UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-Q





(Mark One)





x
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934





For the quarterly period ended December 31, 2010





or





o
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934





Commission File Number 000-19720





ABAXIS, INC.


(Exact name of registrant as specified in its charter)





California
77-0213001(State of Incorporation)
(I.R.S. Employer Identification No.)





3240 Whipple Road


Union City, California 94587


(Address of principal executive offices)





(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 such reports), and (2) has been subject to such filing requirements for the past 90 days.





Yes x                      No o





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes o    No o





Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):





Large accelerated filer o
Accelerated filer x
Non-accelerated filer o

(Do not check if a smaller reporting company)
Smaller reporting company o





Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).





Yes o                      No x





As of February 7, 2011, there were 22,518,000 shares of the Registrant’s common stock outstanding.







1


ABAXIS, INC.


Form 10-Q





For the Quarter Ended December 31, 2010





TABLE OF CONTENTS





PagePART I.  FINANCIAL INFORMATIONItem 1.
Condensed Consolidated Financial Statements (Unaudited):Condensed Consolidated Statements of Income for the Three and Nine Months Ended December 31, 2010 and 2009
3Condensed Consolidated Balance Sheets as of December 31, 2010 and March 31, 2010
4Condensed Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 2010 and 2009
5Notes to Condensed Consolidated Financial Statements
6Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
16Item 3.
Quantitative and Qualitative Disclosures About Market Risk
34Item 4.
Controls and Procedures
34Item 4T.
Controls and Procedures
35PART II.  OTHER INFORMATIONItem 1.
Legal Proceedings
35Item 1A.
Risk Factors
35Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
45Item 3.
Defaults Upon Senior Securities
45Item 4.
Removed and Reserved
45Item 5.
Other Information
45Item 6.
Exhibits
46SIGNATURES
47


2
 Table of Contents


PARTI.  FINANCIAL INFORMATION





Item 1.  Condensed Consolidated Financial Statements (Unaudited)





ABAXIS, INC.


CONDENSED CONSOLIDATED STATEMENTS OF INCOME


(Unaudited)


(In thousands, except share and per share data)





Three Months Ended


Nine Months EndedDecember 31,


December 31,2010


2009


2010


2009Revenues

$
35,906


$
31,005


$
106,136


$
90,892Cost of revenues


16,097



12,709



46,793



37,590Gross profit


19,809



18,296



59,343



53,302Operating expenses:Research and development


2,947



2,835



9,321



8,002Sales and marketing


8,208



7,486



25,249



21,428General and administrative


2,820



2,552



7,596



7,739Total operating expenses


13,975



12,873



42,166



37,169Income from operations


5,834



5,423



17,177



16,133Interest and other income (expense), net


46



(11
)


698



795Income before income tax provision


5,880



5,412



17,875



16,928Income tax provision


2,045



1,982



6,711



6,545Net income

$
3,835


$
3,430


$
11,164


$
10,383Net income per share:Basic net income per share

$
0.17


$
0.16


$
0.50


$
0.47Diluted net income per share

$
0.17


$
0.15


$
0.49


$
0.46Shares used in the calculation of net income per share:Weighted average common shares outstanding - basic


22,398,000



22,035,000



22,309,000



22,002,000Weighted average common shares outstanding - diluted


22,872,000



22,617,000



22,795,000



22,549,000





The accompanying notes are an integral part of these condensed consolidated financial statements.


3
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ABAXIS, INC.


CONDENSED CONSOLIDATED BALANCE SHEETS


(Unaudited)


(In thousands, except share data)





December 31,


March 31,2010


2010ASSETSCurrent assets:Cash and cash equivalents

$
43,556


$
27,857Short-term investments


31,982



32,343Receivables (net of allowances of $314 at December 31, 2010 and $446 at March 31, 2010)


25,271



23,714Inventories


19,588



19,067Prepaid expenses and other current assets


5,249



1,588Net deferred tax assets, current


2,731



3,773Total current assets


128,377



108,342Long-term investments


29,023



36,319Property and equipment, net


16,949



15,544Intangible assets, net


4,169



4,600Net deferred tax assets, non-current


2,701



2,935Other assets


112



76Total assets

$
181,331


$
167,816LIABILITIES AND SHAREHOLDERS’ EQUITYCurrent liabilities:Accounts payable

$
7,595


$
9,404Accrued payroll and related expenses


5,163



5,615Accrued taxes


250



400Other accrued liabilities


1,408



1,256Deferred revenue


955



1,157Warranty reserve


772



1,183Total current liabilities


16,143



19,015Non-current liabilities:Deferred rent


375



163Deferred revenue


1,766



1,359Warranty reserve


95



160Total non-current liabilities


2,236



1,682Commitments and contingencies (Note 8)Shareholders' equity:Preferred stock, no par value; 5,000,000 shares authorized; no shares issued and outstanding


-



-Common stock, no par value; 35,000,000 shares authorized; 22,515,000 and 22,112,000 shares issued and outstanding at December 31, 2010 and at March 31, 2010, respectively


129,719



125,050Retained earnings


33,233



22,069Total shareholders' equity


162,952



147,119Total liabilities and shareholders' equity

$
181,331


$
167,816





The accompanying notes are an integral part of these condensed consolidated financial statements.


4
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ABAXIS, INC.


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)


(In thousands)








Nine Months EndedDecember 31,2010


2009Cash flows from operating activities:Net income

$
11,164


$
10,383Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization


3,326



3,768Investment premium amortization


343



118Net loss on disposals of property and equipment


5



32Net gain on foreign exchange translation


(59
)


(60
)Share-based compensation expense


3,547



3,713Excess tax benefits from share-based awards


(1,908
)


(838
)Provision for deferred income taxes


980



1,698Changes in assets and liabilities:Receivables, net


(1,576
)


232Inventories


(1,250
)


(3,079
)Prepaid expenses and other current assets


(1,983
)


(795
)Other assets


(36
)


(52
)Accounts payable


(1,804
)


3,670Accrued payroll and related expenses


(452
)


980Accrued taxes


294



264Other accrued liabilities


152



159Deferred rent


212



(137
)Deferred revenue


205



(44
)Warranty reserve


(476
)


(679
)Net cash provided by operating activities


10,684



19,333Cash flows from investing activities:Purchases of available-for-sale investments


-



(3,030
)Purchases of held-to-maturity investments


(49,547
)


(41,212
)Proceeds from redemptions of available-for-sale investments


-



3,000Proceeds from maturities and redemptions of held-to-maturity investments


56,861



21,897Purchases of property and equipment


(3,559
)


(1,819
)Net cash provided by (used in) investing activities


3,755



(21,164
)Cash flows from financing activities:Proceeds from the exercise of stock options


1,288



455Tax withholdings related to net share settlements of restricted stock units


(2,004
)


(441
)Excess tax benefits from share-based awards


1,908



838Net cash provided by financing activities


1,192



852Effect of exchange rate changes on cash and cash equivalents


68



24Net increase (decrease) in cash and cash equivalents


15,699



(955
)Cash and cash equivalents at beginning of period


27,857



49,237Cash and cash equivalents at end of period

$
43,556


$
48,282Supplemental disclosure of cash flow information:Cash paid for income taxes, net of refunds

$
5,849


$
4,874Supplemental disclosure of non-cash flow information:Transfers of equipment between inventory and property and equipment, net

$
746


$
1,323Net change in capitalized share-based compensation

$
17


$
60Common stock withheld for employee taxes in connection with share-based compensation

$
2,004


$
441





The accompanying notes are an integral part of these condensed consolidated financial statements.


5
 Table of Contents


ABAXIS, INC.


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





NOTE 1.  DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES





Description of Business. Abaxis, Inc. (“Abaxis,” the “Company” or “we”), incorporated in California in 1989, develops, manufactures, markets and sells portable blood analysis systems for use in the human or veterinary patient-care setting to provide clinicians with rapid blood constituent measurements.





In July 2008, our sales office in Darmstadt, Germany was incorporated as Abaxis Europe GmbH to market, promote and distribute diagnostic systems for medical and veterinary uses.  Abaxis Europe GmbH, our wholly-owned subsidiary, was formed to provide customer support in a timely manner in response to the growing and increasingly diverse services needs of customers in the European market.





Principles of Consolidation.  The accompanying unaudited condensed consolidated financial statements as of and for the three and nine month periods ended December 31, 2010 include the accounts of Abaxis and our wholly-owned subsidiary, Abaxis Europe GmbH.  Intercompany transactions and balances have been eliminated in consolidation.





Basis of Presentation.  We have prepared the unaudited condensed consolidated financial statements included herein pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim periods.  The unaudited condensed consolidated financial statements included herein reflect all normal recurring adjustments, which are, in the opinion of our management, necessary to state fairly the results of operations and financial position for the periods presented.  The results for the three and nine month periods ended December 31, 2010 are not necessarily indicative of the results to be expected for the entire fiscal year ending March 31, 2011 or for any interim or future period.





These unaudited condensed consolidated financial statements should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2010.





Reclassifications.  Certain reclassifications have been made to prior periods’ financial statements to conform to the current period presentation.  These reclassifications did not result in any change in previously reported net income, total assets or shareholders’ equity.





Use of Estimates.  The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires our 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 condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  Such management estimates include allowance for doubtful accounts, fair value of investments, sales and other allowances, valuation of inventory, fair value of purchased intangible assets, useful lives of intangible assets, income taxes, valuation allowance for deferred tax assets, share-based compensation and warranty reserves.  Our management bases their estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.  Our actual results may differ materially from these estimates.





Significant Accounting Policies.The significant accounting policies used in preparation of these condensed consolidated financial statements are consistent with those disclosed in our Annual Report on Form 10-K for the year ended March 31, 2010 filed with the SEC on June 14, 2010, and have not changed significantly as of December 31, 2010.





NOTE 2.  RECENT ACCOUNTING PRONOUNCEMENTS





In October 2009, the Financial Accounting Standards Board (the “FASB”) issued amendments to the accounting standard addressing multiple-deliverable revenue arrangements.  The amendments provide guidance in addressing how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting, and how to allocate the consideration to each unit of accounting.  In an arrangement with multiple deliverables, the delivered items shall be considered a separate unit of accounting if the delivered items have value to the customer on a stand-alone basis.  Items have value on a stand-alone basis if they are sold separately by any vendor or the customer could resell the delivered items on a stand-alone basis; and if the arrangement includes a general right of return relative to the delivered items, delivery or performance of the undelivered items is considered probable and substantially in the control of the vendor.  These amendments are effective for the Company beginning on April 1, 2011.  We are currently evaluating the impact of adopting these amendments on our consolidated financial position, results of operations and cash flows.


6
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NOTE 3.  INVESTMENTS





The following table summarizes short-term and long-term investments by major security type (in thousands):





December 31,

2010


March 31,

2010Amortized Cost


Amortized CostShort-term investmentsHeld-to-maturity:Certificates of deposits

$
13,330


$
15,767Corporate bonds


12,616



10,549Municipal bonds


6,036



6,027Total short-term investments in held-to-maturity

$
31,982


$
32,343Long-term investmentsHeld-to-maturity:Certificates of deposits

$
250


$
6,562Corporate bonds


10,153



5,720Municipal bonds


5,620



3,407U.S. agency securities


13,000



20,630Total long-term investments in held-to-maturity

$
29,023


$
36,319





For our short-term and long-term investments classified as held-to-maturity as of December 31, 2010, we had unrecognized holding gain and (loss) of $133,000 and $(98,000), respectively.  The amortized cost of our investments approximates their fair value.  As of December 31, 2010 and March 31, 2010, we did not have other-than-temporary impairment in the fair value of any individual security classified as held-to-maturity and we had no unrealized gain (loss) on investments. Redemptions in accordance with the callable provisions of the U.S. agency securities during the three months ended December 31, 2010, and 2009, were $5.5 million and $1.4 million, respectively, and during the nine months ended December 31, 2010 and 2009, were $36.1 million and $1.4 million, respectively.





The contractual maturities of short-term and long-term investments as of December 31, 2010 and March 31, 2010, are as follows (in thousands):





December 31,

2010


March 31,

2010Investments

Fair Value


Fair ValueDue in less than one year

$
31,982


$
32,343Due in 1 to 4 years


29,023



36,319Total investments

$
61,005


$
68,662





NOTE 4.  FAIR VALUE MEASUREMENTS





Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (“exit price”) in an orderly transaction between market participants at the measurement date.  FASB Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures,” establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs).  The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).  The three levels of the fair value hierarchy are described below:





Level 1:  Quoted prices (unadjusted) in active markets for identical assets or liabilities.





Level 2:  Directly or indirectly observable inputs as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in markets that are not active.  Level 2 also includes assets and liabilities that are valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates and volatility factors, are corroborated by readily observable data from actively quoted markets for substantially the full term of the financial instrument.





Level 3:  Unobservable inputs that are supported by little or no market data and require the use of significant management judgment.  These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.


7
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The following table summarizes financial assets, measured at fair value on a recurring basis, by level within the fair value hierarchy as of December 31, 2010 and March 31, 2010 (in thousands):





As of December 31, 2010Quoted Prices in Active Markets for Identical Assets


Significant Other Observable Inputs


Significant Unobservable InputsLevel 1


Level 2


Level 3


TotalAssetsCash equivalents

$
3,794


$
-


$
-


$
3,794Total assets at fair value

$
3,794


$
-


$
-


$
3,794





As of March 31, 2010Quoted Prices in Active Markets for Identical Assets


Significant Other Observable Inputs


Significant Unobservable InputsLevel 1


Level 2


Level 3


TotalAssetsCash equivalents

$
4,618


$
-


$
-


$
4,618Total assets at fair value

$
4,618


$
-


$
-


$
4,618





Our Level 1 financial assets are cash equivalents, comprised of money market mutual funds, which are highly liquid instruments with original or remaining maturities of three months or less at the time of purchase that are readily convertible into cash.  The fair value of our Level 1 financial assets is based on quoted market prices of the underlying security.  As of December 31, 2010 and March 31, 2010, we did not have any Level 2 or Level 3 financial assets or liabilities measured at fair value on a recurring basis.





NOTE 5.  INVENTORIES





Inventories include material, labor and overhead, and are stated at the lower of cost (first-in, first-out method) or market.  Components of inventories were as follows (in thousands):





December 31,


March 31,2010


2010Raw materials

$
8,129


$
8,936Work-in-process


3,106



3,421Finished goods


8,353



6,710Inventories

$
19,588


$
19,067





NOTE 6.  WARRANTY RESERVES





We provide for the estimated future costs to be incurred under our standard warranty obligation on our instruments and reagent discs.





Instruments.  Our standard warranty obligation on instruments ranges from one to three years.  The estimated contractual warranty obligation is recorded when the related revenue is recognized and any additional amount is recorded when such cost is probable and can be reasonably estimated.  Cost of revenues reflects estimated warranty expense for instruments sold in the current period and any adjustments in estimated warranty expense for the installed base under our standard warranty obligation based on our quarterly evaluation of service experience.  The estimated accrual for warranty exposure is based on historical experience as to product failures, estimated product failure rates, estimated repair costs, material usage and freight incurred in repairing the instrument after failure and known design changes under the warranty plan.





During the three and nine months ended December 31, 2010, we recorded an adjustment to pre-existing warranties of $150,000 and $714,000, respectively, which reduced our warranty reserves and our cost of revenues, based on both a decrease in our historical experience as to product failures and our judgment of a decrease in estimated product failure rates of instruments.





Reagent Discs.  We record a provision for defective reagent discs when the related sale is recognized and any additional amount is recorded when such cost is probable and can be reasonably estimated.  The warranty cost includes the replacement costs and freight of a defective reagent disc.  During the three and nine months ended December 31, 2010, the provision for warranty expense related to replacement of defective reagent discs was $147,000 and $338,000, respectively.  The balance of accrued warranty reserve related to replacement of defective reagent discs at December 31, 2010 and 2009 was $401,000 and $325,000, respectively, which was classified as a current liability on the condensed consolidated balance sheets.





We evaluate our estimates for warranty reserves on an ongoing basis and believe we have the ability to reasonably estimate warranty costs.  However, unforeseeable changes in factors may impact the estimate for warranty and such changes could cause a material change in our warranty reserve accrual in the period in which the change was identified.


8
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The change in our accrued warranty reserve during the three and nine months ended December 31, 2010 and 2009 is summarized as follows (in thousands):





Three Months Ended


Nine Months EndedDecember 31,


December 31,2010


2009


2010


2009Balance at beginning of period

$
851


$
2,228


$
1,343


$
2,297Provision for warranty expense


319



198



729



599Warranty costs incurred


(153
)


(140
)


(491
)


(610
)Adjustment to pre-existing warranties


(150
)


(668
)


(714
)


(668
)Balance at end of period


867



1,618



867



1,618Non-current portion of warranty reserve


95



245



95



245Current portion of warranty reserve

$
772


$
1,373


$
772


$
1,373





NOTE 7.  LINE OF CREDIT





Through July 2010, we had a line of credit with Comerica Bank-California which provided for borrowings of up to $2.0 million.  In July 2010, we terminated our line of credit with Comerica Bank-California for which we had no outstanding balance due.  In connection with our amended facilities lease agreement in March 2010 (as more fully described in Note 8), our obligation to provide a letter of credit on our facilities of $97,000, which was secured by our line of credit, terminated in April 2010.





NOTE 8.  COMMITMENTS AND CONTINGENCIES





Facilities Lease.  In March 2010, we entered into the Fourth Amendment to Lease Agreement (the “Lease Amendment”) with Whipple Road Holdings, LLC, SFP Crossroads, LLC and Woodstock Bowers, LLC (collectively, the “Landlord”) related to our principal facilities in Union City, California.  Under the Lease Amendment, the lease term was extended from December 2010 to February 2021.  In connection with the Lease Amendment, our obligation to provide a letter of credit with Comerica Bank-California on our facilities, which was secured by our line of credit, terminated in April 2010 (see Note 7 for additional information).  Additionally, pursuant to the Lease Amendment, the Landlord agreed to lease us certain expansion premises consisting of approximately 35,239 rentable square feet in Union City, California (the “Expansion Premises”).  In May 2010, the Landlord tendered possession of the Expansion Premises to us.  The monthly base rental rate for the Expansion Premises was abated for the first three months after May 2010 and thereafter increased to $0.80 per rentable square foot of the Expansion Premises ($28,191 per month).  The base rent for the Expansion Premises increases 3% on each anniversary of March 1 during the term of the lease.  As of December 31, 2010, the aggregate lease commitment on our principal facilities is approximately $14.5 million.





