XNAS:MWIV MWI Veterinary Supply Inc Quarterly Report 10-Q Filing - 5/3/2012

Effective Date 5/3/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 
 

FORM 10-Q

x
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 
For the quarterly period ended March 31, 2012
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 
For the transition period from                      to                      
 
Commission File Number:  000-51468



MWI VETERINARY SUPPLY, INC.
(Exact name of registrant as specified in its Charter)



Delaware
 
02-0620757
(State of Incorporation)
 
(I.R.S. Employer Identification Number)
     
3041 W. Pasadena Dr.
   
Boise, ID
 
83705
(Address of principal executive offices)
 
(Zip Code)
     
(208) 955-8930
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes x  No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
x        
 
Accelerated filer  
o
Non-accelerated filer
o  (Do not check if a smaller reporting company)
Smaller reporting company   
o

 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
 
The number of shares of the registrant’s common stock, $0.01 par value, outstanding as of April 27, 2012 was 12,729,289.



 
INDEX
 

 
PART I.
   
       
Item 1.
   
   
 
       
   
 
       
   
 
       
   
 
       
   
 
       
Item 2.
 
 
       
Item 3.
 
 
       
Item 4.
 
 
       
PART II.
   
       
   
 
       
Item 1.
 
 
       
Item 1A.
 
 
       
Item 2.
 
 
       
Item 3.
 
 
       
Item 4.
 
 
       
Item 5.
 
 
       
Item 6.
 
 


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 1. Financial Statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
MWI VETERINARY SUPPLY, INC.
 
 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 
 
Dollars and shares in thousands, except per share data
 
 
(unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31,
 
Six months ended March 31,
 
 
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
Product sales
$
 488,187
 
$
 348,387
 
$
 930,784
 
$
 696,124
 
Product sales to related party
 
 14,585
 
 
 13,118
 
 
 30,143
 
 
 27,841
 
Commissions
 
 4,398
 
 
 5,607
 
 
 8,144
 
 
 9,321
 
 
Total revenues
 
 507,170
 
 
 367,112
 
 
 969,071
 
 
 733,286
Cost of product sales
 
 440,552
 
 
 316,126
 
 
 839,939
 
 
 632,228
Gross profit
 
 66,618
 
 
 50,986
 
 
 129,132
 
 
 101,058
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Selling, general and administrative expenses
 
 42,933
 
 
 32,450
 
 
 81,840
 
 
 63,497
Depreciation and amortization
 
 2,274
 
 
 1,667
 
 
 4,466
 
 
 3,156
Operating income
 
 21,411
 
 
 16,869
 
 
 42,826
 
 
 34,405
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense
 
 (252)
 
 
 (252)
 
 
 (435)
 
 
 (434)
 
Earnings of equity method investees
 
 79
 
 
 63
 
 
 156
 
 
 136
 
Other
 
 186
 
 
 143
 
 
 374
 
 
 278
 
 
Total other income (expense), net
 
 13
 
 
 (46)
 
 
 95
 
 
 (20)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income before taxes
 
 21,424
 
 
 16,823
 
 
 42,921
 
 
 34,385
Income tax expense
 
 (8,246)
 
 
 (6,491)
 
 
 (16,547)
 
 
 (13,225)
Net income
$
 13,178
 
$
 10,332
 
$
 26,374
 
$
 21,160
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
 
 
 
 
 
Basic
$
 1.04
 
$
 0.83
 
$
 2.09
 
$
 1.70
 
Diluted
$
 1.04
 
$
 0.83
 
$
 2.09
 
$
 1.69
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
 
 
 
Basic
 
 12,619
 
 
 12,462
 
 
 12,600
 
 
 12,438
 
Diluted
 
 12,648
 
 
 12,511
 
 
 12,626
 
 
 12,496
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
See Notes to Condensed Consolidated Financial Statements.
 
 
 
 
 
 
 
 
 


CONDENSED CONSOLIDATED BALANCE SHEETS
Dollars and shares in thousands, except per share data
(unaudited)
 
 
 
 
 
 
 
 
 
 
 
March 31,
 
September 30,
 
 
 
2012
 
2011
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
Current Assets:
 
 
 
 
 
 
Cash and cash equivalents
$
 512
 
$
 606
 
Receivables, net
 
 267,886
 
 
 215,861
 
Inventories
 
 238,884
 
 
 170,065
 
Prepaid expenses and other current assets
 
 6,767
 
 
 10,079
 
Deferred income taxes
 
 2,352
 
 
 1,672
 
 
Total current assets
 
 516,401
 
 
 398,283
 
 
 
 
 
 
 
 
Property and equipment, net
 
 34,615
 
 
 25,209
Goodwill
 
 60,907
 
 
 49,041
Intangibles, net
 
 39,930
 
 
 24,894
Other assets, net
 
 7,216
 
 
 6,792
Total assets
$
 659,069
 
$
 504,219
 
 
 
 
 
 
 
 
Liabilities And Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
Current Liabilities:
 
 
 
 
 
 
Credit facilities
$
 64,484
 
$
 2,907
 
Accounts payable
 
 234,935
 
 
 182,594
 
Accrued expenses and other current liabilities
 
 19,470
 
 
 16,385
 
Current portion of capital lease obligations
 
 764
 
 
 909
 
 
Total current liabilities
 
 319,653
 
 
 202,795
 
 
 
 
 
 
 
 
Deferred income taxes
 
 6,896
 
 
 5,989
 
 
 
 
 
 
 
 
Long-term capital lease obligations
 
 275
 
 
 354
 
 
 
 
 
 
 
 
Other long-term liabilities
 
 3,262
 
 
 2,271
 
 
 
 
 
 
 
 
Commitments and contingencies (see Note 14)
 
 
 
 
 
 
 
 
 
 
 
 
 
Stockholders’ Equity
 
 
 
 
 
 
Common stock $0.01 par value, 40,000 authorized; 12,729 and
 
 
 
 
 
 
 
12,618 shares issued and outstanding, respectively
 
 127
 
 
 126
 
Additional paid in capital
 
 142,380
 
 
 133,759
 
Retained earnings
 
 185,862
 
 
 159,488
 
Accumulated other comprehensive income
 
 614
 
 
 (563)
 
 
Total stockholders’ equity
 
 328,983
 
 
 292,810
Total liabilities and stockholders’ equity
$
 659,069
 
$
 504,219
 
 
 
 
 
 
 
 
See Notes to Condensed Consolidated Financial Statements.
 
 
 
 
 


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Dollars in thousands (unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended March 31,
 
 
 
 
 
2012
 
2011
Cash Flows From Operating Activities:
 
 
 
 
 
 
Net income
$
 26,374
 
$
 21,160
 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
Depreciation and amortization
 
 4,475
 
 
 3,162
 
 
Amortization of debt issuance costs
 
 22
 
 
 33
 
 
Stock-based compensation
 
 772
 
 
 651
 
 
Deferred income taxes
 
 155
 
 
 443
 
 
Earnings of equity method investees
 
 (156)
 
 
 (136)
 
 
Loss on disposal of property and equipment
 
 31
 
 
 - 
 
 
Excess tax benefit of exercise of common stock options
 
 (359)
 
 
 (1,900)
 
 
Other
 
 (40)
 
 
 96
 
 
Changes in operating assets and liabilities (net of effects of business acquisitions):
 
 
 
 
 
 
 
 
Receivables
 
 (28,321)
 
 
 (13,663)
 
 
 
Inventories
 
 (40,073)
 
 
 (4,591)
 
 
 
Prepaid expenses and other current assets
 
 3,479
 
 
 5,183
 
 
 
Accounts payable
 
 26,622
 
 
 (12,332)
 
 
 
Accrued expenses and other current liabilities
 
 2,656
 
 
 505
 
 
 
 
Net cash used in operating activities
 
 (4,363)
 
 
 (1,389)
 
 
 
 
 
 
 
 
 
 
Cash Flows From Investing Activities:
 
 
 
 
 
 
 
Business acquisitions, net of cash acquired
 
 (53,720)
 
 
 (7,000)
 
 
Purchases of property and equipment
 
 (3,282)
 
 
 (9,130)
 
