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

In September 2007, we introduced a veterinary hematology instrument under the name VetScan HM5™. The VetScan HM5 offers a 22-parameter complete blood count (CBC) analysis, including a five-part differential cell counter specifically designed for veterinary applications. In May 2004, we introduced a veterinary hematology instrument that offers an 18-parameter CBC analysis, including a three-part white blood cell differential, marketed originally as the VetScan HMII, and is now referred to as the VetScan HM2™. We currently purchase the hematology instruments from Diatron Medical Instruments PLC. of Budapest, Hungary. Through April 2004, we marketed a veterinary hematology instrument under the name VetScan HMT. We continue to support and service our current population of VetScan HM5, VetScan HM2, VetScan HMII and VetScan HMT hematology instruments. We also market reagent kits to be used with our hematology instruments which we currently purchase from three suppliers: Clinical Diagnostic Solutions, Inc., Diatron and Mallinckrodt Baker BV.
Our sales for any future periods are not predictable with a significant degree of certainty, and may depend on a number of factors outside of our control, including but not limited to inventory or timing considerations by our distributors. We generally operate with a limited order backlog because our products are typically shipped shortly after orders are received. As a result, product sales in any quarter are generally dependent on orders booked and shipped in that quarter. Our expense levels, which are to a large extent fixed, are based in part on our expectations of future revenues. Accordingly, we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. As a result, any such shortfall would negatively affect our operating results and financial condition. In addition, our sales may be adversely impacted by pricing pressure from competitors. Our ability to be consistently profitable will depend, in part, on our ability to increase the sales volumes of our Piccolo and VetScan products and to successfully compete with other competitors. We believe that period to period comparisons of our results of operations are not necessarily meaningful indicators of future results.

CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. On an on-going basis, we evaluate our estimates and the sensitivity of these estimates to deviations in the assumptions used in making them. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. However, there can be no assurance that our actual results will not differ from these estimates.
We have identified the policies below as critical because they are not only important to understanding our financial condition and results of operations, but also because application and interpretation of these policies requires both judgment and estimates of matters that are inherently uncertain and unknown. Accordingly, actual results may differ materially from our estimates. The impact and any associated risks related to these policies on our business operations are discussed below. A more detailed discussion on the application of these and other accounting policies are included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2008.
Revenue Recognition and Deferred Revenue. Our primary customers are distributors and direct customers in both the medical and veterinary markets. Revenues from product sales, net of estimated sales allowances and rebates, are recognized when (i) evidence of an arrangement exists, (ii) upon shipment of the products to the customer, (iii) the sales price is fixed or determinable and
(iv) collection of the resulting receivable is reasonably assured. Rights of return are not provided. We recognize revenue associated with extended maintenance agreements ratably over the life of the contract. Amounts collected in advance of revenue recognition are recorded as a current or non-current liability based on the time from the balance sheet date to the future date of revenue recognition. We provide incentives in the form of free goods or extended maintenance agreements to customers in connection with the sale of our instruments. Revenues from such sales is allocated separately to the instruments and incentives based on the relative fair value of each element. Revenues allocated to incentives is deferred until the goods are shipped to the customer or is recognized ratably over the life of the maintenance contract. We periodically offer trade-in programs to customers for trading in an existing instrument to purchase a new instrument and we will either provide incentives in the form of free goods or reduce the sales price of the instrument. These incentives in the form of free goods are recorded according to the policies described above. Distributor and Customer Rebates. We offer distributor pricing rebates and customer incentives from time to time. The distributor pricing rebates are offered to distributors upon meeting the sales volume requirements during a qualifying period. The distributor pricing rebates are recorded as a reduction to gross revenues during the qualifying period. Cash rebates are offered to customers who purchase specific instruments during a promotional period. Cash rebates are recorded as a reduction to gross revenues. Sales and Other Allowances. We estimate a provision for defective reagent discs as part of sales allowances when we issue credits to customers for defective reagent discs. We also establish, upon shipment of our products to distributors, a provision for potentially defective reagent discs, based on estimates derived from historical experience. The provision for potentially defective reagent discs was recorded in sales allowances, using internal data available to estimate the level of inventory in the distribution channel, the lag time for customers to report defective reagent discs and the historical rates of defective reagent discs. Starting on July 1, 2007, the provision for potentially defective reagent discs is recorded as part of warranty reserves, instead of sales allowances, since we replace defective reagent discs rather than issue a credit to customers. Changes in our estimates for accruals related to provisions for defective reagent discs have not been material to our financial position or results of operations. In the future, the actual defective reagent discs may exceed our estimates, which could adversely affect our financial results. Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts based on our assessment of the collectibility of the amounts owed to us by our customers. In determining the amount of the allowance, we make judgments about the creditworthiness of customers which is mostly determined by the customer's payment history and the outstanding period of accounts. We specifically identify amounts that we believe to be uncollectible and the allowance for doubtful accounts is adjusted accordingly. An additional allowance is recorded based on certain percentages of our aged receivables, using historical experience to estimate the potential uncollectible and our assessment of the general financial condition of our customer base. If our actual collections experience changes, revisions to our allowances may be required, which could adversely affect our operating income.

