Abaxis' CEO Discusses F2Q14 Results - Earnings Call Transcript

Oct.22.13 | About: ABAXIS, Inc. (ABAX)

Abaxis, Inc. (NASDAQ:ABAX)

F2Q14 Earnings Conference Call

October 22, 2013 4:15 pm ET

Executives

Clinton H. Severson - Chairman, President and Chief Executive Officer

Donald Wood - Chief Operations Officer

Rick Betts - Director, U.S. Medical Marketing, Medical Diagnostics

Joe L. Dorame - Managing Partner, Lytham Partners

Analysts

Ross Taylor - C.L. King & Associates

Jim Sidoti - Sidoti & Company

Erin Wilson of Bank - America Merrill Lynch

Nicholas Jansen - Raymond James

David Clair - Piper Jaffray

Jonathan Block - Stifel Nicolaus

Operator

Good day, and welcome to the Abaxis Second Quarter of Fiscal Year 2014 Financial Results Conference Call. All participants will be in listen-only mode. (Operator Instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Mr. Joe Dorame of Lytham Partners. Please go ahead, sir.

Joe L. Dorame

Thank you, Denise. Good afternoon and thank you for joining us today to review the financial results of Abaxis for the second quarter of fiscal year 2014 ended September 30, 2013. As Denise indicated, my name is Joe Dorame. I’m with Lytham Partners, and we are the Investor Relations consulting firm for Abaxis.

With us today, representing the Company, are Mr. Clint Severson, Chairman and Chief Executive Officer; Mr. Al Santa Ines, Chief Financial Officer; Mr. Donald Wood, Chief Operations Officer; and Mr. Rick Betts, Director of North American Medical Marketing. At the conclusion of today’s prepared remarks, we will open the call for a question-and-answer session.

Before we begin, I would like to remind everyone, this conference call includes statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including but not limited to, statements related to the Company’s cash position, financial resources, and potential for future growth, the market acceptance of new or planned product offerings, future recurring revenues and results of operations.

Abaxis claims the protection of the Safe Harbor for forward-looking statements contained in the Reform Act. These forward-looking statements are often characterized by the terms, may, believe, projects, expects or anticipates, or words of similar import, and do not reflect historical facts.

Specific forward-looking statements contained in this conference call may be affected by risks and uncertainties including, but not limited to, those related to the transitioning medical sales to Abbott, losses or system failures with respect to the Company’s facilities or manufacturing operations, fluctuations in quarterly operating results dependent on sole suppliers, the market acceptance of the Company’s products and the continuing development of its products, required FDA clearance and other government approvals, risks associated with manufacturing and distributing its products on a commercial scale free of defects, risks related to the introduction of new instruments manufactured by third-parties, risks associated in competing in the human diagnostic market, risks related to the protection of the Company’s intellectual property or claims of infringement of intellectual property asserted by third parties, risks related to the condition of the United States economy and other risks detailed under Risk Factors in the Annual Report on Form 10-K and other periodic reports filed from time to time with the United States Securities and Exchange Commission. Forward-looking statements speak only as of the date the statements were made. Abaxis does not undertake and specifically disclaims any obligation to update any forward-looking statements.

With that having been said, I would like to turn the call over to Mr. Clint Severson, Chairman and Chief Executive Officer of Abaxis. Clint?

Clinton H. Severson

Thank you very much, Joe, and good afternoon, everybody. I’ll review the accomplishments and the challenges for Q2 FY 2014 and then some of the goals for Q3. And then after my short presentation, I’ll ask Don Wood, our Chief Operations Officer and the Interim Director of North American Animal Health, as well as Rick Betts, our Director of Sales and Marketing for the North American Medical market, to give an update on their respective businesses, and then we'll take questions.

The continuing major challenge in Q2 is working through our transition for mostly direct sales to working with partners. The processes are different and this change in market coverage means the focus of our sales and marketing people is to work more with our partners instead of mostly working with just customers. This process change in Abaxis has been too slow, and with the change in management, we are stepping up the pace.

While MWI is doing a very good job with sales up quarter-over-quarter for four quarters, our small distributors are still experiencing lower sales year-over-year. We are working with our smaller partners to help them set and achieve growth goals in this new environment and expect to see improvements over the next couple of quarters.

Another issue we are dealing with is the imbalance of inventory in our distribution network since the addition of MWI. We have some distributors that have too much disc inventory and not enough cartridges, some with too many hematology instruments and not enough i-STAT instruments, some with too many Prep Profiles and not enough T4 disc, and this imbalance also has a short term negative effect on our gross margins because of lower sales of high-margin discs and higher sales of lower margin other vet consumables and instruments. This is the second quarter we have been working through this. We believe we may have a quarter or two more to go. I'm making sure our distributers have the right balance of products.

Now Abbott has picked up the pace and the results have improved over Q1 with domestic medical sales finishing Q2 2014 at $5.1 million, up 36% quarter-over-quarter but still down about 3% versus Q2 last year. We did sell five Piccolo to a new CRO customer in Q2, with four units to the U.S. and one to the U.K., and more to follow from Rick in a few minutes.

Last quarter, we decided that was in our interest to modify our contract with Abbott and eliminate China from the agreement. Changes in reimbursement and our interest in having Abbott focus on the U.S. market were the reasons for this modification. We are working on launching the Piccolo with partners we are currently interviewing and believe not having a second layer of distribution will provide more flexibility and higher gross margin in this market.

Our AVRL posted lower sales growth quarter-over-quarter and year-over-year but have a significant reduction in net loss, down three times the sales increase quarter-over-quarter, finishing at a loss of under $1 million or $930,000. Our AVRL sales were up 4% quarter-over-quarter and 114% year-over-year and finished Q2 at $2.3 million, and distractions with the changes in distribution along with the focus on tying AVRL services with the instrument sales and spending less time on just selling AVRL services to non-instrument customers, meant less total selling time spend on AVRL in Q2.