 
Proceeds from sale of property and equipment
 
 96
 
 
 - 
 
 
Other investments
 
 (498)
 
 
 79
 
 
 
 
Net cash used in investing activities
 
 (57,404)
 
 
 (16,051)
 
 
 
 
 
 
 
 
 
 
Cash Flows From Financing Activities:
 
 
 
 
 
 
 
Borrowings on credit facilities
 
 255,980
 
 
 172,129
 
 
Payments on credit facilities
 
 (194,562)
 
 
 (153,997)
 
 
Proceeds from issuance of common stock
 
 254
 
 
 189
 
 
Proceeds from exercise of stock options
 
 91
 
 
 69
 
 
Excess tax benefit of exercise of common stock options
 
 359
 
 
 1,900
 
 
Debt issuance costs
 
 (111)
 
 
 - 
 
 
Payment on long-term debt and capital lease obligations
 
 (390)
 
 
 (2,902)
 
 
 
 
Net cash provided by financing activities
 
 61,621
 
 
 17,388
 
 
 
 
 
 
 
 
 
 
Effect of Exchange Rate on Cash and Cash Equivalents
 
 52
 
 
 115
 
 
 
 
 
 
 
 
 
 
(Decrease)/Increase in Cash and Cash Equivalents
 
 (94)
 
 
 63
 
 
 
 
 
 
 
 
 
 
Cash and Cash Equivalents at Beginning of Period
 
 606
 
 
 911
 
 
 
 
 
 
 
 
 
 
Cash and Cash Equivalents at End of Period
$
 512
 
$
 974
 
 
 
 
 
 
 
 
 
 
See Notes to Condensed Consolidated Financial Statements.
 
 
 
 
 


MWI VETERINARY SUPPLY, INC.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
Dollars and sterling pounds in thousands, except share and per share data
 
(unaudited)
 
NOTE 1 — GENERAL
 
Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements include the results of operations, financial position and cash flows of MWI Veterinary Supply, Inc. and its wholly-owned subsidiaries (collectively referred to as “we,” “us,” and “our” throughout this Form 10-Q).  All intercompany balances have been eliminated.
 
In the opinion of our management, the accompanying unaudited condensed consolidated financial statements include all adjustments necessary to present fairly, in all material respects, our results for the periods presented. These condensed consolidated financial statements have been prepared by us pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations.  These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in our 2011 Annual Report on Form 10-K filed with the SEC on November 28, 2011.  The results of operations for the three and six months ended March 31, 2012 are not necessarily indicative of results to be expected for the entire fiscal year.
 
Our unaudited condensed consolidated balance sheet as of September 30, 2011 has been derived from the audited consolidated balance sheet as of that date.
 
Use of Estimates
 
The accompanying unaudited condensed consolidated financial statements have been prepared on the accrual basis of accounting using accounting principles generally accepted in the United States. In preparing financial information, we use certain estimates and assumptions that may affect the reported amounts and disclosures. Some of these estimates require difficult, subjective and complex judgments about matters that are inherently uncertain. As a result, actual results could differ materially from these estimates. Estimates are used when accounting for, among other items, sales returns, allowance for doubtful accounts, customer incentives, vendor rebates, inventories, goodwill and intangible assets, income taxes, impairment of long-lived assets, depreciation and amortization, employee benefits, unearned income and contingencies. The estimates of fair value of assets and liabilities and the disclosure of contingent assets and liabilities as of the balance sheet date and reported amounts of revenue and expenses for the periods are based on assumptions that we believe to be reasonable.
 
Revenue Recognition
 
We sell products we source from vendors to our customers through either a “buy/sell” transaction or an agency relationship with our vendors. In a “buy/sell” transaction, we purchase or take inventory of products from the vendor. When a customer places an order with us, we pick, pack, ship and invoice the customer for the order. We recognize revenue from “buy/sell” transactions as product sales when the product is delivered to the customer. We accept product returns from our customers. We estimate returns based on historical experience and recognize these estimated returns as a reduction of product sales. Product returns have historically not been significant to our financial statements. We record revenues net of sales tax.  In an agency relationship, we generally do not purchase and take inventory of products from vendors. We receive an order from a customer, then transmit the order to the vendor, who picks, packs and ships the order to the customer. In some cases, the vendor invoices and collects payment from the customer, while in other cases we invoice and collect payment from the customer on behalf of the vendor. We receive a commission payment for soliciting the order from the customer and for providing other customer service activities. Commissions are recognized when the services upon which the commissions are based are complete.  Gross billings from agency contracts were $87,962 and $110,696 for the three months ended March 31, 2012 and 2011, respectively, and generated commission revenue of $4,398 and $5,607, respectively.  Gross billings from agency contracts were $155,993 and $181,261 for the six months ended March 31, 2012 and 2011, respectively, and generated commission revenue of $8,144 and $9,321, respectively.
 
Customer incentives are accrued based on the terms of the contracts with each customer. These incentive programs provide that the customer receive an incentive based on their product purchases or attainment of performance goals. Incentives are estimated based on the specific terms in each agreement, historical experience and product growth rates.  Incentives are recognized as a reduction to product sales.
 
Cost of Product Sales and Vendor Rebates
 
Cost of product sales consist of our inventory product cost, including shipping and delivery costs to and from our distribution centers.  Vendor rebates are recorded based on the terms of the contracts or programs with each vendor.  Many of our vendors’ rebate programs are based on a calendar year.  We may receive quarterly, semi-annual or annual performance-based rebates from third-party vendors based upon attainment of certain sales and/or purchase goals. Sales rebates are classified in the accompanying condensed consolidated statements of income as a reduction to cost of product sales at the time the sales performance measures are achieved. Purchase rebates are measured against inventory purchases from the vendors and are classified as a reduction of inventory until the product is sold. When the inventory is sold and purchase measures are achieved, purchase rebates are recognized as a reduction to cost of product sales.
 
Historically, actual results have not significantly deviated from those determined using the estimates described above. We expect that our estimates in the future will continue to be reasonable as our rebates are based on specific vendor program goals and are principally recorded upon achievement of sales or purchase performance measures. Vendors may change or eliminate rebate programs from year to year.
 

NOTE 2 — EFFECT OF RECENTLY ISSUED ACCOUNTING STANDARDS
 
In May 2011, the FASB issued guidance to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between generally accepted accounting principles in the United States and International Financial Reporting Standards. The guidance changes certain fair value measurement principles and enhances the disclosure requirements, particularly for Level 3 fair value measurements. The guidance is effective for our fiscal year beginning October 1, 2012.  We do not believe that the adoption of this guidance will have a material impact on our consolidated financial statements.
 
 In June 2011, the FASB issued guidance on the presentation of comprehensive income in an entity's financial statements. The guidance requires that comprehensive income be presented either in one continuous statement or in two separate but consecutive statements presenting the components of net income and its total, the components of other comprehensive income and its total, and total comprehensive income. The guidance also requires that reclassification adjustments from other comprehensive income to net income be presented in both the components of net income and the components of other comprehensive income. The guidance is effective for our fiscal year beginning October 1, 2012.  We do not believe that the adoption of this guidance will have a material impact on our consolidated financial statements.
 
In September 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-08, Testing Goodwill for Impairment (“ASU 2011-08”) which is intended to simplify goodwill impairment testing by permitting the assessment of qualitative factors to determine whether events and circumstances lead to the conclusion that it is necessary to perform the traditional two-step impairment test. Under ASU 2011-08, entities testing goodwill for impairment now have the option to perform a qualitative assessment before having to calculate the fair value of a reporting unit. If an entity determines, on the basis of qualitative factors, that the fair value of the reporting unit is more-likely-than-not less than the carrying amount, the existing quantitative impairment test is required. Otherwise, no further impairment testing is required. This update is effective for fiscal years beginning after December 15, 2011, with early adoption permitted. We do not believe that the adoption of this provision will have a material impact on our consolidated financial statements.
 