Purchase Commitments.  In October 2008, we entered into an original equipment manufacturing (“OEM”) agreement with Scandinavian Micro Biodevices APS (“SMB”) of Denmark to purchase coagulation analyzers and coagulation cartridges.  In the fourth quarter of fiscal 2009, we started marketing the products and, thereafter, upon achievement of certain milestones by SMB outlined in the agreement, we would be subject to the minimum purchase commitments under the OEM agreement.  These milestones have not yet been met and we are currently purchasing coagulation analyzers and coagulation cartridges on a purchase order basis, but all such purchases will count towards the minimum purchase obligations if and when they are triggered.





In July 2010, we entered into a development and supply equipment agreement with Diatron MI PLC (“Diatron”) of Hungary to purchase Diatron hematology instruments.  Under the agreement, we committed to purchase a minimum number of hematology instruments on an annual basis during the calendar years 2010 and 2011.  At December 31, 2010, our total remaining outstanding commitment due is approximately $2.5 million.  Furthermore, at December 31, 2010, we prepaid $820,000 to Diatron for future purchases of hematology instruments and reagents, which was recorded in prepaid expenses and other currents assets on the condensed consolidated balance sheet.  The commitment amount to Diatron is based on the minimum number of hematology instruments that we are required to purchase, the cost of the instruments and the Euro exchange rate at period-end.  Since the exchange rate can fluctuate in the future, the commitment amount in absolute dollars will change accordingly.





Patent License Agreement.  Effective January 2009, we entered into a license agreement with Inverness Medical Switzerland GmbH (“Inverness”).  Under our license agreement, we licensed co-exclusively certain worldwide patent rights related to lateral flow immunoassay technology in the field of animal health diagnostics in the professional marketplace.  The license agreement provides that Inverness shall not grant any future rights to any third parties under its current lateral flow patent rights in the animal health diagnostics field in the professional marketplace.  The license agreement enables us to develop and market products under rights from Inverness to address animal health and laboratory animal research markets.


9
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In exchange for the license rights, we (i) paid an up-front license fee of $5.0 million to Inverness in January 2009, (ii) agreed to pay royalties during the term of the agreement, based solely on sales of products in a jurisdiction country covered by valid and unexpired claims in that jurisdiction under the licensed Inverness patent rights, and (iii) agreed to pay a yearly minimum license fee of between $500,000 to $1.0 million per year, which fee will be creditable against any royalties due during such calendar year.  The royalties, if any, are payable through the date of the expiration of the last valid patent licensed under the agreement that includes at least one claim in a jurisdiction covering products we sell in that jurisdiction.  The yearly minimum fees became payable starting in fiscal 2011 for so long as we desire to maintain exclusivity under the agreement.





Litigation. On June 28, 2010, we filed a patent infringement lawsuit against Cepheid with respect to Cepheid’s Methicillin-resistant Staphylococcus aureus (MRSA) product, on which Cepheid has ceased paying license royalties.  On December 17, 2010, Cepheid filed its answer and certain counterclaims seeking a finding of non-infringement, unenforceability and invalidity of the asserted patents.  We believe the counterclaims raised by Cepheid are without merit and intend to contest them vigorously.  Because of the cost involved in pursuing patent infringement cases, we believe the cost of this litigation could have a material adverse effect on Abaxis, our consolidated financial position and results of operations.  As of December 31, 2010, we had not recorded future litigation and related expenses to pursuing the patent infringement case and an estimate of such costs cannot be made at this time.





We are involved from time to time in various litigation matters in the normal course of business.  Other than as described above, we believe that the ultimate resolution of these matters will not have a material effect on our financial position or results of operations.  There can be no assurance that existing or future legal proceedings arising in the ordinary course of business or otherwise will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flows.





NOTE 9.  SHARE-BASED COMPENSATION





In accordance with ASC 718, “Compensation-Stock Compensation,” we recognize share-based compensation expense, net of an estimated forfeiture rate, over the requisite service period of the award to employees and directors.  The following table summarizes total share-based compensation expense recognized for share-based awards during the three and nine months ended December 31, 2010 and 2009, which is included in our condensed consolidated statements of income (in thousands, except per share data):





Three Months Ended


Nine Months EndedDecember 31,


December 31,2010


2009


2010


2009Cost of revenues

$
168


$
107


$
475


$
243Research and development


195



235



684



589Sales and marketing


365



335



1,139



884General and administrative


570



771



1,249



1,997Share-based compensation expense before income taxes


1,298



1,448



3,547



3,713Income tax benefit


(476
)


(473
)


(1,327
)


(1,211
)Total share-based compensation expense after income taxes

$
822


$
975


$
2,220


$
2,502Net impact of share-based compensation on:Basic net income per share

$
0.04


$
0.04


$
0.10


$
0.11Diluted net income per share

$
0.04


$
0.04


$
0.10


$
0.11





Share-based compensation has been classified in the condensed consolidated statements of income or capitalized on the condensed consolidated balance sheets in the same manner as cash compensation paid to employees.  Capitalized share-based compensation costs at December 31, 2010 and 2009 were $111,000 and $93,000, respectively, which were included in inventories on our condensed consolidated balance sheets.





Cash Flow Impact





The accounting standard with respect to share-based payment requires cash flows resulting from excess tax benefits to be classified as a part of cash flows from financing activities.  Excess tax benefits are realized tax benefits from tax deductions for exercised stock options and vested restricted stock units in excess of the deferred tax asset attributable to share-based compensation expense for such share-based awards.  Excess tax benefits are considered realized when the tax deductions reduce taxes that otherwise would be payable.  Excess tax benefits classified as a financing cash inflow for the three months ended December 31, 2010 and 2009 were $1.4 million and $487,000, respectively, and for the nine months ended December 31, 2010 and 2009 were $1.9 million and $838,000, respectively.


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Equity Compensation Plans





Our share-based compensation plans are described below.





2005 Equity Incentive Plan.Our 2005 Equity Incentive Plan (the “Equity Incentive Plan”) restated and amended our 1998 Stock Option Plan.  The Equity Incentive Plan allows for the awards of stock options, stock appreciation rights, restricted stock awards, restricted stock units, performance shares, performance units, deferred compensation awards or other share-based awards to employees, directors and consultants.  On October 27, 2010, our shareholders approved an amendment to the Equity Incentive Plan to (i) increase the aggregate number of shares of common stock reserved for issuance under the Equity Incentive Plan by 500,000 shares, (ii) clarify that we may continue to grant performance cash awards under the Equity Incentive Plan and (iii) reapprove the Internal Revenue Code Section 162(m) performance criteria and award limits of the Equity Incentive Plan to permit us to continue to grant awards to key officers that qualify as performance-based compensation under Section 162(m) of the Internal Revenue Code.  As of December 31, 2010, the Equity Incentive Plan provides for the issuance of a maximum of 5,886,000 shares, of which 638,000 shares of common stock were then available for future issuance.





Options granted to employees and directors generally expire ten years from the grant date.  Options granted to employees generally become exercisable over a period of four years based on cliff-vesting terms and continuous employment.  Options granted to non-employee directors generally become exercisable over a period of one year based on monthly vesting terms and continuous service.  See the “Stock Options” section in this Note for additional information.





Restricted stock units awarded to employees generally vest over a period of four years and the awards may also be subject to accelerated vesting upon achieving certain performance-based milestones and continuous employment during the vesting period.  Restricted stock units awarded to non-employee directors generally vest in full one year after the grant date based on continuous service.  See the “Restricted Stock Units” section in this Note for additional information.





1992 Outside Directors’ Stock Option Plan.Under our 1992 Outside Directors’ Stock Option Plan (the “Directors Plan”), options to purchase shares of common stock were automatically granted, annually, to non-employee directors.  Options under the Directors Plan were nonqualified stock options and were granted at the fair market value on the date of grant and expired ten years from the date of grant.  Options granted to non-employee directors generally become exercisable over a period of one year based on monthly vesting terms and continuous service.  The Directors Plan provided for the issuance of a maximum of 250,000 shares.  As of December 31, 2010, all outstanding options under the Directors Plan were fully vested and fully exercisable and no shares of common stock were available for future issuance because the time period for granting options expired in June 2002 in accordance with the terms of the Directors Plan.





Our current practice is to issue new shares of common stock from our authorized shares for share-based awards upon the exercise of stock options or vesting of restricted stock units.





Stock Options





Prior to April 1, 2006, we granted stock options to employees, with an exercise price equal to the closing market price of our common stock on the date of grant and with cliff-vesting terms over four years, conditional on continuous employment with the Company.  In addition, prior to April 1, 2006, we granted stock options to non-employee directors with an exercise price equal to the closing market price of our common stock on the date of grant and became exercisable over a period of one year based on monthly vesting terms, conditional on continuous service to the Company.  There were no stock options granted since the beginning of fiscal 2007 and we did not grant stock options during the three and nine months ended December 31, 2010.





We used the Black-Scholes option pricing model to determine the fair value of stock options granted prior to March 31, 2006.  The fair value of each stock option granted was estimated on the date of the grant using the Black-Scholes option pricing model, based on a multiple option valuation approach.  We have recognized compensation expense during the requisite service period of the stock option.  As of December 31, 2010, we had no unrecognized compensation expense related to stock options granted.


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Stock Option Activity





The following table summarizes information regarding options outstanding and options exercisable at December 31, 2010 and the changes during the nine-month period then ended:





Number of Shares


Weighted Average Exercise Price Per Share


Weighted Average Remaining Contractual Life (Years)


Aggregate Intrinsic Value (In thousands)Outstanding at March 31, 2010


720,000


$
9.15Granted


-



-Exercised


(242,000
)


5.31Canceled or forfeited


-



-Outstanding at December 31, 2010


478,000


$
11.10



2.47


$
7,534Vested and expected to vest at December 31, 2010


478,000


$
11.10



2.47


$
7,534Exercisable at December 31, 2010


478,000


$
11.10



2.47


$
7,534





The aggregate intrinsic value in the table above represents the pre-tax intrinsic value, based on our closing stock price as of December 31, 2010, that would have been received by the option holders had all option holders exercised their stock options as of that date.  Total intrinsic value of stock options exercised during the three months ended December 31, 2010 and 2009 was $3.9 million and $368,000, respectively, and during the nine months ended December 31, 2010 and 2009 was $5.0 million and $1.0 million, respectively.  Cash proceeds from stock options exercised during the three months ended December 31, 2010 and 2009 were $839,000 and $250,000, respectively, and during the nine months ended December 31, 2010 and 2009 were $1.3 million and $455,000, respectively.





Restricted Stock Units





We grant restricted stock unit awards to employees and directors as part of our share-based compensation program which began in fiscal 2007.  The restricted stock unit awards entitle holders to receive shares of common stock at the end of a specified period of time.  Vesting for restricted stock unit awards is based on continuous employment or service of the holder.  Upon vesting, the equivalent number of common shares are typically issued net of tax withholdings.  If the vesting conditions are not met, unvested restricted stock unit awards will be forfeited.  Generally, the restricted stock unit awards vest according to one of the following time-based vesting schedules:





·
Restricted stock unit awards to employees:  Four-year time-based vesting as follows:  five percent vesting after the first year; additional ten percent after the second year; additional 15 percent after the third year; and the remaining 70 percent after the fourth year of continuous employment with the Company.





·
Restricted stock unit awards to non-employee directors:  100 percent vesting after one year of continuous service to the Company.





Certain restricted stock unit awards granted to employees in fiscal 2007 were subject to accelerated vesting upon achieving certain performance-based milestones.  To date, none of the performance-based milestones required for acceleration, related to the fiscal 2007 grants, have been achieved.  Additionally, the Compensation Committee of our Board of Directors (the “Compensation Committee”), in its discretion, may provide in the event of a change in control for the acceleration of vesting and/or settlement of the restricted stock unit held by a participant upon such conditions and to such extent as determined by the Compensation Committee.  Our Board of Directors has adopted an executive change in control severance plan, which it may terminate or amend at any time, that provides that awards granted to executive officers will accelerate fully on a change of control.  The vesting of non-employee director awards granted under the Equity Incentive Plan automatically will also accelerate in full upon a change in control.





The fair value of restricted stock unit awards used in our expense recognition method is measured based on the number of shares granted and the closing market price of our common stock on the date of grant.  Such value is recognized as an expense over the corresponding requisite service period.  The share-based compensation expense is reduced for an estimate of the restricted stock unit awards that are expected to be forfeited.  The forfeiture estimate is based on historical data and other factors, and compensation expense is adjusted for actual results.  As of December 31, 2010, the total unrecognized compensation expense related to restricted stock unit awards granted amounted to $16.0 million, which is expected to be recognized over a weighted average service period of 2.22 years.


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Restricted Stock Unit Activity





The following table summarizes restricted stock unit activity for the nine months ended December 31, 2010:




Number of

Shares


Weighted

Average

Grant Date

Fair Value(1)Unvested at March 31, 2010


864,000


$
21.57Granted


330,000



24.43Vested(2)


(243,000
)


23.42Canceled or forfeited


(12,000
)


23.26Unvested at December 31, 2010


939,000


$
22.07


____________________________________________________________________




(1)
The weighted average grant date fair value of restricted stock units is based on the number of shares and the closing market price of our common stock on the date of grant.


(2)
The number of restricted stock units vested includes shares that we withheld on behalf of our employees to satisfy the statutory tax withholding requirements.





Total intrinsic value of restricted stock units vested during the three months ended December 31, 2010 and 2009 was $118,000 and $52,000, respectively, and during the nine months ended December 31, 2010 and 2009 was $5.9 million and $1.3 million, respectively.  The total grant date fair value of restricted stock units vested during the three months ended December 31, 2010 and 2009 was $129,000 and $63,000, respectively, and during the nine months ended December 31, 2010 and 2009 was $5.7 million and $1.8 million, respectively.





NOTE 10.  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 common shares outstanding during the period.  Diluted net income per share is computed by dividing the 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 using the treasury stock method.  Dilutive potential common shares outstanding include outstanding stock options and restricted stock units.





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





Three Months Ended


Nine Months EndedDecember 31,


December 31,2010


2009


2010


2009Numerator:Net income

$
3,835


$
3,430


$
11,164


$
10,383Denominator:Weighted average common shares outstanding - basic


22,398,000



22,035,000



22,309,000



22,002,000Weighted average effect of dilutive securities:Stock options


297,000



404,000



312,000



399,000Restricted stock units


177,000



178,000



174,000



148,000Weighted average common shares outstanding - diluted


22,872,000



22,617,000



22,795,000



22,549,000Net income per share:Basic net income per share

$
0.17


$
0.16


$
0.50


$
0.47Diluted net income per share

$
0.17


$
0.15


$
0.49


$
0.46





Stock options are excluded from the computation of diluted weighted average shares outstanding if the exercise price of the stock options is greater than the average market price of our common stock during the period because the inclusion of these stock options would be antidilutive to net income per share.  During the three and nine months ended December 31, 2010 and 2009, there were no stock options excluded from the computation of diluted weighted average shares outstanding.


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We excluded the following restricted stock units from the computation of diluted weighted average shares outstanding because the inclusion of these awards would be antidilutive to net income per share:





Three Months Ended


Nine Months EndedDecember 31,


December 31,2010


2009


2010


2009Weighted average number of shares underlying antidilutive restricted stock units


58,000



68,000



269,000



64,000





NOTE 11.  INCOME TAXES





During the three months ended December 31, 2010 and 2009, our income tax provision was $2.0 million, based on an effective tax rate of 35%, and $2.0 million, based on an effective tax rate of 37%, respectively.  During the nine months ended December 31, 2010 and 2009, our income tax provision was $6.7 million, based on an effective tax rate of 38%, and $6.5 million, based on an effective tax rate of 39%, respectively.  The decrease in the effective tax rate during the three and nine months ended December 31, 2010, as compared to the three and nine months ended December 31, 2009, was primarily due to an increase in tax benefits for federal qualified production activities and an increase in federal research and development tax credits net of an expense recognized as a result of a decrease in California deferred tax assets due to a change in tax law impacting California apportionment during the three and nine months ended December 31, 2010.





We did not have any unrecognized tax benefits as of December 31, 2010 or December 31, 2009.  During the three and nine months ended December 31, 2010 and 2009, we did not recognize any interest or penalties related to unrecognized tax benefits.





NOTE 12.  COMPREHENSIVE INCOME





The following is a summary of comprehensive income for the three and nine months ended December 31, 2010 and 2009 (in thousands):





Three Months Ended


Nine Months EndedDecember 31,


December 31,2010


2009


2010


2009Net income

$
3,835


$
3,430


$
11,164


$
10,383Other comprehensive income:Change in unrealized gain (loss) on investments, net of tax


-



3



-



-Comprehensive income

$
3,835


$
3,433


$
11,164


$
10,383





NOTE 13.  SEGMENT REPORTING INFORMATION





Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by our chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance.





We develop, manufacture, market and sell portable blood analysis systems for use in the human or veterinary patient-care setting to provide clinicians with rapid blood constituent measurements.  We identify our reportable segments as those customer groups that represent more than 10% of our combined revenue or gross profit or loss of all reported operating segments.  We manage our business on the basis of the following two reportable segments:  (i) the medical market and (ii) the veterinary market, which segments are based on the products sold by market and customer group.  Each reportable segment has similar manufacturing processes, technology and shared infrastructures.  The accounting policies for segment reporting are the same as for the Company as a whole.  We do not segregate assets by segments since our chief operating decision maker, or decision making group, do not use assets as a basis to evaluate a segment’s performance.





Medical Market





In the medical market reportable segment, we serve a worldwide customer group consisting of military installations (ships, field hospitals and mobile care units), physicians’ office practices across all specialties, urgent care, outpatient and walk-in clinics (free-standing or hospital-connected), health screening operations, home care providers (national, regional or local), nursing homes, ambulance companies, oncology treatment clinics, dialysis centers, pharmacies and hospital labs.  The products manufactured and sold in this segment primarily consist of Piccolo chemistry analyzers and medical reagent discs.





