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

FORM 10-Q

       (Mark One)

OR

Commission File Number: 000-19720

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

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

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

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

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

As of November 2, 2004, there were 19,725,825 shares of the registrant’s common stock outstanding.

ABAXIS, INC.
Report on Form 10-Q
For the Quarter Ended September 30, 2004
TABLE OF CONTENTS

PART I: FINANCIAL INFORMATION

ITEM 1. CONDENSED FINANCIAL STATEMENTS

Abaxis, Inc.
Condensed Statements of Operations
(Unaudited)

See notes to condensed financial statements.

Abaxis, Inc.
Condensed Balance Sheets

See notes to condensed financial statements.

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

See notes to condensed financial statements.

ABAXIS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

1. SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The condensed unaudited financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. These condensed unaudited financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2004. The unaudited condensed financial statements included herein reflect all normal recurring adjustments, which are, in the opinion of management, necessary to state fairly the results of operations and financial position for the periods presented. Certain amounts as presented in the financial statements for the previous periods have been reclassified to conform to the fiscal year ending March 31, 2005 financial statement presentation. The results for the period ended September 30, 2004 are not necessarily indicative of the results to be expected for the entire fiscal year ending March 31, 2005 or for any future period.

Comprehensive Income — Comprehensive income was the same as net income for the three and six months ended September 30, 2004 and 2003.

Pro Forma Net Income and Net Income per Share

The Company has adopted the disclosure provisions of SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure – an amendment of FASB Statement No. 123, “Accounting for Stock-Based Compensation.” These disclosure provisions require prominent disclosures in both annual and interim financial statements of the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company did not change to using the fair value based method of accounting for stock-based employee compensation as permitted by the voluntary transition provisions of SFAS 148; and therefore, adoption of SFAS No. 148 did not have an impact on the financial position, results of operations or cash flows of the Company.

Had compensation cost been recognized based on the fair value at the date of grant, the Company’s net income and basic and diluted net income per share would have been as follows:

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

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

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” which amends FASB Statement No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements of the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company adopted the disclosure provisions of SFAS No. 148 at the beginning of fiscal 2003. On March 31, 2004, the FASB issued an exposure draft, “Share-Based Payment, an Amendment of FASB Statements No. 123 and 95.” This proposed statement would require that stock-based compensation be recognized as a cost in the financial statements and that such cost be measured based on the fair value of the stock-based compensation. If issued in final form as proposed by the FASB, adoption of this proposed statement would have a material, although non-cash, impact on the Company’s statement of operations.

In March 2004, the EITF reached a final consensus on Issue 03-01, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments,” to provide additional guidance in determining whether investment securities have an impairment which should be considered other-than-temporary. The adoption of Issue 03-01 did not have an effect on operating results or financial condition.

3. NET INCOME PER SHARE

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

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

Diluted net income per share does not include the effect of the following common equivalent shares related to outstanding options and warrants, using the treasury stock method and related to preferred shares issuable upon conversion of preferred stock, as their effect would be antidilutive for the three and six months ended September 30, 2004 and 2003:

4. INVENTORY

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

5. WARRANTY RESERVES

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

The warranty reserve activity is summarized as follows for the three- and six-month periods ended September 30, 2004 and 2003:

6. LINE OF CREDIT

The Company has established a 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 4.50% at September 30, 2004, and is payable monthly. Of the $2,000,000 available, $820,000 was committed to secure a letter of credit for the Company’s facilities lease. At September 30, 2004, there was no amount outstanding under the Company’s line of credit. The weighted average interest rate on the line of credit during the three months ended September 30, 2004 and 2003 was 4.17% and 3.94%, respectively.

The line of credit agreement contains certain financial covenants, which are evaluated on a quarterly basis. Included in these financial covenants, among other stipulations, is a requirement that the Company have a minimum net income of $25,000 before preferred stock dividends and accretion in any three quarters of a fiscal year, provided that any loss before preferred stock dividends and accretion incurred in the remaining quarter is not to exceed $250,000. The Company is also required to be profitable, as defined, on a fiscal year to date basis beginning with the six month period ending September 30, 2004 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, 2005. In addition, the Company is required to have a quick ratio, as defined, of not less than 2.00 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 September 30, 2004, the Company was in compliance with these covenants.

Borrowings under the line of credit are collateralized by the Company’s net book value of assets of $58.6 million at September 30, 2004 including its intellectual property.