NOTE 3 BUSINESS ACQUISITIONS
 
On March 21, 2011, MWI Veterinary Supply Co. (“MWI Co.”) purchased substantially all of the assets of Nelson Laboratories Limited Partnership (“Nelson”) for $7,000 in cash.  Nelson was a distributor of animal health products to over 1,100 veterinary practices, primarily in the Midwestern United States.  This acquisition allows us to better serve our customers in this region of the United States.  An intangible asset representing customer relationships acquired in the acquisition has an estimated useful life of 10 years. The amount recorded in goodwill is expected to be deductible for tax purposes over 15 years.
 
On October 31, 2011, MWI Co. purchased substantially all of the assets of Micro Beef Technologies, Ltd. (“Micro”) for $60,880, including $53,400 in cash and 94,359 shares of common stock valued at $7,158, which is the fair value of the common stock as of the date of acquisition and an estimated working capital adjustment of $322.  The $53,400 paid in cash as consideration of Micro was funded with borrowings under our Credit Agreement (as defined in Note 7) as then in effect.  The purchase price remains subject to a post-closing working capital and debt adjustment.  Micro was a value-added distributor to the production animal market, including the distribution of micro feed ingredients, pharmaceuticals, vaccines, parasiticides, supplies and other animal health products.  Micro also was a leading innovator of proprietary, computerized management systems for the production animal market. The intangible assets acquired in the acquisition include customer relationships, covenant not to compete, technology and trade name.  The useful life of the amortizing intangible assets ranges from 5 years to 17 years.  Trade name is a non-amortizing intangible asset.  The amount recorded in goodwill is expected to be deductible for tax purposes over 15 years.
 
The fair values assigned to the tangible and intangible assets acquired and liabilities assumed are based on management's estimates and assumptions, as well as other information compiled by management, including valuations that utilize customary valuation procedures and techniques. We adjusted those valuations during the three months ended March 31, 2012 as a result of further review of these estimates and assumptions. The fair value assigned to the purchased intangible related to customer relationships increased by $3,350, covenant not to compete decreased by $10, technology decreased by $6,100 and trade name decreased by $2,390 compared to the acquisition date as a result of this measurement period adjustment with a corresponding adjustment to the carrying value of goodwill of $5,150. The related impact on amortization recognized from that date is insignificant to the consolidated statements of income.

The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of acquisition, which may be adjusted during the allocation period as defined in Accounting Standards Codification (“ASC”) 280.  These purchase price allocations are based on a combination of valuations and analyses.
 

 
 
 
 
 
 
 
 
 
 
 
2012
 
2011
 
Cash
 
$
 2
 
$
 - 
 
Receivables
 
 
 22,656
 
 
 4,041
 
Inventories
 
 
 28,204
 
 
 3,594
 
Other current assets
 
 
 104
 
 
 - 
 
Property and equipment
 
 
 8,930
 
 
 1,900
 
Goodwill
 
 
 11,648
 
 
 1,823
 
Intangibles
 
 
 15,760
 
 
 140
 
Investments
 
 
 199
 
 
 - 
 
Total assets acquired
 
 
 87,503
 
 
 11,498
 
 
 
 
 
 
 
 
 
Accounts payable
 
 
 25,023
 
 
 4,498
 
Accrued expenses and other liabilities
 
 
 1,600
 
 
 - 
 
Total liabilities assumed
 
 
 26,623
 
 
 4,498
 
 
 
 
 
 
 
 
 
Net assets acquired
 
$
 60,880
 
$
 7,000
 
 
 
 
 
 
 
 

The following table presents information for Micro that is included in our consolidated statements of income from the acquisition date of October 31, 2011 through the end of the quarter ended March 31, 2012:
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Micro's operations included in MWI's results
 
 
 
 
 
 
Three months ended March 31, 2012
 
 
 
Six months ended March 31, 2012
 
 
 
Revenues
 
$
 63,006
 
 
$
 109,167
 
 
 
Net Income
 
$
 1,090
 
 
$
 2,313
 
 
 
 
 
 
 
 
 
 
 
 

The following table presents supplemental pro forma information as if the acquisition of Micro had occurred on October 1, 2011 for the six months ended March 31, 2012 and on October 1, 2010 for the six months ended March 31, 2011 (unaudited):
 

 
 
 
 
 
 
 
 
 
 
 
 
Unaudited Pro Forma Consolidated Results
 
 
 
Six months ended March 31,
 
 
 
 
 
2012
 
 
 
2011
 
 
Revenues
 
$
 991,001
 
 
$
 844,187
 
 
Net Income
 
$
 26,468
 
 
$
 22,645
 
 
 
 
 
 
 
 
 
 
 

The unaudited pro forma consolidated results are not necessarily indicative of what our consolidated results of operations would have been had we completed the acquisition on October 1, 2011 or 2010.  Additionally, the unaudited pro forma consolidated results do not purport to project the future results of operations of the combined company.
 

NOTE 4 RECEIVABLES
 

 
 
 
 
 
 
 
 
 
 
March 31,
 
September 30,
 
 
 
2012
 
2011
 
 
Trade
$
 252,723
 
$
 203,038
 
 
Vendor rebates and programs
 
 17,597
 
 
 15,404
 
 
 
 
 270,320
 
 
 218,442
 
 
Allowance for doubtful accounts
 
 (2,434)
 
 
 (2,581)
 
 
 
$
 267,886
 
$
 215,861
 
 
 
 
 
 
 
 
 

Product sales resulting from transactions with Banfield, The Pet Hospital (“Banfield”) were approximately 6% of total product sales during each of the three and six months ended March 31, 2012 and 2011.  Approximately 7% and 8% of our trade receivables resulted from transactions with Banfield as of March 31, 2012 and September 30, 2011, respectively.
 

NOTE 5 PROPERTY AND EQUIPMENT
 

 
 
 
 
 
 
 
 
 
 
March 31,
 
September 30,
 
 
 
2012
 
2011
 
 
Land
$
 1,762
 
$
 1,723
 
 
Building and leasehold improvements
 
 14,156
 
 
 13,427
 
 
Machinery, furniture and equipment
 
 31,506
 
 
 20,979
 
 
Computer equipment
 
 7,550
 
 
 5,864
 
 
Construction in progress
 
 1,052
 
 
 2,203
 
 
 
 
 56,026
 
 
 44,196
 
 
Accumulated depreciation
 
 (21,411)
 
 
 (18,987)
 
 
 
$
 34,615
 
$
 25,209
 
 
 
 
 
 
 
 
 

Depreciation expense was $1,582 and $1,261 for the three months ended March 31, 2012 and 2011, respectively. Depreciation expense was $3,040 and $2,346 for the six months ended March 31, 2012 and 2011, respectively.
 

NOTE 6 GOODWILL AND INTANGIBLES
 
The changes in the carrying value of goodwill are as follows:
 

 
 
 
 
 
 
 
 
 
 
Goodwill as of September 30, 2011
 
 
 
$
 49,041
 
 
 
Acquisition activity
 
 
 
 
 11,648
 
 
 
Foreign currency adjustments
 
 
 
 
 218
 
 
Goodwill as of March 31, 2012
 
 
 
$
 60,907
 
 
 
 
 
 
 
 
 
 

Balances of intangibles are as follows:
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31,
 
September 30,
 
 
 
 
Useful Lives
 
2012
 
2011
 
 
Amortizing:
 
 
 
 
 
 
 
 
 
 
Customer relationships
 
9-20 years
 
$
 30,866
 
$
 24,981
 
 
Covenants not to compete
 
1-5 years
 
 
 902
 
 
 808
 
 
Technology
 
11 years
 
 
 5,830
 
 
 - 
 
 
Other
 
2-7 years
 
 
 1,056
 
 
 455
 
 
 
 
 
 
 
 38,654
 
 
 26,244
 
 
Accumulated amortization
 
 
 
 
 (6,385)
 
 
 (5,109)
 
 
 
 
 
 
 
 32,269
 
 
 21,135
 
 
Non-Amortizing:
 
 
 
 
 
 
 
 
 
 
Trade names and patents
 
 
 
 
 7,661
 
 
 3,759
 
 
 
 
 
 
$
 39,930
 
$
 24,894
 
 
 
 
 
 
 
 
 
 
 
 

Amortization expense was $697 and $410 for the three months ended March 31, 2012 and 2011, respectively.  Amortization expense was $1,435 and $817 for the six months ended March 31, 2012 and 2011, respectively.  Estimated future annual amortization expense related to intangible assets as of March 31, 2012 is as follows:
 

 
 
 
 
 
 
 
Amount
 
 
Remainder of 2012
$
 1,223
 
 
2013
 
 2,681
 
 
2014
 
 2,508
 
 
2015
 
 2,232
 
 
2016
 
 2,135
 
 
Thereafter
 
 21,490
 
 
 
$
 32,269
 
 
 
 
 
 

The above projection of amortization expense includes preliminary estimates of intangible assets and lives associated with the acquisition of Micro.  These amounts may be adjusted during the allocation period as defined in ASC 805.
 