Veterinary Market





In the veterinary market reportable segment, we serve a worldwide customer group consisting of companion animal hospitals, animal clinics with mixed practices of small animals, birds and reptiles, equine and bovine practitioners, veterinary emergency clinics, veterinary referral hospitals, universities, government, pharmaceutical companies, biotechnology companies and private research laboratories.  The products manufactured and sold in this segment primarily consist of VetScan chemistry analyzers and veterinary reagent discs.  We also sell OEM supplied products in this segment consisting of VetScan hematology instruments and related reagent kits, VetScan VSpro coagulation and specialty analyzers and related consumables (launched in our fourth quarter of fiscal 2009), canine heartworm rapid tests (launched in our fourth quarter of fiscal 2009), and VetScan i-STAT analyzers (launched in our second quarter of fiscal 2010) and related VetScan i-STAT consumables (launched in our first quarter of fiscal 2010).


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The table below summarizes revenues, cost of revenues and gross profit from our two operating segments and from certain unallocated items for the three and nine months ended December 31, 2010 and 2009 (in thousands):





Three Months Ended


Nine Months EndedDecember 31,


December 31,2010


2009


2010


2009Revenues:Medical Market

$
8,126


$
5,172


$
21,421


$
17,280Veterinary Market


26,283



23,889



79,750



67,396Other(1)


1,497



1,944



4,965



6,216Total revenues


35,906



31,005



106,136



90,892Cost of revenues:Medical Market


3,721



2,020



9,927



7,374Veterinary Market


11,153



9,458



33,209



26,496Other(1)


1,223



1,231



3,657



3,720Total cost of revenues


16,097



12,709



46,793



37,590Gross profit:Medical Market


4,405



3,152



11,494



9,906Veterinary Market


15,130



14,431



46,541



40,900Other(1)


274



713



1,308



2,496Gross profit

$
19,809


$
18,296


$
59,343


$
53,302


____________________________________________________________________





(1)
Represents unallocated items, not specifically identified to any particular business segment.





NOTE 14.  REVENUES BY PRODUCT CATEGORY AND GEOGRAPHIC REGION AND SIGNIFICANT CONCENTRATIONS





Revenue Information





The following is a summary of our revenues by product category (in thousands):





Three Months Ended


Nine Months EndedDecember 31,


December 31,Revenues by Product Category

2010


2009


2010


2009Instruments(1)

$
9,289


$
8,461


$
24,256


$
21,291Consumables(2)


24,509



20,105



75,136



61,993Other products


1,753



1,569



5,558



5,015Product sales, net


35,551



30,135



104,950



88,299Development and licensing revenue


355



870



1,186



2,593Total revenues

$
35,906


$
31,005


$
106,136


$
90,892


____________________________________________________________________





(1)
Instruments include chemistry analyzers, hematology instruments, VSpro coagulation and specialty analyzers and i-STAT analyzers.


(2)
Consumables include reagent discs, hematology reagent kits, VSpro coagulation and specialty cartridges, i-STAT cartridges and canine heartworm rapid tests.





The following is a summary of revenues by geographic region based on customer location (in thousands):





Three Months Ended


Nine Months EndedDecember 31,


December 31,Revenues by Geographic Region

2010


2009


2010


2009North America

$
30,068


$
24,907


$
87,385


$
73,792Europe


4,508



4,855



14,838



13,704Asia Pacific and rest of the world


1,330



1,243



3,913



3,396Total revenues

$
35,906


$
31,005


$
106,136


$
90,892


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Significant Concentrations





Revenues from significant customers as a percentage of total revenues were as follows:





Three Months Ended


Nine Months EndedGeographical

December 31,


December 31,Distributor
Location

2010


2009


2010


2009Walco International, Inc., d/b/a DVM Resources
United States


<10
%


12
%


<10
%


11
%





During the three and nine months ended December 31, 2010, there were no distributors or direct customers that accounted for more than 10% of our total worldwide revenues.





At December 31, 2010, one distributor in the United States accounted for 14% of our total receivables balance.  At December 31, 2009, one distributor in the United States accounted for 17% of our total receivables balance.





NOTE 15.  SUBSEQUENT EVENTS





On January 26, 2011, we entered into a Master Technical Testing Services Agreement with the Kansas State University and K-State Diagnostic and Analytical Services Inc., or KDAS/VDL.  Pursuant to this agreement, KDAS/VDL, which is affiliated with Kansas State University, will perform certain diagnostic services at our request on a fee-for-services basis.  We intend to offer these diagnostic services, along with other diagnostic and laboratory services, to clients as part of the Abaxis Veterinary Reference Laboratory, or AVRL, that we are currently in the process of establishing.  The initial term of the agreement is five years and may be extended for additional periods if the parties desire to do so.  We have the right to terminate the agreement at any time on advance written notice, and Kansas State University and KDAS/VDL have a limited right to terminate the agreement under certain circumstances.





In connection with the Master Technical Testing Services Agreement, we also entered into a Master Agreement with two entities affiliated with Kansas State University, the National Institute for Strategic Technology Acquisition and Commercialization, or NISTAC, and the Kansas State University Research Foundation, or KSURF.  Pursuant to the Master Agreement, we issued to NISTAC a warrant to purchase 10,000 shares of our common stock at an exercise price of $3.00 per share, and will be obligated to issue an additional warrant to purchase 20,000 shares of our common stock with an exercise price of $3.00 per share on the date that we first receive samples from a paying customer for which the KDAS/VDL could have performed one or more of the veterinary diagnostic and laboratory testing and related services contemplated by the Master Technical Testing Services Agreement.  Each warrant vests at a rate of 20% annually from its issuance date and has a term of five years.  In addition, under the Master Agreement, we will pay royalties on AVRL sales to KSURF for ten years.  If the Master Technical Testing Services Agreement expires or is terminated early, the royalty obligations will continue for the full ten year period, but at a reduced rate.





Item2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations





FORWARD-LOOKING STATEMENTS





This Management’s Discussion and Analysis of Financial Condition and Results of Operations includes a number of forward-looking statements, which reflect our current views with respect to future events and financial performance.  In this report, the words “will,” “anticipates,” “believes,” “expects,” “intends,” “plans,” “future,” “projects,” “estimates,” “would,” “may,” “could,” “should,” “might,” and similar expressions identify forward-looking statements.  These forward-looking statements are subject to certain risks and uncertainties, including but not limited to those discussed below, in Part II, Item 1A of this report and in Part I, Item 1A of our most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”), that could cause actual results to differ materially from historical results or those anticipated.  Such risks and uncertainties include, but are not limited to, those related to losses or system failures with respect to our facilities or manufacturing operations, fluctuations in quarterly operating results, dependence on sole suppliers, the market acceptance of our products and the continuing development of our products, 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 competing in the human diagnostic market, risks related to the protection of our intellectual property or claims of infringement of intellectual property asserted by third parties, risks related to condition of the United States economy and other risks detailed under “Risk Factors” in this Quarterly Report on Form 10-Q.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.  We assume no obligation to update any forward-looking statements as circumstances change.


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BUSINESS OVERVIEW





Abaxis, Inc. (“Abaxis,” “the Company,” “us” or “we”) was incorporated in California in 1989.  Our principal offices are located at 3240 Whipple Road, Union City, California 94587.  Our telephone number is (510) 675-6500 and 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 SEC.  Our common stock trades on the NASDAQ Global Market under the symbol “ABAX.”





We develop, manufacture, market and sell portable blood analysis systems for use in the human or veterinary patient-care setting to provide clinicians with rapid blood constituent measurements.  Our primary product is a blood analysis system, consisting of a compact 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 14 tests on human patients and 13 tests on veterinary patients.  We manufacture the system in our manufacturing facility in Union City, California and we market our blood chemistry analyzers in both the medical and the veterinary markets, as described below.





·
Medical Market:  We currently market the blood analysis system in the medical market under the name Piccolo® Xpress.  Through October 2006, we marketed the blood analysis system in the medical market as the Piccolo®, now referred to as the Piccolo Classic.  We continue to support and service our current population of Piccolo Xpress and Piccolo Classic chemistry analyzers.




·
Veterinary Market:  We currently market the blood analysis system in the veterinary market under the name VetScan VS2®.  Through March 2006, we marketed the blood analysis system in the veterinary market as the VetScan®, now referred to as the VetScan Classic.  We continue to support and service our current population of VetScan VS2 and VetScan Classic chemistry analyzers.





In September 2007, we introduced a veterinary hematology instrument under the name VetScan HM5.  The VetScan HM5 offers a 22-parameter complete blood count (CBC) analysis, including a five-part differential cell counter specifically designed for veterinary applications.  In May 2004, we introduced a veterinary hematology instrument that offers an 18-parameter CBC analysis, including a three-part white blood cell differential, marketed originally as the VetScan HMII, and is now referred to as the VetScan HM2.  We currently purchase the hematology instruments from Diatron MI PLC (“Diatron”) of Budapest, Hungary.  Through April 2004, we marketed a veterinary hematology instrument under the name VetScan HMT.  We continue to support and service our current population of VetScan HM5, VetScan HM2, VetScan HMII and VetScan HMT hematology instruments.  We also market reagent kits to be used with our hematology instruments which we currently purchase from two suppliers:  Clinical Diagnostic Solutions, Inc. and Diatron.





In July 2008, our sales office in Darmstadt, Germany was incorporated as Abaxis Europe GmbH to market, promote and distribute diagnostic systems for medical and veterinary uses.  As a result, Abaxis Europe GmbH became a wholly-owned subsidiary of Abaxis.  The subsidiary was formed to provide customer support in a timely manner in response to the growing and increasingly diverse services needs of customers in the European market.





In January 2009, we introduced a veterinary coagulation and specialty analyzer under the name VetScan VSpro.  The VetScan VSpro assists in the diagnosis and evaluation of suspected bleeding disorders, toxicity/poisoning, evaluation of disseminated intravascular coagulation, hepatic disease and in monitoring therapy and the progression of disease states.  The point-of-care coagulation analyzer is offered with a combination assay (PT/aPTT test cartridge) for canine testing.  In December 2010, we introduced the VetScan VSpro Fibrinogen Test, to provide quantitative in-vitro determination of fibrinogen levels in equine platelet poor plasma from a citrated stabilized whole blood sample.  The VetScan VSpro Fibrinogen Test is designed for use with the VSpro coagulation and specialty analyzer.  We currently purchase the coagulation and specialty analyzers and related cartridges from Scandinavian Micro Biodevices APS of Farum, Denmark.





In January 2009, we introduced a canine heartworm rapid test under the name VetScan Canine Heartworm Rapid Test.  The VetScan Canine Heartworm Rapid Test is a highly sensitive and specific test for the detection of Dirofilaria immitis in canine whole blood, serum or plasma.  The lateral flow immunoassay technology in the canine heartworm rapid tests provides immediate diagnostic results.





In May 2009, we entered into an exclusive agreement with Abbott Point of Care Inc., granting us the right to sell and distribute Abbott’s i-STAT® 1 handheld instrument (i-STAT 1 analyzer) and associated consumables for blood gas, electrolyte, basic blood chemistry and immunoassay testing in the animal health care market worldwide.  Our right to sell and distribute these products was initially non-exclusive, but became exclusive in all countries of the world, except for Japan, on November 1, 2009.  Our rights in Japan remain non-exclusive for the term of the agreement.  The initial term of the agreement ends on December 31, 2014, and after this initial term, our agreement continues automatically for successive one-year periods unless terminated by either party.  We started marketing and sales activities of the i-STAT cartridges in the first quarter of fiscal 2010.  In the second quarter of fiscal 2010, we started marketing and sales activities of the i-STAT instrument.  We launched an Abaxis-branded version of the i-STAT 1 instrument as part of our VetScan line in the third quarter of fiscal 2010.


17
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Our sales for any future periods are not predictable with a significant degree of certainty, and may depend on a number of factors outside of our control, including but not limited to inventory or timing considerations by our distributors.  We generally operate with a limited order backlog because our products are typically 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.  In addition, our sales may be adversely impacted by pricing pressure from competitors.  Our ability to be consistently profitable will depend, in part, on our ability to increase the sales volumes of our Piccolo and VetScan 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.





CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS





Our condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and pursuant to the rules and regulations of the Securities and Exchange Commission.  The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period.  On an on-going basis, we evaluate our estimates and the sensitivity of these estimates to deviations in the assumptions used in making them.  We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances.  However, there can be no assurance that our actual results will not differ from these estimates.





We have identified the policies below as critical because they are not only important to understanding our financial condition and results of operations, but also because application and interpretation of these policies requires both judgment and estimates of matters that are inherently uncertain and unknown.  Accordingly, actual results may differ materially from our estimates.  The impact and any associated risks related to these policies on our business operations are discussed below.  A more detailed discussion on the application of these and other accounting policies are included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2010.





Revenue Recognition and Deferred Revenue.  Our primary customers are distributors and direct customers in both the medical and veterinary markets.  Revenues from product sales, net of estimated sales allowances and rebates, are recognized when (i) evidence of an arrangement exists, (ii) upon shipment of the products to the customer, (iii) the sales price is fixed or determinable and (iv) collection of the resulting receivable is reasonably assured.  Rights of return are not provided.





We recognize revenue associated with extended maintenance agreements ratably over the life of the contract.  Amounts collected in advance of revenue recognition are recorded as a current or non-current liability based on the time from the balance sheet date to the future date of revenue recognition.  We provide incentives in the form of free goods or extended maintenance agreements to customers in connection with the sale of our instruments.  Revenues from such sales are allocated separately to the instruments and incentives based on the relative fair value of each element.  Revenues allocated to incentives are deferred until the goods are shipped to the customer or are recognized ratably over the life of the maintenance contract.





We periodically offer trade-in programs to customers for trading in an existing instrument to purchase a new instrument and we will either provide incentives in the form of free goods or reduce the sales price of the instrument.  These incentives in the form of free goods are recorded according to the policies described above.





We periodically offer programs to customers whereby certain instruments are made available to customers for rent or on an evaluation basis.  These programs typically require customers to purchase a minimum quantity of consumables during a specified period for which we recognize revenue on the related consumables according to the policies described above.  Depending on the program offered, customers may purchase the instrument during the rental or evaluation period. Proceeds from such sale are recorded as revenue according to the policies described above.  Rental income, if any, are also recorded as revenue according to the policies described above.





Royalties are typically based on licensees’ net sales of products that utilize our technology and are recognized as earned in accordance with the contract terms when royalties from licensees can be reliably measured and collectibility is reasonably assured, such as upon the receipt of a royalty statement from the licensee.  Our royalty revenue depends on the licensees’ use of our technology, and therefore, may vary from period to period and impact our revenues during a quarter.  On June 28, 2010, we notified Cepheid that Cepheid breached its license agreement with us due to Cepheid’s discontinuation of license royalty payments.  On October 1, 2010, we informed Cepheid that the breach had not been cured, and we terminated the entire license, as to all or any Cepheid products.  As a result of the license termination, we expect that our development and licensing revenue will be adversely and materially impacted in our consolidated financial statements during the fourth quarter of our fiscal 2011, for our fiscal year ending March 31, 2011 and in the foreseeable future.


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Distributor and Customer Rebates.  We offer distributor pricing rebates and customer incentives, such as cash rebates, from time to time.  The distributor pricing rebates are offered to distributors upon meeting the sales volume requirements during a qualifying period and are recorded as a reduction to gross revenues during a qualifying period.  Cash rebates are offered to distributors or customers who purchase certain products or instruments during a promotional period and are recorded as a reduction to gross revenues.





Allowance for Doubtful Accounts.  We maintain an allowance for doubtful accounts based on our assessment of the collectibility of the amounts owed to us by our customers.  In determining the amount of the allowance, we make judgments about the creditworthiness of customers which is mostly determined by the customer’s payment history and the outstanding period of accounts.  We specifically identify amounts that we believe to be uncollectible and the allowance for doubtful accounts is adjusted accordingly.  An additional allowance is recorded based on certain percentages of our aged receivables, using historical experience to estimate the potential uncollectible and our assessment of the general financial condition of our customer base.  If our actual collections experience changes, revisions to our allowances may be required, which could adversely affect our operating income.





Fair Value Measurements.  Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (“exit price”) in an orderly transaction between market participants at the measurement date.  The Financial Accounting Standards Board (the “FASB”) Accounting Standards Codification (“ASC”) 820, “Fair Value Measurements and Disclosures,” establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs).  The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).  The three levels of the fair value hierarchy are described below:





Level 1:  Quoted prices (unadjusted) in active markets for identical assets or liabilities.  As of December 31, 2010, we used Level 1 assumptions for our cash equivalents, which are traded in an active market.  The valuations are based on quoted prices of the underlying security that are readily and regularly available in an active market, and accordingly, a significant degree of judgment is not required.





Level 2:  Directly or indirectly observable inputs as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in markets that are not active.  Level 2 also includes assets and liabilities that are valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates and volatility factors, are corroborated by readily observable data from actively quoted markets for substantially the full term of the financial instrument.  As of December 31, 2010, we did not have any Level 2 financial assets or liabilities measured at fair value on a recurring basis.





Level 3:  Unobservable inputs that are supported by little or no market data and require the use of significant management judgment.  These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.  As of December 31, 2010, we did not have any Level 3 financial assets or liabilities measured at fair value on a recurring basis.





Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measure.  Therefore, even when market assumptions are not readily available, our own assumptions are developed to reflect those that market participants would use in pricing the asset or liability at the measurement date.  At December 31, 2010, our short-term investments totaled $32.0 million and our long-term investments totaled $29.0 million, which were classified as held-to-maturity and carried at amortized cost.





Warranty Reserves.We provide for the estimated future costs to be incurred under our standard warranty obligation on our instruments.  Our standard warranty obligation on instruments ranges from one to three years.  The estimated contractual warranty obligation is recorded when the related revenue is recognized and any additional amount is recorded when such cost is probable and can be reasonably estimated.  Cost of revenues reflects estimated warranty expense for instruments sold in the current period and any adjustments in estimated warranty expense for the installed base under our standard warranty obligation based on our quarterly evaluation of service experience.  While we engage in product quality programs and processes, including monitoring and evaluating the quality of our suppliers, our estimated accrual for warranty exposure is based on our historical experience as to product failures, estimated product failure rates, estimated repair costs, material usage and freight incurred in repairing the instrument after failure and known design changes under the warranty plan.