Fair Value of Investments. Various assumptions are used in the valuation models to estimate the fair value of our investments in auction rate securities, including a security's expected future cash flows, market rate of return and term. These assumptions, assessments and the interpretations of relevant market data are subject to uncertainties, are difficult to predict and require significant judgment. The use of different assumptions, applying different judgment to inherently subjective matters and changes in future market conditions could result in significantly different estimates of fair value. Warranty Reserves. We provide for the estimated future costs to be incurred under our standard warranty obligation on our instruments. Our standard warranty obligation on instruments is two years. The estimated contractual warranty obligation is recorded when the related revenue is recognized and any additional amount is recorded when such cost is probable and can be reasonably estimated. While we engage in product quality programs and processes, including monitoring and evaluating the quality of our suppliers, our estimated accrual for warranty exposure is based on historical experience, estimated product failure rates, material usage and freight incurred in repairing the instrument after failure and known design changes.
A provision for defective reagent discs is recorded when related sales are recognized and any additional amounts are recorded when such costs are probable and can be reasonably estimated, at which time they are included in cost of revenues. Prior to July 1, 2007, we primarily issued a credit to customers for defective reagent discs and, therefore, the provision for estimated costs for defective reagent discs, which includes the replacement costs and freight of a defective reagent disc, was recorded as part of sales and other allowances. Starting on July 1, 2007, the provision for defective reagent discs is recorded as part of warranty reserves, since we replace defective reagent discs rather than issue a credit to customers.
We analyze the adequacy of the ending accrual balance of warranty reserves each quarter. The determination of warranty reserves requires us to make estimates of the expected costs to repair or replace the instruments and to replace defective reagent discs under warranty. If actual repair or replacement costs of instruments or replacement costs of reagent discs differ significantly from our estimates, adjustments to cost of revenues may be required.
Inventories. We state inventories at the lower of cost or market, cost being determined using standard costs which approximates the first-in, first-out (FIFO) method. Inventories include material, labor and overhead. We establish provisions for excess, obsolete and unusable inventories after evaluation of future demand and market conditions. If future demand or actual market conditions are less favorable than those estimated by management or if a significant amount of the material were to become unusable, additional inventory write-downs may be required, which would have a negative effect on our operating income.
Long-Lived Assets. The carrying value of our long-lived assets is reviewed for impairment, in accordance with Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We look to current and future profitability, as well as current and future undiscounted cash flows, excluding financing costs, as primary indicators of recoverability. An impairment loss would be recognized when the sum of the undiscounted future net cash flows expected to result from the use of the asset and its eventual disposal is less than the carrying amount. If impairment is determined to exist, any related impairment loss is calculated based on fair value.
Income Taxes. We account for income taxes under the provisions of SFAS No. 109, "Accounting for Income Taxes." Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amounts to be recovered.
Share-Based Compensation Expense. Effective April 1, 2006, we adopted SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123(R)") using the modified prospective method. Under the fair value provisions of SFAS No. 123(R), we recognize share-based compensation expense, net of an estimated forfeiture rate, for those shares expected to vest over the requisite service period of the award to employees and directors.
We use the Black-Scholes option pricing model to determine the fair value of stock options granted prior to March 31, 2006. Determining the appropriate fair value model and calculating the fair value of share-based awards requires highly subjective assumptions, as described below.
• Risk-free interest rate: The risk-free interest rate is based on U.S. Treasury yields in effect at the time of grant for the expected term of the option.