We are committed to making AVRL a key part of our strategy, but in order for this to work, we need to tie both instruments and AVRL services together. This is a change from our previous quarters where setting up an AVRL customer without an in-house instrument purchase was encouraged. This is a deviation from our proposal of splitting the sample, doing your routine test in-house and sending out the specialty test to AVRL. Without the point-of-care capabilities in our new account, our solution is not compelling enough to satisfy some vet practices. So it is mostly a waste of time and expense to deviate from our complete solution.

Now even with these challenges, total worldwide vet sales grew 8% when compared to Q2 last year to finish at $38 million and we're up 4% versus last quarter. Domestic vet sales finished Q2 at $31.1 million, up 7% year-over-year and 4% quarter-over-quarter. Total sales for Q2 FY'14 finished at $45.9 million, up 4% year-over-year and 6% quarter-over-quarter. Worldwide medical sales for Q2 finished at $7.2 million, up 19% quarter-over-quarter, mostly due to higher sales to Abbott. Year-over-year, medical sales were down 10%, but if you exclude our first large CRO deal closed last year, worldwide medical sales will be down only 2%.

Domestic sales totaled $37.3 million, up 4% year-over-year and 8% quarter-over-quarter. International sales in Q2 finished at $8.5 million, up 2% year-over-year and flat quarter-over-quarter. However, international sales in Q2 last year included about $720,000 from our first large CRO account. So if that is excluded, international sales would have been up 11% year-over-year. European sales finished Q2 at $6.4 million, down 1% percent year-over-year, but ex the CRO deal they would have been up 10% versus Q2 last year. Pac Rim sales for Q2 totaled $2.1 million, up 13% versus Q2 last year.

Vet disc sales at 1 million units were down year-over-year by about 7% due to the imbalance of inventory in our distribution channel. This imbalance of vet disc inventory started with the addition of MWI and mostly affects our small partners. Their forecasts were wrong and they ordered too many discs in Q3 and Q4 last year, and now we are making the adjustments. Based on our internal calculations, actual shipments of discs to end users in Q2 FY'14 were approximately 1.2 million units, which were up about 8% versus Q2 of last year. In dollars, vet disc sales totaled $16.1 million, down about 5% versus Q2 of last year.

Medical disc sales finished the quarter at 635,000 units, up 10% year-over-year and 9% quarter-over-quarter. A pickup from Abbott was the main reason for the increase. In dollars, medical disc sales totaled $4.8 million, down 3% year-over-year, due to the lower average selling price to Abbott, but up quarter-over-quarter by 7% due to the higher volume. Total disc sales of 1.6 million units were down about 1% year-over-year and down about 6% quarter-over-quarter due to the issues discussed earlier.

Other vet consumable revenues that include, i-STAT, coag cartridges, rapid tests, and hematology reagent packs, finished Q2 2014 at $7.7 million, up 4% versus Q2 last year but down about 1% versus last quarter.

Instrument sales for Q2 finished very strong at 1,768 units, up 13% year-over-year and up 44% quarter-over-quarter. In dollars, instrument sales finished at $13.5 million, up 17% year-over-year and 56% quarter-over-quarter. The strong performance was due to higher sales to both Abbott and MWI.

In Q2, we sold 577 VetScans versus 572 in Q2 last year and 475 last quarter. We sold 480 hematology instruments versus 372 Q2 last year and 271 last quarter, and 242 Piccolos versus 259 Q2 last year and 126 last quarter. And finally, we sold 469 i-STAT and coag instruments versus 364 Q2 last year and 357 last quarter.

Now one word of caution when comparing instrument sales Q2 this year versus Q2 last year. We sold about 373 more units that went into the distributor inventory Q2 this year than Q2 last year. This change was due to a commitment made by one of our vet distributor partners for a year-end promotion that started this month and will run through December.

Now, 30% of our sales for the quarter were capital sales, about 70% were consumables and other. This compares with 26%-74% Q2 last year and 20%-80% last quarter. 19% of total sales were international while 81% were North American. This compares with 19%-81% Q2 last year and 20%-80% last quarter. 16% of total sales were medical sales, 83% were vet sales and 1% other. This compares with 18%-79%-3% Q2 of last year and 14%-84%-2% last quarter.

Disc average selling price finished Q2 this year at $12.80, down $0.41 versus Q2 last year and down $0.28 versus last quarter into lower vet disc sales. Disc cost for the quarter came in at $3.91, up $0.04 versus Q2 last year and up $0.01 versus last quarter, also due to lower volume. Disc margin finished the quarter at 69% versus 71% Q2 last year.

Our sales mix with higher instrument sales along with growth in the lower margin other vet consumable sales and fewer vet disc sales led to lower gross margins for Q2 this year, which finished at 47.7%, down from 52.2% Q2 last year and 48.4% last quarter. Once we fix the inventory imbalance and see shipments of vet discs back to normal, we expect gross margins to get back to the low to mid 50% level.

Operating expenses at $16.2 million were 35.3% of sales, were down from the adjusted non-GAAP operating expenses of 38.3% of sales which were adjusted due to the legal settlement in Q2 of last year, and down from last quarter's 37.7% sales. Excluding the adjustment due to the legal settlement in Q2 of last year, operating expenses finished at 45% of sales.

Sales and marketing expenses for Q2 2014 totaled $9.9 million or 21.6% of sales, and they were down from 26% of sales in Q2 of last year and down from 23.2% of sales last quarter. R&D expenses at $3.4 million were 7.5% of sales, were down from 8.1% of sales Q2 last year but up from 7.4% of sales last quarter. Admin expenses at $2.9 million were 6.2% of sales, were up from 6% of the non-GAAP admin expenses in Q2 last year but down from the 10.4% GAAP admin expenses Q2 of last year. Last quarter, admin expenses were 7.1% of sales.

