Abaxis, Inc. F4Q10 (Qtr End 03/31/10) Earnings Call Transcript

May. 3.10 | About: ABAXIS, Inc. (ABAX)

Abaxis, Inc. (NASDAQ:ABAX)

F4Q10 (Qtr End 03/31/10) Earnings Call Transcript

April 29, 2009 4:15 pm ET

Executives

Joe Dorame – IR, Lytham Partners

Clint Severson – Chairman and CEO

Martin Mulroy – VP, Veterinary Sales and Marketing, North America

Brenton Hanlon – VP, Medical Sales and Marketing, North America

Al Santa Ines – VP, Finance and CFO

Vladimir Ostoich – VP, Government Affairs and VP, Marketing for the Pacific Rim

Analysts

Jim Sidoti – Sidoti and Company

Jonathan Block – SunTrust

Ross Taylor – CL King

Albert Almond [ph]

Operator

Good afternoon, and welcome to the Abaxis fourth quarter and fiscal year 2010 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. Please note this event is being recorded.

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

Joe Dorame

Thank you, Ryan. Good afternoon. Thank you, for joining us today to review the financial results for Abaxis for the fourth quarter and fiscal year 2010 ended March 31st, 2010. Again, my name is Joe Dorame. I'm with Lytham Partners and we are the financial relations consulting firm for Abaxis.

On the call today are Mr. Clint Severson, Chairman and Chief Executive Officer, Mr. Al Santa Ines, Chief Financial Officer, Mr. Donald Wood, Chief Operations Officer, Mr. Martin Mulroy, Vice President, North American Health Sales and Marketing, Mr. Brenton Hanlon, Vice President, North American Sales and Marketing. At the conclusion of today's prepared remarks, we'll open the call for a Q&A session.

I'd like to remind everyone this 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, market acceptance of new or planned product offerings, process improvements and product manufacturing quality and efficiencies in future production of company products.

Abaxis claims 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, believes, 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 market acceptance of the company's products and continuing development of its products, required FDA clearance and other governmental 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 with entering the human diagnostic market on a larger scale, risks related to the protection of the company's intellectual property or claims on infringement of intellectual property asserted by third parties, risks related to the condition of the United States economy, risks involved of carrying inventory and other risks detailed under Risk Factors in the company's 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 statement was made. Abaxis does not undertake and specifically disclaims any obligation to update any forward-looking statements.

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

Clint Severson

Thank you very much, Joe. Good afternoon, everybody. I will review the accomplishments and the challenges for Q4 2010 and the fiscal year as well as some of the goals for fiscal year 2011. Then after my short presentation, I'll ask Marty Mulroy, our VP of North American Vet Sales and Marketing and Brenton Hanlon, our VP of Sales and Marketing from North American Medical to give an update on their respective businesses. We will then take questions.

Clearly, the challenge for Q4 was net income. Q4 net income per share was flat year-over-year, mostly due to higher operating expenses. We finished Q4 at 42.1% of sales and include a $1.5 million non-cash stock compensation charge and lower gross margins due to sales mix, higher non-cash compensation charges, a higher incentive pay for year-end bonuses.

While most of these are temporary, we believe the mix of lower OEM products will negatively affect gross margins next year. However, if we can manage the sales and marketing costs operating margins should continue to expand.

Q4 '09 operating expenses were 39 – Q4 '09 operating expenses were 39.8% of sales and the total cash stock compensation charge last year was 443,000. Our net income per share for Q4, excluding the charge would have finished at $0.16 versus $0.12 reported today and we'll talk more about this later on the call.

We finished the quarter and the fiscal year with record sales. Q4 sales totaled $33.7 million up 28% year-over-year and up 8.6% quarter-over-quarter. For fiscal year 2010, total sales were up 18%, finishing at just 125 – just under a $125 million.

Record Vet sales for Q4 at $25 million were up 28% year-over-year and 5% quarter-over-quarter. For the year, total Vet sales finished at $92.4 million up 25%, an excellent performance considering this difficult market.

Total North American sales for Q4 finished at a record $27.6 million, up 24% year-over-year and up 10.8% quarter-over-quarter. For the year, North American sales hit a milestone totaling more than $100 million for the first time, finishing at $101million 4000,000 up 15% year-over-year.

Total international sales for Q4 of $6.1 million were up 48% year-over-year and flat quarter-over-quarter. For the year, international sales were at record levels totaling $23.2 million up 30%. European sales for Q4 totaled $4.8 million, up 50.9% year-over-year and flat quarter-over-quarter. For the year, European sales finished at $18.5 million, also a new record up 32%.