A provision for defective reagent discs is recorded when the related sale is recognized and any additional amount is recorded when such cost is probable and can be reasonably estimated, at which time they are included in cost of revenues.  The warranty cost includes the replacement costs and freight of a defective reagent disc.


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 Table of Contents




As of December 31, 2010, our current portion of warranty reserves for instruments and reagent discs totaled $772,000 and our non-current portion of warranty reserves for instruments totaled $95,000, which reflects our estimate of warranty obligations based on the estimated product failure rates, the number of instruments in standard warranty and estimated repair and related costs of instruments, and an estimate of defective reagent discs and replacement and related costs of a defective reagent disc.





Each quarter, we reevaluate our estimate of warranty reserves, including our assumptions.  During the three and nine months ended December 31, 2010, we recorded an adjustment to pre-existing warranties of $150,000 and $714,000, respectively, which reduced our warranty reserves and our cost of revenues, based on both a decrease in our historical experience as to product failures and our judgment of a decrease in estimated product failure rates of instruments.  We began experiencing a decrease in the estimated product failure rates since we began taking steps to resolve manufacturing problems on blood chemistry analyzers primarily from fiscal 2008 related to quality control for key components that we obtain from our suppliers and to design issues of the key components required and accordingly, starting in the third quarter of fiscal 2010, we recorded adjustments to our estimated accrual for warranty exposure based on our quarterly evaluation of service experience.





We review the historical warranty cost trends and analyze the adequacy of the ending accrual balance of warranty reserves each quarter.  The determination of warranty reserves requires us to make estimates of the estimated product failure rate, expected costs to repair or replace the instruments and to replace defective reagent discs under warranty.  If actual repair or replacement costs of instruments or replacement costs of reagent discs differ significantly from our estimates, adjustments to cost of revenues may be required.  Additionally, if factors change and we revise our assumptions on the product failure rate of instruments or reagent discs, then our warranty reserves and cost of revenues could be materially impacted in the quarter of revision, as well as in following quarters.





Inventories.  We state inventories at the lower of cost or market, cost being determined using standard costs which approximate actual costs using the first-in, first-out (FIFO) method.  Inventories include material, labor and overhead.  We establish provisions for excess, obsolete and unusable inventories after evaluation of future demand and market conditions.  If future demand or actual market conditions are less favorable than those estimated by management or if a significant amount of the material were to become unusable, additional inventory write-downs may be required, which would have a negative effect on our operating income.





Valuation of Long-Lived Assets.  We evaluate the carrying value of our long-lived assets, such as property and equipment and amortized intangible assets, whenever events or changes in business circumstances or our planned use of long-lived assets indicate that the carrying amount of an asset may not be fully recoverable or their useful lives are no longer appropriate.  We look to current and future profitability, as well as current and future undiscounted cash flows, excluding financing costs, as primary indicators of recoverability.  An impairment loss would be recognized when the sum of the undiscounted future net cash flows expected to result from the use of the asset and its eventual disposal is less than the carrying amount.  If impairment is determined to exist, any related impairment loss is calculated based on fair value and long-lived assets are written down to their respective fair values.





Income Taxes.  We account for income taxes using the liability method under which deferred tax assets and liabilities are determined based on the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  Valuation allowances are established, when necessary, to reduce deferred tax assets to the amounts expected to be recovered.





We recognize and measure benefits for uncertain tax positions using a two-step approach.  The first step is to evaluate the tax position taken or expected to be taken in a tax return by determining if the weight of evidence indicates that it is more likely than not that the tax position will be sustained upon audit, including resolution of any related appeals or litigation processes.  For tax positions that are more likely than not to be sustained upon audit, the second step is to measure the tax benefit as the largest amount that is more than 50 percent likely to be realized upon settlement.  Significant judgment is required to evaluate uncertain tax positions.  At December 31, 2010 and 2009, we had no uncertain tax positions.  Our policy is to include interest and penalties related to gross unrecognized tax benefits within our provision for income taxes.  During the three and nine months ended December 31, 2010 and 2009, we did not recognize any interest or penalties related to uncertain tax positions in the condensed consolidated statements of income, and at December 31, 2010 and 2009, we had no accrued interest or penalties.





Share-Based Compensation Expense.  We recognize share-based compensation expense, net of an estimated forfeiture rate, over the requisite service period of the award to employees and directors.





There were no stock options granted since the beginning of fiscal 2007 and we did not grant stock options during the three and nine months ended December 31, 2010.  For stock options granted prior to March 31, 2006, we use the Black-Scholes option pricing model to determine the fair value.  Determining the appropriate fair value model and calculating the fair value of share-based awards requires highly subjective assumptions, including risk-free interest rate, expected stock price volatility, expected term and expected dividends.


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For restricted stock units, share-based compensation expense is based on the fair value of our stock at the grant date and recognized net of an estimated forfeiture rate, over the requisite service period of the award.  As a result, if factors change and we use different assumptions, our share-based compensation expense could be materially different in the future.





As required by fair value provisions of share-based compensation, employee share-based compensation expense recognized is calculated over the requisite service period of the awards and reduced for estimated forfeitures.  The forfeiture rate is estimated based on historical data of our share-based compensation awards that are granted and cancelled prior to vesting and upon historical experience of employee turnover.  Changes in estimated forfeiture rates and differences between estimated forfeiture rates and actual experience may result in significant, unanticipated increases or decreases in share-based compensation expense from period to period.  To the extent we revise our estimate of the forfeiture rate in the future, our share-based compensation expense could be materially impacted in the quarter of revision, as well as in following quarters.





Share-based compensation expense resulted in a material impact on our earnings per share and on our condensed consolidated financial statements for fiscal 2010 and during the three and nine months ended December 31, 2010.  The impact of share-based compensation expense on our condensed consolidated financial results is disclosed in Note 9, “Share-Based Compensation” in the Notes to Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.  We expect that share-based compensation will materially impact our consolidated financial statements in the foreseeable future.





RESULTS OF OPERATIONS





Abaxis develops, manufactures, markets and sells portable blood analysis systems for use in the human or veterinary patient-care setting to provide clinicians with rapid blood constituent measurements.  We operate in two segments:  (i) the medical market and (ii) the veterinary market.  See “Segment Results” in this section for a detailed discussion.





Total Revenues





Revenues by Geographic Region and by Product Category.Revenues by geographic region based on customer location and revenues by product category during the three and nine months ended December 31, 2010 and 2009 were as follows (in thousands, except percentages):





Three Months Ended








Nine Months EndedDecember 31,


Change


December 31,


ChangeIncrease/


Percent








Increase/


PercentRevenues by Geographic Region

2010


2009


(Decrease)


Change


2010


2009


(Decrease)


ChangeNorth America

$
30,068


$
24,907


$
5,161



21
%

$
87,385


$
73,792


$
13,593



18
%Percentage of total revenues


84
%


80
%










82
%


81
%Europe


4,508



4,855



(347
)


(7
)%


14,838



13,704



1,134



8
%Percentage of total revenues


13
%


16
%










14
%


15
%Asia Pacific and rest of the world


1,330



1,243



87



7
%


3,913



3,396



517



15
%Percentage of total revenues


3
%


4
%










4
%


4
%Total revenues

$
35,906


$
31,005


$
4,901



16
%

$
106,136


$
90,892


$
15,244



17
%Three Months Ended










Nine Months EndedDecember 31,


Change


December 31,


ChangeIncrease/


Percent










Increase/


PercentRevenues by Product Category


2010



2009


(Decrease)


Change



2010



2009


(Decrease)


ChangeInstruments(1)

$
9,289


$
8,461


$
828



10
%

$
24,256


$
21,291


$
2,965



14
%Percentage of total revenues


26
%


27
%










23
%


23
%Consumables(2)


24,509



20,105



4,404



22
%


75,136



61,993



13,143



21
%Percentage of total revenues


68
%


65
%










71
%


68
%Other products


1,753



1,569



184



12
%


5,558



5,015



543



11
%Percentage of total revenues


5
%


5
%










5
%


6
%Product sales, net


35,551



30,135



5,416



18
%


104,950



88,299



16,651



19
%Percentage of total revenues


99
%


97
%










99
%


97
%Development and licensing revenue


355



870



(515
)


(59
)%


1,186



2,593



(1,407
)


(54
)%Percentage of total revenues


1
%


3
%










1
%


3
%Total revenues

$
35,906


$
31,005


$
4,901



16
%

$
106,136


$
90,892


$
15,244



17
%


____________________________________________________________________





(1)
Instruments include chemistry analyzers, hematology instruments, VSpro coagulation and specialty analyzers and i-STAT analyzers.


(2)
Consumables include reagent discs, hematology reagent kits, VSpro coagulation and specialty cartridges, i-STAT cartridges and canine heartworm rapid tests.


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Three Months Ended December 31, 2010 Compared to Three Months Ended December 31, 2009





North America.  During the three months ended December 31, 2010, total revenues in North America increased 21%, or $5.2 million, as compared to the three months ended December 31, 2009.  The change in total revenues in North America was attributed to the following:





·
Sales of our Piccolo chemistry analyzers in North America (excluding the U.S. government) increased 59%, or $450,000, primarily due to an increase in units sold to distributors resulting from higher sales to end users during the three months ended December 31, 2010.





·
Sales of our Piccolo chemistry analyzers to the U.S. government increased $741,000, primarily due to an increase in the needs for our products during the three months ended December 31, 2010, which were not predictable.





·
Sales of our VetScan chemistry analyzers in North America decreased 16%, or $448,000, primarily due to inventory stock adjustments by distributors during the three months ended December 31, 2010 as a result of lower sales to end users due to a slow economy.





·
Medical reagent discs sales in North America (excluding the U.S. government) increased 43%, or $1.1 million, primarily due to an increase in units sold resulting from an expanded installed base of our Piccolo chemistry analyzers.





·
Medical reagent discs sales to the U.S. government increased 142%, or $474,000, primarily due to an increase in the needs for our products during the three months ended December 31, 2010, which were not predictable.





·
Veterinary reagent discs sales in North America increased 16%, or $1.5 million, primarily due to an increase in units sold resulting from an expanded installed base of our VetScan chemistry analyzers.





·
Total sales of our VetScan hematology instruments and hematology reagent kits in North America increased 31%, or $917,000, primarily attributed to (a) an increase in units of VetScan hematology instruments sold due to lower average selling prices, and (b) an increase in units of VetScan hematology reagent kits sold resulting from an expanded installed base of our VetScan hematology instruments.





·
Total sales from our original equipment manufacturer (“OEM”) supplied products in North America increased 21%, or $699,000, during the three months ended December 31, 2010, primarily due to the commencement of sales and marketing activities for our VetScan i-STAT analyzers (launched in the second quarter of fiscal 2010) and related VetScan i-STAT consumables (launched in the first quarter of fiscal 2010).





·
Total revenues from development and licensing in North America decreased 59%, or $515,000, during the three months ended December 31, 2010, primarily based on the licensees’ decreased use of our technology, which varies from period to period.  On June 28, 2010, we notified Cepheid that Cepheid breached its license agreement with us due to Cepheid’s discontinuation of license royalty payments.  On October 1, 2010, we informed Cepheid that the breach had not been cured, and we terminated the entire license, as to all or any Cepheid products.  For further information, see Note 8 of the Notes to the Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q.





Europe.  During the three months ended December 31, 2010, total revenues in Europe decreased 7%, or $347,000, as compared to the three months ended December 31, 2009.  The change in total revenues in Europe was attributed to the following:





·
Sales of our VetScan chemistry analyzers in Europe decreased 36%, or $355,000, primarily due to the timing of inventory purchases by a distributor during the three months ended December 31, 2010.





·
Medical reagent discs sales in Europe increased 23%, or $110,000, primarily due to an increase in units sold resulting from an expanded installed base of our Piccolo chemistry analyzers.





·
Veterinary reagent discs sales in Europe decreased 8%, or $194,000, primarily due to lower inventory stock needs by a distributor during the three months ended December 31, 2010, resulting from a new warehouse distribution channel setup in Germany by our subsidiary, Abaxis Europe GmbH, during fiscal 2011 to provide customer support in a more timely manner.





Significant concentration.There were no distributors or direct customers that accounted for more than 10% of our total worldwide revenues during the three months ended December 31, 2010. One distributor in the United States, DVM Resources, accounted for 12% of our total worldwide revenues during the three months ended December 31, 2009.


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Nine Months Ended December 31, 2010 Compared to Nine Months Ended December 31, 2009





North America.  During the nine months ended December 31, 2010, total revenues in North America increased 18%, or $13.6 million, as compared to the nine months ended December 31, 2009.  The change in total revenues in North America was attributed to the following:





·
Sales of our Piccolo chemistry analyzers in North America (excluding the U.S. government) increased 43%, or $977,000, primarily due to an increase in units sold to distributors resulting from higher sales to end users during the nine months ended December 31, 2010.





·
Medical reagent discs sales in North America (excluding the U.S. government) increased 18%, or $1.6 million, primarily due to an increase in units sold resulting from an expanded installed base of our Piccolo chemistry analyzers.





·
Medical reagent discs sales to the U.S. government increased 39%, or $505,000, primarily due to an increase in the needs for our products during the third quarter of fiscal 2011, which were not predictable.





·
Veterinary reagent discs sales in North America increased 9%, or $2.8 million, primarily due to an increase in units sold resulting from an expanded installed base of our VetScan chemistry analyzers and higher average selling prices during the nine months ended December 31, 2010.





·
Total sales of our VetScan hematology instruments and hematology reagent kits in North America increased 19%, or $1.6 million, primarily attributed to (a) an increase in units of VetScan hematology instruments sold due to lower average selling prices, and (b) an increase in units of VetScan hematology reagent kits sold resulting from an expanded installed base of our VetScan hematology instruments.





·
Total sales from our OEM supplied products in North America increased 106%, or $6.7 million, during the nine months ended December 31, 2010, primarily due to the commencement of sales and marketing activities for our VetScan VSpro coagulation and specialty analyzers and related consumables (launched in the fourth quarter of fiscal 2009), canine heartworm rapid tests (launched in the fourth quarter of fiscal 2009), and VetScan i-STAT analyzers (launched in the second quarter of fiscal 2010) and related VetScan i-STAT consumables (launched in the first quarter of fiscal 2010).





·
Total revenues from development and licensing in North America decreased 54%, or $1.4 million, during the nine months ended December 31, 2010, primarily based on the licensees’ decreased use of our technology, which varies from period to period.  On June 28, 2010, we notified Cepheid that Cepheid breached its license agreement with us due to Cepheid’s discontinuation of license royalty payments.  On October 1, 2010, we informed Cepheid that the breach had not been cured, and we terminated the entire license, as to all or any Cepheid products.  For further information, see Note 8 of the Notes to the Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q.





Europe.  During the nine months ended December 31, 2010, total revenues in Europe increased 8%, or $1.1 million, as compared to the nine months ended December 31, 2009.  The change in total revenues in Europe was attributed to the following:





·
Sales of our Piccolo chemistry analyzers in Europe increased 60%, or $611,000, primarily due to an increase in sales to distributors during the first and second quarters of fiscal 2011.





·
Sales of our VetScan chemistry analyzers in Europe decreased 25%, or $670,000, primarily due to lower inventory purchases by a distributor during the nine months ended December 31, 2010, resulting from a slow economy and a new warehouse distribution channel setup in Germany by our subsidiary, Abaxis Europe GmbH, during fiscal 2011 to provide customer support in a more timely manner.





·
Medical reagent discs sales in Europe increased 14%, or $224,000, primarily due to an increase in units sold resulting from an expanded installed base of our Piccolo chemistry analyzers.





·
Veterinary reagent discs sales in Europe increased 9%, or $651,000, primarily due to an increase in units sold resulting from an expanded installed base of our VetScan chemistry analyzers.





·
Total sales from our OEM supplied products in Europe increased $305,000 during the nine months ended December 31, 2010, primarily due to the commencement of sales and marketing activities for our VetScan i-STAT analyzers (launched in the second quarter of fiscal 2010) and related VetScan i-STAT consumables (launched in the first quarter of fiscal 2010).





Asia Pacific and rest of the world.  During the nine months ended December 31, 2010, total revenues in Asia Pacific and rest of the world increased 15%, or $517,000, as compared to the nine months ended December 31, 2009.  The change in total revenues in Asia Pacific and rest of the world was attributed to the following:





·
Veterinary reagent discs sales in Asia Pacific and rest of the world increased 13%, or $207,000, primarily due to an increase in units sold to distributors during the nine months ended December 31, 2010.





·
Total sales from our OEM supplied products in Asia Pacific and rest of the world increased $369,000 during the nine months ended December 31, 2010, primarily due to the commencement of sales and marketing activities for our VetScan i-STAT analyzers (launched in the second quarter of fiscal 2010) and related VetScan i-STAT consumables (launched in the first quarter of fiscal 2010).


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 Table of Contents


Significant concentration.There were no distributors or direct customers that accounted for more than 10% of our total worldwide revenues during the nine months ended December 31, 2010. One distributor in the United States, DVM Resources, accounted for 11% of our total worldwide revenues during the nine months ended December 31, 2009.





Segment Results





Three Months Ended December 31, 2010 Compared to Three Months Ended December 31, 2009





The following table presents revenues, cost of revenues, gross profit and percent of revenues by operating segments for the three months ended December 31, 2010 and 2009 (in thousands, except percentages):




Three Months EndedDecember 31,


Change2010


Percent of Revenues(1)


2009


Percent of Revenues(1)


Increase/

(Decrease)


Percent ChangeRevenues:Medical Market

$
8,126



100
%

$
5,172



100
%

$
2,954



57
%Percentage of total revenues


23
%






17
%Veterinary Market


26,283



100
%


23,889



100
%


2,394



10
%Percentage of total revenues


73
%






77
%Other(2)


1,497







1,944







(447
)


(23
)%Percentage of total revenues


4
%






6
%Total revenues


35,906







31,005







4,901



16
%Cost of revenues:Medical Market


3,721



46
%


2,020



39
%


1,701



84
%Veterinary Market


11,153



42
%


9,458



40
%


1,695



18
%Other(2)


1,223







1,231







(8
)


(1
)%Total cost of revenues


16,097







12,709







3,388



27
%Gross profit:Medical Market


4,405



54
%


3,152



61
%


1,253



40
%Veterinary Market


15,130



58
%


14,431



60
%


699



5
%Other(2)


274







713







(439
)


(62
)%Gross profit

$
19,809






$
18,296






$
1,513



8
%


____________________________________________________________________





(1)
The percentages reported are based on our revenues by operating segment.