7. COMMITMENTS AND CONTINGENCIES

In November 2003, the Company entered into an OEM agreement with Diatron Messtechnik GmbH (DIATRON) of Austria to purchase DIATRON hematology instruments. Under the terms of the agreement, the Company committed to purchase a minimum number of hematology units from DIATRON once the product was qualified for sale. Qualification occurred in May 2004 and accordingly, the Company has minimum purchase commitments. As of September 30, 2004, the outstanding commitment for fiscal 2005 through 2009 was $489,000, $2,671,000, $2,671,000, $2,671,000 and $2,671,000, respectively.

8. PRODUCT CATEGORY, CUSTOMER AND GEOGRAPHIC INFORMATION

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

The following is a summary of revenues by customer group:

The following is a summary of revenues by geographic region based on customer location:

Two distributors, Vedco Inc. and DVM Resources accounted for 26% and 14%, respectively, of total revenues for the three-month period ended September 30, 2004, and 30% and 15%, respectively, of total revenues for the three-month period ended September 30, 2003. Vedco Inc and DVM Resources accounted for 26% and 15%, respectively, of total revenues for the six-month period ended September 30, 2004, and 28% and 15%, respectively, of total revenues for the six-month period ended September 30, 2003.

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

9. REDEEMABLE CONVERTIBLE PREFERRED STOCK — SERIES E

Redeemable Convertible Preferred Stock — Series E — In October 2003, under the terms of the Company’s Certificate of Determination with respect to the Series E Preferred Stock (the “Series E Preferred”), the Series E convertible preferred stock automatically converted into shares of common stock after twenty consecutive trading days where the per share closing price of the Company’s common stock as reported on the Nasdaq National Market exceeded $12.00. During fiscal 2004, 5,570 shares of Series E convertible preferred stock were converted into 856,907 shares of common stock in accordance with the specified exchange ratio.

10. SHAREHOLDERS’ EQUITY

Convertible Preferred Stock — Series D — In October 2003, under the terms of the Company’s Certificate of Determination with respect to the Series D Preferred Stock (the “Series D Preferred”), the Series D convertible preferred stock automatically converted into shares of common stock after twenty consecutive trading days where the per share closing price of the Company’s common stock as reported on the Nasdaq National Market exceeded $14.00. During fiscal 2004, 6,508 shares of Series D convertible preferred stock were converted into 929,699 shares of common stock in accordance with the specified exchange ratio.

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

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

Business Overview

Abaxis, Inc. (“us” or “we”), incorporated in California in 1989, develops, manufactures and markets portable blood analysis systems for use in any veterinary or human patient-care setting to provide clinicians with rapid blood constituent measurements. Our principal offices are located at 3240 Whipple Road, Union City, California 94587 and our telephone number at that location is (510) 675-6500. 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) portable analyzer and a series of single-use plastic discs, called reagent discs, containing all the chemicals required to perform a panel of up to 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 (microliters) 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 continue to support and service our current population of VetScan HMT hematology customers.

In May 2004, we introduced a veterinary 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.

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 successfully compete with other competitors. We believe that period to period comparisons of our results of operations are not necessarily meaningful indicators of future results.

Results of Operations

Total Revenues

The following is a summary of revenues for each group of products and services provided by the Company for the three and six months ended September 30, 2004 and 2003:

Total revenues increased 18% from $11,523,000 for the three months ended September 30, 2003 to $13,635,000 for the three months ended September 30, 2004. The growth in revenue was due to increased sales of reagent discs and kits of 31% or $2,108,000 for the three months ended September 30, 2004, as compared to the three months ended September 30, 2003. The increased unit sales of reagent discs and kits sold is attributable to the increased worldwide demand in both the medical and veterinary markets and driven by a higher consumption rate of users and to the expanded installed base of our instruments.

Total revenues increased 23% from $21,849,000 for the six months ended September 30, 2003 to $26,877,000 for the six months ended September 30, 2004. The growth in revenue was partially due to a net increase of instruments sold of 14% or $1,042,000 for the six months ended September 30, 2004, as compared to the six months ended September 30, 2003. The increase in instrument sales is primarily due to improved sales productivity of our VetScan DXS systems per sales personnel in the United States market. Reagent discs and kits increased by 31% or $4,086,000 for the six months ended September 30, 2004, as compared to the six months ended September 30, 2003. The increased unit sales of reagent discs and kits sold is attributable to the increased worldwide demand in both the medical and veterinary markets and driven by a higher consumption rate of users and to the expanded installed base of our instruments.