Operating income totaled $5.7 million, up 67% excluding the gain from the legal settlement in Q2 of last year. After the adjustments for the legal fees and bonuses, non-GAAP operating income for Q2 last year was $6.3 million. Quarter-over-quarter, operating income was up 23%.

Pre-tax income finished at $6.2 million, down from the pre-tax income in Q2 last year that included the $17.25 million legal settlement and totaled $20.9 million. Excluding adjustments and legal fees and legal settlement, the pre-tax income for Q2 last year finished at $6.5 million. Quarter-over-quarter, pre-tax was up 23%.

Net income for Q2 FY '14 totaled $4 million, down from the GAAP net income in Q2 FY '13 that totaled $12.9 million and down slightly from the $4.1 million non-GAAP net income from Q2 last year. Earnings per share for Q2 FY '14 finished at $0.18 a share, the same as the adjusted non-GAAP earnings for Q2 last year. Quarter-over-quarter, net income was up 24%.

On the R&D side of the business, we have completed the development, clinical trials and submitted our [indiscernible] test to the USDA and look forward to clearance at any time. The development of the other three rapid tests is on schedule to be completed by the end of the calendar year.

We signed a deal with [Lambda Joan] (ph), a small company that has the technology that will allow us to do high sensitivity immunoassays on the disc. The feasibility has started, and if successful, we'll start on product development in about six to eight months.

Now going through Q3 include working with our vet distributors to help them manage their inventories so we can eliminate the imbalances that have existed over the last couple of quarters. In additions, we are working with all our partners to up their overall performance which includes working with our field sales team to optimize the selling process so it becomes more consistent with our new sales model of working through distribution partners. We are reorganizing field structure and are changing the comp plans on incentive pays, more aligned with our goals. More from Don in a few minutes.

Keeping the focus on our AVRL business is also a priority, not only growing sales but continue to make improvements in our cost structure. Our team in Kansas did a nice job last quarter reducing the loss to $1 million and now we need to make sure all new VetScan customers get a chance to experience the benefits of using AVRL along with the new Abaxis instrumentation. Q3 is usually a strong instrument quarter, so we should have more opportunities to promote AVRL this quarter.

On the medical side of our business, we continue to work on the four clinical research opportunities for the Piccolo, and as I indicated before, we did sell five Piccolos last quarter to a new CRO account. On the retail side of our medical business, we are training the folks at the validation sites for our first new customer this week and are working on helping them set up a couple more sites this quarter. More from Rick in a few minutes.

With that, Don, you're on.

Donald Wood

Good afternoon. The U.S. vet business continues to transition this quarter from primarily a direct sales model including working with local and regional distributors with less than 10% market share to a model with less selling direct and transitioning to a traditional distributor-partner model once we've added MWI, a national distributor, who currently has a 30% market share in the U.S.

Our transition has covered three quarters now and Q2 fiscal year 2014 revenues of $30.8 million was up 7% or $2.1 million year-over-year and we were up 4% or $1.3 million quarter-over-quarter. As you can see, results are improving as we continue to balance the distributor inventory mix and imbalances issues that Clint spoke about. We've begun meeting with our distributor partners to improve our performance back to double-digit growth model that we historically have been. Our new management team is busy delivering a new target list and opportunities to all our distributors along with new programs to offer a complete solution sale to the veterinarian. This has been viewed as good news by our distributors and there is much excitement going forward.

In additions to the 7% year-on-year growth in revenue, our highlights from our second fiscal quarter 2014 include, disc revenues up 39% year-on-year at $9.8 million; total instruments sold in Q2 was 1,201, up 22% year-over-year; and chemistry instruments up 12% on the year, hematology 17%, and i-STAT instruments up 119%. Our national accounts revenue was trending nicely and is up 89% year-on-year and 32% up quarter-on-quarter, demonstrating the hard work is paying off into this segment of the market. We expect further good news as we explore additional opportunities.

AVRL with net revenues of $2.3 million was up 4% or $97,000 from the prior quarter and 114% versus year ago. Additionally last quarter, 212 facilities combined instrument purchases with one of our AVRL programs accounting for 332 instruments sold and $2.4 million in our instrument revenue, and I'm very excited about the expense controls leading to a large reduction in our net loss. AVRL is the leading focus for our new management team going forward and we are expecting improved results over the next few quarters.

AVRL has also successfully completed the bidirectional interface with AVImark, the largest practice management system provider to the veterinary industry, covering an estimated 30% of all vet clinics nationally. This allows AVRL to integrate into their laboratory management system to streamline ordering of tests, results reporting and automatically delivering the results to the vet and invoice to patients for those services. This additions will improve our opportunity to add new customers to AVRL.

Finally, I wanted to update you on organizational changes in the North American Animal Health business unit. With the retirement of our Chief Commercial Officer, Mr. Marty Mulroy, we have promoted Dr. Craig Tockman to lead our vet sales group and he will be responsible for all outside sales activities. Craig has been a veterinarian since 1989 and grew his practice into five locations. He has been with Abaxis for over 12 years where he developed utilization programs for our customers, created training programs for our sales teams, participated in multiple product launches including AVRL where he represented the voice of our customer. He also managed a field sales team leading them to a number one position in the country. He's been riding with our sales team for years helping them in their performance and adding to their success.

David Bannister has been with Abaxis for over six years as a Director of Customer Care and has developed an incredible customer focus team here at Abaxis. David has over 36 years of experience including the past 28 years specifically in medical diagnostics segments for laboratory diagnostics. David will be in charge of all inside activities in Union City. Both Craig and David will report directly to me and they both demonstrate the strong bench that we have built here in Abaxis and with them our future very strong. Our distributors and our sales force are very excited about the changes and we look forward to nothing but great results from Craig and David. Thank you.