Pac-Rim sales for Q4 finished at $1.2 million up 38% year-over-year but down about 2% quarter-over-quarter. For the year, Pac-Rim sales totaled $4.6 million, also a new record up 24%.

Worldwide medical sales for Q4 finished at $6.9 million up 36% year-over-year and up 33% quarter-over-quarter, a positive indicator our new strategy is working. For the year, Medical sales totaled $24 million, down about 2.5% but at a level we can clearly build from.

Government sales for Q4 finished at $774,000 up 9.6% year-over-year and up 64% over last quarter's depressed levels. For the year, government sales totaled $3.6 million down 19.5%, mostly due to lower instrument sales in Q3 and Q4.

Total instrument sales in units finished very strong for the quarter at 1,065 units up 350 units or 49% compared to Q4 last year. In dollars, total instrument sales finished up 36%. Slightly lower average selling prices on chemistry instruments and a mix of lower priced I-Stat and co-ag units were the reason for the lower percentage increase in dollars. For Q4, we sold 399 VetScans versus 345 last year and 572 last quarter. For the year, we sold 1,722 VetScans, up 13%.

We sold 236 hematology instruments versus 177 Q4 last year and 256 last quarter. For the year we sold 894 hematology instruments up 11%. We sold 150 Piccolos, including six units to the government versus 96 Q4 last year and 134 last quarter. The run rate of non-government Piccolo instrument sales is as follows, Q4 '09 82 units, Q1 2010 88 units, Q2 '10 168 units, Q3 2010 130 units and Q4 144 units. So far, we're seeing a nice quarter-over-quarter build. For the year, we sold 576 Piccolos down about 19% due to the change in strategy.

And finally, we sold 288, 280 co-ag and I-Stat units versus 97 Q4 last year and 250 last quarter. For the year, we sold 844 co-ag and I-Stat instruments versus 97 in fiscal year 2009. For the year, we sold a total of 4,036 instruments up 29% or 897 units.

The total disc sales were also at record levels, finishing Q4 at 1.542 million units up 14% year-over-year and 21% quarter-over-quarter. In dollars, disc sales finished Q4 up 12% year-over-year and 17% quarter-over-quarter. For the year, total disc sales totaled 5.731 million units up 9%. In dollars, total disc sales finished up 12%.

Medical disc sales had 582,430 units for Q4 2010, a new record were up 41% year-over-year and 51% quarter-over-quarter. For the year, Medical disc sales totaled 1.888 million units up 10% and Vet disc sales finished at 3.844 million units up 8%.

22% of total sales were capital sales while 78% were consumables. This compares to 21/79 Q4 last year, 27/73 last quarter. For the year, the mix was 23/77. 18% of total sales in Q4 were international sales while 82% were domestic. This compares with 16/84 Q4 last year and 20/80 last quarter. For the year, international sales represented 19% of the total and domestic 81%.

20% of total sales Q4 2010 were medical sales, 74% Vet and 6% other. This compares with 19/74/7 in Q4 last year and 17/77/6 last quarter. For the year, medical sales were 19% of total sales, Vet 74% and 7% other.

Discuss average selling price for the year finished at a record $12.56 up $0.42 versus FY '09 or up 3%. Average disc cost for the year of $4.07 was down $0.31 or about $0.07 versus FY '09. Total disc gross margin finished at 68% for the year up about 360 basis points versus last year.

Gross margins for Q4 2010 were up 19 basis points year-over-year, finishing at 55.9%. Gross margin quarter-over-quarter, however, was down 310 basis points mostly due to a higher incentive pay, costs associated with moving our disc molds to a higher volume factory, lower royalty revenue and higher sales of OEM products.

To help everybody understand the impact of OEM products on gross margins early in the sales cycle, I've broken out the gross margin for our core products that include chemistry and hematology instruments as well as consumables manufactured in our factory.

The history is as follows. For Q4 FY '09, core product gross margins were 55% for the whole year of FY '09 54%, Q1 2010 58%, Q2 2010 59%, Q3 2010 60% and Q4, the quarter we just finished, 2010 59%. Now for the year, total gross margin for FY 2010 was up 237 basis points and finished at 57.9%. Gross profit for the quarter finished at $18.820 million up 28% year-over-year and up 2.9% quarter-over-quarter. For the year, our gross profit was up 23%.

As I mentioned earlier, operating expenses for the quarter finished at 42.1% of sales up 230 basis points year-over-year, including the $1.5 million non-cash compensation charge. Total expenses for the year at $51.3 million or 41.2% of sales, were up 255 basis points versus last year, mostly due to the non-cash compensation charge.