Medical Market Results

Revenues from the medical market increased 23% or $367,000 from $1,618,000 for the three months ended September 30, 2003 to $1,985,000 for the three months ended September 30, 2004. Sales of our Piccolo systems decreased 35% or $391,000 primarily due to decreased sales to the U.S. military of 39% or $246,000 and in the United States market (excluding the U.S. military) of 43% or $168,000. We sold 60 Piccolo systems in the three months ended September 30, 2004, a 34% decrease from 91 Piccolo systems sold in the three months ended September 30, 2003. Sales of our reagent discs in the medical market increased 152% or $715,000, as we sold 110,000 reagent discs in the three months ended September 30, 2004, compared to 43,000 reagent discs sold in the three months ended September 30, 2003.

Revenues from the medical market increased 31% or $1,000,000 from $3,225,000 for the six months ended September 30, 2003 to $4,225,000 for the six months ended September 30, 2004. Sales of our Piccolo systems increased 1% or $13,000 as we sold 155 Piccolo systems in the six months ended September 30, 2004, compared to 146 Piccolo systems in the six months ended September 30, 2003. The lower average selling price on the Piccolo systems for the six months ended September 30, 2004, compared to the six months ended September 30, 2003, is due to the different selling prices of our Piccolo systems sold in various geographic locations. Sales of our reagent discs increased 89% or $1,024,000, as we sold 199,000 reagent discs in the six months ended September 30, 2004, compared to 97,000 reagent discs sold in the six months ended September 30, 2003.

Veterinary Market Results

Revenues from the veterinary market increased 20% or $1,859,000 from $9,374,000 for the three months ended September 30, 2003 to $11,233,000 for the three months ended September 30, 2004. Sales of our VetScan and hematology systems increased 14% or $430,000, mainly from improved sales productivity per sales personnel in the United States. We sold a total of 413 VetScan and hematology systems in the three months ended September 30, 2004, a 6% increase from 390 instruments sold in the three months ended September 30, 2003. Sales of reagent discs and kits increased 22% or $1,393,000, as we sold 596,000 reagent discs in the three months ended September 30, 2004, compared to 507,000 reagent discs sold in the three months ended September 30, 2003. Also, we sold 3,873 hematology reagent kits in the three months ended September 30, 2004, an increase of 42% from 2,729 hematology reagent kits sold in the three months ended September 30, 2003.

Revenues from the veterinary market increased 23% or $4,123,000 from $17,620,000 for the six months ended September 30, 2003 to $21,743,000 for the six months ended September 30, 2004. Sales of our VetScan and hematology instruments increased 19% or $1,029,000, mainly from improved sales productivity per sales personnel in the United States. We sold a total of 782 VetScan and hematology systems in the six months ended September 30, 2004, a 13% increase from 691 instruments sold in the six months ended September 30, 2003. Sales of reagent discs and kits increased 25% or $3,062,000 as we sold 1,208,000 reagent discs in the six months ended September 30, 2004, compared to 986,000 reagent discs sold in the six months ended September 30, 2003. Also, we sold 6,847 hematology reagent kits in the six months ended September 30, 2004, an increase of 37% from 4,985 hematology reagent kits sold in the six months ended September 30, 2003.

Revenues by Geographical Location

The following is a summary of revenues by geographic region based on customer location for the three and six months ended September 30, 2004 and 2003:

Total revenues in the United States increased 19% or $1,887,000 for the three months ended September 30, 2004 as compared to the three months ended September 30, 2003. Total instrument sales increased 4% or $126,000. Sales of our VetScan and hematology systems increased 23% or $540,000, primarily due to improved sales productivity of our VetScan DXS systems per sales personnel in the United States. The net increase in instrument sales was offset by a decrease of 41% or $414,000 of our Piccolo systems, primarily due to a 39% or $246,000 decrease in sales to the U.S. military. Sales of our reagent discs and hematology reagent kits increased 31% or $1,804,000, due to both a higher consumption rate of institutional users and to the expanded installed base of our instruments.

Total revenues in the United States increased 23% or $4,311,000 for the six months ended September 30, 2004 as compared to the six months ended September 30, 2003. Total instrument sales increased 17% or $1,002,000. Sales of our VetScan and hematology systems increased 28% or $1,159,000, primarily due to improved sales productivity of our VetScan DXS systems per sales personnel in the United States. The net increase in instrument sales was offset by a decrease of 8% or $157,000 of our Piccolo systems, primarily due to a 20% or $236,000 decrease in sales to the U.S. military. Sales of our reagent discs and hematology reagent kits increased 30% or $3,411,000, due to both a higher consumption rate of institutional users and to the expanded installed base of our instruments.