NOTE 7 DEBT
 
The following table presents the outstanding debt and capital lease obligations as of March 31, 2012 and September 30, 2011:
 

 
 
 
 
 
 
 
 
 
 
 
 
March 31,
 
September 30,
 
 
 
 
 
2012
 
 
2011
 
 
Revolving credit facility, 1.10% interest as of March 31, 2012
$
 55,900
 
$
 - 
 
 
Sterling revolving credit facility, 1.70% interest as of March 31,  2012
 
 8,584
 
 
 2,907
 
 
Capital lease obligations (1)
 
 1,039
 
 
 1,263
 
 
Total debt and capital lease obligations
 
 65,523
 
 
 4,170
 
 
 
Less: Long-term capital lease obligations
 
 (275)
 
 
 (354)
 
 
Total debt included in current liabilities
$
 65,248
 
$
 3,816
 
 
 
 
 
 
 
 
 
 
 
(1) The capital lease obligations have varying maturity dates.
 
 
 
 
 
 
 
 
 
 

Revolving Credit Facility — On November 1, 2011, MWI Co. as borrower, entered into a Third Amendment to Credit Agreement (the “Third Amendment”) with MWI Veterinary Supply, Inc. and Memorial Pet Care, Inc., as guarantors, and Bank of America, N.A. and Wells Fargo Bank, N.A. as lenders (collectively, the “Lenders”), amending the Credit Agreement dated December 13, 2006, and as amended from time to time, by and among MWI Co., MWI Veterinary Supply, Inc., Memorial Pet Care, Inc. and the Lenders (the  “Credit Agreement”).  As discussed in Note 3 – Business Acquisitions, MWI Co.’s purchase of the assets of Micro was completed on October 31, 2011, using borrowing capacity that existed prior to the effectiveness of the Third Amendment.  The Third Amendment increased the aggregate revolving commitment of the Lenders under the Credit Agreement from $100,000 to $150,000 and extended the maturity date of the Credit Agreement from March 1, 2013 to November 1, 2016.  Under the Third Amendment, the margin on variable interest rate borrowings now ranges from 0.95% to 1.50%.  The margin previously ranged from 1.50% to 2.25% under the Second Amendment.  The Third Amendment also reduced the commitment fee from a range of 0.2% to 0.35% to a range of 0.15% to 0.25% depending on the funded debt to EBITDA ratio.  The Credit Agreement contains financial covenants, including a fixed charge ratio and a funded debt to EBITDA ratio.  We were in compliance with all of the covenants as of March 31, 2012 and September 30, 2011.
 
Sterling revolving credit facility— On November 5, 2010, Centaur Services Limited (“Centaur”), a wholly owned subsidiary of MWI Co. entered into a £12,500 unsecured revolving line of credit facility (the “sterling revolving credit facility”) with Wells Fargo Bank, N.A. London Branch (“Wells Fargo”).  The sterling revolving credit facility is for a three year term with interest paid at the end of the applicable one month, three month or six month interest period.  Interest is based on LIBOR for the applicable interest period plus an applicable margin of 1.05% to 1.90%.  The facility contains financial covenants requiring Centaur to maintain a minimum tangible net worth of £3,000.  As of March 31, 2012 and September 30, 2011, Centaur was in compliance with the covenant.
 

NOTE 8 FAIR VALUE OF FINANCIAL INSTRUMENTS
 
Current fair value accounting guidance includes a hierarchy that is intended to increase consistency and comparability in fair value measurements and disclosures.  This hierarchy prioritizes inputs to valuation techniques based on observable and unobservable data.  The guidance categorizes these inputs used in measuring fair value into three levels which include the following:
 
·  
Level 1 – observable inputs such as quoted prices in active markets;
 
·  
Level 2 – inputs, other than quoted prices, that are observable for the asset or liability, either directly or indirectly.  These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active; and
 
·  
Level 3 – unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.
 
As of March 31, 2012 and September 30, 2011, financial instruments include cash and cash equivalents, receivables and accounts payable, and the fair values approximate book values due to their short maturities.
 
In November 2011, we entered into our revolving credit facility in the United States and in November 2010, we amended our sterling revolving credit facility in the United Kingdom.  Because these amendments were done relatively recently and include interest rates based on current market conditions, we believe that the estimated fair value of our debt was materially the same as our carrying value.
 

NOTE 9 COMMON STOCK AND STOCK-BASED AWARDS
 
 
2002 Stock Plan
 
We have a 2002 Stock Plan (the “2002 Plan”) to provide our directors, executives and other key employees with additional incentives by allowing them to acquire an ownership interest in us and, as a result, encouraging them to contribute to our success. As of March 31, 2012 and September 30, 2011, we had 60,440 and 67,032 shares, respectively, of our common stock available for issuance under the 2002 Plan. The options granted under the 2002 Plan are nonqualified stock options that have an exercise price per share equal to fair market value of the common stock at the time of grant. The term of each option is determined by our board of directors or by a designated committee of the board.  The term of any option may not exceed ten years from the date of grant.  All options that were granted under this plan have been exercised.
 
 
2005 Stock Plan
 
We have a 2005 Stock-Based Award and Incentive Compensation Plan (the “2005 Plan”), under which we may offer restricted and unrestricted shares of our common stock and grant options to purchase shares of our common stock to selected employees and non-employee directors. The purpose of the 2005 Plan is to promote our long-term financial success by attracting, retaining and rewarding eligible participants. As of March 31, 2012 and September 30, 2011, we had 925,119 and 932,438 shares, respectively, of our common stock available for issuance under the 2005 Plan. As of March 31, 2012, 26,148 options to purchase common stock were outstanding with a weighted average exercise price of $17.56 per share and expiring through September 2015. 
 
The 2005 Plan permits us to grant stock options (both incentive stock options and non-qualified stock options), restricted and unrestricted stock and deferred stock. The compensation committee will determine the number and type of stock-based awards to each participant, the exercise price of each award, the duration of the award (not to exceed ten years), vesting provisions and all other terms and conditions of such award in individual award agreements. The 2005 Plan provides that upon termination of employment with us, unless determined otherwise by the compensation committee at the time options are granted, the exercise period for vested awards will generally be limited, provided that vested awards will be canceled immediately upon a termination for cause or voluntary termination. The 2005 Plan provides for the cancellation of all unvested awards upon termination of employment with us, unless determined otherwise by the compensation committee at the time awards are granted.
 
We did not grant common stock options during each of the six months ended March 31, 2012 and 2011.  During the six months ended March 31, 2012 and 2011, we issued 5,750 and 3,000 shares of restricted stock under the 2005 Plan.  During the three months ended March 31, 2012 and 2011, we recognized $427 and $657 of compensation expense related to stock grants, respectively.  During the six months ended March 31, 2012 and 2011, we recognized $868 and $904 of compensation expense related to stock grants, respectively.
 
We also have an employee stock purchase plan (“ESPP”) that allows substantially all employees to purchase shares of our common stock at 95% of the fair market value on the date of purchase.  The purchase date is the last trading date of the purchase periods, which begin in March, June, September and December.  Employees accumulate amounts through payroll deductions during the purchase period of between 1% and 10% but no more than $20 annually.  An employee is allowed to purchase a maximum of 200 shares per purchase period.  During the six months ended March 31, 2012 and 2011, we issued 3,520 and 3,070 shares, respectively, of our common stock under the ESPP.
 

NOTE 10 INCOME TAXES
 
Our effective tax rate for the three months ended March 31, 2012 and 2011 was 38.5% and 38.6%, respectively.  Our effective tax rate for the six months ended March 31, 2012 and 2011 was 38.6% and 38.5%, respectively.
 