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





Medical Market





Revenues for Medical Market Segment





During the three months ended December 31, 2010, total revenues in the medical market increased 57%, or $3.0 million, as compared to the three months ended December 31, 2009.  Components of the change were as follows:





Instruments.  Total revenues from Piccolo chemistry analyzers increased 79%, or $1.2 million, during the three months ended December 31, 2010, as compared to the three months ended December 31, 2009.  The changes were primarily attributed to (a) an increase in revenues in North America (excluding the U.S. government) of 59%, or $450,000, primarily due to an increase in units sold to distributors resulting from higher sales to end users during the three months ended December 31, 2010, and (b) an increase in Piccolo chemistry analyzers sold to the U.S. government of $741,000, primarily due to an increase in the needs for our products during the three months ended December 31, 2010, which were not predictable.





Consumables.  Total revenues from medical reagent discs increased 50%, or $1.7 million, during the three months ended December 31, 2010, as compared to the three months ended December 31, 2009.The changes were primarily attributed to (a) an increase in revenues in North America (excluding the U.S. government) of 43%, or $1.1 million, primarily due to an increase in units sold resulting from an expanded installed base of our Piccolo chemistry analyzers, (b) an increase in medical reagent discs sold to the U.S. government of 142%, or $474,000, primarily due to an increase in the needs for our products during the three months ended December 31, 2010, which were not predictable, and (c) an increase in revenues in Europe of 23%, or $110,000, primarily due to an increase in units sold resulting from an expanded installed base of our Piccolo chemistry analyzers.


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 Table of Contents




Gross Profit for Medical Market Segment





Gross profit for the medical market segment increased 40%, or $1.3 million, during the three months ended December 31, 2010, as compared to the three months ended December 31, 2009.  Gross profit percentages for the medical market segment during the three months ended December 31, 2010 and 2009 were 54% and 61%, respectively.  In absolute dollars, the increase in gross profit for the medical market segment was primarily due to an increase in units of Piccolo chemistry analyzers and medical reagent discs sold during the three months ended December 31, 2010.  The increase in gross profit was partially offset by higher manufacturing costs on medical reagent discs during the three months ended December 31, 2010.  As a percentage, the decrease in gross profit was primarily due to an adjustment to pre-existing warranties during the three months ended December 31, 2009.





Veterinary Market





Revenues for Veterinary Market Segment





During the three months ended December 31, 2010, total revenues in the veterinary market increased 10%, or $2.4 million, as compared to the three months ended December 31, 2009.  Total revenues from veterinary instruments decreased 5%, or $327,000, during the three months ended December 31, 2010, as compared to the three months ended December 31, 2009.  Total revenues from consumables in the veterinary market increased 16%, or $2.7 million, during the three months ended December 31, 2010, as compared to the three months ended December 31, 2009.  Components of the change were as follows:





·
Sales of our VetScan chemistry analyzers decreased 23%, or $941,000, during the three months ended December 31, 2010, as compared to the three months ended December 31, 2009.  The decrease in revenues was primarily attributed to (a) a decrease in revenues in North America of 16%, or $448,000, primarily due to inventory stock adjustments by distributors during the three months ended December 31, 2010 as a result of lower sales to end users due to a slow economy, and (b) a decrease in revenues in Europe of 36%, or $355,000, primarily due to the timing of inventory purchases by a distributor during the three months ended December 31, 2010.





·
Total revenues from veterinary reagent discs increased 12%, or $1.5 million, during the three months ended December 31, 2010, as compared to the three months ended December 31, 2009.  The increase in revenues was primarily attributed to an increase in revenues in North America of 16%, or $1.5 million, primarily due to an increase in units sold resulting from an expanded installed base of our VetScan chemistry analyzers, partially offset by a decrease in revenues in Europe of 8%, or $194,000, primarily due to lower inventory stock needs by a distributor during the three months ended December 31, 2010, resulting from a new warehouse distribution channel setup in Germany by our subsidiary, Abaxis Europe GmbH, during fiscal 2011 to provide customer support in a more timely manner.





·
Total sales of our VetScan hematology instruments and hematology reagent kits increased 29%, or $968,000, during the three months ended December 31, 2010, as compared to the three months ended December 31, 2009.  The increase in revenues was primarily attributed to an increase in revenues in North America of 31%, or $917,000, due to (a) an increase in units of VetScan hematology instruments sold due to lower average selling prices, and (b) an increase in units of VetScan hematology reagent kits sold resulting from an expanded installed base of our VetScan hematology instruments.





·
Total sales from our OEM supplied products increased 25%, or $841,000, during the three months ended December 31, 2010, primarily in North America due to the commencement of sales and marketing activities for our VetScan i-STAT analyzers (launched in the second quarter of fiscal 2010) and related VetScan i-STAT consumables (launched in the first quarter of fiscal 2010).





Gross Profit for Veterinary Market Segment





Gross profit for the veterinary market segment increased 5%, or $699,000, during the three months ended December 31, 2010, as compared to the three months ended December 31, 2009.  Gross profit percentages for the veterinary market segment during the three months ended December 31, 2010 and 2009 were 58% and 60%, respectively.  In absolute dollars, the increase in gross profit for the veterinary market segment was primarily due to an increase in units of veterinary reagent discs and hematology reagent kits sold during the three months ended December 31, 2010.  The increase in gross profit was partially offset by (a) a decrease in units of VetScan chemistry analyzers sold during the three months ended December 31, 2010, and (b) higher manufacturing costs on veterinary reagent discs during the three months ended December 31, 2010.  As a percentage, the decrease in gross profit was primarily due to higher relative sales of VetScan i-STAT analyzers and related consumables, which have a lower gross margin contribution.


25
 Table of Contents




Nine Months Ended December 31, 2010 Compared to Nine Months Ended December 31, 2009





The following table presents revenues, cost of revenues, gross profit and percent of revenues by operating segments for the nine months ended December 31, 2010 and 2009 (in thousands, except percentages):





Nine Months EndedDecember 31,


Change2010


Percent of Revenues(1)


2009


Percent of Revenues(1)


Increase/

(Decrease)


Percent ChangeRevenues:Medical Market

$
21,421



100
%

$
17,280



100
%

$
4,141



24
%Percentage of total revenues


20
%






19
%Veterinary Market


79,750



100
%


67,396



100
%


12,354



18
%Percentage of total revenues


75
%






74
%Other(2)


4,965







6,216







(1,251
)


(20
)%Percentage of total revenues


5
%






7
%Total revenues


106,136







90,892







15,244



17
%Cost of revenues:Medical Market


9,927



46
%


7,374



43
%


2,553



35
%Veterinary Market


33,209



42
%


26,496



39
%


6,713



25
%Other(2)


3,657







3,720







(63
)


(2
)%Total cost of revenues


46,793







37,590







9,203



24
%Gross profit:Medical Market


11,494



54
%


9,906



57
%


1,588



16
%Veterinary Market


46,541



58
%


40,900



61
%


5,641



14
%Other(2)


1,308







2,496







(1,188
)


(48
)%Gross profit

$
59,343






$
53,302






$
6,041



11
%


____________________________________________________________________





(1)
The percentages reported are based on our revenues by operating segment.


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





Medical Market





Revenues for Medical Market Segment





During the nine months ended December 31, 2010, total revenues in the medical market increased 24%, or $4.1 million, as compared to the nine months ended December 31, 2009.  Components of the change were as follows:





Instruments.  Total revenues from Piccolo chemistry analyzers increased 35%, or $1.7 million, during the nine months ended December 31, 2010, as compared to the nine months ended December 31, 2009.  The changes were primarily attributed to (a) an increase in revenues in North America (excluding the U.S. government) of 43%, or $977,000, primarily due to an increase in units sold to distributors resulting from higher sales to end users during the nine months ended December 31, 2010, and (b) an increase in revenues in Europe of 60%, or $611,000, primarily due to an increase in sales to distributors during the first and second quarters of fiscal 2011.





Consumables.  Total revenues from medical reagent discs increased 19%, or $2.3 million, during the nine months ended December 31, 2010, as compared to the nine months ended December 31, 2009.  The increase in revenues from medical reagent discs was primarily attributed to (a) an increase in revenues in North America (excluding the U.S. government) of 18%, or $1.6 million, primarily due to an increase in units sold resulting from an expanded installed base of our Piccolo chemistry analyzers, (b) an increase in medical reagent discs sold to the U.S. government of 39%, or $505,000, primarily due to an increase in the needs for our products during the third quarter of fiscal 2011, which were not predictable, and (c) an increase in revenues in Europe of 14%, or $224,000, primarily due to an increase in units sold resulting from an expanded installed base of our Piccolo chemistry analyzers.





Gross Profit for Medical Market Segment





Gross profit for the medical market segment increased 16%, or $1.6 million, during the nine months ended December 31, 2010, as compared to the nine months ended December 31, 2009.  Gross profit percentages for the medical market segment during the nine months ended December 31, 2010 and 2009 were 54% and 57%, respectively.  In absolute dollars, the increase in gross profit for the medical market segment was primarily due to an increase in units of Piccolo chemistry analyzers and medical reagent discs sold during the nine months ended December 31, 2010.


26
 Table of Contents




Veterinary Market





Revenues for Veterinary Market Segment





During the nine months ended December 31, 2010, total revenues in the veterinary market increased 18%, or $12.4 million, as compared to the nine months ended December 31, 2009.  Total revenues from veterinary instruments increased 8%, or $1.3 million, during the nine months ended December 31, 2010, as compared to the nine months ended December 31, 2009.  Total revenues from consumables in the veterinary market increased 22%, or $10.8 million, during the nine months ended December 31, 2010, as compared to the nine months ended December 31, 2009.  Components of the change were as follows:





·
Sales of our VetScan chemistry analyzers decreased 7%, or $655,000, during the nine months ended December 31, 2010, as compared to the nine months ended December 31, 2009.  The decrease in revenues was primarily attributed to a decrease in revenues in Europe of 25%, or $670,000, primarily due to lower inventory purchases by a distributor during the nine months ended December 31, 2010, resulting from a slow economy and a new warehouse distribution channel setup in Germany by our subsidiary, Abaxis Europe GmbH, during fiscal 2011 to provide customer support in a more timely manner.





·
Total revenues from veterinary reagent discs increased 9%, or $3.7 million, during the nine months ended December 31, 2010, as compared to the nine months ended December 31, 2009.  The increase in revenues was primarily attributed to (a) an increase in revenues in North America of 9%, or $2.8 million, primarily due to an increase in units sold resulting from an expanded installed base of our VetScan chemistry analyzers and higher average selling prices during the nine months ended December 31, 2010, (b) an increase in revenues in Europe of 9%, or $651,000, primarily due to an increase in units sold resulting from an expanded installed base of our VetScan chemistry analyzers, and (c) an increase in revenues in Asia Pacific and rest of the world of 13%, or $207,000, primarily due to an increase in units sold to distributors during the nine months ended December 31, 2010.





·
Total sales of our VetScan hematology instruments and hematology reagent kits increased 18%, or $1.8 million, during the nine months ended December 31, 2010, as compared to the nine months ended December 31, 2009.  The increase in revenues was primarily attributed to an increase in revenues in North America of 19%, or $1.6 million, due to (a) an increase in units of VetScan hematology instruments sold due to lower average selling prices, and (b) an increase in units of VetScan hematology reagent kits sold resulting from an expanded installed base of our VetScan hematology instruments.





·
Total sales from our OEM supplied products increased 114%, or $7.3 million, during the nine months ended December 31, 2010, primarily in North America due to the commencement of sales and marketing activities for our VetScan VSpro coagulation and specialty analyzers and related consumables (launched in the fourth quarter of fiscal 2009), canine heartworm rapid tests (launched in the fourth quarter of fiscal 2009), and VetScan i-STAT analyzers (launched in the second quarter of fiscal 2010) and related VetScan i-STAT consumables (launched in the first quarter of fiscal 2010).





Gross Profit for Veterinary Market Segment





Gross profit for the veterinary market segment increased 14%, or $5.6 million, during the nine months ended December 31, 2010, as compared to the nine months ended December 31, 2009.  Gross profit percentages for the veterinary market segment during the nine months ended December 31, 2010 and 2009 were 58% and 61%, respectively.  In absolute dollars, the increase in gross profit for the veterinary market segment was primarily due to (a) an increase in units of veterinary reagent discs sold and higher average selling prices of veterinary reagent discs during the nine months ended December 31, 2010, (b) an increase in units of hematology instruments and hematology reagent kits sold during the nine months ended December 31, 2010, and (c) sales of our VetScan i-STAT analyzers and related consumables.  The increase in gross profit was partially offset by higher unit costs from our supplier of VetScan i-STAT consumables during the nine months ended December 31, 2010, primarily due to a pricing promotion during the nine months ended December 31, 2009.  As a percentage, the decrease in gross profit was primarily due to higher relative sales of VetScan i-STAT analyzers and related consumables, which have a lower gross margin contribution.





Cost of Revenues





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





Three Months Ended








Nine Months EndedDecember 31,


Change


December 31,


ChangeIncrease/


Percent








Increase/


Percent2010


2009


(Decrease)


Change


2010


2009


(Decrease)


ChangeCost of revenues

$
16,097


$
12,709


$
3,388



27
%

$
46,793


$
37,590


$
9,203



24
%Percentage of total revenues


45
%


41
%










44
%


41
%


27
 Table of Contents


Cost of revenues includes the costs associated with manufacturing, assembly, packaging, warranty repairs, test and quality assurance for our instruments and consumables and manufacturing overhead, including costs of personnel and equipment associated with manufacturing support.





Three Months Ended December 31, 2010 Compared to Three Months Ended December 31, 2009





The increase in cost of revenues, in absolute dollars, during the three months ended December 31, 2010, as compared to the three months ended December 31, 2009, was primarily due to an increase in sales of our Piccolo chemistry analyzers, medical and veterinary reagent discs, and VetScan i-STAT analyzers and related consumables.  As a percentage of total revenues, the increase in cost of revenues during the three months ended December 31, 2010, as compared to the three months ended December 31, 2009, was primarily due to a pricing promotion by our supplier of VetScan i-STAT consumables during the three months ended December 31, 2009.


Nine Months Ended December 31, 2010 Compared to Nine Months Ended December 31, 2009





The increase in cost of revenues, in absolute dollars, during the nine months ended December 31, 2010, as compared to the nine months ended December 31, 2009, was primarily due to an increase in sales of our medical and veterinary reagent discs and VetScan i-STAT analyzers and related consumables.  As a percentage of total revenues, the increase in cost of revenues during the nine months ended December 31, 2010, as compared to the nine months ended December 31, 2009, was primarily due to a pricing promotion by our supplier of VetScan i-STAT consumables during the nine months ended December 31, 2009.





Gross Profit





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





Three Months Ended








Nine Months EndedDecember 31,


Change


December 31,


ChangeIncrease/


Percent








Increase/


Percent2010


2009


(Decrease)


Change


2010


2009


(Decrease)


ChangeTotal gross profit

$
19,809


$
18,296


$
1,513



8
%

$
59,343


$
53,302


$
6,041



11
%Total gross margin


55
%


59
%










56
%


59
%





Three Months Ended December 31, 2010 Compared to Three Months Ended December 31, 2009





Gross profit during the three months ended December 31, 2010 increased 8%, or $1.5 million, as compared to the three months ended December 31, 2009, primarily due to the following:  (a) an increase in units of Piccolo chemistry analyzers and medical reagent discs sold during the three months ended December 31, 2010, and (b) an increase in units of veterinary reagent discs and hematology reagent kits sold during the three months ended December 31, 2010.  The increase in gross profit was partially offset by (a) a decrease in units of VetScan chemistry analyzers sold during the three months ended December 31, 2010, and (b) higher manufacturing costs on medical and veterinary reagent discs during the three months ended December 31, 2010.  As a percentage, the decrease in gross margin during the three months ended December 31, 2010, as compared to the three months ended December 31, 2009, was primarily due to (a) an adjustment to pre-existing warranties during the three months ended December 31, 2009, and (b) higher relative sales of VetScan i-STAT analyzers and related consumables, which have a lower gross margin contribution.





Nine Months Ended December 31, 2010 Compared to Nine Months Ended December 31, 2009


Gross profit during the nine months ended December 31, 2010 increased 11%, or $6.0 million, as compared to the nine months ended December 31, 2009, primarily due to the following:  (a) an increase in units of Piccolo chemistry analyzers and medical reagent discs sold during the nine months ended December 31, 2010, (b) an increase in units of veterinary reagent discs sold and higher average selling prices of veterinary reagent discs during the nine months ended December 31, 2010, (c) an increase in units of hematology instruments and hematology reagent kits sold during the nine months ended December 31, 2010, and (d) sales of our VetScan i-STAT analyzers and related consumables.  The increase in gross profit was partially offset by higher unit costs from our supplier of VetScan i-STAT consumables during the nine months ended December 31, 2010, primarily due to a pricing promotion during the nine months ended December 31, 2009.  As a percentage, the decrease in gross margin during the nine months ended December 31, 2010, as compared to the nine months ended December 31, 2009, was primarily due to higher relative sales of VetScan i-STAT analyzers and related consumables, which have a lower gross margin contribution.


28
 Table of Contents




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








Nine Months EndedDecember 31,


Change


December 31,


ChangeIncrease/


Percent








Increase/


Percent2010


2009


(Decrease)


Change


2010


2009


(Decrease)


ChangeResearch and development expenses

$
2,947


$
2,835


$
112



4
%

$
9,321


$
8,002


$
1,319



16
%Percentage of total revenues


8
%


9
%










9
%


9
%
 
 Research and development expenses consist of personnel costs (including salaries, benefits and share-based compensation expense), consulting expenses and materials and related expenses associated with the development of new tests and test methods, clinical trials, product improvements and optimization and enhancement of existing products.
 
