XNAS:WOOF VCA Inc Quarterly Report 10-Q Filing - 6/30/2012

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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 June 30, 2012
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 001-16783
___________________________________________________ 
VCA Antech, Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
 
95-4097995
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
12401 West Olympic Boulevard
Los Angeles, California 90064-1022
(Address of principal executive offices)
(310) 571-6500
(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 [  ].
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ].
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 [  ]
 
 
 
Non-accelerated filer [  ]
  
Smaller reporting company [  ]
(Do not check if a smaller reporting company)
  
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X].
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: common stock, $0.001 par value, 87,760,371 shares as of August 3, 2012.
 
 
 
 
 
VCA Antech, Inc. and Subsidiaries
Form 10-Q
June 30, 2012
Table of Contents
 
Page
Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



PART I.
FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS

VCA Antech, Inc. and Subsidiaries
Condensed, Consolidated Balance Sheets
(Unaudited)
(In thousands, except par value)
 
June 30, 2012
 
December 31, 2011
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
64,067

 
$
63,651

Trade accounts receivable, less allowance for uncollectible accounts of $15,599 and $14,978 at June 30, 2012 and December 31, 2011, respectively
65,299

 
58,279

Inventory
54,282

 
48,661

Prepaid expenses and other
23,923

 
21,883

Deferred income taxes
27,671

 
26,310

Prepaid income taxes
21,310

 
18,373

Total current assets
256,552

 
237,157

Property and equipment, net
384,704

 
370,646

Goodwill
1,345,529

 
1,237,607

Other intangible assets, net
107,927

 
92,403

Notes receivable, net
6,232

 
6,202

Deferred financing costs, net
4,868

 
5,435

Other
45,383

 
45,918

Total assets
$
2,151,195

 
$
1,995,368

Liabilities and Equity
 
 
 
Current liabilities:
 
 
 
Current portion of long-term debt
$
34,974

 
$
32,571

Accounts payable
34,798

 
37,797

Accrued payroll and related liabilities
46,857

 
42,658

Other accrued liabilities
56,270

 
43,968

Total current liabilities
172,899

 
156,994

Long-term debt, less current portion
613,181

 
586,282

Deferred income taxes
116,945

 
101,229

Other liabilities
35,574

 
25,947

Total liabilities
938,599

 
870,452

Commitments and contingencies

 

Redeemable noncontrolling interests
6,985

 
6,964

Preferred stock, par value $0.001, 11,000 shares authorized, none outstanding

 

VCA Antech, Inc. stockholders’ equity:
 
 
 
Common stock, par value $0.001, 175,000 shares authorized, 87,741 and 86,796 shares outstanding as of June 30, 2012 and December 31, 2011, respectively
88

 
87

Additional paid-in capital
379,624

 
361,715

Retained earnings
815,223

 
745,658

Accumulated other comprehensive income
5

 
418

Total VCA Antech, Inc. stockholders’ equity
1,194,940

 
1,107,878

Noncontrolling interests
10,671

 
10,074

Total equity
1,205,611

 
1,117,952

Total liabilities and equity
$
2,151,195

 
$
1,995,368



The accompanying notes are an integral part of these condensed, consolidated financial statements.

1

VCA Antech, Inc. and Subsidiaries
Condensed, Consolidated Income Statements
(Unaudited)
(In thousands, except per share amounts)



 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2012
 
2011
 
2012
 
2011
Revenue
$
438,372

 
$
376,105

 
$
847,837

 
$
731,228

Direct costs
337,765

 
279,273

 
653,851

 
554,618

Gross profit
100,607

 
96,832

 
193,986

 
176,610

Selling, general and administrative expense
38,997

 
26,663

 
78,048

 
52,846

Net loss on sale of assets
112

 
60

 
635

 
149

Operating income
61,498

 
70,109

 
115,303

 
123,615

Interest expense, net
4,364

 
4,575

 
8,451

 
8,594

Business combination adjustment gain

 

 
(5,719
)
 

Other income
(148
)
 
(67
)
 
(355
)
 