As of March 31, 2012, we had $23 of unrecognized tax benefits, of which $15 would impact our effective rate if recognized. Our policy for classifying interest and penalties associated with unrecognized tax benefits is to include such items in income tax expense.  The amount of interest and penalties recognized during the six months ended March 31, 2012 and 2011 was not material.
 
With few exceptions, we are no longer subject to income tax examination for years before 2007 in the U.S. and significant state and local jurisdictions.  We are no longer subject to income tax examination for years before 2009 in significant foreign jurisdictions.
 

NOTE 11 — COMPUTATION OF EARNINGS PER SHARE
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31,
 
 
 
2012
 
2011
 
 
 
Basic
 
Diluted
 
Basic
 
Diluted
 
Net income
$
 13,178
 
$
 13,178
 
$
 10,332
 
$
 10,332
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
 12,619
 
 
 12,619
 
 
 12,462
 
 
 12,462
 
Effect of diluted securities
 
 
 
 
 
 
 
 
 
 
 
 
 
Stock options and restricted stock
 
 
 
 
 29
 
 
 
 
 
 49
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average diluted shares outstanding
 
 
 
 
 12,648
 
 
 
 
 
 12,511
 
Earnings per share
$
 1.04
 
$
 1.04
 
$
 0.83
 
$
 0.83
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Anti-dilutive shares excluded from calculation
 
 
 
 
 - 
 
 
 
 
 
 - 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended March 31,
 
 
 
2012
 
2011
 
 
 
Basic
 
Diluted
 
Basic
 
Diluted
 
Net income
$
 26,374
 
$
 26,374
 
$
 21,160
 
$
 21,160
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding
 
 12,600
 
 
 12,600
 
 
 12,438
 
 
 12,438
 
Effect of diluted securities
 
 
 
 
 
 
 
 
 
 
 
 
 
Stock options and restricted stock
 
 
 
 
 26
 
 
 
 
 
 58
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average diluted shares outstanding
 
 
 
 
 12,626
 
 
 
 
 
 12,496
 
Earnings per share
$
 2.09
 
$
 2.09
 
$
 1.70
 
$
 1.69
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Anti-dilutive shares excluded from calculation
 
 
 
 
 - 
 
 
 
 
 
 - 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

NOTE 12 RELATED PARTIES
 
MWI Co. holds a 50.0% membership interest in Feeders’ Advantage LLC (“Feeders’ Advantage”).  MWI Co. charged Feeders’ Advantage for certain operating and administrative services in the amounts of $233 and $211 for the three months ended March 31, 2012 and 2011, respectively. MWI Co. charged Feeders’ Advantage for certain operating and administrative services in the amounts of $497 and $452 for the six months ended March 31, 2012 and 2011, respectively.  Sales of products to Feeders’ Advantage were $14,585 and $13,118, which represented 3% and 4% of total product sales for each of the three months ended March 31, 2012 and 2011, respectively.  Sales of products to Feeders’ Advantage were $30,143 and $27,841, which represented 3% and 4% of total product sales for each of the six months ended March 31, 2012 and 2011, respectively.
 
MWI Co. provides Feeders’ Advantage with a line-of-credit to finance its day-to-day operations. This line-of-credit bears interest at the prime rate. The interest due on the line-of-credit is calculated and charged to Feeders’ Advantage on the last day of each month. Conversely, to the extent MWI Co. has a payable balance due to Feeders’ Advantage, the payable balance accrues interest in favor of Feeders’ Advantage at the average federal funds rates in effect for that month.  MWI Co. had a payable balance to Feeders’ Advantage of $1,650 as of March 31, 2012 and a receivable balance from Feeders’ Advantage of $756 as of September 30, 2011.
 

NOTE 13 STATEMENTS OF CASH FLOWS – SUPPLEMENTAL AND NON-CASH DISCLOSURES
 

 
 
 
 
 
 
 
 
 
 
Six months ended March 31,
 
 
 
2012
 
2011
 
 
Supplemental Disclosures
 
 
 
 
 
 
 
Cash paid for interest
$
 368
 
$
 283
 
 
Cash paid for income taxes
 
 14,110
 
 
 7,644
 
 
Non-cash Activities
 
 
 
 
 
 
 
Issuance of restricted common stock for asset acquisition
 
 7,158
 
 
 - 
 
 
Capital lease asset additions and related obligations
 
 140
 
 
 - 
 
 
Equipment acquisitions financed with accounts payable
 
 201
 
 
 122
 
 
 
 
 
 
 
 
 

NOTE 14 COMMITMENTS AND CONTINGENCIES
 
On February 7, 2012, Harold and Darroll Wotton removed MWI’s lawsuit against them from Idaho State Court to the United States District Court for the District of Idaho.  MWI’s suit is described in the Company’s Form 10-Q for the three months ended December 31, 2011 (the “Form 10-Q Disclosure”) and alleges, among other things, breach by the Wottons of the non-competition provisions in the Asset Purchase Agreements pursuant to which MWI purchased the business of its Securos division. On February 21, 2012, Harold and Darroll Wotton voluntarily dismissed their suit against MWI and Mr. John Francis in Massachusetts. On February 29, 2012, Harold and Darroll Wotton answered MWI’s complaint in Idaho and asserted a counterclaim against MWI that was substantially similar to the claims asserted in Massachusetts, which claims are described in the Form 10-Q Disclosure. The counterclaim did not name Mr. Francis as a defendant and added counts for declaratory judgment regarding the restrictive covenants in Harold Wotton’s and Darroll Wotton’s respective employment agreements. On April 18, 2012, in opposition to MWI’s motion to dismiss certain of their counterclaims, Harold and Darroll Wotton withdrew their claims for misrepresentation and wrongful termination, along with their request for rescission of the Asset Purchase Agreements and employment agreements in their claim for fraud in the inducement.  MWI believes that the counterclaim is wholly without merit and intends to vigorously defend against this action. MWI also believes that the likelihood of incurring material losses is remote, and therefore has not accrued any amount in the Company’s financial statements. Because the nature of litigation is inherently uncertain, MWI cannot predict the outcome of this matter at this time.

NOTE 15 OTHER COMPREHENSIVE INCOME
 
The components of comprehensive income were as follows:
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31,
 
Six months ended March 31,
 
 
 
2012
 
2011
 
2012
 
2011
Net income
$
 13,178
 
$
 10,332
 
$
 26,374
 
$
 21,160
Other comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation
 
 1,802
 
 
 1,868
 
 
 1,177
 
 
 820
 
 
Total comprehensive income
$
 14,980
 
$
 12,200
 
$
 27,551
 
$
 21,980
 
 
 
 
 
 
 
 
 
 
 
 
 
 


 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Stockholders of
MWI Veterinary Supply, Inc.
Boise, Idaho

We have reviewed the accompanying condensed consolidated balance sheet of MWI Veterinary Supply, Inc. and subsidiaries (the "Corporation") as of March 31, 2012, and the related condensed consolidated statements of income for the three-month and six-month periods ended March 31, 2012 and 2011 and of cash flows for the six-month periods ended March 31, 2012 and 2011.  These interim financial statements are the responsibility of the Corporation’s management.
 
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
 
Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
 
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of MWI Veterinary Supply, Inc. and subsidiaries as of September 30, 2011, and the related consolidated statements of income, stockholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated November 28, 2011, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of September 30, 2011 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
 
/s/ DELOITTE & TOUCHE LLP
Boise, Idaho
May 3, 2012


Item 2.                      Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
All dollar amounts are presented in thousands, except for per share amounts.
 
Overview
 
We are a leading distributor of animal health products to veterinarians in the United States and the United Kingdom. We sell our products to veterinarians in both the companion and production animal markets. Our growth has primarily been from internal growth initiatives and, to a lesser extent, selective acquisitions.  On October 31, 2011, we acquired substantially all of the assets of Micro Beef Technologies, Ltd. (“Micro”), which was a value-added distributor to the production animal market, including the distribution of micro feed ingredients, pharmaceuticals, vaccines, parasiticides, supplies, and other animal health products.  Micro was also a leading innovator of proprietary, computerized management systems for the production animal market.  On March 21, 2011, we acquired substantially all of the assets of Nelson Laboratories Limited Partnership (“Nelson”), which was a distributor of animal health products to veterinarians in the midwestern United States.  Our financial results are disclosed as one reportable segment.
 