Sales and marketing expenses for Q4 finished at 26% of sales versus 24% of sales Q4 last year and last quarter and were up due to costs associated with the full consolidation of the I-Stat business and the incentive compensation paid due to the extraordinary Q4 28% sales growth in our Vet business. For the year, sales and marketing expenses, including non-cash compensation charges, finished at 24% of sales versus 23% of sales last year.

R&D expenses, including the charge at 8% of sales was down from 8.5% of sales Q4 last year and 9% of sales last quarter. For the year, R&D expenses finished at 8.6% of sales compared with 7.9% of sales last year.

Admin expenses, including the charge of 8.3% of sales were down from 7.2% of sales Q4 last year and 8.2% of sales last quarter, mostly due to the non-cash charge. For the year, admin expenses at 8.4% of sales versus 7.3% of sales last year.

Operating income finished Q4 2010 at $4.642 million, up 11% year-over-year but down 14% quarter-over-quarter, mostly due to higher incentive pay and lower gross profit. Ex the non-cash charge, operating income would have finished at $6.266 million or up 35%.

For the year, operating income finished at $20.8 million up 17%. Excluding the non-cash charge, operating income would have finished at $26.1 million up 34%.

Net income was negatively affected by foreign exchange losses and higher taxes and finished flat for the quarter at $0.12 compared to Q4 last year. For FY 2010, net income totaled $13.23 million up 8% or $0.58 a share. Excluding the non-cash charge, net income would have totaled $16.619 million or $0.74 a share.

On the R&D side of the business, we're focused on the development of hemoglobin on the disc for both the Vet and medical markets. Expansion of the rapid test menu is also a high priority. We expect most of the product development and submissions to the regulatory authorities will be completed this year.

Goals for 2011 include keeping the sales and earnings growth at double digits with a goal of $1 a share in earnings. Implementing our new segment focused marketing and sales strategy in the medical market and expanding that sales force once all of our marketing assumptions are validated, expanding our market coverage and in the vet market with a focus on maintaining our sales momentum and improving productivity and reducing costs as a percent of sales, completing the development of hemoglobin in four more rabbit tests for the vet market, reducing expenses as a percent of sales and a continued focus on new factory initiatives and investments to make progress on the 2-by-2 goals.

Now as I've mentioned over the last few quarters, I exercised a 70,000 share stock option that was close to expiring in October of '08 and because the price of Abaxis stock was so unattractive, I borrowed the cash from a bank to exercise the option and pay the taxes. Because of this obligation, I may sell some Abaxis stock over the next few months to pay back the bank.

In addition, because the tax law changes in 2011, I may also exercise other vested options in this calendar year and may need to sell some stock to pay the options, price and tax.

With that out of the way, Marti, you're on.

Martin Mulroy

Thank you, Clint. Good afternoon. In my prepared remarks, I'll break out a few numbers for the Abaxis North American Animal Health business. The North American Animal Health organization generated revenues of $20 million in the fourth quarter of our fiscal year, up 22% or $3.7 million year-over-year and up 6% or $1.2 million in the record revenue reported last quarter.

For the fiscal year, Animal Health recorded revenues of $72.8 million, up 23% or $13.5 million versus same period last year. For the fiscal year, instrument revenue was up 5%, in terms of total units and all our instruments provided for a recurring reagent business, FY '10 was up 37%, our shipping a record 2,604 instruments.

The moderate revenue increase compared to the significant unit sales increase, the overall blended instrument ASP decline is attributable to the rapid acceptance of and our bundling of the lower cost blood gas and coagulation instruments with our chemistry and hematology offering. This has allowed us to continue to penetrate the overall market and we expect will allow us to sustain the rapid growth in our business.

Instrument revenue in Q4 was $4.3 million up 17% year-over-year. Consumable revenue for the quarter was up 24% from a year ago and up 16% versus Q3. For the fiscal year, our consumable revenue was up 29%.

Abaxis integration and consolidation of the i-STAT business, while requiring investment, was seamless to the marketplace. The team here, field sales, sales management, customer service, tech service and professional services, product management and marketing all did a great job representing to the marketplace Abaxis as a world class, customer-centric organization.

I'd like to also we significantly stepped up marketing efforts in other areas in Q4 with aggressive new branding to support the expanded VetScan instrument and consumable product line. In support of these products, we increased and broadened the marketing mix with continuing education programs, new e-lead generation programs, direct mail, increased advertising and new multimedia, promotional programs underway.