(9
)
Income before provision for income taxes
57,282

 
65,601

 
112,926

 
115,030

Provision for income taxes
21,504

 
25,536

 
40,827

 
44,469

Net income
35,778

 
40,065

 
72,099

 
70,561

Net income attributable to noncontrolling interests
1,458

 
453

 
2,534

 
2,110

Net income attributable to VCA Antech, Inc
$
34,320

 
$
39,612

 
$
69,565

 
$
68,451

Basic earnings per share
$
0.39

 
$
0.46

 
$
0.80

 
$
0.79

Diluted earnings per share
$
0.39

 
$
0.45

 
$
0.79

 
$
0.78

Weighted-average shares outstanding for basic earnings per share
87,589

 
86,535

 
87,443

 
86,445

Weighted-average shares outstanding for diluted earnings per share
88,723

 
87,304

 
88,555

 
87,303



The accompanying notes are an integral part of these condensed, consolidated financial statements.

2

VCA Antech, Inc. and Subsidiaries
Condensed, Consolidated Statements of Comprehensive Income
(Unaudited)
(In thousands)

 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2012
 
2011
 
2012
 
2011
Net income(1) 
$
35,778

 
$
40,065

 
$
72,099

 
$
70,561

Other comprehensive income:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(1,369
)
 
47

 
(442
)
 
296

Unrealized (loss) gain on foreign currency
(178
)
 
48

 
47

 
237

Tax benefit (expense)
70

 
(19
)
 
(18
)
 
(92
)
Other comprehensive (loss) gain
(1,477
)
 
76

 
(413
)
 
441

Total comprehensive income
34,301

 
40,141

 
71,686

 
71,002

Comprehensive income attributable to noncontrolling interests(1) 
(1,458
)
 
(453
)
 
(2,534
)
 
(2,110
)
Comprehensive income attributable to VCA Antech, Inc
$
32,843

 
$
39,688

 
$
69,152

 
$
68,892

 ____________________________
(1) 
Includes approximately $1.3 million and $1.1 million of net income related to redeemable and mandatorily redeemable noncontrolling interests for the six months ended June 30, 2012 and June 30, 2011, respectively.



































The accompanying notes are an integral part of these condensed, consolidated financial statements.

3

VCA Antech, Inc. and Subsidiaries
Condensed, Consolidated Statements of Equity
(Unaudited)
(In thousands)



 
Common Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income
 
Noncontrolling
Interests
 
 Total
 
Shares
 
Amount
 
 
 
 
 
Balances, December 31, 2010
86,179

 
$
86

 
$
347,848

 
$
650,253

 
$
737

 
$
10,561

 
$
1,009,485

Net income (excludes $830 and $227 related to redeemable and mandatorily redeemable noncontrolling interests, respectively)

 

 

 
68,451

 

 
1,053

 
69,504

Other comprehensive income

 

 

 

 
441

 

 
441

Distribution to noncontrolling interests

 

 

 

 

 
(607
)
 
(607
)
Purchase of noncontrolling interests

 

 
263

 

 

 
(874
)
 
(611
)
Share-based compensation

 

 
2,531

 

 

 

 
2,531

Issuance of common stock under stock incentive plans
416

 
1

 
2,455

 

 

 

 
2,456

Stock repurchases

 

 
(2,337
)
 

 

 

 
(2,337
)
Excess tax benefit from stock options

 

 
906

 

 

 

 
906

Tax shortfall and other from stock options and awards

 

 
(460
)
 

 

 

 
(460
)
Balances, June 30, 2011
86,595

 
$
87

 
$
351,206

 
$
718,704

 
$
1,178

 
$
10,133

 
$
1,081,308

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balances, December 31, 2011
86,796

 
$
87

 
$
361,715

 
$
745,658

 
$
418

 
$
10,074

 
$
1,117,952

Net income (excludes $463 and $839 related to redeemable and mandatorily redeemable noncontrolling interests, respectively).