Historically, we estimate that approximately two-thirds of our total revenues have been generated from sales to the companion animal market and one-third from sales to the production animal market. While we expect that the majority of our business will continue to be generated from the companion animal market, we expect that the product mix will shift to an increasing amount of our revenues being generated from sales to the production animal market as a result of the Micro acquisition. The state of the overall economy in both the United States and United Kingdom and consumer spending have impacted both the companion animal and production animal markets, with tightening credit markets, volatile commodity prices in milk, grain, corn and feeder cattle, and changes in weather patterns (e.g. droughts or seasons of higher precipitation) also affecting demand in the production animal market.  Both the companion animal and production animal markets have been integral to our financial results and we intend to continue supporting both markets.
 
Industry
 
We believe that the growth in the companion animal market in both the United States and United Kingdom has slowed as a result of a decrease in consumer spending but has shown signs of a recovery in 2012.  Historically, growth in the companion animal market has been due to the increasing number of households with companion animals, increased expenditures on animal health and preventative care, an aging pet population, advancements in pharmaceuticals and diagnostic testing and extensive marketing programs sponsored by companion animal nutrition and pharmaceutical companies. While the average order size for companion animal health products is often smaller than production animal health products, companion animal health products typically have higher margins. We intend to continue to penetrate this market through internal growth initiatives and selective acquisitions.  We believe that some of our customers in this market have experienced liquidity issues as a result of the tightening credit markets.
 
Product sales in the production animal market in both the United States and United Kingdom are impacted by volatility in commodity prices such as milk, corn, grain and feeder cattle, changes in weather patterns (e.g. droughts or seasons of higher precipitation that determine how long cattle will graze) and changes in the general economy.  Milk price declines in the dairy market have a significant impact on dairy farmers.  This creates cash-flow challenges for these farmers and in turn, could impact the time it takes for us to collect our outstanding accounts receivable from these customers as well as affect the overall collectability of these accounts.  However, we still believe that it is important to our business to service this market and we intend to continue to support production animal veterinarians with a broad range of products and value-added services. Historically, sales in this market have been largely driven by spending on animal health products to improve productivity, weight gain and disease prevention, as well as a growing focus on food safety.
 
We generally extend some level of credit to our customers without requiring collateral, which exposes us to credit risk.  If customers’ cash flow or operating and financial performance deteriorates, or if they are unable to make scheduled payments or obtain other sources of credit, they may not be able to pay or may delay payment to us, or in some cases may return products to us.  We continually assess our customers’ ability to pay us and adjust our allowance for doubtful accounts, as necessary.
 
Our quarterly sales and operating results have varied significantly in the past, and will likely continue to do so in the future. Historically, our total revenues have typically been higher during the spring and fall months due to increased sales of production animal products. Product use cycles for production animal products are directly related to medical procedures performed by veterinarians on production animals during the spring and fall months. These buying patterns can also be affected by the marketing programs or price increase announcements of vendors and distributors, which can cause veterinarians to purchase production animal health products earlier than those products are needed. This kind of early purchasing may reduce our sales in the months these purchases would have otherwise been made.
 
Sales
 
We sell products that we source from our vendors to our customers through either a “buy/sell” transaction or an agency relationship with our vendors. In a “buy/sell” transaction, we purchase or take inventory of products from our vendors. When a customer places an order with us, we pick, pack, ship and invoice the customer for the order. We record sales from “buy/sell” transactions, which account for the vast majority of our business, as revenues in conformity with generally accepted accounting principles in the United States. In an agency relationship, we generally do not purchase and take inventory of products from our vendors. When we receive an order from our customer, we transmit the order to our vendor, who picks, packs and ships the order to our customer. In some cases, our vendor invoices and collects payment from our customer, while in other cases we invoice and collect payment from our customer on behalf of our vendor. We receive a commission payment for soliciting the order from our customer and for providing other customer service activities. The aggregate revenues we receive in agency transactions constitute the “commissions” line item on our consolidated statements of income and are recorded in conformity with accounting principles generally accepted in the United States. Our vendors determine the method we use to sell our products. Historically, vendors have occasionally switched between the “buy/sell” and agency models for particular products in response to market conditions related to that particular product. A switch between models can impact our revenues and our operating income. We cannot know in advance when a vendor will switch between the “buy/sell” and agency models or what impact, if any, such a change may have. A switch can occur even with vendors with whom we have written agreements, because most of our agreements with vendors have relatively short terms and are terminable with or without cause on short notice, normally 30 to 90 days. The impact of any individual change from a “buy/sell” to an agency model depends on the costs and expenses associated with a particular product, and can have either a positive or a negative effect on our profitability.
 
We typically renegotiate vendor contracts annually.  These vendor contracts may include terms defining margins, rebates, commissions, exclusivity requirements and the manner in which we go to market.  For example, vendors could require us to distribute their products on an exclusive basis, which could cause us to forego distributing competing products which may also be profitable.  Conversely, competitors could obtain exclusive rights to market particular products, which we would be unable to market.  If we lose the right to distribute products under such exclusive agreements, we may lose access to certain products and lose a competitive advantage.  Exclusivity agreements could allow potential competitors to sell products that we cannot offer and erode our market share.  In addition, vendors have the ability to expand the distributors that they use which could have a material adverse effect on our business.
 
On April 20, 2012, one of our vendors, IDEXX Laboratories, Inc., a manufacturer of veterinary diagnostic products (“IDEXX”), announced a change to its U.S. distributor strategy as a result of an ongoing investigation by the Federal Trade Commission of IDEXX’s “competitive products” policy.  Currently, MWI is a national distributor for IDEXX, and has agreed to the terms of IDEXX’s competitive products policy which restricts MWI’s ability to distribute certain competing products.  IDEXX has announced that going forward, it intends that one of its three national distributors will be converted from a “value added distributor” to a “generalist,” with the result being that the distributor chosen as the generalist will not be restricted by any exclusivity requirements, but will be entitled to receive lower margins on the distribution of any IDEXX products than will any value added distributors.  MWI is currently in discussions with IDEXX on the matter and is currently reviewing the financial impact to MWI if it were to agree to convert from a value added distributor to a generalist.  MWI’s current contract with IDEXX remains in effect and is scheduled to terminate on December 31, 2012, and a change to MWI’s relationship with IDEXX if any will only result after negotiations of a new contract with IDEXX.
 
Some of our current and future vendors may decide to compete with us in the future by pursuing or increasing their efforts in direct marketing and sales of their products. These vendors could sell their products at lower prices and maintain a higher gross margin on their product sales than we can. In this event, veterinarians or animal owners may elect to purchase animal health products directly from these vendors.  As an example of this type of event, we were a sales agent for a pet food line for most of fiscal year 2011 that we will not represent in fiscal year 2012 because that manufacturer chose to sell their products direct and not through sales agents.
 
Many of our vendors’ rebate programs are based on a calendar year.  Historically, the three months ended December 31 has been our most significant quarter for recognition of rebates.  This trend has slowed some in recent years due to certain changes in vendor contracts but it still remains our largest quarter for vendor rebates.  Vendor rebates based on sales are classified in our accompanying consolidated statements of income as a reduction to cost of product sales at the time the sales performance measures are achieved. Purchase rebates are measured against inventory purchases from the vendors and are a reduction of inventory until the product is sold. When the inventory is sold, purchase rebates are recognized as a reduction to cost of product sales.
 