• Expected stock price volatility: We estimate the volatility of our common stock at the date of grant based on the historical volatility of our common stock.

• Expected term: We estimate the expected term of stock options granted based on historical exercise and post-vesting termination patterns, which we believe are representative of future behavior.

• Expected dividends: We have not paid cash dividends on our common stock and we do not anticipate paying cash dividends in the foreseeable future; consequently, we use an expected dividend yield of zero.

For restricted stock units, the assumptions to calculate compensation expense is based on the fair value of our stock at the grant date. As a result, if factors change and we use different assumptions, our share-based compensation expense could be materially different in the future.
As required by SFAS No. 123(R), employee share-based compensation expense recognized is calculated based on the awards expected to vest and reduced for estimated forfeitures. The forfeiture rate is estimated based on historical data of our share-based awards that are granted and cancelled prior to vesting and upon historical experience of employee turnover. Changes in estimated forfeiture rates and differences between estimated forfeiture rates and actual experience may result in significant, unanticipated increases or decreases in share-based compensation expense from period to period. To the extent we revise our estimate of the forfeiture rate in the future, our share-based compensation expense could be materially impacted in the quarter of revision, as well as in following quarters.
RESULTS OF OPERATIONS
We develop, manufacture, market and sell portable blood analysis systems for use in the human or veterinary patient-care setting to provide clinicians with rapid blood constituent measurements. We operate in two segments: (i) the medical market and (ii) the veterinary market. See "Segment Results" in this section for a detailed discussion.
Total Revenues
Revenues by Geographic Region and by Product Category. Revenues by geographic region based on customer location and revenues by product category during the three months ended June 30, 2008 and 2007 were as follows (in thousands, except percentages):

                                         Three Months Ended
                                              June 30,                      Change
                                                                    Increase/       Percent
  Revenues by Geographic Region           2008          2007       (Decrease)       Change
  North America                        $   20,295     $ 19,169     $     1,126             6 %
  Percentage of total revenues                 83 %         84 %
  Europe                                    3,385        3,057             328            11 %
  Percentage of total revenues                 14 %         13 %
  Asia Pacific and rest of the world          892          705             187            27 %
  Percentage of total revenues                  3 %          3 %

  Total revenues                       $   24,572     $ 22,931     $     1,641             7 %




                                        Three Months Ended
                                             June 30,                      Change
                                                                   Increase/       Percent
  Revenues by Product Category           2008          2007       (Decrease)       Change
  Instruments                         $    7,802     $  6,464     $     1,338            21 %
  Percentage of total revenues                32 %         28 %
  Reagent discs and kits                  14,893       14,259             634             4 %
  Percentage of total revenues                61 %         62 %
  Other products                           1,110        1,737            (627 )         (36 %)
  Percentage of total revenues                 4 %          8 %

  Product sales, net                      23,805       22,460           1,345             6 %
  Percentage of total revenues                97 %         98 %
  Development and licensing revenue          767          471             296            63 %
  Percentage of total revenues                 3 %          2 %

  Total revenues                      $   24,572     $ 22,931     $     1,641             7 %