We also increased trade show and conference participation at all levels. We added headcount in field sales, professional services and customer service and plan on more organizational and infrastructure enhancements this quarter as well, while as Clint mentioned, the goal now on a go-forward basis, keeping expenses in line with the rapid revenue growth. Clint?

Clint Severson

Great. Thank you very much, Marti. Brenton, you're next.

Brenton Hanlon

Thanks, Clint. Good afternoon, everyone. In Q4, we continued to focus on repeatable and scalable approaches to penetrating the U.S. point of care testing market and at present we view the market in terms of two macro segments, the small practice segment and the medical system segment.

The small practice segment is our traditional market and we continue to focus on internal medicine physicians, merging care centers and oncology clinics. We've stabilized the sales organization and all of our empty territories are now filled, which means at present we have 15 sales people in the field along with three managers and a full-time field training specialist.

The second macro segment, large medical systems is new to us and we've enjoyed some early success. This segment includes integrated delivery networks such as hospital systems, merging care chains, wellness organizations, older care chains, reference laboratories and retail clinics. In Q4, we finalized an agreement with another large hospital system, a leading institution in the Pacific Northwest.

We also expanded within two large accounts that we had closed in Q3. These types of accounts are complicated sale, but once customers experience the benefits of the Piccolo, they tend to increase their usage over time. This business has a long sales cycle and it's difficult to forecast, but as we ride the learning curve, we hope to close at two large accounts per quarter.

As for actual results, Q4 instrument revenues were $936,000 or 86% higher year-over-year and 22% higher quarter-over-quarter. We shipped a total of 128 instruments, which was below our record 196 placements in Q3.

Q3 is traditionally our highest instrument placement period due to distributor promotions and year-end tax credit effects. But in my mind, the key metric is our Q4 placements were 78% higher than the same period last year.

Of the 126 Piccolos we've placed in Q4, 85 were revenue units into our traditional small practice segment. 16 were additional reagent rental units for our health screening company that we closed in Q3. This company now has 42 Piccolos running our orders.

12 units were additional revenue units for an urgent care chain in Texas that we closed in Q3 and 15 were the initial reagent rental units for the hospital system that we closed in Q4. I'm encouraged that approximately 35% of our Q4 Piccolo placements were within the large customer segment in which we are able to leverage our selling activities.

Turning to the rotor side of our business, Q4 rotor sales were 3.8 million, which was 40% higher year-over-year and 39% higher quarter-over-quarter. With the sales channel properly balanced, we now expect rotor sales to more closely track new instrument placements.

So in summary, overall Q4 sales were $4.9 million, 46% higher year-over-year and 39% higher quarter-over-quarter. Going forward, we plan to continue to grow our customer base on the relatively predictable small practice segment and we plan to systematically expand our presence within the higher risk, higher reward medical systems segment with the goal, as I mentioned, of closing two large accounts each quarter.

Thank you. Back to you, Clint.

Clint Severson

Great. Thank you, Brenton. Okay. With that, we're open for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Jim Sidoti of Sidoti and Company.

Jim Sidoti – Sidoti and Company

Good afternoon, Clint. Can you hear me okay?

Clint Severson

We can.

Jim Sidoti – Sidoti and Company

Great. Great. Let's start with the non-cash charge. It was about $3.5 million this year. What do you expect that to be in fiscal 2011?

Al Santa Ines

It will be slightly lower than the year that we just ended.

Jim Sidoti – Sidoti and Company

Okay. So around $3 million or so?

Al Santa Ines

No, I would say it's about $600,000, $700,000 lower.

Jim Sidoti – Sidoti and Company

Okay. Okay. And then on Piccolo placements, Clint, I think you said the number was 150, but Brenton was using a number more like 126. Is that U.S. versus overall? Or…

Clint Severson

Yes, I do the total worldwide number, which is mostly U.S. -- Brenton breaks out the U.S. number.

Jim Sidoti – Sidoti and Company

Now, were any of those 150 shipped from a distributor or did they all ship from your plant?

Clint Severson

These are shipped from Abaxis.

Jim Sidoti – Sidoti and Company

So are you – have you purged all the inventory from the distributors at this point?

Clint Severson

The inventory – there is no distributor inventory.

Jim Sidoti – Sidoti and Company

Okay. All right. Great. Now, Brenton in the past couple of calls, you've talked about a couple of large national accounts that you were hoping to close. Are those still open?