Vendor Consolidation
 
In the United States, our top ten vendors supplied products that accounted for approximately 74% and 72% of our revenues for the six months ended March 31, 2012 and 2011, respectively, and 71% of our revenues for the fiscal year ended September 30, 2011.  Pfizer supplied products that accounted for approximately 23% and 24% of our revenues during the six months ended March 31, 2012 and 2011, respectively, and 24% of our revenues for our fiscal year ended September 30, 2011.  Of the Pfizer supplied products, production animal products under a livestock agreement accounted for approximately 14% and 12% of our revenues during the six months ended March 31, 2012 and 2011, respectively, and approximately 13% of our revenues for our fiscal year ended September 30, 2011.  Merck (formerly known as Intervet/Schering-Plough) supplied products that accounted for approximately 14% and 12% of our revenues during the six months ended March 31, 2012 and 2011, respectively, and 11% of our revenues for our fiscal year ended September 30, 2011.  No other vendor accounts for more than 10% of our revenues in the United States.  Merial, a subsidiary of Sanofi-Aventis, supplies the majority of their products to us under an agency relationship.  Commission revenue generated from Merial products accounted for approximately 47% and 42% of total commission revenues during the six months ended March 31, 2012 and 2011, respectively, and 47% of total commission revenues for our fiscal year ended September 30, 2011.
 
For more information on our business, see our Annual Report on Form 10-K filed with the SEC on November 28, 2011.
 



Results of Operations
 
The following table summarizes our results of operations for the three and six months ended March 31, 2012 and 2011, in dollars and as a percentage of total revenues.
 

 
 
 
 
Three months ended March 31,
 
Six months ended March 31,
 
 
 
 
2012
 
%
 
2011
 
%
 
2012
 
%
 
2011
 
%
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Product sales
$
 488,187
 
96.2
%
 
$
 348,387
 
94.9
%
 
$
 930,784
 
96.0
%
 
$
 696,124
 
94.9
%
 
Product sales to related party
 
 14,585
 
2.9
%
 
 
 13,118
 
3.6
%
 
 
 30,143
 
3.1
%
 
 
 27,841
 
3.8
%
 
Commissions
 
 4,398
 
0.9
%
 
 
 5,607
 
1.5
%
 
 
 8,144
 
0.9
%
 
 
 9,321
 
1.3
%
 
 
 
Total revenues
 
 507,170
 
100.0
%
 
 
 367,112
 
100.0
%
 
 
 969,071
 
100.0
%
 
 
 733,286
 
100.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of product sales
 
 440,552
 
86.9
%
 
 
 316,126
 
86.1
%
 
 
 839,939
 
86.7
%
 
 
 632,228
 
86.2
%
Gross profit
 
 66,618
 
13.1
%
 
 
 50,986
 
13.9
%
 
 
 129,132
 
13.3
%
 
 
 101,058
 
13.8
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SG&A expenses
 
 42,933
 
8.5
%
 
 
 32,450
 
8.8
%
 
 
 81,840
 
8.4
%
 
 
 63,497
 
8.7
%
Depreciation and amortization
 
 2,274
 
0.4
%
 
 
 1,667
 
0.5
%
 
 
 4,466
 
0.5
%
 
 
 3,156
 
0.4
%
Operating income
 
 21,411
 
4.2
%
 
 
 16,869
 
4.6
%
 
 
 42,826
 
4.4
%
 
 
 34,405
 
4.7
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other income (expense):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense
 
 (252)
 
-
%
 
 
 (252)
 
-
%
 
 
 (435)
 
-
%
 
 
 (434)
 
-
%
 
Earnings of equity method
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
investees
 
 79
 
-
%
 
 
 63
 
-
%
 
 
 156
 
-
%
 
 
 136
 
-
%
 
Other
 
 186
 
-
%
 
 
 143
 
-
%
 
 
 374
 
-
%
 
 
 278
 
-
%
 
 
 
Total other income (expense)
 
 13
 
-
%
 
 
 (46)
 
-
%
 
 
 95
 
-
%
 
 
 (20)
 
-
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income before taxes
 
 21,424
 
4.2
%
 
 
 16,823
 
4.6
%
 
 
 42,921
 
4.4
%
 
 
 34,385
 
4.7
%
Income tax expense
 
 (8,246)
 
(1.6)
%
 
 
 (6,491)
 
(1.8)
%
 
 
 (16,547)
 
(1.7)
%
 
 
 (13,225)
 
(1.8)
%
Net income
$
 13,178
 
2.6
%
 
$
 10,332
 
2.8
%
 
$
 26,374
 
2.7
%
 
$
 21,160
 
2.9
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
$
 1.04
 
 
 
 
$
 0.83
 
 
 
 
$
 2.09
 
 
 
 
$
 1.70
 
 
 
 
Diluted
$
 1.04
 
 
 
 
$
 0.83
 
 
 
 
$
 2.09
 
 
 
 
$
 1.69
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding (in thousands):
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
 12,619
 
 
 
 
 
 12,462
 
 
 
 
 
 12,600
 
 
 
 
 
 12,438
 
 
 
 
Diluted
 
 12,648
 
 
 
 
 
 12,511
 
 
 
 
 
 12,626
 
 
 
 
 
 12,496
 
 
 



Three Months Ended March 31, 2012 Compared to Three Months Ended March 31, 2011
 
Total Revenues.  Total revenues increased 38.2% to $507,170 for the three months ended March 31, 2012, from $367,112 for the three months ended March 31, 2011.  Excluding the acquisition of the assets of Micro, revenue growth in the United States was 22.9% for the quarter ended March 31, 2012, compared to the same period in the prior fiscal year.  Revenues from Micro, which was acquired on October 31, 2011, were $63,006 for the quarter ended March 31, 2012.  Revenue growth in the United Kingdom was 11.6% for the quarter ended March 31, 2012, compared to the same period in the prior fiscal year, consisting of 13.7% organic growth partially offset by a decline of  2.1% related to foreign currency exchange. Excluding the revenues from Micro, revenues in the United States attributable to existing customers represented approximately 70% of the growth in revenues and revenues attributable to new customers represented approximately 30% of the growth in revenues during the three months ended March 31, 2012.  For the purpose of calculating growth rates of new and existing customer revenue, we have defined a new customer as a customer that did not purchase product from us in the corresponding fiscal quarter of the prior year, with the remaining customer base being considered existing customers.  Revenues from new customers for each fiscal quarter are summed to arrive at the estimated year-to-date revenue for new customers.
 
Product sales to related party increased by 11.2% to $14,585 for the three months ended March 31, 2012, from $13,118 for the three months ended March 31, 2011.  Commissions decreased to $4,398 for the three months ended March 31, 2012, from $5,607 for the three months ended March 31, 2011. Commissions were negatively impacted by the loss of a pet food line that we represented for most of fiscal year 2011 that we will not represent in fiscal year 2012 and a shift in commissions revenues to buy-sell revenues for certain parasiticides.
 
Gross Profit.  Gross profit increased by 30.7% to $66,618 for the three months ended March 31, 2012, from $50,986 for the three months ended March 31, 2011.  The change in gross profit is primarily a result of increased total revenues as discussed above.  Gross profit as a percentage of total revenues was 13.1% and 13.9% for the three months ended March 31, 2012 and 2011, respectively.  The decrease in gross profit as a percentage of total revenues was due to lower product margins, a decrease in commissions and lower vendor rebates as a percentage of total revenues.  Product margin decreased primarily due to a shift in product mix and certain vendor pricing programs that were in effect in the same period of the prior fiscal year that were not in effect during the three months ended March 31, 2012.  Vendor rebates for the three months ended March 31, 2012 decreased by approximately $210 compared to the three months ended March 31, 2011.
 
Selling, General and Administrative (“SG&A”).  SG&A expenses increased 32.3% to $42,933 for the three months ended March 31, 2012, from $32,450 for the three months ended March 31, 2011.  The increase in SG&A expenses was primarily due to the addition of Micro and compensation costs from increased headcount to support the revenue growth.  SG&A expenses as a percentage of total revenues were 8.5% for the three months ended March 31, 2012, compared to 8.8% for the three months ended March 31, 2011.
 
Depreciation and Amortization. Depreciation and amortization increased 36.4% to $2,274 for the three months ended March 31, 2012, from $1,667 for the three months ended March 31, 2011.  The increase was primarily related to the acquisition of Micro.
 
