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WOOF > SEC Filings for WOOF > Form 10-Q on 9-Nov-2012All Recent SEC Filings

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Form 10-Q for VCA ANTECH INC


9-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

                                        Page

  Introduction                           25

  Executive Overview                     25

  Critical Accounting Policies           28

Consolidated Results of Operations 30

Segment Results 31

Liquidity and Capital Resources 36


Introduction
The following discussion should be read in conjunction with our condensed, consolidated financial statements provided under Part I, Item I of this Quarterly report on Form 10-Q. We have included herein statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We generally identify forward-looking statements in this report using words like "believe," "intend," "expect," "estimate," "may," "plan," "should plan," "project," "contemplate," "anticipate," "predict," "potential," "continue," or similar expressions. You may find some of these statements below and elsewhere in this report. These forward-looking statements are not historical facts and are inherently uncertain and outside of our control. Any or all of our forward-looking statements in this report may turn out to be wrong. They can be affected by inaccurate assumptions we might make, or by known or unknown risks and uncertainties. Many factors mentioned in our discussion in this report will be important in determining future results. Consequently, no forward-looking statement can be guaranteed. Actual future results may vary materially. Factors that may cause our plans, expectations, future financial condition and results to change are described throughout this report and in our Annual Report on Form 10-K, particularly in "Risk Factors," Part I, Item 1A of that report.
The forward-looking information set forth in this Quarterly Report on Form 10-Q is as of November 9, 2012, and we undertake no duty to update this information unless required by law. Shareholders and prospective investors can find information filed with the SEC after November 9, 2012 at our website at http://investor.vcaantech.com or at the SEC's website at www.sec.gov. We are a leading North American animal healthcare company. We provide veterinary services and diagnostic testing services to support veterinary care and we sell diagnostic imaging equipment and other medical technology products and related services to veterinarians. We also provide both online and printed communications, education and information, and analytical based marketing solutions to the veterinary community.
Our reportable segments are as follows:

            Our Animal Hospital segment operates the largest network of
             freestanding, full-service animal hospitals in the United States and
             Canada. Our animal hospitals offer a full range of general medical
             and surgical services for companion animals. We treat diseases and
             injuries, offer pharmaceutical and retail products and perform a
             variety of pet wellness programs, including health examinations,
             diagnostic testing, routine vaccinations, spaying, neutering and
             dental care. At September 30, 2012, our animal hospital network
             consisted of 601 animal hospitals in 41 states and in three Canadian
             provinces.


            Our Laboratory segment operates the largest network of veterinary
             diagnostic laboratories in the nation. Our laboratories provide
             sophisticated testing and consulting services used by veterinarians
             in the detection, diagnosis, evaluation, monitoring, treatment and
             prevention of diseases and other conditions affecting animals. At
             September 30, 2012, our laboratory network consisted of 55
             laboratories serving all 50 states and certain areas in Canada.

Our "All Other" category includes the results of our Medical Technology, Vetstreet and ThinkPets operating segments. Each of these segments did not meet the materiality thresholds to be reported individually.
The practice of veterinary medicine is subject to seasonal fluctuation. In particular, demand for veterinary services is significantly higher during the warmer months because pets spend a greater amount of time outdoors where they are more likely to be injured and are more susceptible to disease and parasites. In addition, use of veterinary services may be affected by levels of flea infestation, heartworms and ticks, and the number of daylight hours. The unstable path and slow pace of the economic recovery and continued competition predominantly in the laboratory business, continues to negatively impact our revenue. We are unable to forecast the timing or degree of an economic recovery. Further, trends in the general economy may not be reflected in our business at the same time or in the same degree as in the general economy. The timing and degree of any economic recovery, and its impact on our business, are among the important factors that could cause our actual results to differ from our forward-looking information. Executive Overview
During the three and nine months ended September 30, 2012, we achieved an increase in consolidated revenue primarily from acquired animal hospitals and other acquired businesses, as well as, organic growth in our animal hospital and laboratory businesses. Our Animal Hospital same-store revenue increased 1.1%, adjusted for one less business day in 2012 compared to


2011, for the three months ended September 30, 2012 and increased 1.3%, for the nine months ended September 30, 2012. Our Laboratory internal revenue, adjusted for differences in billing days, increased 3.5% and 3.7%, for the three and nine months ended September 30, 2012, respectively. Our overall operating income increased 5.8% for the three months ended September 30, 2012, as compared to the prior-year comparable period. The increase was primarily due to the acquisition of Associate Veterinary Clinics (1981) LTD ("AVC"), ThinkPets, Inc. ("ThinkPets") and improved results from our laboratory business segment. Our overall operating income for the nine months ended September 30, 2012 declined 2.7%, as compared to the prior-year comparable period. The decline was primarily due to a decrease in gross margins in our Animal Hospital segment, which was caused by an increase in labor and other costs, and increased selling, general and administrative expenses.

