four-year period. The present value of such obligations were recorded concurrent with the respective sales using a discount rate of 9.75%.

At March 31, 2004, there was no outstanding balance on our line of credit, which is payable upon demand.

At March 31, 2004, there was no outstanding balance on our equipment financing loan. In March 2004, we paid off the remaining outstanding balance of our equipment financing loan. Total repayments on our equipment financing loan during fiscal 2004 was $933,000.

The future minimum payments under our capital and operating leases at March 31, 2004 are as follows:

	Capital		Operating
	Leases		Leases
Fiscal Year Ending March 31,
2005	$              24,000		$            953,000
2006	17,000		975,000
2007	—		1,008,000
2008	—		1,048,000
2009	—		1,090,000
Thereafter	—		2,009,000
Total minimum lease payments	41,000		$         7,083,000
Less amounts representing interest (9.9% to 26.7%)	3,000
Present value of minimum lease payments	38,000
Less amounts due within one year	22,000
Long-term portion	$              16,000

In connection with our facility lease agreement, we have established a letter of credit for $820,000, which is secured by our line of credit. The letter of credit will be reduced to $410,000 if 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.

Purchase Commitments

In November 2003, we entered into an OEM agreement with Diatron Messtechnik GmbH (DIATRON) of Austria to purchase DIATRON hematology instruments. Under the terms of the agreement, we are commited to purchase a minimum number of hematology units from DIATRON once their product was qualified for sale. Qualification occurred in May 2004 and accordingly, we have minimum purchase commitments. The outstanding commitment for fiscal 2005 through 2009 was $2,376,000, $2,592,000, $2,592,000, $2,592,000 and $2,592,000, respectively.

In November 2001, we arrived at general terms with S.A. Scientific, Inc., of San Antonio, Texas, to purchase canine heartworm antigen tests over a period of four years. In December 2002, we reached an out-of-court settlement with one of our competitors, Idexx Laboratories, Inc., which alleged in an action filed with the United States District Court for the District Court of Maine that the canine heartworm antigen test supplied to us by S.A. Scientific infringed on two of Idexx’s patents. In light of the terms of this settlement, we do not believe, based on the general terms that we have agreed to with S.A. Scientific, that we will be obligated to purchase any of the canine heartworm antigen tests. 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.

Contingencies

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.

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.

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.

        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 attributable to common shareholders in four of the last twelve fiscal quarters ended March 31, 2004. There can be no assurance that we will experience profitability in the future. As of March 31, 2004, we have incurred cumulative net losses of $38 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:

        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 blood chemistry 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:

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

        Our core compact blood chemistry analyzer product differs substantially from current blood chemistry analyzers on the market. Our primary competition is from centralized laboratories that offer a greater number of tests than our products, but do so at 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, available line of credit and anticipated revenue from the sales of our products will be adequate to satisfy our currently planned operating and financial requirements through March 31, 2005, 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 products.

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

        To the extent that our existing resources and anticipated revenue from the sale of our products are insufficient to fund our activities or if we are unable to meet the financial 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 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 Rely On Patents And Other Proprietary Information, The Loss Of Any Of Which Would Negatively Affect Our Business

        As of June 2004, 33 patent applications have been filed on behalf of Abaxis 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

        Although we have gained experience marketing our VetScan System products for the past eight 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.

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 Piccolo and VetScan 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 Piccolo and VetScan systems may be unable to detect errors which could result in the misdiagnosis of human or veterinary 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 Piccolo and VetScan systems. Therefore, even if a mass defect within a lot or lots of reagent discs were detected by our Piccolo and VetScan 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-three 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 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 magnesium assay, 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 products. Two distributors, Vedco Inc. and DVM Resources accounted for 27% and 16%, respectively, of total revenues for fiscal 2004, 36% and 11%, respectively, of total revenues for fiscal 2003 and 41% and 8%, respectively, of total revenues for fiscal 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 distribution agreements for our VetScan products in Argentina, Australia, Austria, Bahrain, Belgium, France, Germany, Greece, Israel, Italy, Japan, Korea, Kuwait, Mexico, New Zealand, Nigeria, Norway, Poland, Portugal, South Africa, Spain, Switzerland, United Arab Emirates, the United Kingdom and Venezuela. 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 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 Oregon, 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 Corporatioin, 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 purchase the HMII instruments from DIATRON of Austria. To date, we have qualified these two suppliers to produce the reagents for the hematology instruments: Mallinckrodt Baker BV and Clinical Diagnostic Solutions, Inc.

        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.

        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:

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

        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 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 Clearance 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 21 CFR820 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 U.S. 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 and Local 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 December 2003, 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 the Quality System Regulation, 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 Potentially 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 $54,000 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.