In the United States, two distributors, Vedco Inc. and DVM Resources accounted for 26% and 14%, respectively, of total worldwide revenues for the three months ended September 30, 2004, and 30% and 15%, respectively, of total revenues for the three months ended September 30, 2003. Vedco Inc. and DVM Resources accounted for 26% and 15%, respectively, of total worldwide revenues for the six months ended September 30, 2004, and 28% and 15%, respectively, of total revenues for the six months ended September 30, 2003.

Total revenues in Europe increased 17% or $217,000 for the three months ended September 30, 2004 as compared to the three months ended September 30, 2003. Sales of our Piccolo systems increased 71% or $48,000 due to the increasing awareness of our medical instruments. Sales of our reagent discs and hematology reagent kits increased 35% or $231,000 due to both a higher consumption rate of institutional users and to the expanded installed base of our instruments.

Total revenues in Europe increased 23% or $525,000 for the six months ended September 30, 2004 as compared to the six months ended September 30, 2003. Sales of our Piccolo systems increased 125% or $125,000 due to the increasing awareness of our medical instruments. Sales of our VetScan and hematology systems decreased 13% or $113,000, primarily due to a transition between vendors for our hematology system in the first quarter of fiscal 2005. Sales of our reagent discs and hematology reagent kits increased 41% or $513,000 due to both a higher consumption rate of institutional users and to the expanded installed base of our instruments.

Total revenues in Asia and Latin America increased 2% or $8,000 for the three months ended September 30, 2004 as compared to the three months ended September 30, 2003. Total sales of our instruments decreased 46% or $72,000 mainly due to a delay by a distributor in obtaining the required approvals for sales of Abaxis products in the respective countries. Sales of our reagent discs and hematology reagent kits increased 27% or $73,000 due to both a higher consumption rate of institutional users and to the expanded installed base of our instruments.

Total revenues in Asia and Latin America increased 28% or $192,000 for the six months ended September 30, 2004 as compared to the six months ended September 30, 2003. The increase was primarily attributable to sales of our reagent discs and hematology reagent kits, an increase of 37% or $162,000 due to both a higher consumption rate of institutional users and to the expanded installed base of our instruments.

During the third quarter of fiscal 2005, we expect to introduce marketing programs to emphasize instrument sales in both the veterinary and medical markets, as well as continue our marketing efforts of our Piccolo systems to the U.S. military. Also, we plan to increase our sales force and offer enhanced incentive programs to retain highly skilled sales professionals.

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 percentage decrease in cost of product sales as a percentage of total revenues during the three and six months ended September 30, 2004 as compared to the three and six months ended September 30, 2003 was attributable to continued increases in sales volume of reagent discs and the lower unit costs resulting from improved manufacturing processes and absorption of fixed costs of our facilities. The increase in cost of product sales in absolute dollars during the three and six months ended September 30, 2004 as compared to the three and six months ended September 30, 2003 was primarily attributable to continued increases in sales volume of both instruments and reagent discs.

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. The increase in selling, general and administrative expenses in absolute dollars during the three and six months ended September 30, 2004 as compared to the three and six months ended September 30, 2003 is mainly due to an increase in headcount in sales and marketing (including customer support) and expenses relating to Sarbanes-Oxley compliance.

Research and Development Expense

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. The increase in research and development expenses in absolute dollars during the three and six months ended September 30, 2004, as compared to the three and six months September 30, 2003 is due to new product development in both the medical and veterinary markets. 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 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 the three and six months ended September 30, 2004 and 2003:

Interest Income

Interest income primarily consists of interest earned on cash and cash equivalents. The increase of 89% or $33,000 in the three months ended September 30, 2004, as compared to the three months ended September 30, 2003 and the increase of 53% or $45,000 in the six months ended September 30, 2004, as compared to the six months ended September 30, 2003 was primarily due to higher average invested balances.

Interest Expense and Other Income (Expense), Net

Interest expense and other income (expense) primarily consists of interest incurred on our capital lease, equipment financing loan, co-promotion agreement with Abbott Laboratories and net loss on disposal of equipment. The decrease of 37% or $11,000 in the three months ended September 30, 2004, as compared to the three months ended September 30, 2003 and the decrease of 48% or $23,000 in the six months ended September 30, 2004, as compared to the six months ended September 30, 2003 was primarily due to the reduced balances on our capital lease, repayment of our equipment loan in March 2004 and a net loss on disposal of equipment.