Six Months Ended March 31, 2012 Compared to Six Months Ended March 31, 2011
 
Total Revenues.  Total revenues increased 32.2% to $969,071 for the six months ended March 31, 2012, from $733,286 for the six months ended March 31, 2011.  Excluding the acquisition of the assets of Micro, revenue growth in the United States was 18.5% for the six months ended March 31, 2012, compared to the same period in the prior fiscal year.  Revenues from Micro, which was acquired on October 31, 2011, were $109,167 for the six months ended March 31, 2012.  Revenue growth in the United Kingdom was 11.3% for the six months ended March 31, 2012, compared to the same period in the prior fiscal year, consisting of 12.7% organic growth partially offset by a decline of  1.4% related to foreign currency exchange. Excluding the revenues from Micro, revenues in the United States attributable to existing customers represented approximately 65% of the growth in revenues and revenues attributable to new customers represented approximately 35% of the growth in revenues during the six months ended March 31, 2012.
 
Product sales to related party increased by 8.3% to $30,143 for the six months ended March 31, 2012, from $27,841 for the six months ended March 31, 2011.  Commissions decreased to $8,144 for the six months ended March 31, 2012, from $9,321 for the six months ended March 31, 2011. Commissions were negatively impacted by the loss of a pet food line that we represented for most of fiscal year 2011 that we will not represent in fiscal year 2012, partially offset by growth in other agency products that we represent.
 
Gross Profit.  Gross profit increased by 27.8% to $129,132 for the six months ended March 31, 2012, from $101,058 for the six months ended March 31, 2011.  The change in gross profit is primarily a result of increased total revenues as discussed above.  Gross profit as a percentage of total revenues was 13.3% and 13.8% for the six months ended March 31, 2012 and 2011, respectively.  The decrease in gross profit as a percentage of total revenues was due to lower product margins, a decrease in commissions and lower vendor rebates as a percentage of total revenues.  Vendor rebates for the six months ended March 31, 2012 increased by approximately $327 compared to the six months ended March 31, 2011.
 
Selling, General and Administrative (“SG&A”).  SG&A expenses increased 28.9% to $81,840 for the six months ended March 31, 2012, from $63,497 for the six months ended March 31, 2011.  The increase in SG&A expenses was primarily due to the addition of Micro and compensation costs from increased headcount to support the revenue growth.  SG&A expenses as a percentage of total revenues were 8.4% for the six months ended March 31, 2012, compared to 8.7% for the six months ended March 31, 2011.
 
Depreciation and Amortization. Depreciation and amortization increased 41.5% to $4,466 for the six months ended March 31, 2012, from $3,156 for the six months ended March 31, 2011.  The increase was primarily related to the acquisition of Micro.
 
Critical Accounting Policies
 
The preparation of financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities.  The accompanying condensed consolidated financial statements are prepared using the same critical accounting policies discussed in our Annual Report on Form 10-K filed with the SEC on November 28, 2011.
 
Liquidity and Capital Resources
 
Our principal sources of liquidity are cash flows generated from operations and borrowings on our credit facilities. We use capital primarily to fund day-to-day operations and to maintain sufficient inventory levels in order to promptly fulfill customer orders and to expand our operations and sales growth. We believe our capital resources, including our ability to borrow funds from our credit facilities, will be sufficient to meet our anticipated cash needs for at least the next twelve months.
 
We generally extend some level of credit to our customers without requiring collateral, which exposes us to credit risk. If customers’ cash flow or operating and financial performance deteriorates, or if they are unable to make scheduled payments or obtain other sources of credit, they may not be able to pay or may delay payment to us, or in some cases may return products to us. Any inability of current and/or potential customers to pay us for our products and/or services due to their deteriorating financial condition or otherwise may adversely affect our results of operations and financial condition. Volatility in commodity prices, such as milk, corn, grain and feeder cattle, and deteriorating economic conditions can have a significant impact on the financial results of our customers. We continually assess our customers’ ability to pay us and adjust our allowance for doubtful accounts, as necessary.
 
On November 1, 2011, MWI Co. as borrower, entered into a Third Amendment to Credit Agreement (the “Third Amendment”) with MWI Veterinary Supply, Inc. and Memorial Pet Care, Inc., as guarantors, and Bank of America, N.A. and Wells Fargo Bank, N.A. as lenders (collectively, the “Lenders”), amending the Credit Agreement dated December 13, 2006, and as amended from time to time, by and among MWI Co., MWI Veterinary Supply, Inc., Memorial Pet Care, Inc. and the Lenders (the  “Credit Agreement”).  As discussed in Note 3 – Business Acquisitions, MWI Co.’s purchase of the assets of Micro was completed on October 31, 2011, using borrowing capacity that existed prior to the effectiveness of the Third Amendment.  The Third Amendment increased the aggregate revolving commitment of the Lenders under the Credit Agreement from $100 million to $150 million and extended the maturity date of the Credit Agreement from March 1, 2013 to November 1, 2016.  Under the Third Amendment, the margin on variable interest rate borrowings now ranges from 0.95% to 1.50%.  The margin previously ranged from 1.50% to 2.25% under the Second Amendment.  The Third Amendment also reduced the commitment fee from a range of 0.2% to 0.35% to a range of 0.15% to 0.25% depending on the funded debt to EBITDA ratio.  The Credit Agreement contains financial covenants, including a fixed charge ratio and a funded debt to EBITDA ratio.  We were in compliance with all of the covenants as of March 31, 2012 and September 30, 2011.  Our outstanding balance on the revolving credit facility at March 31, 2012 and September 30, 2011 was $55,900 and $0, respectively, and the interest rate was 1.10% as of March 31, 2012.
 
On November 5, 2010, Centaur entered into a £12,500 unsecured revolving line of credit facility (the “sterling revolving credit facility”) with Wells Fargo Bank, N.A. London Branch (“Wells Fargo”).  The sterling revolving credit facility is for a three year term with interest paid at the end of the applicable one month, three month or six month interest period.  Interest is based on LIBOR for the applicable interest period plus an applicable margin of 1.05% to 1.90%.  The facility contains financial covenants requiring Centaur to maintain a minimum tangible net worth of £3,000 which is to be calculated at end of each fiscal year.  Our outstanding balance on the revolving credit facility at March 31, 2012 was £5,370, or $8,584 using the current exchange rate as of March 31, 2012, and the interest rate was 1.70% as of March 31, 2012.
 
Operating Activities.  For the six months ended March 31, 2012, cash used in operations was $4,363 and was primarily attributable to net income of $26,374 offset by changes in working capital which was used to accommodate the growth in revenues and strategic inventory purchases.
 
For the six months ended March 31, 2011, cash used in operations was $1,389 and was primarily attributable to net income of $21,160 offset by changes in working capital.  Accounts payable decreased $12,332 as strategic inventory purchases were made during the quarter ended September 30, 2010 to support our organic growth of that quarter, and payments for those purchases were made during the six months ended March 31, 2011 but we have kept inventory levels higher to support our growth.  Receivables increased $13,663 due to revenue growth.  Inventories increased $4,591 to support the continued organic revenue growth.
 
Investing Activities.  For the six months ended March 31, 2012, net cash used in investing activities was $57,404.  We paid $53,720 in cash for the acquisition of the assets of Micro. Additionally, we paid for capital expenditures of $3,282 primarily related to information technology and our new distribution center in Harrisburg, Pennsylvania.
 
For the six months ended March 31, 2011, net cash used in investing activities was $16,051.  We paid $7,000 in cash for the acquisition of Nelson. Additionally, we paid for capital expenditures of $9,130 which primarily related to an office building purchased in Boise, Idaho for our headquarters, equipment for our new distribution center in Visalia, California to accommodate the growth needs in that region and other distribution center technology.
 
Financing Activities.  For the six months ended March 31, 2012, net cash provided by financing activities was $61,621, which was primarily due to net borrowings of $61,418 on our credit facilities.  Our revolving credit facilities are used to fund strategic acquisitions, meet our working capital requirements and make capital purchases.
 
For the six months ended March 31, 2011, net cash provided by financing activities was $17,388, which was primarily due to net borrowings of $18,132 on our credit facilities.  
 
Contractual Obligations and Guarantees
 
For information on our contractual obligations and guarantees, see our Annual Report on Form 10-K filed on November 28, 2011 with the SEC.
 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk
 
We are exposed to market risks primarily from changes in interest rates, in particular, the Daily LIBOR F