Brenton Hanlon

We have a lot of national accounts on the front burner. Some are hospital systems. So we closed one of those last quarter. Some are from the list that I mentioned. And we're continuing to work all of those diligently and as I mentioned, we expect or we hope to close two per quarter.

Jim Sidoti – Sidoti and Company

Okay. I think there were a couple of wellness providers, health checking organizations. Are those accounts still open or are you still working on those?

Brenton Hanlon

Yeah. We have several wellness organizations. We have other organizations that we're working closely with. And these are long sales cycles, so we'll close them as we can close them.

Jim Sidoti – Sidoti and Company

Okay.

Brenton Hanlon

But they're all – but, Jim, they're all still on the line.

Jim Sidoti – Sidoti and Company

That's what I was asking. You haven't lost any at this point?

Brenton Hanlon

No.

Jim Sidoti – Sidoti and Company

Okay. Then on the gross margin, Clint, you listed several factors, which pressured to gross margin in the quarter. Can you just give them to me, like in order of significance? Was the incentive play the big deal or the worldly revenue? Or…

Clint Severson

Okay. So the royalty revenue was probably a couple hundred thousand dollars.

Al Santa Ines

About 1.2%.

Clint Severson

Yes.

Al Santa Ines

Margin impact.

Jim Sidoti – Sidoti and Company

Okay.

Clint Severson

1.2% on royalty. Then you have the – clearly there's lower gross margin on the early stage of OEM products, when you first introduce them the margins are lower. As you consolidate them into your business, the margins go up. And clearly, higher incentive paid for the year-end bonuses. We had an unbelievable year here at Abaxis, sales up 18%, operating income up 17%, even including the charge. So clearly, people got more bonus. And at the last quarter of the year, all bonuses adjust for the year. And then we have this 2-by-2 program, $2 for a rotor and $2,000 for an instrument.

And part of this process is getting your rotor manufacturing into the factories that are high throughput factories. So we moved our molds 13, 14, I don't know the exact number from a low-volume factory to a high-volume factory. And clearly when you move all your manufacturing molds, all of the costs are going to go up. And so, yes, there were – all of that was a piece of it.

Jim Sidoti – Sidoti and Company

Okay. Now the incentive pay that I assume that's a fourth quarter event?

Clint Severson

It's a fourth quarter event. Yes.

Jim Sidoti – Sidoti and Company

And then the OEM shift, that should improve as we get through fiscal 2011?

Clint Severson

Yes. No, I think the gross margins on the i-STAT products; the business that we inherited the business that we consolidated is 32%. The new business that we generate through the i-STAT products is 48%. So as the new business becomes a bigger percentage of the total, the gross margins go up. And so in the early stages, you're selling some new stuff. Most of the stuff is – you're consolidating existing business into your company. So that clearly affects it.

Jim Sidoti – Sidoti and Company

Don's had it for three months now, I'm surprised he hasn't fixed that yet.

Clint Severson

Yes. Well, this has got nothing to do with Don. It's got to do with what we pay for the stuff.

Jim Sidoti – Sidoti and Company

Yes. No, I know. All right. And then just on headcount, can you tell me, Marti and how many you added on the vet side? And Brenton, how many on the human side?

Martin Mulroy

Field…

Clint Severson

Did you add any this quarter?

Martin Mulroy

Field sales, we added two. Professional services, we added one. I believe, well, yes overall customer care went to two.

Brenton Hanlon

And Jim, in the fourth quarter, I added two sales people and that brings us back up to the 15 that sustained territories that we have identified.

Martin Mulroy

Yes. And Jim, I'm sorry, to add one in sales field sales management as well.

Jim Sidoti – Sidoti and Company

Okay. So that's a total of six?

Martin Mulroy

Yes.

Jim Sidoti – Sidoti and Company

And then I assume you'll add a couple more every quarter as we go through the year?

Martin Mulroy

On average, yes.

Jim Sidoti – Sidoti and Company

Okay. Great. Just a follow-up, on the stock comp, the reason it ticked up is because you had a large number of options vested this year. I assume on the next plan you're going to have a similar number in vest? Is that why it's staying around 3 million?

Clint Severson

So the non-cash stock compensation at Abaxis is long-term compensation. It's not short term. So what happens is when a grant is given, it vests 5% the first year, 10% the second year, 15% the third year and 70% the fourth year. So once options and other stock compensation were required to be expensed, we changed the vesting schedule to make it all long-term compensation. So you take a big hit the fourth year of the first grant and that was 2010.

Jim Sidoti – Sidoti and Company

Okay. So I assume there's another grant that came on the next year?