Income Tax Provision

For the three months ended September 30, 2004 and 2003, the effective tax rate was 40% and 3%, respectively. For the six months ended September 30, 2004 and 2003, the effective tax rate was 39% and 3%, respectively. The increase in our effective tax rate is attributable to the elimination of the valuation allowance relating to our deferred tax assets in fiscal 2004. The valuation allowance was eliminated because we concluded that it was more likely than not that the deferred tax assets would be realized.

Preferred Dividends

In October 2003, under the terms of our respective Certificates of Determination with respect to both the Series D Preferred Stock and Series E Preferred Stock, all outstanding shares of 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 September 30, 2004, we had $19,987,000 in cash, cash equivalents and short-term investments as compared to $17,322,000 at March 31, 2004.

Cash provided (used) in the six months ended September 30, 2004 and 2003 was as follows:

Operating Activities – Net cash provided by operating activities for the six months ended September 30, 2004 was $3,230,000. This was primarily the result of net income of $2,775,000 offset by the effects of non-cash expenses including depreciation and amortization of $890,000, stock option income tax benefits of $422,000, an increase in current net deferred tax assets of $231,000 and a decrease in non-current net deferred tax assets of $1,426,000. Other changes included a decrease of $209,000 in prepaid expenses, deposits and other assets and increases totaling $1,109,000 in accounts payable, deferred rent, deferred revenue, warranty reserve and other accrued liabilities. Uses of cash from operating activities included increases totaling $2,854,000 in trade receivables and inventories and decreases totaling $530,000 in accrued payroll and related expenses and long-term commission obligation.

We anticipate that we will 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 facility, which includes the ongoing costs related to continuing development of our current and future products; and additional pre-clinical testing and clinical trials for our current and future products; and the design and production of our next generation blood chemistry analyzers.

We anticipate 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 at least the next twelve months. Our future capital requirements will largely depend upon the increased market acceptance of our point-of-care blood analyzer products. However, our sales for any future periods are not predictable with a significant degree of certainty. Regardless, we may seek to raise additional funds to leverage our internal expansion into the human medical market or pursue strategic acquisition opportunities.

Investing Activities – Net cash used in investing activities was $1,331,000 for the six months ended September 30, 2004, which primarily related to the purchase of $1,338,000 of property and equipment. Net cash used in investing activities for the six months ended September 30, 2003 was $540,000. The increase in property and equipment relates to purchases of equipment to support both our increasing capacity requirements and our goal of more efficient production lines and also our new product introduction.

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 $766,000 for the six months ended September 30, 2004 included $776,000 from the exercise of common stock options and warrants offset by repayments of $10,000 on our capital lease obligations. Net cash provided by financing activities of $359,000 for the six months ended September 30, 2003 included net cash proceeds of $626,000 from the exercise of common stock options and warrants offset by repayments totaling $267,000 on our equipment loan and capital lease obligations. In March 2004, we paid off the outstanding balance on our equipment financing loan.

Preferred Stock – In October 2003, under the terms of our respective Certificates 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 – We have established a 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 4.50% at September 30, 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. At September 30, 2004, there was no amount outstanding under our line of credit. The weighted average interest rate on the line of credit during the three months ended September 30, 2004 and 2003 was 4.17% and 3.94%, respectively.

The line of credit agreement contains 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, 2004 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, 2005. In addition, we are required to have a quick ratio, as defined, of not less than 2.00 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 September 30, 2004, we were in compliance with these covenants.

Borrowings under the line of credit are collateralized by our net book value of assets of $58.6 million at September 30, 2004 including our intellectual property.

Critical Accounting Policies – We have identified certain accounting policies as critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to the identified critical accounting policies on our business operations are discussed in our Annual Report on Form 10-K for the fiscal year ended March 31, 2004 filed with the Securities and Exchange Commission.

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

New Accounting Pronouncements – 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. The adoption of FIN 46-R in the first quarter of fiscal 2005 did not have an impact on our financial position, results of operations or cash flows.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” which 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 at the beginning of fiscal 2003. On

March 31, 2004, the FASB issued an exposure draft, “Share-Based Payment, an Amendment of FASB Statements No. 123 and 95.” This proposed statement would require that stock-based compensation be recognized as a cost in the financial statements and that such cost be measured based on the fair value of the stock-based compensation. If issued in final form as proposed by the FASB, our adoption of this proposed statement would have a material, although non-cash, impact on our statement of operations.