 

 

 
69,565

 

 
1,232

 
70,797

Other comprehensive loss

 

 

 

 
(413
)
 

 
(413
)
Distribution to noncontrolling interests

 

 

 

 

 
(635
)
 
(635
)
Share-based compensation

 

 
7,767

 

 

 

 
7,767

Issuance of common stock under stock incentive plans
472

 
1

 
2,190

 

 

 

 
2,191

Issuance of common stock for acquisitions
473

 

 
10,500

 

 

 

 
10,500

Stock repurchases

 

 
(2,805
)
 

 

 

 
(2,805
)
Excess tax benefit from stock options

 

 
248

 

 

 

 
248

Tax benefit and other from stock options and awards

 

 
9

 

 

 

 
9

Balances, June 30, 2012
87,741

 
$
88

 
$
379,624

 
$
815,223

 
$
5

 
$
10,671

 
$
1,205,611



The accompanying notes are an integral part of these condensed, consolidated financial statements.

4

VCA Antech, Inc. and Subsidiaries
Condensed, Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)


 
Six Months Ended
June 30,
 
2012
 
2011
Cash flows from operating activities:
 
 
 
Net income
$
72,099

 
$
70,561

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
37,363

 
26,456

Amortization of debt issue costs
642

 
774

Provision for uncollectible accounts
2,551

 
2,492

Business combination adjustment gain
(5,719
)
 

Net loss on sale of assets
635

 
149

Share-based compensation
7,767

 
2,531

Deferred income taxes
10,020

 
10,833

Excess tax benefit from exercise of stock options
(248
)
 
(906
)
Other
(528
)
 
(202
)
Changes in operating assets and liabilities:
 
 
 
Trade accounts receivable
(6,900
)
 
(7,813
)
Inventory, prepaid expense and other assets
(5,795
)
 
(5,222
)
Accounts payable and other accrued liabilities
(1,805
)
 
(7,994
)
Accrued payroll and related liabilities
1,102

 
16,021

Income taxes
(2,516
)
 
7,940

Net cash provided by operating activities
108,668

 
115,620

Cash flows from investing activities:
 
 
 
Business acquisitions, net of cash acquired
(75,828
)
 
(11,804
)
Real estate acquired in connection with business acquisitions

 
(1,900
)
Property and equipment additions
(37,165
)
 
(28,434
)
Proceeds from sale of assets
78

 
140

Other
55

 
(493
)
Net cash used in investing activities
(112,860
)
 
(42,491
)
Cash flows from financing activities:
 
 
 
Repayment of debt
(43,318
)
 
(14,164
)
Proceeds from issuance of long-term debt
50,000

 

Proceeds from revolving credit facility
50,000

 

Repayment of revolving credit facility
(50,000
)
 

Payment of financing costs
(122
)
 

Distributions to noncontrolling interest partners
(1,631
)
 
(1,141
)
Proceeds from issuance of common stock under stock option plans
2,885

 
2,456

Excess tax benefit from exercise of stock options
248

 
906

Stock repurchases
(2,770
)
 
(2,337
)
Other
(656
)
 
(345
)
Net cash provided by (used in) financing activities
4,636

 
(14,625
)
Effect of currency exchange rate changes on cash and cash equivalents
(28
)
 
153

Increase in cash and cash equivalents
416

 
58,657

Cash and cash equivalents at beginning of period
63,651

 
97,126

Cash and cash equivalents at end of period
$
64,067

 
$
155,783

 
 
 
 
 
 
 
 

The accompanying notes are an integral part of these condensed, consolidated financial statements.

5

VCA Antech, Inc. and Subsidiaries
Condensed, Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)


 
Six Months Ended
June 30,
 
2012
 
2011
Supplemental disclosures of cash flow information:
 
 
 
Interest paid
$
7,788

 
$
8,127

Income taxes paid
$
32,685

 
$
25,696

Supplemental schedule of noncash investing and financing activities:
 
 
 
Detail of acquisitions:
 
 
 
Fair value of assets acquired
$
147,527

 
$
11,889

Fair value of pre-existing investment in AVC
(11,850
)
 

Noncontrolling interest
(8,161
)
 

Cash paid for acquisitions
(75,328
)
 
(11,445
)
Cash paid to debt holders
(25,915
)
 

Issuance of common stock for acquisitions
(10,500
)
 

Holdbacks
(1,525
)
 
(500
)
Liabilities assumed
$
14,248

 
$
(56
)


The accompanying notes are an integral part of these condensed, consolidated financial statements.