Clint Severson

Yes, there was grants but it doesn't go up. So for instance, excluding the non-cash compensation charge, our operating income went up about, I don't have the exact number, but about $8 million, excluding the charge. And the charge was about $4 million. So that means we had a net increase of $4 million in operating income. Now if our operating income goes up $8 million next year, 2011 we keep all the $8 million.

Jim Sidoti – Sidoti and Company

Okay.

Clint Severson

Because it's not going to go up again.

Jim Sidoti – Sidoti and Company

Right. Right. It's not going to go up, but it's not going to go down because you have the final year's plan would…

Clint Severson

I mean, it'll go down a little bit because what happens is people that don't vest, because they leave the company, they do not vest in their long-term stock compensation, you have to take the charge for the year, okay, that they would have vested and then you get a credit for it the next year.

Jim Sidoti – Sidoti and Company

Right. Okay. And then just last question for Marti. Now that you have the chemistry, the hematology, you have the coagulation system, the heart worm, the i-STAT are you – is it easier for you to penetrate some of the IDECS and the healthcare accounts?

Martin Mulroy

Yes, it is.

Jim Sidoti – Sidoti and Company

Where is your strategy? I mean, are you going after both or one over the other? Or…

Martin Mulroy

We're going after both of those and the commercial laboratory services as well.

Jim Sidoti – Sidoti and Company

Okay. So would you say the 299 VetScans you placed were – was that pretty evenly distributed among the three or…

Martin Mulroy

That number I think is worldwide. I mean as far as North American Animal Health, we are pretty much – well, we're evenly distributed in terms of converting commercial add business to Abaxis in-house and other points of care instruments to Abaxis in-house.

Jim Sidoti – Sidoti and Company

Okay.

Martin Mulroy

And then if you break out the in-house that we convert to our in-house, it's – we do have a bit more success with IDECS, but because there's more of them. There's quite a bit more.

Jim Sidoti – Sidoti and Company

Right.

Martin Mulroy

IDECS has a lot more market penetration than has been, obviously.

Jim Sidoti – Sidoti and Company

Exactly. Okay. All right. Thank you.

Clint Severson

Great. Thank you.

Operator

Our next question comes from Jonathan Block of SunTrust.

Jonathan Block – SunTrust

Thanks. Can you hear me okay? I'm out here on the road.

Clint Severson

Yes. We can hear you fine, Jonathan.

Jonathan Block – SunTrust

Okay. Great. Thanks. Al, maybe the first one, I'll just start with you. On the royalty revenue, has something changed there? In other words a contract and we should extrapolate that into fiscal year '11 or is that more of a onetime specific to the fourth quarter?

Al Santa Ines

We just received lower royalties this last quarter.

Jonathan Block – SunTrust

But do you expect that trend to continue into fiscal year '11? In other words, the $1.7 million should we – is that our new run rate or closer to $2 million to $2.1 million?

Al Santa Ines

No, we don't know exactly how. It depends on how much they will be using our technology to make the product.

Jonathan Block – SunTrust

Okay. Okay. I just wanted to make sure the contract didn't change or anything like that? And then, Brenton, I think this one would be for you. If you can talk, obviously the Piccolos are going well, the trends are great. If you could talk to the utilization of the Piccolo into the accounts, where they're going now and then even more granularity, the utilization of what you would deem, I believe you called it sort of the small and the large, how many are one per day?

Brenton Hanlon

On the smaller – let me start with the smaller accounts. They're around about three to four rotors a day. The larger accounts, the – what I call the hospital systems, the medical systems accounts, their utilization is considerably larger than that on a per unit basis, per instrument basis. So I would expect, over time when you look at the mix if you blend it, our utilization per placement is going to increase over time.

We just completed a customer service survey and if I recall, something like 85% of our customers reported that over time their Piccolo utilization increased. They wrote a utilization increase. Around 85% also reported improved efficiency and I'm pleased to report we had 99% customer satisfaction on that survey. So I think our score card is good. Once we get the product in there, I think people see the benefit and they use it more often, particularly in those larger accounts.

Jonathan Block – SunTrust

Great. And then, Clint, I think this one would be for you. I mean, like you mentioned, gross margins, a mix shift in there. You're making some investments prior on the 2-by-2. So I don't want to penalize you there, but without giving guidance, when I looked at fiscal year '11, the OpEx line, such as R&D, sales and marketing and G&A, do you think you'll be able to show some leverage in each one of those expense items if you hit your top-line plans?