In March 2004, the EITF reached a final consensus on Issue 03-01, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments,” to provide additional guidance in determining whether investment securities have an impairment which should be considered other-than-temporary. The adoption of Issue 03-01 did not have an effect on operating results or financial condition.

RISK FACTORS THAT MAY AFFECT OUR PERFORMANCE

        Our future performance is subject to a number of risks. If any of the following risks actually occur, our business could be harmed and the trading price of our common stock could decline. You should also refer to other information contained in our annual report for the fiscal year ended March 31, 2004, as filed on Form 10-K, including the financial statements included therein and the notes related thereto.

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

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

        We recognized a net loss attributable to common shareholders in three of the last twelve fiscal quarters ended September 30, 2004. There can be no assurance that we will experience continued profitability in the future. As of September 30, 2004, we have incurred cumulative net losses of $35 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, difficult to penetrate 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 September 30, 2004, 33 patent applications have been filed on behalf of Abaxis with the United States Patent and Trademark Office, of which 28 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:

        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

        As of September 30, 2004, we have thirty-four 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 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. Since 2003, we have received 510(k) clearance from the U.S. Food and Drug Administration to begin selling tests, namely high density lipoprotein, magnesium assay and triglycerides, for the 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 26% and 14%, respectively, of total revenues for the three-month period ended September 30, 2004, and 30% and 15%, respectively, of total revenues for the three-month period ended September 30, 2003. Vedco Inc and DVM Resources accounted for 26% and 15%, respectively, of total revenues for the six-month period ended September 30, 2004, and 28% and 15%, respectively, of total revenues for the six-month period ended September 30, 2003. 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 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:

        For our hematology instruments purchased from Diatron, we are subject to minimum purchase requirements for a period of five years. 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 medical 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 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

        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 11 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.

        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 CFR 820 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 facility 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.

        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.

        Recently, the U.S. Food and Drug Administration (FDA) granted waived status under CLIA regulations for our lipids test panel when used in conjunction with our Piccolo point of care analyzer. Waived status permits 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. We cannot assure you that we will successfully receive the waived status from the FDA for our other products. 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.

        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 Sarbanes-Oxley Act of 2002, as well as changes to Nasdaq listing standards and proposed accounting changes by the Securities and Exchange Commission, we will 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.

If Requirements Relating to Accounting Treatment For Employee Stock Options Are Changed, We May Be Forced to Change Our Business Practices

        We currently account for the issuance of stock options under APB Opinion No. 25, “Accounting for Stock Issued to Employees.” If proposals currently under consideration by accounting standards organizations and governmental authorities are adopted, we may be required to treat the value of the stock options granted to employees as a compensation expense. As a result, we could decide to reduce the number of stock options granted to employees or to grant options to fewer employees. This could affect our ability to retain existing employees and attract qualified candidates, and increase the cash compensation we would have to pay to them. In addition, such a change could have a negative effect on our earnings.

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 years, our stock price closed at a high of $22.80 on January 26, 2004 and a low of $3.19 on October 2, 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 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to financial market risks with respect to interest rates on our line of credit, cash equivalent investments and short-term 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 4.50% at September 30, 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 September 30, 2004.

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

Item 4. Controls and Procedures

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

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

CEO and CFO Certifications

Attached, as Exhibits 31 and 32, are two separate forms of certifications of the CEO and the CFO. The certifications attached as Exhibits 31.1 and 31.2 are required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 (the “Section 302 Certification”). The information contained in this Item 4 relates to the Controls Evaluation referred to in the Section 302 Certifications, and should be read with the Section 302 Certifications for a more complete understanding of the topics presented.

Disclosure Controls and Internal Controls

Our management, including the CEO and CFO, has a responsibility for establishing and maintaining adequate disclosure and internal controls over our financial reporting. Disclosure Controls are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms. Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Internal Controls are procedures that are designed with the objective of providing reasonable assurance that our transactions are properly authorized, our assets are safeguarded against unauthorized or improper use, and our transactions are properly recorded and reported, all to permit the preparation of our financial statements in conformity with GAAP.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

        Not applicable.

Item 3. Defaults Upon Senior Securities

        Not applicable.

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

        Not applicable.

Item 5. Other Information

        Not applicable.

Item 6. Exhibits

(a) Exhibits included herein:

(b) Reports on Form 8-K

On July 22, 2004, we submitted a Current Report on Form 8-K to release our quarterly earnings announcement.

SIGNATURES

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

ABAXIS, INC.
(Registrant)