6

VCA Antech, Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements
June 30, 2012
(Unaudited)


 
1.
Nature of Operations
Our company, VCA Antech, Inc. (“VCA”) is a Delaware corporation formed in 1986 and is based in Los Angeles, California. We are an animal healthcare company with the following four operating segments: animal hospitals (“Animal Hospital”), veterinary diagnostic laboratories (“Laboratory”), veterinary medical technology (“Medical Technology”) and Vetstreet.
Our animal hospitals offer a full range of general medical and surgical services for companion animals. Our animal hospitals treat diseases and injuries, provide pharmaceutical products and perform a variety of pet-wellness programs, including health examinations, diagnostic testing, vaccinations, spaying, neutering and dental care. At June 30, 2012, we operated 592 animal hospitals throughout 41 states and in Canada.
We operate a full-service veterinary diagnostic laboratory network serving all 50 states and certain areas in Canada. Our laboratory network provides 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 June 30, 2012, we operated 54 laboratories of various sizes located strategically throughout the United States and Canada.
Our Medical Technology business sells digital radiography and ultrasound imaging equipment, provides education and training on the use of that equipment, provides consulting and mobile imaging services, and sells software and ancillary services to the veterinary market.
Our Vetstreet business provides online communications, professional education, marketing solutions and an ecommerce platform for independent animal hospitals. In addition, Vetstreet.com provides a robust selection of products, information and services to the pet-owning community.
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.


2.
Basis of Presentation
Our accompanying unaudited, condensed, consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) for interim financial information and in accordance with the rules and regulations of the United States Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and notes required by GAAP for annual financial statements as permitted under applicable rules and regulations. In the opinion of management, all normal recurring adjustments considered necessary for a fair presentation have been included. The results of operations for the three and six months ended June 30, 2012 are not necessarily indicative of the results to be expected for the full year ending December 31, 2012. For further information, refer to our consolidated financial statements and notes thereto included in our 2011 Annual Report on Form 10-K.

The preparation of our condensed, consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in our condensed, consolidated financial statements and notes thereto. Actual results could differ from those estimates.







7


VCA Antech, Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
June 30, 2012
(Unaudited)


3.
Goodwill and Other Intangible Assets
Goodwill
The following table presents the changes in the carrying amount of our goodwill for the six months ended June 30, 2012 (in thousands):
 
 
Animal
Hospital
 
Laboratory
 
All Other
 
Total
Balance as of December 31, 2011
$
1,035,401

 
$
96,810

 
$
105,396

 
$
1,237,607

Goodwill acquired
102,819

 
8

 
10,569

 
113,396

Other (1)
(5,104
)
 
2

 
(372
)
 
(5,474
)
Balance as of June 30, 2012 (2)
$
1,133,116

 
$
96,820

 
$
115,593

 
$
1,345,529

 ____________________________
(1) 
Other includes acquisition-price adjustments, which consist primarily of an adjustment related to capital leases, buy- outs and foreign currency translation adjustments.

(2) 
Net of accumulated impairment losses of $21.3 million recorded in 2011, all related to our medical technology business, included in "All Other" in the above table.
We had no impairment losses during the six months ended June 30, 2012.
Other Intangible Assets
Our amortizable intangible assets at June 30, 2012 and December 31, 2011 are as follows (in thousands):
 
 
As of June 30, 2012
 
As of December 31, 2011
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
Noncontractual customer relationships
$
101,683

 
$
(28,103
)
 
$
73,580

 
$
82,891

 
$
(21,147
)
 
$
61,744

Covenants not-to-compete
12,859

 
(7,020
)
 
5,839

 
13,035

 
(8,067
)
 
4,968

Favorable lease assets
7,163

 
(3,568
)
 
3,595

 
5,571

 
(3,210
)
 
2,361

Trademarks
7,898

 
(1,995
)
 
5,903

 
7,405

 
(1,686
)
 
5,719

Contracts
4,062

 
(437
)
 
3,625

 
3,500

 
(185
)
 
3,315

Technology
19,183

 
(3,832
)
 
15,351

 
16,589

 
(2,342
)
 
14,247

Client lists
84

 
(50
)
 
34

 
84

 
(35
)
 
49

Total
$
152,932

 
$
(45,005
)
 