Clinton H. Severson

Great. Thank you, Don. Okay now, Rick, you're on.

Rick Betts

Thank you, Clint. Good afternoon all. For the quarter, the domestic medical division finished with revenues of $5.07 million, up 36% from $3.71 million in the previous quarter but down 3% from last year. The quarter yielded 119 Piccolos that were put into use and 540,000 reagent discs consumed. The Piccolo total includes 155 placed by Abbott with the remainder being spread across our Canadian clinical trials, the cruise line and retail health businesses. More on those respective areas in a moment.

Abbott's progress grew nicely overall this quarter. Their sales included a large placement of over 30 instruments to a single urgent care customer further illustrating that the Piccolo continues to be the standard of care in the expanding urgent care segment. Now nine months into selling the Piccolo, Abbott sales organization is becoming seasoned with the product and the positioning in the POL market. The Abbott sales engine has a ton of horsepower, and through an increased marketing effort as fuel, we expect the acceleration to continue.

Our heightened focus in Canada is paying dividend and the market acceptance of the Piccolo product continues to rise. In half a year, we already have more new customers up North and double the revenue from the entire previous year. With a provincial RFP concluding and our Class 3 submission to Health Canada completed, we expect this upcoming quarter to be a very exciting one for the Piccolo in Canada.

In the clinical trials market, we closed and engaged a substantial pilot with one of the world's largest clinical trials laboratory in partnership with a very large and respected pharmaceutical company. As Clint mentioned, this pilot contains five sites, four in the U.S. and one in the U.K. The Piccolos were purchased for this pilot and it is short in duration, months versus years. When complete, it will prove with actionable metrics the Piccolo's value to the patient recruitment aspect of clinical trials initiation. This pilot served as the second major proof point for the Piccolo's utility in clinical trials and with our growing pipeline of interested organizations, we are excited about what the future holds for this segment.

On the retail health front, we executed a confidentiality agreement with the new customer we mentioned last quarter. While we won't be able to mention the names or specifics moving forward, I can say that the initiative is underway and progressing nicely. As Clint mentioned, the sites are installed, the operator trainings are in progress, and the initiative is expanding to other areas of the country as the pharmacy chain prepares itself to take the lead in the process of Obamacare world.

Thank you and I'll now turn it back over to Clint.

Clinton H. Severson

Great. Thank you very much, Rick, and now we're open for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question will come from Ross Taylor of C.L. King. Please go ahead.

Ross Taylor - C.L. King & Associates

It's a lot of information to go through, but I'll just start off on the VetScan rotor inventories or maybe just the vet consumable inventories in general, I mean the imbalances that you have now, is that kind of driven by the addition of MWI nine months ago or are there other factors that work, that caused some of those inventory imbalances at the small distributors?

Clinton H. Severson

I think the small distributors when they put in their quarterly forecast in Q3 and Q4 did not expect the kind of competition that they got from MWI and their response to the competition was less than our expectations as far as their ability to protect their business, and they didn't do a very good job of protecting their business. So the consequences for that are clearly, they're going to get less gross margin, they're going to get less participation if they don't pick up the pace, and so I think the ability of them to respond to this was totally tied to their overconfidence and their customer base is going to be loyal to them. And I think that our response to their lack of response was not up to speed as well, that we should've pushed harder to make sure that they clearly understood that it wasn't going to be as easy as it looked in the past when the distribution of our veterinary consumables was very limited out there. And so it went from very limited availability to availability from a large national distributor, which some of these guys didn't take seriously, and so that's what happened.

Ross Taylor - C.L. King & Associates

Okay. And this might be a hard question to give a concise answer to on this call, but how do you go about working with all your distribution partners, North American vet, retail, but just all of them, in driving their business so that you actually get some incremental growth from the change in distribution that occurred at the beginning of this year? And maybe a little bit related to this question, my first question is, I think you alluded to it may take another two quarters or so to work through the rotor or the consumable inventory issue. Is there anything with expiration date that maybe will kind of help keep that short or make the people get those out into the market?

Clinton H. Severson

Yes, I think the first thing you need is a very clear communication to the distributor partners that you have that they've kind of dropped the ball, and in the beginning our communication wasn't that clear to them, it didn't get very clear until July, and then there was issues with denial and those kinds of things, and of course now we've got everybody's attention because clearly when they lose a customer not to a competitor but – I mean a competitor product, but to a competitor distributor, that clearly affects their businesses.

And so, the first thing you do is you get agreement that we have a problem. The second thing is to identify how big the problem is. And then the third thing is to put programs in place to get your business back growing again. And so we've been meeting with our smaller partners. They clearly understand where they are at, at this point in time and they are responding to us by putting together proposals for programs that they are going to implement in the next couple of quarters to turn that around, and we are supporting them with extra support when they are successful and we're not supporting them with extra support when they are not successful.

So I think we have a clear understanding where we're at, we have a clear understanding of what needs to happen and we're in the process of putting the implementation plans in place, and I think that they have a very good chance of picking up the pace and getting back to where they were going before. It's just a matter of focus and determination to do it and that's what we're doing.

Now, as far as whether it's one quarter or two quarters, there are expiration dates on this stuff. So clearly there are products that will expire if they bought it in Q3 of last year and they haven't sold it by Q3 of this year. And so clearly that will make a difference in our sales but our interest is getting our smaller distributors up to speed back growing again and competition should make them better, and I think overconfidence was the problem in the early days.

Ross Taylor - C.L. King & Associates

Okay. And just two other questions. It sounds like you're trying to do some sort of emphasis or promotions related to AVRL which I think you alluded to the fact that you would like each of your new VetScan buyers to also have an opportunity to experience AVRL, and I just wondered if there's some kind of co-promotion activity that's being done specifically in that regard. And then my last and final question is, I think Rick alluded to your retail clinic partner potentially expanding this to other parts of the country and I just wondered if you could give a little color on that.