Three Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2007 North America. During the three months ended June 30, 2008, total revenues in North America increased 6%, or $1.1 million, as compared to the three months ended June 30, 2007. Components of the change in North America were as follows:
Instruments. During the three months ended June 30, 2008, total revenues from instruments sold in North America increased 27%, or $1.3 million, as compared to the three months ended June 30, 2007. The primary factors of the change were as follows:
(i) Sales of our Piccolo chemistry analyzers to the U.S. government increased 1176%, or $694,000, primarily due to an increase in the U.S. Military's needs for our products, which were not predictable. Sales of our Piccolo chemistry analyzers in North America (excluding the U.S. government) decreased 9%, or $150,000.
(ii) Sales of our VetScan chemistry analyzers in North America increased 42%, or $710,000, primarily due to quality improvements on our analyzers.
(iii) Sales of our hematology instruments in North America increased 4%, or $67,000. Reagent discs and kits. During the three months ended June 30, 2008, total revenues from reagent discs and kits sold in North America increased 1%, or $100,000, as compared to the three months ended June 30, 2007. The primary factors of the change were as follows:
(i) Medical reagent discs sales in North America (excluding the U.S. government) increased 51%, or $894,000, primarily due to the expanded installed base of our Piccolo chemistry analyzers. Medical reagent discs sold to the U.S. government increased 28%, or $132,000.
(ii) Veterinary reagent discs sales in North America decreased 11%, or $969,000, primarily due to decreased demand as a result of inventory balancing by our distributors.
(iii) Sales of our hematology reagent kits in North America increased 6%, or $43,000. Other products. During the three months ended June 30, 2008, total revenues from other products sold in North America decreased 35%, or $591,000, as compared to the three months ended June 30, 2007. The net decrease in other products was primarily due to an increase in maintenance contracts offered to customers from time to time as incentives in the form of free goods in connection with the sale of our products. Development and licensing. During the three months ended June 30, 2008, total revenues from development and licensing in North America increased 63%, or $296,000, as compared to the three months ended June 30, 2007. The increase from development and licensing revenue is primarily due to a licensing agreement with Cepheid, related to our proprietary technology, the Orbos® Discrete Lyophilization Process. Significant concentration. There were no distributors or direct customers that accounted for more than 10% of our total worldwide revenues for the three months ended June 30, 2008. One distributor in the United States, DVM Resources, accounted for 15% of our total worldwide revenues for the three months ended June 30, 2007. Europe. During the three months ended June 30, 2008, total revenues in Europe increased 11%, or $328,000, as compared to the three months ended June 30, 2007. Components of the change in Europe were as follows:
Instruments. During the three months ended June 30, 2008, total revenues from instruments sold in Europe decreased 10%, or $135,000, as compared to the three months ended June 30, 2007. The primary factors of the change were as follows:
(i) Sales of our Piccolo chemistry analyzers in Europe increased 6%, or $15,000.
(ii) Sales of our VetScan chemistry analyzers in Europe decreased 17%, or $164,000.
(iii) Sales of our hematology instruments in Europe increased 14%, or $14,000. Reagent discs and kits. During the three months ended June 30, 2008, total revenues from reagent discs and kits sold in Europe increased 29%, or $496,000, as compared to the three months ended June 30, 2007. The primary factors of the change were as follows:
(i) Medical reagent discs sales in Europe increased 79%, or $173,000.
(ii) Veterinary reagent discs sales in Europe increased 23%, or $322,000, primarily due to the expanded installed base of our VetScan chemistry analyzers.
(iii) Sales of our hematology reagent kits in Europe were substantially the same as in the three months ended June 30, 2007. Other products. During the three months ended June 30, 2008, total revenues from other products sold in Europe decreased 70%, or $33,000, as compared to the three months ended June 30, 2007.

Asia Pacific and rest of the world. During the three months ended June 30, 2008, total revenues in Asia Pacific and rest of the world increased 27%, or $187,000, as compared to the three months ended June 30, 2007. Components of the change in Asia Pacific and rest of the world were as follows:
Instruments. During the three months ended June 30, 2008, total revenues from instruments sold in Asia Pacific and rest of the world increased 82%, or $152,000, as compared to the three months ended June 30, 2007. The primary factors of the change were as follows:
(i) Sales of our Piccolo chemistry analyzers in Asia Pacific and rest of the world increased 32%, or $14,000.
(ii) Sales of our VetScan chemistry analyzers in Asia Pacific and rest of the world increased 128%, or $97,000.
(iii) Sales of our hematology instruments in Asia Pacific and rest of the world increased 63%, or $41,000. Reagent discs and kits. During the three months ended June 30, 2008, total revenues from reagent discs and kits sold in Asia Pacific and rest of the world increased 7%, or $38,000, as compared to the three months ended June 30, 2007. The primary factors of the change were as follows:
(i) Medical reagent discs sales in Asia Pacific and rest of the world decreased 31%, or $16,000. . . .