Financing Transaction
On January 25, 2012 we amended our Amended and Restated Credit and Guaranty Agreement, dated as of August 16, 2011. The amendment replenishes the aggregate amount of uncommitted incremental facilities available under our senior credit facility to a maximum of $100 million, after giving effect to the funding of $50 million of new term loan commitments on January 24, 2012, which were drawn in connection with the additional investment made in AVC, detailed below. Acquisitions
Our growth strategy includes the acquisition of independent animal hospitals. We currently anticipate that during the current year, we will acquire $100 million to $120 million of annualized Animal Hospital revenue, exclusive of the acquisition of AVC. We evaluate the acquisition of animal hospital chains and laboratories, or related businesses, if favorable opportunities are presented. The following table summarizes the changes in the number of facilities operated by our Animal Hospital and Laboratory segments during the nine months ended September 30, 2012:

Animal Hospitals:
Beginning of period         541
Acquisitions, excluding AVC  24
Acquisitions, merged         (4 )
AVC acquisition              44
Sold, closed or merged       (4 )
End of period               601

Laboratories:
Beginning of period          53
Created                       2
End of period                55


The following table summarizes the aggregate consideration for the 24 independent animal hospitals acquired during the nine months ended September 30, 2012, and the allocation of the acquisition price (in thousands):
Consideration:

 Cash                                            $ 51,744
 Holdback                                           1,475
 Earnout contingent consideration                     934
   Fair value of total consideration transferred $ 54,153

Allocation of the Purchase Price:
 Tangible assets                                 $  1,995
 Identifiable intangible assets                     9,184
 Goodwill (1)                                      42,974
   Total                                         $ 54,153


____________________________

(1) We expect that $40.0 million of the goodwill recorded for these acquisitions, as of September 30, 2012, will be deductible for income tax purposes.
AVC
On January 31, 2012, we increased our investment in AVC by approximately CDN $81 million (approximately US $81 million) becoming the sole non-veterinarian shareholder of AVC. At the time of the additional investment, AVC operated 44 animal hospitals in three Canadian provinces, offering services ranging from primary care, to specialty referral services and 24-hour emergency care. This investment and planned additional investments in AVC will facilitate our continued expansion in the Canadian market. At the time of the investment, AVC had annualized revenue of approximately CDN $95 million (approximately US $95 million). Our consolidated financial statements reflect the operating results of AVC since January 31, 2012.
The following table summarizes the total investment and the preliminary allocation of the investment in AVC (in thousands):

Consideration:
 Cash                                            $ 48,819
 Cash paid to debt holders                         25,915
   Fair value of total consideration transferred $ 74,734

Allocation of the Purchase Price:
 Tangible assets                                 $ 11,743
 Identifiable intangible assets                    23,561
 Goodwill (1)                                      77,565
 Other liabilities assumed                        (18,124 )
                                                   94,745
 Noncontrolling interest                           (8,161 )
 Fair value of pre-existing investment in AVC     (11,850 )
   Total                                         $ 74,734


____________________________

(1) As of September 30, 2012, we expect that approximately $362,000 of the goodwill recorded for this acquisition will be deductible for income tax purposes. The allocation of the additional investment is preliminary, because certain items have not been completed or finalized,


including but not limited to, the valuation of assets, primarily property and equipment.
The pro forma impact on revenue and earnings have not been disclosed as the amounts were immaterial to the financial statements as a whole. ThinkPets
On February 1, 2012, we acquired 100% interest in ThinkPets for $21 million, payable by delivery of 473,389 shares of VCA common stock and $10.5 million in cash. We intend to consolidate the business of ThinkPets with our Vetstreet business, which we expect will improve the products and services it offers to clients of both companies. Our consolidated financial statements reflect the operating results of ThinkPets since February 1, 2012.
The following table summarizes the preliminary purchase price and the preliminary allocation of the investment in ThinkPets (in thousands):
Consideration:

 Cash                                            $  7,468
 Issuance of common stock for acquisitions         10,500
 Holdback                                           1,050
   Fair value of total consideration transferred $ 19,018

Allocation of the Purchase Price:
 Tangible assets                                 $  2,078
 Identifiable intangible assets                     7,221
 Goodwill (1)                                      11,194
 Other liabilities assumed                         (1,475 )
   Total                                         $ 19,018


____________________________

(1) As of September 30, 2012, we expect that approximately $821,000 of the goodwill recorded for this acquisition will be deductible for income tax purposes. The allocation of the purchase price is preliminary because certain items have not been completed or finalized, including but not limited to, the valuation of assets, including intangible assets, and liabilities. The pro forma impact on revenue and earnings have not been disclosed as the amounts were immaterial to the financial statements as a whole.