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 Piccolo or VetScan 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 past two fiscal years, our stock price closed at a high of $22.80 on January 26, 2004 and a low of $3.00 on August 19, 2002. The following factors may affect the market price of our common stock:

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

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

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

        In addition, our board of directors has the authority to issue up to 5,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the 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 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

For our line of credit, which provides for borrowings of up to $2,000,000, the interest rate is equal to the prime rate minus 0.25%, which totaled 3.75% at March 31, 2004. 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 March 31, 2004.

For our equipment loan, the interest rate was equal to 1.00% over the prime rate. There was no outstanding balance on our equipment loan at March 31, 2004.

All of our sales are denominated in U.S. dollars, except for sales under our terminated OEM agreement to provide VetScan systems to MELET which were denominated in Euros. During fiscal 2004, our sales to MELET were 2% of our total revenues. At March 31, 2004, the net receivable from MELET was $53,000.

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 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

          Report of Independent Registered Public Accounting Firm

          Balance Sheets at March 31, 2004 and 2003

          Statements of Operations for the Years Ended March 31, 2004, 2003 and 2002

          Statements of Shareholders' Equity for the Years Ended March 31, 2004, 2003 and 2002

          Statements of Cash Flows for the Years Ended March 31, 2004, 2003 and 2002

          Notes to Financial Statements

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Abaxis, Inc.:

We have audited the accompanying balance sheets of Abaxis, Inc. (the “Company”) as of March 31, 2004 and 2003, and the related statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended March 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material respects, the financial position of the Company as of March 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended March 31, 2004 in conformity with accounting principles generally accepted in the United States of America.

/s/ DELOITTE & TOUCHE LLP
San Jose, California
June 11, 2004

ABAXIS, INC.
BALANCE SHEETS
	March 31,
ASSETS	2004		2003
Current assets:
Cash and cash equivalents	$        9,324,000		$      10,430,000
Short-term investments	7,998,000		—
Trade receivables (net of allowances of $257,000 in 2004 and $267,000 in 2003)	8,202,000		7,482,000
Inventories	5,736,000		4,982,000
Prepaid expenses	384,000		667,000
Net deferred tax asset - current	609,000		—
Total current assets	32,253,000		23,561,000
Property and equipment, net	8,191,000		8,580,000
Intangible assets, net	675,000		—
Deposits and other assets	155,000		227,000
Net deferred tax asset - non-current	20,624,000		—
Total assets	$      61,898,000		$      32,368,000
LIABILITIES, CONVERTIBLE PREFERRED STOCK  AND  SHAREHOLDERS'  EQUITY
Current liabilities:
Accounts payable	$        2,721,000		$        2,084,000
Dividends payable	28,000		408,000
Accrued payroll and related expenses	2,853,000		1,811,000
Other accrued liabilities	319,000		377,000
Warranty reserve	181,000		123,000
Deferred revenue	264,000		378,000
Current portion of capital lease obligations	22,000		58,000
Current portion of long-term debt	—		467,000
Total current liabilities	6,388,000		5,706,000
Capital lease obligations, less current portion	16,000		38,000
Long-term debt, less current portion	—		466,000
Deferred rent	409,000		321,000
Deferred revenue, less current portion	474,000		318,000
Commission obligation, less current portion	39,000		75,000
Total non-current liabilities	938,000		1,218,000
Commitments and contingencies (Note 8)
Redeemable convertible preferred stock, Series E, no par value:
issued and outstanding shares - 0 in 2004 and 5,570 in 2003,
(liquidation preference of $0 in 2004 and $5,570,000 in 2003)	—		3,176,000
Shareholders' equity:
Convertible preferred stock, Series D, no par value:  authorized shares - 5,000,000;
issued and outstanding shares - 0 in 2004 and 6,508 in 2003	—		3,143,000
Common stock, no par value: authorized shares - 35,000,000; issued and outstanding
shares - 19,520,237 in 2004 and 16,816,095 in 2003	92,441,000		80,608,000
Accumulated deficit	(37,869,000)		(61,483,000)
Total shareholders' equity	54,572,000		22,268,000
Total liabilities, convertible preferred stock and shareholders' equity	$      61,898,000		$      32,368,000
See notes to financial statements.