 Three and Nine Months Ended December 31, 2010 Compared to Three and Nine Months Ended December 31, 2009
 
 The increase in research and development expenses, in absolute dollars, during the three and nine months ended December 31, 2010, as compared to the three and nine months ended December 31, 2009, was primarily due to new product development and enhancement of existing products and clinical trials.  Research and development expenses are based on the project activities planned and the level of spending depends on budgeted expenditures.  The projects primarily relate to new product development in both the medical and veterinary markets and costs related to compliance with FDA regulations and clinical trials.  Share-based compensation expense during the three months ended December 31, 2010 and 2009 was $195,000 and $235,000, respectively, and during the nine months ended December 31, 2010 and 2009 was $684,000 and $589,000, respectively.
 
 We anticipate the absolute dollar amount of research and development expenses for fiscal 2011 to increase from fiscal 2010 but remain consistent as a percentage of total revenues, as we develop 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 or cost effective.
 
 Sales and Marketing
 
 The following sets forth our sales and marketing expensesfor the periods indicated (in thousands, except percentages):
 
 Three Months Ended








Nine Months EndedDecember 31,


Change


December 31,


ChangeIncrease/


Percent








Increase/


Percent2010


2009


(Decrease)


Change


2010


2009


(Decrease)


ChangeSales and marketing expenses

$
8,208


$
7,486


$
722



10
%

$
25,249


$
21,428


$
3,821



18
%Percentage of total revenues


23
%


24
%










24
%


24
%
 
 Sales and marketing expenses consist of personnel costs (including salaries, benefits and share-based compensation expense), commissions and travel-related expenses for personnel engaged in selling, costs associated with advertising, lead generation, marketing programs, trade shows and services related to customer and technical support.
 
 Three and Nine Months Ended December 31, 2010 Compared to Three and Nine Months Ended December 31, 2009
 
 The increase in sales and marketing expenses, in absolute dollars, during the three and nine months ended December 31, 2010, as compared to the three and nine months ended December 31, 2009, was primarily due to personnel-related costs resulting from (a) an increase in headcount in various divisions, including sales and marketing, customer service and technical service, to support the growth in both our medical and veterinary markets and (b) an increase in commission expenses, which are based on the achievement of established goals.  Share-based compensation expense during the three months ended December 31, 2010 and 2009 was $365,000 and $335,000, respectively, and during the nine months ended December 31, 2010 and 2009 was $1.1 million and $884,000, respectively.
 
 General and Administrative
 
 The following sets forth our general and administrative expenses for the periods indicated (in thousands, except percentages):
 
 Three Months Ended








Nine Months EndedDecember 31,


Change


December 31,


ChangeIncrease/


Percent








Increase/


Percent2010


2009


(Decrease)


Change


2010


2009


(Decrease)


ChangeGeneral and administrative expenses

$
2,820


$
2,552


$
268



11
%

$
7,596


$
7,739


$
(143
)


(2
)%Percentage of total revenues


8
%


8
%










7
%


9
%
  29
 Table of Contents
  General and administrative expenses consist of personnel costs (including salaries, benefits and share-based compensation expense), and expenses for outside professional services related to general corporate functions, including accounting, human resources and legal.
 
 Three and Nine Months Ended December 31, 2010 Compared to Three and Nine Months Ended December 31, 2009
 
 The increase in general and administrative expenses, in absolute dollars, during the three months ended December 31, 2010, as compared to the three months ended December 31, 2009, was primarily due to legal expenses related to pursuing a patent infringement case (see Note 8 of the Notes to the Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q for further information).  The decrease in general and administrative expenses, in absolute dollars, during the nine months ended December 31, 2010, as compared to the nine months ended December 31, 2009, was primarily due to lower personnel-related costs resulting from a decrease in share-based compensation expense during the nine months ended December 31, 2010 as forfeiture estimates were adjusted to reflect actual forfeitures when an award vests.  Share-based compensation expense during the three months ended December 31, 2010 and 2009 was $570,000 and $771,000, respectively, and during the nine months ended December 31, 2010 and 2009 was $1.2 million and $2.0 million, respectively.
 
 Interest and Other Income (Expense), Net
 
 The following sets forth our interest and other income (expense), net, for the periods indicated (in thousands):
 
 Three Months Ended





Nine Months EndedDecember 31,


Change


December 31,


ChangeIncrease/








Increase/2010


2009


(Decrease)


2010


2009


(Decrease)Interest and other income (expense), net

$
46


$
(11
)

$
57


$
698


$
795


$
(97
)
 
 Interest and other income (expense), net consists primarily of interest earned on cash and cash equivalents, investments and foreign currency exchange gains and losses.
 
 Three and Nine Months Ended December 31, 2010 Compared to Three and Nine Months Ended December 31, 2009
 
 The increase in interest and other income (expense), net, during the three months ended December 31, 2010, as compared to the three months ended December 31, 2009, was primarily attributed to higher average invested balances in our investment portfolio during fiscal 2011, compared to the same period in fiscal 2010.  The decrease in interest and other income (expense), net, during the nine months ended December 31, 2010, as compared to the nine months ended December 31, 2009, was primarily attributed to unfavorable foreign currency exchange rates during fiscal 2011, compared to the same period in fiscal 2010.
 
 Income Tax Provision
 
 The following sets forth our income tax provision for the periods indicated (in thousands, except percentages):
 
 Three Months Ended


Nine Months EndedDecember 31,


December 31,2010


2009


2010


2009Income tax provision

$
2,045


$
1,982


$
6,711


$
6,545Effective tax rate


35
%


37
%


38
%


39
%
 
 Three and Nine Months Ended December 31, 2010 Compared to Three and Nine Months Ended December 31, 2009
 
 During the three months ended December 31, 2010 and 2009, our income tax provision was $2.0 million, based on an effective tax rate of 35%, and $2.0 million, based on an effective tax rate of 37%, respectively.  During the nine months ended December 31, 2010 and 2009, our income tax provision was $6.7 million, based on an effective tax rate of 38%, and $6.5 million, based on an effective tax rate of 39%, respectively.  The decrease in the effective tax rate during the three and nine months ended December 31, 2010, as compared to the three and nine months ended December 31, 2009, was primarily due to an increase in tax benefits for federal qualified production activities and an increase in federal research and development tax credits net of an expense recognized as a result of a decrease in California deferred tax assets due to a change in tax law impacting California apportionment during the three and nine months ended December 31, 2010.
  30
 Table of Contents
  LIQUIDITY AND CAPITAL RESOURCES
 
 Total cash, cash equivalents and short-term and long-term investments at December 31, 2010 and March 31, 2010 were as follows (in thousands, except percentages):
 
 December 31,


March 31,2010


2010Cash and cash equivalents

$
43,556


$
27,857Short-term investments


31,982



32,343Long-term investments


29,023



36,319Total cash, cash equivalents and investments

$
104,561


$
96,519Percentage of total assets


58
%


58
%
 Cash Flow Changes
 
 Cash provided by (used in) the nine months ended December 31, 2010 and 2009 were as follows (in thousands):
 
 Nine Months EndedDecember 31,2010


2009Net cash provided by operating activities

$
10,684


$
19,333Net cash provided by (used in) investing activities


3,755



(21,164
)Net cash provided by financing activities


1,192



852Effect of exchange rate changes on cash and cash equivalents


68



24Net increase (decrease) in cash and cash equivalents

$
15,699


$
(955
)
 
 At December 31, 2010, we had net working capital of $112.2 million compared to $89.3 million at March 31, 2010.  Cash and cash equivalents at December 31, 2010 were $43.6 million compared to $27.9 million at March 31, 2010.  The increase in cash and cash equivalents during the nine months ended December 31, 2010 was primarily due to net cash provided by operating activities of $10.7 million and proceeds from maturities and redemptions of investments of $56.9 million, partially offset by purchases of investments of $49.5 million and purchases of property and equipment of $3.6 million and payments made for tax withholdings related to net share settlements of restricted stock units of $2.0 million.
 
 Operating Activities
 
 During the nine months ended December 31, 2010, we generated $10.7 million in cash from operating activities, compared to $19.3 million during the nine months ended December 31, 2009.  The cash provided by operating activities during the nine months ended December 31, 2010 was primarily the result of net income of $11.2 million, adjusted for the effects of non-cash adjustments including depreciation and amortization of $3.3 million and share-based compensation expense of $3.5 million, partially offset by a decrease of $1.9 million related to excess tax benefits from share-based awards.
 
 Other changes in operating activities during the nine months ended December 31, 2010 were as follows:
 
 (i) Receivables, net increased by $1.6 million, from $23.7 million at March 31, 2010 to $25.3 million as of December 31, 2010, primarily due to higher sales during the quarter ended December 31, 2010.
 
 (ii) Inventories increased by $521,000, from $19.1 million at March 31, 2010 to $19.6 million as of December 31, 2010, primarily due to an increase in finished goods during the quarter ended December 31, 2010 to support future demand.
 
 (iii) Prepaid expenses and other current assets increased by $3.6 million, from $1.6 million at March 31, 2010 to $5.2 million as of December 31, 2010, primarily due to the timing of income tax payments.
 
 (iv) Current net deferred tax assets decreased by $1.1 million, from $3.8 million at March 31, 2010 to $2.7 million as of December 31, 2010, primarily as a result of the utilization of California research and development tax credits carryovers.
 
 (v) Accounts payable decreased by $1.8 million, from $9.4 million at March 31, 2010 to $7.6 million as of December 31, 2010, primarily due to the timing and payment of services and inventory purchases.
 
 (vi) Total warranty reserves decreased by $476,000, resulting from a decrease in the current portion of warranty reserves of $411,000, from $1.2 million at March 31, 2010 to $772,000 as of December 31, 2010, and a decrease in the non-current portion of warranty reserves of $65,000, from $160,000 at March 31, 2010 to $95,000 as of December 31, 2010.  The net change in warranty reserves is based on (a) the number of instruments in standard warranty and estimated repair costs and (b) an estimate of defective reagent discs and replacement costs.  During the nine months ended December 31, 2010, total warranty reserves for instruments decreased based on both our historical experience and estimated product failure rates of instruments.  We began experiencing a decrease in the estimated product failure rates since we began taking steps to resolve manufacturing problems on blood chemistry analyzers primarily from fiscal 2008 related to quality control for key components that we obtain from our suppliers and to design issues of the key components required and accordingly, starting in the third quarter of fiscal 2010, we recorded adjustments to our estimated accrual for warranty exposure based on our quarterly evaluation of service experience.
  31
 Table of Contents
  We anticipate that we will incur incremental additional costs to support our future operations, including further additional pre-clinical testing and clinical trials for our current and future products; research and design costs related to the continuing development of our current and future products; acquisition of capital equipment for our manufacturing facility and costs to support our strategic alliance with Kansas State University, K-State Veterinary Diagnostic Lab, and the commercial arm of Kansas State University, the National Institute for Strategic Technology Acquisition and Commercialization, to provide a full service commercial laboratory for veterinarians across the United States.  Furthermore, during the three months ended December 31, 2010, we incurred legal costs related to compliance in an investigation by the United States Federal Trade Commission of a competitor and in the future we may incur additional related costs.
 
 Investing Activities
 
 Net cash provided by investing activities during the nine months ended December 31, 2010 totaled $3.8 million, compared to net cash used in investing activities of $21.2 million during the nine months ended December 31, 2009.  Changes in investing activities were as follows:
 
 Investments.  Cash used to purchase investments in certificates of deposits, corporate bonds, municipal bonds and U.S. agency securities totaled $49.5 million during the nine months ended December 31, 2010.  Cash provided by proceeds from maturities and redemptions of investments in certificates of deposits, corporate bonds, municipal bonds and U.S. agency securities totaled $56.9 million during the nine months ended December 31, 2010.
 
 Property and Equipment.  Cash used to purchase property and equipment totaled $3.6 million during the nine months ended December 31, 2010, primarily to support (a) new product introduction, (b) increased capacity requirements in our production line and (c) leasehold improvements on our expansion premises (see Facilities Lease of the Contractual Obligations section for additional information).  We anticipate that we will continue to purchase property and equipment as necessary in the normal course of our business.
 
 Financing Activities
 
 Net cash provided by financing activities during the nine months ended December 31, 2010 totaled $1.2 million, primarily due to proceeds from the exercise of stock options of $1.3 million and excess tax benefits from share-based awards of $1.9 million, partially offset by payments made for tax withholdings related to net share settlements of restricted stock units of $2.0 million.
 
 Contractual Obligations
 
 Facilities Lease.  In March 2010, we entered into the Fourth Amendment to Lease Agreement (the “Lease Amendment”) with Whipple Road Holdings, LLC, SFP Crossroads, LLC and Woodstock Bowers, LLC (collectively, the “Landlord”) related to our principal facilities in Union City, California.  Under the Lease Amendment, the lease term was extended from December 2010 to February 2021.  In connection with the Lease Amendment, our obligation to provide a letter of credit with Comerica Bank-California on our facilities, which was secured by our line of credit, terminated in April 2010 (see Note 7 of the Notes to the Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q for further information).  Additionally, pursuant to the Lease Amendment, the Landlord agreed to lease us certain expansion premises consisting of approximately 35,239 rentable square feet in Union City, California (the “Expansion Premises”).  In May 2010, the Landlord tendered possession of the Expansion Premises to us.  The monthly base rental rate for the Expansion Premises was abated for the first three months after May 2010 and thereafter increased to $0.80 per rentable square foot of the Expansion Premises ($28,191 per month).  The base rent for the Expansion Premises increases 3% on each anniversary of March 1 during the term of the lease.  As of December 31, 2010, the aggregate lease commitment on our principal facilities is approximately $14.5 million.
 
 Purchase Commitments.In October 2008, we entered into an original equipment manufacturing (“OEM”) agreement with Scandinavian Micro Biodevices APS (“SMB”) of Denmark to purchase coagulation analyzers and coagulation cartridges.  In the fourth quarter of fiscal 2009, we started marketing the products and, thereafter, upon achievement of certain milestones by SMB outlined in the agreement, we would be subject to the minimum purchase commitments under the OEM agreement.  These milestones have not yet been met and we are currently purchasing coagulation analyzers and coagulation cartridges on a purchase order basis, but all such purchases will count towards the minimum purchase obligations if and when they are triggered.
 
 In July 2010, we entered into a development and supply equipment agreement with Diatron MI PLC (“Diatron”) of Hungary to purchase Diatron hematology instruments.  Under the agreement, we committed to purchase a minimum number of hematology instruments on an annual basis during the calendar years 2010 and 2011.  At December 31, 2010, our total remaining outstanding commitment due is approximately $2.5 million.  Furthermore, at December 31, 2010, we prepaid $820,000 to Diatron for future purchases of hematology instruments and reagents, which was recorded in prepaid expenses and other currents assets on the condensed consolidated balance sheet.  The commitment amount to Diatron is based on the minimum number of hematology instruments that we are required to purchase, the cost of the instruments and the Euro exchange rate at period-end.  Since the exchange rate can fluctuate in the future, the commitment amount in absolute dollars will change accordingly.
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  Patent License Agreement.  Effective January 2009, we entered into a license agreement with Inverness Medical Switzerland GmbH (“Inverness”).  Under our license agreement, we licensed co-exclusively certain worldwide patent rights related to lateral flow immunoassay technology in the field of animal health diagnostics in the professional marketplace.  The license agreement provides that Inverness shall not grant any future rights to any third parties under its current lateral flow patent rights in the animal health diagnostics field in the professional marketplace.  The license agreement enables us to develop and market products under rights from Inverness to address animal health and laboratory animal research markets.
 
 In exchange for the license rights, we (i) paid an up-front license fee of $5.0 million to Inverness in January 2009, (ii) agreed to pay royalties during the term of the agreement, based solely on sales of products in a jurisdiction country covered by valid and unexpired claims in that jurisdiction under the licensed Inverness patent rights, and (iii) agreed to pay a yearly minimum license fee of between $500,000 to $1.0 million per year, which fee will be creditable against any royalties due during such calendar year.  The royalties, if any, are payable through the date of the expiration of the last valid patent licensed under the agreement that includes at least one claim in a jurisdiction covering products we sell in that jurisdiction.  The yearly minimum fees became payable starting in fiscal 2011 for so long as we desire to maintain exclusivity under the agreement.
 
 Line of Credit.  Through July 2010, we had a line of credit with Comerica Bank-California which provided for borrowings of up to $2.0 million.  In July 2010, we terminated our line of credit with Comerica Bank-California for which we had no outstanding balance due.  In connection with our amended facilities lease agreement in March 2010 (as more fully described in Note 8 of the Notes to the Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q for further information), our obligation to provide a letter of credit on our facilities of $97,000, which was secured by our line of credit, terminated in April 2010.
 
 Contingencies
 
 On June 28, 2010, we filed a patent infringement lawsuit against Cepheid with respect to Cepheid’s Methicillin-resistant Staphylococcus aureus (MRSA) product, on which Cepheid has ceased paying license royalties.  On December 17, 2010, Cepheid filed its answer and certain counterclaims seeking a finding of non-infringement, unenforceability and invalidity of the asserted patents.  We believe the counterclaims raised by Cepheid are without merit and intend to contest them vigorously.  Because of the cost involved in pursuing patent infringement cases, we believe the cost of this litigation could have a material adverse effect on Abaxis, our consolidated financial position and results of operations.  As of December 31, 2010, we have not recorded future litigation and related expenses to pursuing the patent infringement case and an estimate of such costs cannot be made at this time.
 
 We are involved from time to time in various litigation matters in the normal course of business.  Other than as described above, we believe that the ultimate resolution of these matters will not have a material effect on our financial position or results of operations.  There can be no assurance that existing or future legal proceedings arising in the ordinary course of business or otherwise will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flows.
 
 Off-Balance Sheet Arrangements
 
 We have no off-balance sheet arrangements.
 
 Financial Condition
 
 We anticipate that our existing capital resources and anticipated revenues from the sales of our products will be adequate to satisfy our currently planned operating and financial requirements through at least the next 12 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 pursue strategic opportunities.
 