Critical Accounting Policies
Our consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States ("GAAP"), which require management to make estimates and assumptions that affect reported amounts. The estimates and assumptions are based on historical experience and on other factors that management believes to be reasonable. Actual results may differ from those estimates. Critical accounting policies represent the areas where more significant judgments and estimates are used in the preparation of our consolidated financial statements. A discussion of such critical accounting policies, which include revenue recognition, other intangible assets, capitalized software costs, income taxes, and self-insured liabilities can be found in our 2011 Annual Report on Form 10-K. There have been no material changes to the policies noted above as of this quarterly report on Form 10-Q for the period ended September 30, 2012. A summary of our valuation of goodwill accounting policy is discussed below.


Valuation of Goodwill

At September 30, 2012, we had $1.4 billion of goodwill, accounting for 62% of our total assets. Our goodwill represents the excess of the cost of our acquired entities over the net of the amounts assigned to identifiable assets acquired and liabilities assumed.

We test our goodwill for impairment annually, or sooner if circumstances indicate impairment may exist, in accordance with goodwill guidance. We adopted the end of October as our annual impairment testing date, which allows us time to accurately complete our impairment testing process in order to incorporate the results in our annual financial statements and timely file those statements with the Securities and Exchange Commission ("SEC") in accordance with our accelerated filing requirements. We monitor our reporting units on a quarterly basis and have not identified any events subsequent to the 2011 testing date which would indicate any impairment may have occurred in any of our reporting units.

The recognition and measurement of a goodwill impairment loss involves either a high-level qualitative assessment of the fair value of each reporting unit or a more detailed calculation. We have not presently elected to rely on a qualitative assessment, as a result of the narrow margin between the fair value and carrying value of certain reporting units that existed at the previous measurement date.

Accordingly, we first identify a potential impairment by comparing the estimated fair value of our reporting units with the carrying value of our reporting units, with carrying value defined as the reporting unit's net assets, including goodwill. If the estimated fair value of our reporting units is greater than our carrying value, there is no impairment and the second step is not needed.

If we identify a potential impairment in the first step, we then measure the amount of impairment. The amount of the impairment is determined by allocating the estimated fair value of the reporting unit, as determined in step one, to the reporting unit's net assets based on fair value as calculated in an acquisition. In this hypothetical acquisition, the residual estimated fair value, after allocation to the reporting units' identifiable net assets, is the estimated fair value of goodwill. If the estimated fair value of goodwill is less than the carrying amount of goodwill, goodwill is considered impaired and written down to the estimated fair value with a corresponding charge to earnings. However, if the estimated fair value of goodwill is greater than the carrying amount of goodwill, goodwill is not considered impaired and is not adjusted to the estimated fair value.
Our estimated fair values are calculated in accordance with generally accepted accounting principles related to fair value and utilize generally accepted valuation techniques, consisting primarily of discounted cash flow techniques and market comparables, where applicable. These valuation methods involve the use of significant assumptions and estimates such as forecasted growth rates, valuation multiples, the weighted-average cost of capital, and risk premiums, which are based upon the best available market information and are consistent with our long-term strategic plans. Changes in our estimates, such as forecasted cash flows, could affect the estimated fair value of our reporting units and could result in a goodwill impairment charge that could be material, particularly for our Animal Hospital and Vetstreet reporting units. Our laboratory reporting unit exceeded its carrying value by a substantial margin as of our last testing date. No events have occurred subsequent to December 31,2011, which would indicate any impairment may have occurred in any of our reporting units.
Our Animal Hospital reporting unit, which has approximately $1.2 billion of goodwill as of September 30, 2012, marginally exceeded its carrying value during the 2011 testing. Negative changes in the undiscounted cash flows related to variables, such as revenue growth rates, margins, or the discount rate, could result in a decrease in the estimated fair value of our Animal Hospital reporting unit and could ultimately result in a substantial goodwill impairment charge. The performance of our Animal Hospital reporting unit, and in turn, the risk of goodwill impairment, is subject to a number of risks and uncertainties, some of which are outside of our control.
Our Vetstreet reporting unit, which has approximately $96.1 million of goodwill as of September 30, 2012, has faced operational delays in part due to our upgrading and migration of their information technology systems from their former parent MediMedia, to their own Corporate data center. Additionally, certain aspects of its planned product offerings have also been delayed. Any continued delays, strengthening of competitive product offerings and future strategic plans may affect the timing of undiscounted cash flows for the overall business and accordingly could result in a decrease in the estimated fair value of our Vetstreet reporting unit. As a result we could experience a substantial goodwill impairment charge.


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