ABAXIS,  INC.
STATEMENTS  OF  OPERATIONS
	Year Ended March 31,
	2004		2003		2002
Product sales, net	$   46,599,000		$   34,532,000		$     30,418,000
Development and licensing revenue	275,000		248,000		213,000
Total revenues	46,874,000		34,780,000		30,631,000
Costs and operating expenses:
Cost of product sales	22,966,000		17,755,000		15,966,000
Selling, general and administrative	14,431,000		11,564,000		9,333,000
Research and development	4,757,000		3,888,000		3,834,000
Total costs and operating expenses	42,154,000		33,207,000		29,133,000
Income from operations	4,720,000		1,573,000		1,498,000
Interest and other income	173,000		217,000		91,000
Interest and other expense	(68,000)		(149,000)		(269,000)
Income before income taxes	4,825,000		1,641,000		1,320,000
Income tax provision (benefit)	(19,208,000)		5,000		16,000
Net income	24,033,000		1,636,000		1,304,000
Preferred dividends and accretion (a)	(419,000)		(1,235,000)		(1,033,000)
Net income attributable to common shareholders	$   23,614,000		$        401,000		$          271,000
Basic net income per share	$              1.30		$              0.02		$                0.02
Diluted net income per share	$              1.16		$              0.02		$                0.02
Weighted average common shares outstanding - basic	18,128,181		16,634,447		16,264,153
Weighted average common shares outstanding - diluted	20,387,167		17,014,313		16,811,326

(a)     For fiscal 2004, includes preferred dividends of $419,000. For fiscal 2003, includes preferred dividends of $865,000 and a non-cash preferred dividend charge of $370,000 related to the beneficial conversion feature contained in the Company’s Series E Preferred Stock issued in April 2002. For fiscal 2002, includes preferred dividends of $446,000 and a non-cash preferred dividend charge of $587,000 related to the beneficial conversion feature contained in the Company’s Series E Preferred Stock issued in March 2002. See Notes 10 & 11.

See notes to financial statements.

ABAXIS,  INC.
STATEMENTS  OF  SHAREHOLDERS'  EQUITY
									Deferred Stock Compensation		Accumulated Deficit		Shareholders’ Equity
	Convertible Preferred Stock				Common Stock
	Shares		Amount		Shares		Amount
Balances at April 1, 2001	6,578		$             3,213,000		16,102,451		$          74,453,000		$                  (16,000)		$        (62,155,000)		$                 15,495,000
Option exercises and related tax benefits	—		—		133,901		417,000		—		—		417,000
Amounts related to Series E convertible preferred stock issuance:
Proceeds allocated to common      stock warrants	—		—		—		645,000		—		—		645,000
Non cash issuance costs-      common stock warrants      issued to advisors	—		—		—		240,000		—		—		240,000
Beneficial conversion      feature, net of deemed      dividend and accretion	—		—		—		587,000		—		(587,000)		—
Accrued dividends on Series D convertible preferred stock	—		—		—		—		—		(446,000)		(446,000)
Conversion of Series D convertible preferred stock into common stock	(20)		(20,000)		2,857		20,000		—		—		—
Common stock issued for dividends payable					100,526		446,000		—		—		446,000
Revaluation of non-employee options and warrants granted prior to fiscal 2001	—		—		—		(3,000)		3,000		—		—
Amortization of deferred compensation	—		—		—		—		13,000		—		13,000
Compensation expense for non-employee options granted in fiscal 2001 and 2002	—		—		—		38,000		—		—		38,000
Net income	—		—		—		—		—		1,304,000		1,304,000
Balances at March 31, 2002	6,558		3,193,000		16,339,735		76,843,000		—		(61,884,000)		18,152,000
Option exercises and related tax benefits	—		—		131,642		377,000		—		—		377,000
Accrued dividends on Series D convertible preferred stock	—		—		—		—		—		(456,000)		(456,000)
Accrued dividends on Series E convertible preferred stock	—		—		—		—		—		(409,000)		(409,000)
Common stock issued for dividends payable	—		—		35,654		230,000		—		—		230,000
Adjustment on issuance cost for Series D convertible preferred stock	—		—		—		(29,000)		—		—		(29,000)
Conversion of Series D convertible preferred stock into common stock	(50)		(50,000)		7,142		50,000		—		—		—
Conversion of Series E convertible preferred stock into common stock	—		—		276,922		1,800,000		—		—		1,800,000
Amounts related to Series E convertible preferred stock issuance:
Proceeds allocated to common      stock warrants	—		—		—		590,000		—		—		590,000
Non cash issuance costs-      common stock warrants      issued to advisors	—		—		—		216,000		—		—		216,000
Common stock issued related to      issuance costs	—		—		25,000		145,000		—		—		145,000
Beneficial conversion feature,      net of deemed dividend      and accretion	—		—		—		370,000		—		(370,000)		—
Compensation expense for non-employee options	—		—		—		16,000		—		—		16,000
Net income	—		—		—		—		—		1,636,000		1,636,000
Balances at March 31, 2003	6,508		3,143,000		16,816,095		80,608,000		—		(61,483,000)		22,268,000
Option exercises and related tax benefits	—		—		281,640		3,122,000		—		—		3,122,000
Warrant exercises	—		—		497,498		1,569,000		—		—		1,569,000
Accrued dividends on Series D convertible preferred stock	—		—		—		—		—		(238,000)		(238,000)
Accrued dividends on Series E convertible preferred stock	—		—		—		—		—		(181,000)		(181,000)
Common stock issued for dividends payable	—		—		138,398		799,000		—		—		799,000
Conversion of Series D convertible preferred stock into common stock	(6,508)		(3,143,000)		929,699		3,143,000		—		—		—
Conversion of Series E convertible preferred stock into common stock	—		—		856,907		3,176,000		—		—		3,176,000
Compensation expense for non-employee options	—		—		—		24,000		—		—		24,000
Net income	—		—		—		—		—		24,033,000		24,033,000
Balances at March 31, 2004	—		$                              —		19,520,237		$           92,441,000		$                               —		$       (37,869,000)		$                54,572,000
See notes to financial statements.