Clinton H. Severson

Okay, so I'll let Rick go first and then I'll go next.

Rick Betts

Sure. So, just a little color on that since we do have the confidentiality agreement, I did mention that it is expanding to the other areas of the country. The part of the country that they are working with now is the West Coast, and so they are going to implement something additionally on the East Coast here during this pilot phase timeframe.

Clinton H. Severson

Okay, and what was your first question again, Ross?

Ross Taylor - C.L. King & Associates

It sounded like you were going to do some kind of co-promotion that stand with AVRL.

Clinton H. Severson

Okay, so along with some of the disruption and the big changes with direct sales to distributors sales and some of this negative surprises that some of our management people will experience because they never expected it would be a challenge to do this. The message to the field sales force regarding AVRL got a little bit mulled along the way as well, and as I indicated before, starting – when you're doing a demo for a new account, you start with a VetScan, you end with AVRL, and there are lots of advantages for a customer that approaches Abaxis instruments to do a deal with us on AVRL both from a financial point of view, from a service point of view, from even the pictures that we include with some of the results are very helpful for the veterinarian when counselling with the pet owner on whether to treat or not to treat.

So there's always advantages and we had – some of our salespeople actually do that. With every instrument sale, they are presenting the AVRL solution, and then we've got others that were spending more time trying to chase AVRL business in accounts that don’t have our instrumentation just to hit a number. And so the message to the people wasn't as clear as it really needs to be. And so we're clearing that up now with the changes that we've made in the management and I think the people that have had a lot of success in AVRL is because of the tie-up with the instruments and those stories need to get out to the field as well as to our existing customers that already have our point-of-care estimates. So this is part of the whole change that we're going through here at Abaxis but we expect it to pickup next quarter.

Ross Taylor - C.L. King & Associates

Alright, thank you. That's all my questions. Thanks.

Operator

The next question will come from Jim Sidoti of Sidoti & Company. Please go ahead.

Jim Sidoti - Sidoti & Company

Let's start with the VetScans, I believe you said that you sold 577 this quarter versus 572, is that right?

Clinton H. Severson

Yes.

Jim Sidoti - Sidoti & Company

Now you said something about some of those went into a distributor. Can you just elaborate on that?

Clinton H. Severson

Yes, so we've changed our model here at Abaxis from mostly direct sales to mostly sales through distributors. And so this involves with distributors taking inventory that normally when we are selling direct, there was a lot less inventory that was taken by distributors. So this is a change. So while we need to be – we disclose a lot, we do a lot of disclosure here and I do a lot of disclosure to make sure people understand where we're at.

Now the downside of doing a lot of this disclosure is we have competitors that are on the other line listening to all the things that we are saying. So there's a limit to the amount of disclosure that I can really give and remain competitive in the marketplace. But we sell a lot of vet instruments now. We have the VetScan, we have the hematology machines, we have the i-STAT machine for blood gases and we have the coag machine.

And so, when I say that 373 more units went into distributor inventory Q2 this year versus Q2 last year, it's all those instruments, it's not just the VetScan, it's a combination of them. So, while I don't want to not be completely transparent, there's a limit to what I can talk about. And so I just want to caution everybody that we do have a change in the way we sell our product, and in some cases where there is big promotional activity going on, a distributor may choose to have enough inventory so they can ship immediately, overnight, whatever, and in case of a aggressive type of promotion, they may want to have the product on the shelf so they can implement at their speed.

And so I just wanted to caution everybody that this is taking place. The year-end, December quarter, is a big instrument quarter and it's not only Abaxis that uses the advantage that you have from the taxman to buy an instrument, other companies do the same thing. And so, that's the reason the 373 more this year than last year went into inventory.

Jim Sidoti - Sidoti & Company

Okay. So I guess that you might see a small drop in VetScan placement this next quarter but nothing too drastic?

Clinton H. Severson

Yes, see I think it depends on how well they do. So if they do really well with their promotion and we get a lot of momentum going, the sales may go up, who knows, I mean you really don't know because again we're still transitioning through this process.

Jim Sidoti - Sidoti & Company

Okay, and it sounds like similar to last quarter, MWI was up quarter-over-quarter but the small distributors were light again on the vet [indiscernible].

Clinton H. Severson

Yes, but they are like…

Jim Sidoti - Sidoti & Company

Okay. MWI started it. In the first quarter, it ordered around 6 million, it's gone up every quarter since then. Do you anticipate that levelling off or you think they'll continue to accelerate?

Clinton H. Severson

I think clearly it depends on the combination of not only their individual performance but clearly the performance of our sales team out there in assisting in these new instrument sales, and also the performance – are the little guys going to pick up the pace a little bit. I think you know the whole process of working through distribution versus doing direct sales as I think I mentioned last quarter is going from kind of a cowboy mentality where you get up Monday morning and you knock on doors and you do demos, you'd bicker on the price, you close deal, and there's not a lot of analytical work and there's not a lot of work with other salespeople, you kind of do it on your own, and working through distribution is totally different. You got to do more analyzing of the territory, identifying the prospects that are likely to buy a VetScan or hematology machine or whatever over the next 12 to 18 months, meet with your distributor rep, share with them what your goals are, what you're trying to do, and then solicit their help in meeting some of the objectives you believe need to be met to make a deal happen. And so this whole process is something that our salespeople are figuring out and I think we were too slow, we didn't respond quick enough, and that we're picking up the pace now.

Jim Sidoti - Sidoti & Company

Alright. Let's switch over to the medical side, you mentioned the change in strategy with Abbott. Timing-wise, when should we expect you to announce the distributor in China and start to have some business there?