Clint Severson

Okay. So we think that sales and marketing expense will be lower as a percentage of sales. Admin will be lower as a percentage of sales. And R&D will be lower to flat as a percent of sales, depending on how much investment we do in the 2-by-2. And so we kind of have to take that as it comes. Clearly, yes, the engineering team would love to just staff up on the 2-by-2 because the return is so high on it, but if you do that too fast, it's going to hurt your earnings if you do it too fast. So we're doing it measured.

Jonathan Block – SunTrust

Okay.

Clint Severson

So overall, we're expecting expenses as a percent of sales to go down and clearly that was one of my goals in FY '11 that I talked about earlier.

Jonathan Block – SunTrust

Great. Maybe I'll just throw one more and just to keep it manageable, I'll follow-up with you offline, but, Al, tax rate in fiscal year '11, what are you expecting? How does that change if our friends in government put in the R&D tax credit? Thanks, guys.

Al Santa Ines

You can use 39% for next year. We expect, hopefully Congress gets their act together and passes those Federal R&D credits that we deserve, okay and plus, some other things that we're doing in the company.

Jonathan Block – SunTrust

And if they pass it, I'm sorry, that 39%, would that go down to 37-ish? Is that the right way?

Al Santa Ines

No. I don't think it will go down because California, okay, the apportionment is changing in fiscal year 2012. We need to estimate that, okay? It will favor us in 2012, but it might hit us in 2011 that's the change in business year in California, okay?

Jonathan Block – SunTrust

Okay. 39% it is. Thanks, guys. I'll follow-up offline.

Clint Severson

Great. Thank you.

Operator

(Operator Instructions). Now our next question comes from Ross Taylor of CL King.

Ross Taylor – CL King

I have a couple of questions. Maybe I'll start with Marti on the debt side. I compute that in terms of units, you must have sold 960,000 vet rotors in the quarter, which has you up about 2% year-over-year and I just wondered if I have those numbers right? And I know there's some volatility in your vet rotor numbers. I just wondered if changes in distributor ordering patterns or some shipments to Europe might have affected things up or down in the quarter?

Martin Mulroy

Al's nodding. Your numbers are about right, close enough? Right?

Al Santa Ines

Close enough, yes.

Martin Mulroy

I don't manage the European business, but I can tell you Animal health. There is no pattern to distributor orders. They're all over the place and if somebody's having cash flow issues they try to cut back their inventory, somebody's trying to hit a goal they pull up a little bit of inventory, somebody's trying to reduce their freight costs they want to make sure they pack a truck it's all over the place. So, yes, there's always a little bit of fluctuation there. As to the economy, yes, absolutely, traffic's down in the clinic. They're may be some less rotor utilization at the clinic level, but I'll distribute through a combination of distributor ordering patterns, a little bit to the economy, but I'm positive in moving forward.

Ross Taylor – CL King

Okay.

Clint Severson

Yes. I think, Ross, I'll add to that too. You can't look at Vet rotors in the quarter. You have to look at them for the year.

Ross Taylor – CL King

Right. Yes, I know there's definitely some quarterly volatility, so that's why I was just…

Clint Severson

There's volatility in the quarter. You have to look at it from a year, year-over-year, yes.

Ross Taylor – CL King

Okay. And another question related to the Vet business with regards to the I-Stat business, I think there was some additional G&A expenses you had to kind of support the existing customer base or kind of service them and can you estimate how much that was during the quarter? And how close are you to the point where those expenses would start to come down or go away?

Clint Severson

Okay. So, I'll comment because I look at all of the expenses. I don't have any exact number, but I can tell you that you have training expense, you have literature expense, you have additional, we hired additional temporary customer service and technical service people to make sure every customer gets touched. We hire more shipping people because most of these orders were direct.

So, you add all that stuff together and it's, I don't know, hundreds of thousands of dollars of expenses that come with the full integration of the product. And then, over time that becomes part of your operating expenses. Your sales go up, but those expenses don't go up. In fact, the literature expense, the training, all that stuff disappears. So, gosh, if I put a number on it, I'd guess around $400,000, something like that.

Ross Taylor – CL King

Okay. And you think most of that does stick around permanently or is some of it going to diminish?

Clint Severson

The stuff will diminish.

Ross Taylor – CL King

Okay.

Clint Severson

All the creative work for the collateral, all the printing costs, that's all done, training field sales done, training sales management done, training cuts for service, tech service, the sales administration team all the time put into document control, it's all done.