 

38

ABAXIS, INC.
STATEMENTS  OF  CASH  FLOWS
	Year Ended March 31,
	2004		2003		2002
Operating activities:
Net income	$             24,033,000		$                1,636,000		$                1,304,000
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	1,708,000		1,634,000		1,717,000
(Gain) on sale of property and equipment	—		(10,000)		—
Stock option income tax benefits	1,902,000		—		—
Common stock issued for employee benefit plans	73,000		197,000		—
Stock based compensation, including amortization of
deferred stock compensation	24,000		16,000		51,000
Adjustment for issuance cost on Series D convertible preferred stock	—		(29,000)		—
Changes in assets and liabilities:
Trade receivables	(720,000)		(558,000)		636,000
Interest receivable	—		—		2,000
Inventories	(717,000)		600,000		318,000
Prepaid expenses	283,000		(191,000)		(250,000)
Net deferred tax assets	(21,233,000)		—		—
Deposits and other assets	72,000		(120,000)		313,000
Accounts payable	637,000		170,000		(1,708,000)
Accrued payroll and related expenses	1,042,000		371,000		475,000
Warranty reserve and other accrued liabilities	—		(189,000)		73,000
Deferred rent	88,000		123,000		157,000
Deferred revenue	42,000		(104,000)		36,000
Long-term commission obligation	(36,000)		(21,000)		(22,000)
Net cash provided by operating activities	7,198,000		3,525,000		3,102,000
Investing activities:
Purchase of short-term investments	(7,998,000)		—		—
Purchase of property and equipment	(1,281,000)		(1,168,000)		(873,000)
Purchase of intangible assets	(750,000)		—		—
Proceeds from sale of property and equipment	—		11,000		—
Net cash used in investing activities	(10,029,000)		(1,157,000)		(873,000)
Financing activities:
Proceeds from equipment financing	—		—		1,400,000
Repayment of equipment financing	(933,000)		(467,000)		(1,653,000)
Borrowings under line of credit	—		1,000,000		2,600,000
Repayment of line of credit	—		(3,000,000)		(2,371,000)
Repayment of capital lease obligations	(58,000)		(104,000)		(515,000)
Net cash proceeds from issuance of preferred stock, Series E	—		6,812,000		—
Exercise of common stock options	1,147,000		180,000		396,000
Exercise of common stock warrants	1,569,000		—		—
Dividends paid	—		(457,000)		—
Net cash provided by (used in) financing activities	1,725,000		3,964,000		(143,000)
Net increase (decrease) in cash and cash equivalents	(1,106,000)		6,332,000		2,086,000
Cash and cash equivalents at beginning of year	10,430,000		4,098,000		2,012,000
Cash and cash equivalents at end of year	$               9,324,000		$           10,430,000		$               4,098,000
Supplemental disclosures of cash flow information:
Cash paid for interest, net of interest capitalized	$                     58,000		$                 146,000		$                  260,000
Taxes paid	$                   211,000		$                      5,000		$                              —
Noncash financing activities —
Proceeds receivable from stock offering, net	$                              —		$                              —		$               3,446,000
Preferred stock dividends and accretion	$                  419,000		$                  778,000		$               1,033,000
Issuance of common stock for conversion of preferred stock and
payment of dividends payable	$            12,877,000		$               2,080,000		$                  466,000
Warrants and options issued for services and issuance costs	$                             —		$                  361,000		$                  240,000
Capital lease obligations incurred in connection with acquisition of fixed assets	$                             —		$                              —		$                    10,000
See notes to financial statements.

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ABAXIS, INC.