Clinton H. Severson

Okay, so China is very complex and there's been a lot of changes in the distribution over the last I would say six to nine months. So we're interviewing potential distributors. Vladimir has been doing this for the last few weeks I guess. And so finding the right partner is the most important thing for us. And so once we identify somebody that we believe can be effective long-term, we'll sign them up. Until we find somebody that we believe long-term will be an effective partner for us, we're going to wait, we're going to wait till we find the right party.

Jim Sidoti - Sidoti & Company

You think you'll have likely in place by the beginning of fiscal 2015?

Clinton H. Severson

Well, I would say that that's a strong possibility, yes. And given the size of the country, it is very likely that we'll have multiple partners.

Jim Sidoti - Sidoti & Company

Okay. That makes sense. And you also think you'll have some revenue from your pharmacy partner in fiscal 2015?

Clinton H. Severson

We do, absolutely.

Jim Sidoti - Sidoti & Company

Alright. And then finally, Abbott, now it's nine months since that agreement was put in place, and I assume that in the U.S., that that agreement is still in place. So, I would imagine that for the fourth quarter, if they want to hit the minimum, they're going to have to pick up the pace quite a bit. That sounds reasonable?

Clinton H. Severson

Yes, I mean I think the response from Abbott has been very positive. I think the slow start was something I fully expected and I think they've picked up the pace and I think they are doing fine. So I mean clearly the objective here is, what is the long-term opportunity with Abbott, and by long-term I mean three to five years, what is the three to five year opportunity? And so we know what the last nine month opportunity was and that's not very attractive to us, but the three to five year opportunity right now looks very attractive to us.

And so the question is, can we rely on the expectations that three to five years is going to come out the way we expect it to and we monitor on a quarterly basis. So on a quarterly basis, we monitor. So Rick meets with the Abbott people every quarter to review what happened, what worked, what didn't work, what we can do to support their efforts and what's the forecast for the next quarter and what the three to five year outlook appear to be right now. And as long as that is where we believe that can be, we're happy.

Jim Sidoti - Sidoti & Company

Okay, but was there a minimum order that they were obligated to buy in calendar…

Clinton H. Severson

Yes, there are minimums in the contract, yes.

Jim Sidoti - Sidoti & Company

Okay, and I assume based on their performance the first three quarters of the year that they were behind schedule?

Clinton H. Severson

We don't disclose what the minimums are in the contract, but I can tell you their start was slow.

Jim Sidoti - Sidoti & Company

Okay, so if the start was slow in their minimums, you would think that by the end of the year, they need to pick things up?

Clinton H. Severson

Yes, I mean I think again it's clearly the outlook for the next three to five years is what I'm interested in, when it's finished what does it look like, and right now the outlook for the next three to five years looks very good. And so we're just in the very early stages of this thing. So the minimums just give you an opportunity to renegotiate the contract should you not believe in the next three to five years. So if you don’t believe in the next three to five years, then the missing minimums allows you to renegotiate the deal. But if you believe the next three to five years meet your expectations, then there's no incentive to renegotiate the agreement.

Jim Sidoti - Sidoti & Company

Okay. So my next question, I just want to make it clear, as we look out into the fiscal 2015, you should have more revenue from Abbott, you should have potential revenue from CROs and potential revenue from the retail opportunity, the pharmacy opportunity, so you would think in 2015 that medical business should pickup quite a bit?

Clinton H. Severson

We do.

Jim Sidoti - Sidoti & Company

Okay, alright, thank you.

Operator

The next question will come from Erin Wilson of Bank of America Merrill Lynch. Please go ahead.

Erin Wilson of Bank - America Merrill Lynch

In the past you've given us some more information on volume trends and number of customers in AVRL, could you provide us I guess just more metrics there and how is your overall retention rate with the offering?

Clinton H. Severson

So I think the retention rate on the customers that have the point-of-care products is very good. I mean it ties in together beautifully. You do your routines, you get the results immediately, and then the specialty tests, we can get service, sometimes better than the incumbents. I think it's very good. I think when we go in and we sign up an AVRL with a customer that does not have the point-of-care equipment, we tend to get some of the specialty test. So the customer doesn't really go away. It's just that they are doing business with a competitor at the same time.

So that type of a customer doesn't really generate the kinds of revenues that make it that interesting for us to go out and solicit, even though there are exceptions to that rule like there are exceptions to every rule. And I think so the important customer growth that we had last quarter, the important ones are the ones Don disclosed in his little talk, and it was 200 and some VetScan instrument customers that signed up with AVRL. Those are the important ones. Did I answer your question?

Erin Wilson of Bank - America Merrill Lynch

Yes. And on the gross margin, how should we think about the quarterly progression, can you sort of rank the puts and takes with regard - I know a lot of it is volume driven but if there's any other factor you'd consider?

Clinton H. Severson

No, I think the gross margin next quarter goes up, the quarter after that goes up, the quarter after that goes up. Clearly I'm guessing because I don’t know what the revenue numbers are but we believe it goes up from here.

Erin Wilson of Bank - America Merrill Lynch

Okay. And I guess switching or speaking to the human health care segment, I guess in your view, does the recent partnership between Walgreens, their clinic and a smaller diagnostic company in your neighborhood, does that sort of underscores the value proposition of the point-of-care testing model in the retail channel and as well just some more efforts with CVS?

Clinton H. Severson

We believe it does. I think it shows, the Walgreens announcement shows that they are looking at what can be done to serve the patient in this Obamacare world. There's going to be a tremendous amount of patients that are hitting the primary care marketplace and companies like the Walgreens of the world, Target stores, CVS, all of those retail health providers are readying their organization to handle that influx of patients. So we do believe that it's going to be a growing market and the frontline of care, the future of care in the United States. That answered your question?

Erin Wilson of Bank - America Merrill Lynch

Yes, thanks so much.

Operator

Our next question will come from Nicholas Jansen of Raymond James. Please go ahead.