 RECENT ACCOUNTING PRONOUNCEMENTS
 
 A discussion of recent accounting pronouncements is included in Note 2 of the Notes to the Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q.
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  Item3.  Quantitative and Qualitative Disclosures About Market Risk
 
 Interest Rate Risk
 
 We are exposed to the impact of interest rate changes with respect to our short-term and long-term investments.
 
 Our investment objective is to invest excess cash in cash equivalents and in various types of investments to maximize yields without significantly increased risk.  At December 31, 2010, our short-term investments totaled $32.0 million, consisting of certificates of deposits, corporate bonds and municipal bonds and our long-term investments totaled $29.0 million, consisting of certificates of deposits, corporate bonds, municipal bonds and U.S. agency securities.
 
 We have the ability to hold the investments classified as held-to-maturity in our investment portfolio at December 31, 2010 until maturity and therefore, we believe we have no material exposure to interest rate risk.  A sensitivity analysis assuming a hypothetical 10% movement in interest rates applied to our total investment balances at December 31, 2010 indicated that such market movement would not have a material effect on our business, operating results or financial condition.  We have not experienced any significant loss on our investment portfolio during either fiscal 2010 or during the nine months ended December 31, 2010.
 
 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 the Financial Accounting Standards Board Accounting Standards Codification 815, “Derivatives and Hedging.”
 
 Foreign Currency Rate Fluctuations
 
 We operate primarily in the United States and a majority of our revenues, cost of revenues, operating expenses and capital purchasing activities are transacted in U.S. dollars.  However, we are exposed to foreign currency exchange rate fluctuations on the hematology instruments and hematology reagent kits purchased from Diatron MI PLC, which are primarily denominated in Euros.
 
 In July 2008, the Germany sales office was incorporated as our wholly-owned subsidiary, Abaxis Europe GmbH, to market, promote and distribute diagnostic systems for medical and veterinary uses.  Abaxis Europe GmbH’s functional currency is in U.S. dollars.  Foreign currency denominated account balances of our subsidiary are remeasured into U.S. dollars at the end-of-period exchange rates for monetary assets and liabilities, and historical exchange rates for nonmonetary assets. Accordingly, the effects of foreign currency transactions, and of remeasuring the financial condition into the functional currency, resulted in foreign currency gains and losses, which were included in “Interest and other income (expense), net” on our condensed consolidated statements of income.
 
 For our sales denominated in local currencies, we are exposed to foreign currency exchange rate fluctuations on revenues and collection of receivables.  To the extent the U.S. dollar strengthens against the Euro currency, the translation of the foreign currency denominated transactions may result in reduced cost of revenues and operating expenses.  Similarly, our cost of revenues and operating expenses will increase if the U.S. dollar weakens against the Euro currency.
 
 Other than the foregoing, there have been no material changes in our market risk during the nine months ended December 31, 2010 compared to the disclosures in Part II, Item 7A of our Annual Report on Form 10-K for the fiscal year ended March 31, 2010.
 
 Item4.  Controls and Procedures
 
 Evaluation of Disclosure Controls and Procedures
 
 The Company’s management, with the participation of the Company’s principal executive officer and principal financial officer, has evaluated that the effectiveness of the Company’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”), as of the end of the period covered by this report.  Based on such evaluation, the Company’s principal executive officer and principal financial officer, have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective.
 
 Changes in Internal Control over Financial Reporting
 
 There were no changes in our internal control over financial reporting during the fiscal quarter ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act.
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  Inherent Limitations on Controls and Procedures
 
 A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.  Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.  Accordingly, even an effective system of internal control will provide only reasonable assurance that the objectives of the internal control system are met.
 
 Item4T.  Controls and Procedures
 
 Not applicable.
 
 PARTII - OTHER INFORMATION
 
 Item 1.  Legal Proceedings
 
 On June 28, 2010, we filed a patent infringement lawsuit against Cepheid with respect to Cepheid’s Methicillin-resistant Staphylococcus aureus (MRSA) product, on which Cepheid has ceased paying license royalties.  On December 17, 2010, Cepheid filed its answer and certain counterclaims seeking a finding of non-infringement, unenforceability and invalidity of the asserted patents.  We believe the counterclaims raised by Cepheid are without merit and intend to contest them vigorously.  Because of the cost involved in pursuing patent infringement cases, we believe the cost of this litigation could have a material adverse effect on Abaxis, our consolidated financial position and results of operations.  As of December 31, 2010, we have not recorded future litigation and related expenses to pursuing the patent infringement case and an estimate of such costs cannot be made at this time.
 
 We are involved from time to time in various litigation matters in the normal course of business.  Other than as described above, we believe that the ultimate resolution of these matters will not have a material effect on our financial position or results of operations.  There can be no assurance that existing or future legal proceedings arising in the ordinary course of business or otherwise will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flows.
 
 Item1A.  Risk Factors
 
 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,” “continue,” “could,” “estimates,” “expects,” “future,” “intends,” “may,” “might,” “plans,” “projects,” “will” 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 additional risks not presently known to us or that we currently believe are immaterial that may also significantly impair our business operations.
 
 In evaluating our business, you should carefully consider the following risks in addition to the other information in our Annual Report on Form 10-K for the fiscal year ended March 31, 2010 as filed with the Securities and Exchange Commission on June 14, 2010.  We note these factors for investors as permitted by the Private Securities Litigation Reform Act of 1995.  It is not possible to predict or identify all such factors and, therefore, you should not consider the following risks to be a complete statement of all the potential risks or uncertainties that we face.
 
 Our facilities and manufacturing operations are vulnerable to natural disasters and other unexpected losses.  Any such losses or system failures or delays may harm our business.
 
 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 blood chemistry analyzers or the reagent discs used in the blood chemistry 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 or other significant loss or problem.  Accordingly, if our location in Union City, California experienced a system failure or regulatory problem that temporarily shuts 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.  Any of these events could harm our operating results and business.
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  We are not able to predict sales in future quarters and a number of factors affect our periodic results, which makes our quarterly operating results less predictable.
 
 We are not able to accurately predict our sales in future quarters.  Our revenue in the medical and veterinary markets is derived primarily by selling to 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 blood chemistry analyzers, as we typically sell our blood chemistry analyzers to new users.  Accordingly, our sales in any one quarter or period are not indicative of our sales in any future period.
 
 We generally operate with a 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.
 
 The sales cycle for our products can fluctuate, which may cause revenue and operating results to vary significantly from period to period.  We believe this fluctuation is primarily due (i) to seasonal patterns in the decision making processes by our independent distributors and direct customers, (ii) to inventory or timing considerations by our distributors and (iii) on the purchasing requirements of the U.S. Government to acquire our products.  Accordingly, we believe that period to period comparisons of our results of operations are not necessarily meaningful.
 
 In the future, our periodic operating results may vary significantly depending on, but not limited to, a number of factors, including:
 
 ·
new product announcements made by us or our competitors;
 
 ·
changes in our pricing structures or the pricing structures of our competitors;
 
 ·
our ability to develop, introduce and market new products on a timely basis, or at all;
 
 ·
our manufacturing capacities and our ability to increase the scale of these capacities;
 
 ·
the mix of product sales between our instruments and our consumable products;
 
 ·
the amount we spend on research and development; and
 
 ·
changes in our strategy.
 
 We depend on limited or sole suppliers, many of whom we have not entered into contractual relationships with, and failure of our suppliers to provide the components or products to us could harm our business.
 
 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, 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 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 stand-alone products:  Amano Enzyme USA Co., Ltd., Genzyme Corporation, Kikkoman Corporation Biochemical Division, Microgenics Corporation, a division of Thermo Fisher Scientific, Roche Molecular Biochemicals of Roche Diagnostics Corporation, a division of F. Hoffmann-La Roche, Ltd., SA Scientific Co., Sigma Aldrich Inc. and Toyobo Specialties (formerly Shinko American Inc.).
 
 ·
Blood Chemistry Analyzer Components:  Our blood analyzer products use several technologically-advanced components that we currently purchase from a limited number of vendors, including certain components from a single-source supplier, Hamamatsu Corporation and UDT Sensors (a division of OSI Optoelectronics).  Our analyzers also use a printer that is primarily made by Seiko North America Corporation.  The loss of the supply of any of these components could force us to redesign our blood chemistry analyzers.
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  We market original equipment manufacturer supplied products that are currently available from limited sources as discussed below:
 
 ·
Hematology Instruments and Reagents:  Our hematology instruments are manufactured by Diatron MI PLC (“Diatron”) in Hungary and are purchased by us as a completed instrument.  In addition, currently, we have qualified two suppliers to produce the reagents for our hematology instruments:  Clinical Diagnostic Solutions, Inc. and Diatron.
 
 ·
Coagulation and Specialty Analyzers and Cartridges:  Our coagulation and specialty analyzers and cartridges are manufactured by Scandinavian MicroBiodevices APS in Denmark and are purchased by us as completed products.
 
 ·
i-STAT Analyzers and Cartridges:Our i-STAT 1 analyzers and cartridges are manufactured by Abbott Point of Care Inc. in North America and are purchased by us as completed products.
 
 We primarily operate on a purchase order basis with most of our suppliers and, therefore, 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 may be potential alternate suppliers available for these critical components, to date we have not qualified additional vendors beyond those referenced above and cannot assure you we would be able to enter into arrangements with additional vendors on favorable terms, or at all.  For the suppliers of original equipment manufactured products that we have long-term contracts with, there can be no assurance that these suppliers will always fulfill their obligations under these contracts, or that any suppliers will not experience disruptions in their ability to supply our requirements for products.  In addition, under some contracts with suppliers we have minimum purchase obligations and our failure to satisfy those obligations may result in loss of some or all of our rights under these contracts.
 
 Because we are dependent on a limited number of suppliers and manufacturers for 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 adversely affect our business and financial condition.
 
 We would fail to achieve anticipated revenue if the market does not accept our products.
 
 We believe that 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 a greater overall cost and require 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.
 
 In the human medical market, we have relatively limited experience in large-scale sales of our Piccolo blood chemistry analyzers.  Although we believe that our blood chemistry analyzers offer consumers many advantages, including substantial cost savings according to our analyses, in terms of implementation of the actual product, 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 Piccolo blood chemistry analyzers and our other products, we will suffer lost sales and could fail to achieve anticipated revenue.
 
 Historically, in the veterinary market, we have marketed our VetScan systems through both direct sales and distribution channels to veterinarians.  We continue to develop new animal blood tests to expand our product offerings and we cannot be assured that these tests will be accepted by the veterinary market.  Any failure to achieve market acceptance with our current or future products would harm our business and financial condition.
 
 We rely on patents and other proprietary information, the loss of which would negatively affect our business.
 
 As of December 31, 2010, 53 patent applications have been filed on our behalf with the United States Patent and Trademark Office (“USPTO”), of which 31 patents have been issued and 27 patents are currently active.  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 us, 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 USPTO maintains all patent applications that are not filed in any foreign jurisdictions in secrecy until it issues the patents (when a patent application owner files a request for nonpublication) 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 USPTO, to determine who will be issued a patent.  These proceedings could be costly and could be decided against us.
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  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.
 
 On June 28, 2010, we filed a patent infringement lawsuit against Cepheid with respect to Cepheid’s Methicillin-resistant Staphylococcus aureus (MRSA) product, on which Cepheid has ceased paying license royalties.  On December 17, 2010, Cepheid filed its answer and certain counterclaims seeking a finding of non-infringement, unenforceability and invalidity of the asserted patents.  We believe the counterclaims raised by Cepheid are without merit and intend to contest them vigorously.  Because of the cost involved in pursuing patent infringement cases, we believe the cost of this litigation could have a material adverse effect on our business, our consolidated financial position and results of operations.  As of December 31, 2010, we have not recorded future litigation and related expenses to pursuing the patent infringement case and an estimate of such costs cannot be made at this time.
 
 We must increase sales of our Piccolo and VetScan products or we may not be able to increase or sustain profitability.
 
 Our ability to continue to be profitable and to increase profitability will depend, in part, on our ability to increase our sales volumes of our Piccolo and VetScan products.  Increasing the sales volume of our products will depend upon, among other things, our ability to:
 
 ·
continue to improve our existing products and develop new and innovative products;
 
 ·
increase our sales and marketing activities;
 
 ·
effectively manage our manufacturing activities; and
 
 ·
effectively compete against current and future competitors.
 
 We cannot assure you that we will be able to successfully increase our sales volumes of our products to increase or sustain profitability.
 
 We must continue to develop our sales, marketing and distribution experience in the human diagnostic market or our business will not grow.
 
 We have limited sales, marketing and distribution experience with our Piccolo chemistry analyzers in the human diagnostic market.  Accordingly, we cannot assure you that:
 
 ·
we will be able to establish and maintain effective distribution arrangements in the human diagnostic market;
 
 ·
any distribution arrangements that we are able to establish will be successful in marketing our products; or
 
 ·
the costs associated with sales, marketing and distributing our products will not be excessive.
 
 Should we fail to effectively develop our sales, marketing and distribution efforts, our growth will be limited and our results of operations will be adversely affected.
 
 We depend on key members of our management and scientific staff and, if we fail to retain and recruit qualified individuals, our ability to execute our business strategy and generate sales would be harmed.
 
 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.  We may not be able to continue to attract and retain skilled and experienced marketing, sales and manufacturing personnel on acceptable terms in the future because numerous medical products and other high technology companies compete for the services of these qualified individuals.  We currently do not maintain key man life insurance on any of our employees.
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  We rely primarily on distributors to sell our products and we rely on sole distributor arrangements in a number of countries. Our failure to successfully develop and maintain these relationships could adversely affect our business.
 
 We sell our medical and veterinary products primarily through a limited number of 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 operate on a purchase order basis with the distributors and the distributors are 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.
 
 We depend on a number of distributors in North America who distribute our VetScan products.  We depend on our distributors to assist us in promoting our products in the veterinary market, and accordingly, if one or more of our distributors were to stop selling our products in the future, we may experience a temporary sharp decline or delay in our sales revenue until our customers identify another distributor or purchase products directly from us.
 
 In the United States medical market, we depend on a few distributors for our Piccolo products.  We entered into formal distribution agreements with the following distributors to sell and market Piccolo chemistry analyzers and medical reagent discs:  Henry Schein’s Medical Group, McKesson Medical-Surgical Inc. and PSS World Medical, Inc.  We depend on these distributors to assist us in promoting market acceptance of our Piccolo chemistry analyzers.  The loss of any of these distributors would have a materially negative impact on our operating results and financial condition.
 
 Internationally, we rely on only a few distributors for our products in both the medical and veterinary diagnostic markets.  We currently rely on distributors that carry either our medical or veterinary products in the following countries:  Afghanistan, Australia, Austria, Bahrain, Belgium, Canada, Czech Republic, Denmark, France, Germany, Hong Kong, India, Ireland, Israel, Italy, Japan, Korea, Macao, the Netherlands, New Zealand, the Philippines, Portugal, Romania, Russia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Arab Emirates, the United Kingdom and the United States.  Our distributors in each of these countries are responsible for obtaining the necessary approvals to sell our new and existing products.  These distributors may not be successful in obtaining proper approvals for our new and existing products in their respective countries, and they may not be successful in marketing our products.  Furthermore, an inability of, or any delays by, our distributor in receiving the necessary approvals for our new or other products can adversely impact our revenues in a country.  We plan to continue to enter into additional distributor relationships to expand our international distribution base and presence.  However, we may not be successful in entering into additional distributor relationships on favorable terms, or at all.  In addition, 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 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, and our business and financial condition may be harmed as a result.
 
 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 chemistry analyzers.  Historically, we have developed reagent discs suitable for the human medical and veterinary diagnostic markets.  We have received 510(k) clearances from the U.S. Food and Drug Administration (“FDA”) for 26 test methods in the human medical market.  These tests are included in standard tests for which the medical community receives reimbursements from third-party payors such as health maintenance organizations (“HMOs”) and Medicare.  We may not be able to successfully manufacture or market these reagent discs.  Our failure to meet these challenges will materially adversely affect our operating results and financial condition.
 
 We rely on relationships with partners and other third parties that license our technologies and pay us royalties on sales of their products.  Failure to maintain these relationships, poor performance by these companies or disputes with these companies could negatively impact our business.
 
 We rely on collaborative relationships with other companies for revenues resulting from royalties payable by these third parties in connection with technologies that they license from us.  For example, we entered into a license agreement with Cepheid in fiscal 2006 to license a portion of our patent portfolio covering lyophilization technology.  Under the agreement, Cepheid paid us royalties based on sales of Cepheid products using the licensed technology.  On October 1, 2010, we terminated the entire license as to all or any of Cepheid products due to Cepheid’s discontinuation of license royalty payments.  As a result of this license termination, we expect that our development and licensing revenue will be adversely and materially impacted.  If other third parties fail to perform under license agreement or generate royalties to the level of our expectations, our operating results may be harmed.  In addition, reliance on collaborative relationships poses a number of risks, including the risk that;
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  ·
we may not be able to control the amount and timing of resources that our collaborators may devote to products from which we derive royalties;
 
 ·
disputes may arise with respect to the ownership of rights to technology developed with our partners;
 
 ·
disagreements with our partners could cause delays in, or termination of, the research, development or commercialization of products or result in litigation or arbitration;
 
 ·
contracts with our partners may fail to provide significant protection or may fail to be effectively enforced if one of these partners fails to perform;
 
 ·
should a partner fail to develop or commercialize products based on technologies we may license, we may not receive any future payments or any royalties for the technologies or products;
 
 ·
collaborative arrangements are often terminated or allowed to expire, such as our former license with Cepheid, which would adversely impact our royalty revenues; and
 
 ·
our corporate partners may be unable to pay us, particularly in light of current economic conditions.
 
 Given these risks, there is a great deal of uncertainty regarding the success of our current and future collaborative efforts.
 
 We may not be able to compete effectively with larger, more established entities or their products, or with future organizations or future products, which could cause our sales to decline.
 
 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 primarily 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” (a listing of our competitors is listed below).
 