Ross Taylor – CL King

Okay. All right, that's helpful. Switching over to the Medical side, Clint, you mentioned a number of 150 Piccolo instruments in total. And I just wondered, is that 150 instruments that you actually booked as revenues or is that placements that includes reagent rentals as well?

Clint Severson

No. It's only – the number you get from me on my quarterly call is only revenue sales and that's 150 because I think going forward, maybe next fiscal year, we'll maybe do a number of total placements and then add revenue to it. But, I think you've got to make sure that you're measuring apples and apples and you're not throwing in a whole bunch of other categories. So, it's 150 Piccolo sales those were sales, revenue generating, shipped from Abaxis and that included six from the government.

Ross Taylor – CL King

Okay. And last question, this is also on the Medical, I wonder if you can comment at all just in terms of how your Piccolo pipeline is building, whether you feel like you're getting faster or better traction with the small accounts or with the hospital systems?

Clint Severson

We have a lot of – we've hired a lot of new people in the last – who have been with us for less than a year. We only have four people that have been with us for more than a year. That's a unusual situation in a sales organization. So the younger and newer people are, of course, still building their pipelines. I mean they started out with no pipeline and so naturally over-time, if we can prevent the turnover of the past then people will be operating off of the pipeline. So, I guess the short answer to your question is, yes. We're working on building our pipeline and, yes, our pipeline is improving every day.

Clint Severson

Okay. I'll just make a comment on that as well. I think when we changed our strategy from chasing leads and chasing numbers to focus, which started April '09, we had about 12 people in the field. And now when we changed our strategy to some of those folks that didn't like the new strategy and they left and then we added another three people. So fundamentally, the market coverage didn't change that much. Okay.

And so, what we want to do now is we want to implement the strategy as laid out with the assumptions that we made and then we want to validate them. And the validation is simply – it's very simple. You're increasing your numbers every quarter. You're increasing your sales every quarter without adding a bunch more market coverage.

And because the assumptions that you make as sales people operate at a certain productivity level, they use so many rotors a day that the marketing team can identify through their lead generation, enough leads to keep the sales people productive and that, all those assumptions that we made and I think what's happening is it's proving to be true. And we do need a couple of more quarters here of making sure that what we believe to be true is truly true and then once we do then we'll scale this model up. And I think that the numbers speak for themselves.

Ross Taylor – CL King

Okay, that's great. Thanks, very much.

Clint Severson

Yes. Thank you.

Operator

(Operator Instructions) Our next question comes from Albert Almond [ph], a private investor.

Albert Almond

Clint?

Clint Severson

Yes?

Albert Almond

Can you give us an update on your China initiative?

Clint Severson

Okay. So, we happen to have Vladimir sitting right here listening in. Vladimir, he's in charge of Asia. So maybe, Vladimir, maybe you can give a few sentences here on China.

Vladimir Ostoich

Yes. If only you heard that about six or seven months ago we got approval by the Chinese FDA for all our systems. However, about three months ago we were notified that the, that approval was only valid by these rules. And now we need to get approval and please hear this carefully, age in the regional chemistry. And since we have about 30 of them, this is going to be a lifetime exercise.

We have a team of people working with us in China. I have been there working with the American Embassy because that sounded extremely unusual to us. However, everybody in the diagnostic business is going through the same process. At this point, I have no clear understanding how long would it take because this is a brand new set of rules and regulations. I had three meetings with the Chinese FDA in Beijing and they could not in any way provide me with clear guidelines of what they want. So, that's where we stand.

Albert Almond

Very good, sir. Thank you.

Vladimir Ostoich

Thank you.

Operator

(Operator Instructions). And this time, there are no further questions. I'd like to turn the conference back over to Mr. Clint Severson for any remarks.

Clint Severson

Great. Thank you. For those of you that were on our conference call Q4 2009, you might remember that after completing that difficult fiscal year, that was the first year that our growth was less than double-digits that one of the primary objectives for 2010 was to increase the sales and earning goal from single-digits to double-digits. That was the number one thing, number one objective.

And so now that this is over, the fiscal year is over and you all heard the numbers, sales for the year are up 18% and operating earnings up 17%, even though we had a big non-cash compensation charge. And I want to thank the employees throughout the company that performed at an extremely efficient level in a very difficult environment with a lot of distractions you have with a lot of new products coming on board, that tendency is to, yes, to lose track of the overall goal.

And they just did a fantastic job and I want to publicly thank them all. And I also want to thank all of you for participating in our year-end conference call and we look forward to the Q1 call in July. So with that, thank you very much.

Operator

That does conclude today's teleconference. Thank you for participating. You may now disconnect.

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