Nicholas Jansen - Raymond James

Maybe if you can just update on the rapid assay front? I know you were looking to have a couple of new tests approved by year-end, maybe just your timeline on those and your expectations going forward as those reach the market with your larger distribution partner?

Clinton H. Severson

So the [indiscernible] test has been developed, the clinical trials have been done and it is at the USDA. We have three other tests that we're working on. The schedule is for them to be developed by the end of the calendar year, and either submitted in December or in early January and right now we are on schedule.

Nicholas Jansen - Raymond James

That's it for me. Thanks guys.

Operator

The next question will come from David Clair of Piper Jaffray. Please go ahead.

David Clair - Piper Jaffray

So first question for me, just if you think about all the distributor things that are going on, if you normalize for everything, do you think that the MWI agreement has led to share gains for Abaxis?

Clinton H. Severson

Clearly when you look at end user disc sales on the vet side, they were up 8%, and we continue to sell instruments versus competition giving instruments away for free. So I think that they change with a disruption to our field organization that did not expect things to be materially different but they were materially different. And so that was the management failure, it's really what that was. I'll take responsibility for that. But I think now we have a management team with Craig and with David and Don, they clearly understand it and we're in the process of working it through the organization.

So I think we're still gaining share out there, probably not as much as we were before because of this transition, but we have targeted a lot of customers out there, in the thousands that we believe that we can sell the VetScan to if we can get in to do a demo. And so clearly communicating that to our distributors, our little ones and our big ones, and sharing with them our approach, why we think a VetScan is a better approach for this particular practice. And what we need them to do to help us get in there to share the information with the account so they can make a decision in their self-interest what's best for them. I mean that's really what we do in our field sales organization today versus what we did before which was kind of get up in the morning and knock on the door and do the demo and bicker on the price and all that kind of stuff.

So it is different but I think all of our distributors now are on board with what needs to be done and I think we're going to have a distribution network out there that's more competitive, that's more goal driven, and I think the fact that the consumables were lightly distributed in the past led some people to believe that they were entitled to a certain amount of business whether they protected it or not, and of course that's not the case. So I think that as we come out the other end of this, we're going to be stronger and better, more aligned with, our targets are going to be clear, everything's going to be more clear in a quarter or two.

David Clair - Piper Jaffray

Okay. And then on the medical side, I guess a couple of questions. So do you think that Abbott sales team is fully ramped now, do you think they are kind of fully trained and they are basically making a full effort to sell? And secondly, the way that the arrangement is designed, is there any kind of out for Abaxis if a year or two down the road it isn't living up to your expectations?

Clinton H. Severson

The second part of your question is, absolutely there is. So we have a contract that has minimums in it, the things they have to meet, and if they don't meet them, there are alternatives for us. And of course if we don't – if we get to the point we don't believe in the next three to five years, I mean clearly that renegotiation will take place. At this point in time though based on their increased performance and based on some of the things that we know that everybody else in the world does not know because we are under confidentiality, we believe that the strategy that Abbott has is a solid one, a really good one. And we think that together with Abbott and the other things that they are doing, is going to be a huge benefit to Abaxis and we're going to sell thousands of Piccolos.

And I think – now while I did not listen to the Abbott call, I did read part of the transcript and clearly point-of-care was mentioned in their call a number of times. And of course point-of-care strategy in the medical market without chemistry is not going anywhere. And so our Piccolo I think will be very important, I'll let Abbott speak for themselves, but my opinion is it's going to be very important as they roll out their new initiatives. And so I believe the next three to five years look really attractive.

Rick Betts

The first part of your question was about the sales people. So yes, so the Abbott sales organisation, we've been working with every one of their sales representatives and their sales leadership since they took over selling the product in January of this year, and it's been nine months. I can't say enough about the sales team. They are a team of professionals that rivalled the professionalism of our own sales team. They've done a great job in assimilating the product and their sales organization is like any other sales organisation where they'll have some key performers who get it early and are out, don't need any help moving forward, and then there's just some of those folks that do need a little bit more boosting and education to gain a level of competency in selling. So for the most part however though, Abbott sales team has assimilated the product and their mission ready to sell and are doing so on a regular basis.

David Clair - Piper Jaffray

Okay, thanks for that. And then just one last question, you continue to build up a nice stockpile of cash, any plans for that, Clint?

Clinton H. Severson

So at every Board meeting we discuss things that potentially we can do to enhance our shareholder value. We discuss buybacks, we discuss dividends, and I'll be bringing that up on the agenda for our Board meeting that convenes tomorrow, and we have, right now we have authorization for a buyback I think of $40 million. So yes, we will be having those discussions at the Board meeting tomorrow.

David Clair - Piper Jaffray

Thank you.

Operator

(Operator Instructions) The next question will come from Jon Block of Stifel. Please go ahead.

Jonathan Block - Stifel Nicolaus

I think the first one, Clint, can you provide the revenue or the approximate revenue associated with that 373 instruments that went into distribution?

Clinton H. Severson

Yes, it's actually really easy to figure out, Jon. You take the 1,700, then you take the $13.5 million, divide it by 1,766 and you get an average number and then you multiply that times 373 and there you go.

Jonathan Block - Stifel Nicolaus

Fair enough, but I guess I'm trying to figure out – I understand the basic math, but I'm just trying to figure out if it was weighted more towards VetScans versus i-STATs versus coags, so that's why I'm asking you for the exact amount that you may have in front of you.

Clinton H. Severson

So didn't calculate the dollars myself but it's all of them, it's everything. It's not – I mean I don’t have the exact number in front of me out here but based on what was ordered, it was all of the above.

Jonathan Block - Stifel Nicolaus

Okay, perfect, thanks. And then you mentioned the reason why you wanted the distribution, someone clearly wants to maybe get a little bit more aggressive and do a promo, have you guys given any thought about giving the AVRL rights to distributors to sell them? I mean you mentioned how it's important to try to bundle, that's where you seem to be having the most success, the retention is the highest, is it something Clint that you would handover to a distributor to try to get a little bit more traction with AVRL?