 Historically, hospitals and commercial laboratories perform most of the human diagnostic testing, and veterinary specialized commercial laboratories perform most of the veterinary medical testing.  We have identified five principal factors that we believe customers typically use to evaluate our products and those of our competitors.  These factors include the following:
 
 ·
range of tests offered;
 
 ·
immediacy of results;
 
 ·
cost effectiveness;
 
 ·
ease of use; and
 
 ·
reliability of results.
 
 We believe that we compete effectively on each of these factors except for the range of tests offered.  Clinical laboratories are effective at processing large panels of tests using skilled technicians and complex equipment.  While our current offering of reagent discs cannot provide the same broad range of tests, we believe that in certain 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.  In addition, 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 on the basis of range of tests offered.
 
 Competition in the human and veterinary diagnostic markets is intense.  Our principal competitors in the human diagnostic market are Alere (formerly Inverness Medical Technologies), Alfa Wassermann S.P.A., i-STAT Corporation (which was purchased by Abbott Laboratories), Johnson & Johnson (including its subsidiary, Ortho-Clinical Diagnostics, Inc.), Kodak (DT60 analyzer), Polymedco, Inc. and F. Hoffman-La Roche (Reflotron system).  Our principal competitors in the veterinary diagnostic market are Idexx Laboratories, Inc. and Heska Corporation.  Many of our competitors have significantly larger product lines to offer and 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 significantly expand our direct sales force in order to compete in these markets.  On January 26, 2011, we formed a strategic alliance with Kansas State University, K-State Veterinary Diagnostic Lab, and the commercial arm of Kansas State University, the National Institute for Strategic Technology Acquisition and Commercialization.  We believe this alliance will provide a full service commercial laboratory for veterinarians across the United States.  As a result, we will incur significant expenses in connection with this strategic alliance and may incur additional significant expenses in exploring other future opportunities, for which the outcome is uncertain.  Pursuing these and other strategic opportunities could distract our management, or divert or expend our limited capital and other resources, which could adversely impact our operating results and financial condition in the future.
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  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 (the “CMS”) set 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 would 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 and our business and financial condition would be harmed.
 
 We are subject to numerous governmental regulations and regulatory changes are difficult to predict and may be damaging to our business.
 
 Need for Government Regulation for our Products
 
 Our Piccolo products are medical devices subject to regulation by the FDA, under the Federal Food, Drug, and Cosmetic Act, or (“FDCA”).  Medical devices, to be commercially distributed in the United States, must receive either 510(k) premarket clearance or Premarket Approval (“PMA”) from the FDA pursuant to the FDCA prior to marketing.  Devices deemed to pose relatively less risk are placed in either class I or II, which generally requires the manufacturer to submit a premarket notification requesting permission for commercial distribution; this is known as 510(k) clearance.  Most lower risk, or class I, devices are exempted from this requirement.  Devices deemed by the FDA to pose the greatest risk, such as life-sustaining, life supporting or implantable devices, or devices deemed not substantially equivalent to a previously 510(k) cleared device or a preamendment class III device for which PMA applications have not been called, are placed in class III requiring PMA approval.  The FDA has classified our Piccolo products as class I or class II devices, depending on their specific intended uses and indications for use.
 
 510(k) Clearance Pathway.  To obtain 510(k) clearance, a manufacturer must submit a premarket notification demonstrating that the proposed device is substantially equivalent in intended use, principles of operation, and technological characteristics to a previously 510(k) cleared device or a device that was in commercial distribution before May 28, 1976 for which the FDA has not called for submission of PMA applications.  The FDA’s 510(k) clearance pathway usually takes from three to six months, but it can take longer.
 
 After a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, requires a new 510(k) clearance or could require a PMA approval.  The FDA requires each manufacturer to make this determination in the first instance, but the FDA can review any such decision.  If the FDA disagrees with a manufacturer’s decision not to seek a new 510(k) clearance, the agency may retroactively require the manufacturer to seek 510(k) clearance or PMA approval.  The FDA also can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance or PMA approval is obtained, to redesign the device or to submit new data or information to the FDA.  Products marketed following the FDA clearance also are subject to significant postmarket requirements.
 
 As of December 31, 2010, we have received the FDA premarket clearance for our Piccolo chemistry analyzer and 26 reagent tests that we have on 15 reagent discs.  We are currently developing additional tests which we will have to clear with the FDA through the 510(k) notification procedures.  These new test products are crucial for our continued success in the human medical market.  If we do not receive 510(k) clearance for a particular product, we will not be able to market that product in the United States until we provide additional information to the FDA and gain premarket clearance.  The inability to market a new product during this time could harm our future sales.
 
 APHIS Licensure of Veterinary Biologics
 
 On October 8, 2009, we announced that we received licensure of our canine heartworm antigen (“CHW”) test utilizing a rotor-based assay system consisting of eleven other important canine health determinations from the Animal and Plant Health Inspection Service (“APHIS”).  The CHW diagnostic product is regulated as a veterinary biologic under the Virus, Serum, and Toxin Act of 1913.  Veterinary biologics are licensed as are their manufacturing facilities.  Products are subject to extensive testing to establish their purity, safety, potency, and efficacy.  Licensed biologics are also required to be prepared in accordance with a filed Outline of Production, among other requirements.  Failure to comply with APHIS licensure or post-marketing approval requirements can result in the inability to obtain product or establishment licenses or cause the revocation or suspension of such licenses.
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  We are currently developing additional tests that will be subject to APHIS licensure as veterinary biologics.  If we do not receive licensure for these additional tests, we will not be able to market those products in the United States, which could also harm our sales and financial condition.
 
 Need to Comply with Manufacturing Regulations and Various Federal, State, Local and International 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 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 inspections.  In addition, various state regulatory agencies may regulate the manufacture of our products.
 
 Federal, state, local and international 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.
 
 To date, we have complied with the following federal, state, local and international regulatory requirements:
 
 ·
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 manufacturing facility in Union City, California.
 
 ·
In May 2002, we received our ISO 9001 certification, expanding our compliance with international quality standards.
 
 ·
In December 2003, we received ISO 13485 Quality System certification as required by the 2003 European In Vitro Device Directive.  This certified our quality system specifically to medical devices.
 
 ·
In both September 2005 and March 2003, the FDA conducted a facility inspection and verified our compliance with the 21 CFR 820 Regulation.
 
 ·
In September 2005, we received the Canadian Medical Device Conformity Assessment System stamp on our ISO 13485 certificate to signify compliance with Health Canada regulations.
 
 ·
In August 2008, the FDA conducted an additional facility inspection to verify our compliance with 21 CFR 820 Regulation.
 
 ·
In October 2009, we received our recertification to the ISO 13485:2003 Quality System Standard for medical devices.
 
 ·
In October 2009, we received a United States Veterinary Biologics Establishment License from the United States Department of Agriculture.
 
 ·
In December 2010, the State of California Food and Drug Branch conducted a routine facility inspection to verify our compliance with Good Manufacturing Practices for medical devices.
 
 ·
In December 2010, the FDA conducted a routine facility inspection to verify our compliance with the 21 CFR 820 Quality System Regulation.
 
 We cannot assure you that we will successfully pass the latest FDA inspection or any 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.  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.  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.  Although we believe that we will be able to comply with all applicable regulations of the FDA and of the State of California, including the Quality System Regulation, current regulations depend on administrative interpretations.  Future interpretations made by the FDA, CMS or other regulatory bodies may adversely affect our business.
 
 Effects of the Clinical Laboratory Improvement Amendments on our Products
 
 Our Piccolo products are also affected by the Clinical Laboratory Improvement Amendments (the “CLIA”) of 1988.  The CLIA are intended to ensure the quality and reliability of all medical testing in the United States regardless of where the tests are performed.  The current CLIA regulations divide laboratory tests into the following three categories:
 
 ·
waived;
 
 ·
moderately complex; and
 
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highly complex.
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  Many of the tests performed using the Piccolo chemistry analyzer 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 some Piccolo products to customers who meet the standards of a laboratory.  To receive “laboratory” certification, a testing facility must be certified by the CMS.  After the testing facility receives a “laboratory” certification, it must then meet the CLIA regulations.  Because we can only sell some Piccolo products to testing facilities that are certified “laboratories,” the market for some products is correspondingly constrained.
 
 We can currently offer the following Piccolo reagent discs as waived tests to the medical market:  Basic Metabolic Panel, Comprehensive Metabolic Panel, Electrolyte Panel, General Chemistry 6, General Chemistry 13, Kidney Check, Lipid Panel, Lipid Panel Plus, Liver Panel Plus, MetLyte 8 Panel and Renal Function Panel.  Waived status permits untrained personnel to run the Piccolo chemistry analyzer using these tests; thus, extending the sites (doctors’ offices and other point-of-care environments) that can use the Piccolo chemistry analyzer.  Although we are engaged in an active program to test and apply for CLIA waivers for additional analytes, we cannot assure you that we will successfully receive CLIA waived status from the FDA for other products.  Consequently, for the reagent discs that have not received CLIA waived status, the market for our Piccolo products may be confined to those testing facilities that are certified as “laboratories” and our growth would be limited accordingly, which could harm our business and financial condition.
 
 We have incurred and may continue to incur, in future periods, significant share-based compensation charges which may adversely affect our reported financial results.
 
 In accordance with Accounting Standards Codification 718, “Compensation-Stock Compensation,” issued by the Financial Accounting Standards Board, we measure all share-based payments to employees using a fair-value-based method and we record such expense in our results of operations.  The fair value of restricted stock unit awards used in our expense recognition method is measured based on the number of shares granted and the closing market price of our common stock on the date of grant.  Such value is recognized as an expense, net of an estimated forfeiture rate, over the corresponding requisite service period.  Since fiscal 2007, we have granted restricted stock unit awards annually to employees based on the following time-based vesting schedule over a four-year period:  five percent vesting after the first year; additional ten percent after the second year; additional 15 percent after the third year; and the remaining 70 percent after the fourth year of continuous employment.  Since we began granting restricted stock units as part of our share-based compensation program in fiscal 2007, share-based compensation expense related to restricted stock units had a material impact on our earnings per share and on our consolidated financial statements and we expect that it will continue to adversely impact our reported results of operations, particularly in the fourth year of vesting for the restricted stock unit awarded to employees.  As of December 31, 2010, our unrecognized compensation expense related to restricted stock unit awards granted to employees and directors to date totaled $16.0 million, which is expected to be recognized over a weighted average service period of 2.22 years.
 
 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 to pay material uninsured claims.
 
 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 occurs in limited quantities, that we have not anticipated or otherwise.  Our Piccolo and VetScan chemistry analyzers may be unable to detect all errors which could result in the misdiagnosis of human or veterinary patients.
 
 Should we manufacture and ship defective products, we may be subject to substantial claims under our warranty policy or product liability laws.  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 chemistry analyzers.  Therefore, even if a mass defect within a lot or lots of reagent discs were detected by our Piccolo and VetScan chemistry analyzers, the replacement of such reagent discs free of charge would be costly and could materially harm our financial condition.  Further, in the event that a product defect is not detected in our Piccolo chemistry analyzer, 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.  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 could subject us to claims above the amount of our coverage and would materially adversely affect our business and our financial condition.
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  We could fail to achieve anticipated revenue if we experience problems related to the manufacture of our blood chemistry analyzers.
 
 We manufacture our blood chemistry analyzers at our manufacturing facility in Union City, California.  During fiscal 2008, we experienced problems related to the manufacture of our new blood chemistry analyzer, which were primarily related to difficulties and delays in obtaining certain key components that we purchase from various suppliers.  These manufacturing problems were primarily related to quality control issues for key components that we obtain from our suppliers and to design issues of the key components required in our blood chemistry analyzer.  Our difficulties in obtaining an adequate amount of quality components for the manufacture of our blood chemistry analyzer had a materially adverse impact on our sales of VetScan chemistry analyzers in fiscal 2008.  We believe that we have taken appropriate steps to resolve these issues, including securing quality parts from our suppliers, but there can be no assurance that our efforts to resolve these manufacturing difficulties will continue to prove to be successful or that similar supply problems will not arise in the future.  If we are unable to prevent similar problems from occurring in the future, we may not be able to manufacture sufficient quantities to meet anticipated demand and, therefore, will not be able to effectively market and sell our blood chemistry analyzers; accordingly, our revenue and business would be materially adversely affected.
 
 Fluctuations in foreign exchange rates and the possible lack of financial stability in foreign countries could prevent overseas sales growth.
 
 Our international sales are currently primarily denominated in U.S. dollars.  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 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.
 
 We are subject to increasingly complex requirements from legislation requiring companies to evaluate internal control over financial reporting.
 
 Rules adopted by the Securities and Exchange Commission pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require an assessment of internal control over financial reporting by our management and an attestation of the effectiveness of our internal controls over financial reporting by an independent registered public accounting firm.  We have an ongoing program to perform the assessment, testing and evaluation to comply with these requirements and we expect to continue to incur significant expenses for Section 404 compliance on an ongoing basis.
 
 Our management assessed the effectiveness of our internal control over financial reporting as of our fiscal years ended March 31, 2010 and 2009.  Although we received an unqualified opinion on our consolidated financial statements for the fiscal years ended March 31, 2010 and 2009, and on the effectiveness of our internal control over financial reporting as of March 31, 2010 and 2009, we cannot predict the outcome of our testing in future periods.  In the event that our internal control over financial reporting is not effective as defined under Section 404, or any failure to implement required new or improved controls, or difficulties encountered in implementation could harm operating results or prevent us from accurately reporting financial results or cause a failure to meet our reporting obligations in the future.  If management cannot assess internal control over financial reporting is effective, or our independent registered public accounting firm is unable to provide an unqualified attestation report on such assessment, investor confidence and our share value may be negatively impacted.
 
 We must comply with strict and potentially costly environmental regulations or we could pay significant fines.
 
 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.  Our costs to comply with applicable environmental regulations consist primarily of handling and disposing of human and veterinary blood samples for testing (whole blood, plasma, serum).  Although we believe that we have complied with applicable laws and regulations in all material respects and have not been required to take any action to correct any noncompliance, we may have to incur significant costs to comply with environmental regulations if our manufacturing to commercial levels continues to increase.  In addition, if a government agency determines that we have not complied with these laws, rules and regulations, we may have to pay significant fines and/or take remedial action that would be expensive and we do not carry environmental-related insurance coverage.
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  Our operating results could be materially affected by unanticipated changes in our tax provisions or exposure to additional income tax liabilities.
 
 Our determination of our tax liability is subject to review by applicable tax authorities.  Any adverse outcome of such a review could have an adverse effect on our operating results and financial condition.  In addition, the determination of our provision for income taxes and other tax liabilities requires significant judgment including our determination of whether a valuation allowance against deferred tax assets is required.  Although we believe our estimates and judgments are reasonable, the ultimate tax outcome may differ from the amounts recorded in our consolidated financial statements and may materially affect our financial results in the period or periods for which such determination is made.
 
 Our stock price is highly volatile and investing in our stock involves a high degree of risk, which could result in substantial losses for investors.
 
 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 quarter ended December 31, 2010, the closing sale prices of our common stock on the NASDAQ Global Market ranged from $22.71 to $28.35 per share and the closing sale price on December 31, 2010, was $26.85 per share.  During the last eight fiscal quarters ended December 31, 2010, our stock price closed at a high of $29.22 per share on September 16, 2009 and a low of $13.50 per share on January 23, 2009.  Many factors may affect the market price of our common stock, including:
 
 ·
fluctuation in our operating results;
 
 ·
announcements of technological innovations or new commercial products by us or our competitors;
 
 ·
changes in governmental regulation in the United States and internationally;
 
 ·
prospects and proposals for health care reform;
 
 ·
governmental or third-party payors’ controls on prices that our customers may pay for our products;
 
 ·
developments or disputes concerning our patents or our other proprietary rights;
 
 ·
product liability claims and public concern as to the safety of our devices or similar devices developed by our competitors; and
 
 ·
general market conditions.
 
 Because our stock price is so volatile, investing in our common stock is highly risky.  A potential investor must be able to withstand the loss of his entire investment in our common stock.
 
 Our 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 shareholders, 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 and, consequently, negatively affect our stock price.
 
 Item2.    Unregistered Sales of Equity Securities and Use of Proceeds
 
 Not applicable.
 
 Item3.    Defaults Upon Senior Securities
 
 Not applicable.
 
 Item4.    Removed and Reserved
 
 Item5.    Other Information
 
 Not applicable.
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  Item6.   Exhibits
 
 Exhibit No.
Description of Document3.1
Restated Articles of Incorporation (Filed with the Securities and Exchange Commission as an exhibit with our Annual Report on Form 10-K for the fiscal year ended March 31, 1993 and incorporated herein by reference.)3.2
Certificate of Amendment of Amended and Restated Articles of Incorporation (Filed with the Securities and Exchange Commission as an exhibit with our Quarterly Report on Form 10-Q for the quarterly period ended December 31, 1996 and incorporated herein by reference.)3.3
By-laws (Filed with the Securities and Exchange Commission in our Registration Statement No. 33-44326 on December 11, 1991 and incorporated herein by reference.)3.4
Amendment to the By-laws (Filed with the Securities and Exchange Commission as an exhibit with our Current Report on Form 8-K on July 30, 2007 and incorporated herein by reference.)4.1
Registration Rights Agreement, dated as of March 29, 2002 (Filed with the Securities and Exchange Commission as an exhibit with our Current Report on Form 8-K on May 13, 2002 and incorporated herein by reference.)4.2
Reference is made to Exhibit 3.1, Exhibit 3.2, Exhibit 3.3 and Exhibit 3.4.10.1*
Amended and Restated Executive Employment Agreement, dated as of October 27, 2010, with Clinton H. Severson31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1#
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2#
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 *
Management contract or compensatory plan or arrangement.
 
 #
This certification accompanies this Quarterly Report on Form 10-Q.  The certification is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Abaxis, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Quarterly Report on Form 10-Q and irrespective of any general incorporation language contained in any such filing.
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  SIGNATURES
 
 Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 ABAXIS, INC.(Registrant)Date: February 9, 2011
BY:
/s/ Clinton H. SeversonClinton H. SeversonPresident, Chief Executive Officer and Director(Principal Executive Officer)Date: February 9, 2011
BY:
/s/ Alberto R. Santa InesAlberto R. Santa InesChief Financial Officer and Vice Presidentof Finance(Principal Financial and Accounting Officer)
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