Clinton H. Severson

Yes, there's been some debate in-house on using our distribution to help us present the AVRL solution, and I think Don is actually looking at that. He's going to be meeting with some of our distributors over the next couple of months and that's a subject that they are going to discuss. I think that in most cases, our salesperson is the one that assist in the closing of the sale. Certainly our salesperson does the demo. And I think it is important that we incentivise, and this is something that we really haven't done a very good job of in the past few quarters, incentivise our salespeople to sell a VetScan as they get so much money for a VetScan, but if they tie it to an AVRL contract that sticks, they get more.

And so these are the kinds of incentives that Don and his team are putting in place to drive our goals because I think some of the incentive programs that we have here for our field salespeople were more tied to a direct model than they were to the distributor model, which was clearly a management error. And so I think those two things will pick up the pace at AVRL.

Jonathan Block - Stifel Nicolaus

Okay. And maybe just two more if I may. What I was startled with a little bit is, you mentioned the little guys picking up the pace, they were surprised with the success of MWI and they were a little bit blindsided by that and they need to pick up the pace going forward, why do you have conviction that they can do that? In other words, do you believe that these guys have the ability to successfully move market share and what are you doing to help that occur? Are you working closely hand in hand with them and do you see them starting to have that ability to actually move share to you guys, because they weren't focused on that before, they were just order takers?

Clinton H. Severson

Okay, so they weren't really just order takers, they just really didn't depend their business, they depend their business. So if you move from an environment where Abaxis consumables are not widely distributed because none of the national distributors carry the products, so they are not widely distributed, it's easy to get complacent because the orders just keep coming in, you don't have to really go out there and make sure your customer is happy with your service, make sure your delivery is competitive with the other guys' delivery, make sure that you haven't overpriced your products, all those kinds of things, they just kind of went in and took the order and everybody was pretty happy.

Okay now you add a national distributor that has more capabilities of more market coverage and be happy to target some of your accounts and you are laying down. That's pretty easy picking for a large distributor, a sophisticated distributor, and whereas if you would've been on the ball, then they probably wouldn't have been able to do that because we don't want them doing that. We want them going out selling new customers, not picking off our little distributor customers. So clearly there was a lapse in execution by these people.

Okay, another thing is, we have somewhere high 20s, low 30% market share. This 70% of the market out there we have to go, and when we were focused mostly on direct sales, we were kind of doing everything ourselves when it came to new instrument sales and we weren't really including our smaller distributors very much, so only about 15% of our instrument sales in the past were through distribution. And so there wasn't – so a lot of the skills in selling instruments was kind of lost over that period of time. So when in fact, there's a lot of things that our smaller distributors can do to help us break into an account that for whatever reason we can't get in there but they might have some contacts to get in there and none of that was utilized. So we weren't utilizing any of that.

So we have a new kind of a new game going on here where our salespeople now have to manage their territories differently and we will include our small distributors along with MWI in our plans for each sales territory because every one of our salespeople has a list of customers that they believe would be better served with a VetScan than what they are doing, better served with AVRL than what they are using, and all we need to do is get in there and make our proposal.

Jonathan Block - Stifel Nicolaus

Got it. And last one for you, I don't even talk about another quarter of inventory to stocking, but I am a bit surprised that you think there's still another quarter or two left in the channel, and so can you just talk to what you expect maybe over the next six months if we isolate the vet consumables, should we actually be thinking about those numbers being down year-over-year for the next one to two quarters, thanks guys?

Clinton H. Severson

So we don’t know for sure honestly. We're still working through this, but generally we operate conservatively here. So that's why say we'll probably have a quarter or two to go, and whether it is a quarter or two or not, I'm not really sure because we really don't guide, but if it's less than a quarter or two, we'll be very pleased to announce better results than what people expect. But clearly by the end of our fiscal year, we'll be out of this, we'll be back to normal and we'll have a field sales team that's hitting on all cylinders working in the new environment.

Jonathan Block - Stifel Nicolaus

Clint, very last one if I can I promise, I think last quarter, like you said you don't guide but you still talk to the bottom line growing or alluded to growth year-over-year, are you still confident with that occurring here in fiscal 2014?

Clinton H. Severson

So with the revelations that have come about over the last couple of months, I'm not really sure. So I think that I haven't given up on growing this thing year-over-year at the end of the year but we've got half the year to go, we've got half the year left. And clearly it's going to depend on how effective Don and Craig and David are now at getting people picking up the pace, and I think on the medical side, all the work that's being done with retail and with clinical research and with the opportunity we have in Canada and the stuff that's going on in Europe, I mean clearly those are huge upsides that are probably not going to happen this fiscal year. Now some of it is going to happen this fiscal year but not the really big numbers. So we don't guide and we're sticking with that and we do the best we can to run this business for the more biased towards the long-term than just a short-term number.

Jonathan Block - Stifel Nicolaus

Understood. Thanks Clint.

Operator

Ladies and gentlemen, this will conclude the question-and-answer session. I would like to turn the call back to Mr. Severson for his closing remarks.

Clinton H. Severson

Great. I want to thank everybody for tuning in and thank the new domestic sales and marketing team, Don, Craig and David, thank them for their efforts and putting everything together over the last I guess 10 or 12 days. I think they are doing a great job and I look forward to talking with everybody in our January call. So thank you very much for tuning in.

Operator

Ladies and gentlemen, the conference has now concluded. We thank you for attending today's presentation. You may now disconnect your lines.

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Abaxis (ABAX): FQ1 EPS of $0.18 misses by $0.03. Revenue of $45.9M (+4% Y/Y) misses by $2.7M. (PR)