$
107,927

 
$
129,075

 
$
(36,672
)
 
$
92,403


 



8


VCA Antech, Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
June 30, 2012
(Unaudited)


3.
Goodwill and Other Intangible Assets, continued

The following table summarizes our aggregate amortization expense related to other intangible assets (in thousands):
 
 
Three Months Ended
June 30,
Six Months Ended
June 30,
 
2012
 
2011
2012
 
2011
Aggregate amortization expense
$
5,342

 
$
2,604

$
10,218

 
$
5,259

The estimated amortization expense related to intangible assets for the remainder of 2012 and each of the succeeding years thereafter, as of June 30, 2012, is as follows (in thousands):

Remainder of 2012
$
10,748

2013
19,710

2014
17,298

2015
15,429

2016
12,201

Thereafter
32,541

Total
$
107,927

 
4.
Other Accrued Liabilities
Other accrued liabilities consisted of the following (in thousands):
 
 
June 30,
2012
 
December 31,
2011
Deferred revenue
$
10,807

 
$
7,025

Accrued health insurance
5,746

 
5,553

Deferred rent
4,062

 
3,626

Accrued consulting fees
2,886

 
2,886

Holdbacks and earnouts
3,297

 
2,250

Customer deposits
3,258

 
2,281

Accrued lab service rebates
289

 
332

Other
25,925

 
20,015

 
$
56,270

 
$
43,968


 




9


VCA Antech, Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
June 30, 2012
(Unaudited)


5.
Long-Term Obligations
Senior Credit Facility
On January 25, 2012, we executed an amendment (the "first amendment") to our Amended and Restated Credit and Guaranty Agreement entered into as of August 16, 2011 (our "senior credit facility"). On January 24, 2012, we issued new term loans in the aggregate principal amount of $50.0 million, which reduced the amount of uncommitted incremental facilities we could thereafter elect to request from $100.0 million in the aggregate to $50.0 million in the aggregate. The aforementioned amendment on January 25, 2012 replenished the aggregate principal amount of uncommitted incremental facilities by $50.0 million to permit us to request up to an aggregate principal amount of $100.0 million in uncommitted incremental facilities. The funds borrowed from the Incremental Facility were used to repay in full amounts borrowed to fund an additional investment in Associate Veterinary Clinics (1981) LTD ("AVC") on February 1, 2012. In connection with the first amendment we incurred $122,300 in financing costs, of which approximately $47,300 were recognized as part of income from continuing operations and $75,000 were capitalized as deferred financing costs.
The following table summarizes our long-term obligations at June 30, 2012 and December 31, 2011 (in thousands):

 
June 30,
2012
 
December 31,
2011
Revolver
$

 
$

Senior term notes at the adjusted Eurodollar rate + 1.75% (2.00% at June 30, 2012)
608,203

 
573,984

Other debt and capital lease obligations
39,952

 
44,869

Total debt obligations
648,155

 
618,853

Less - current portion
(34,974
)
 
(32,571
)
 
$
613,181

 
$
586,282


Interest Rate. In general, borrowings under the senior term notes and the revolving credit facility bear interest, at our option, on either:
 
the base rate (as defined below) plus the applicable margin. The applicable margin for a base rate loan is an amount equal to the applicable margin for Eurodollar rate (as defined below) minus 1.00%; or


the adjusted Eurodollar rate (as defined below), plus a margin of 1.75% (Level II, see table below) per annum until the date of delivery of the compliance certificate and the financial statements for the period ended June 30, 2012, at which time the applicable margin will be determined by reference to the leverage ratio in effect from time to time as set forth in the following table:
Level
 
Leverage Ratio
 
Applicable Margin for
Eurodollar Rate Loans
 
Applicable Revolving
Commitment Fee %
I
 
≥ 2.50:1.00
 
2.25%
 
0.50%
II
 
< 2.50:1.00 and ≥ 1.75:1.00
 
1.75%
 
0.375%
III
 
< 1.75:1.00 and ≥ 1.00:1.00
 
1.50%
 
0.25%
IV
 
< 1.00:1.00
 
1.25%
 
0.20%
The base rate for the senior term notes is a rate per annum equal to the greatest of Wells Fargo Bank, N.A. ("Wells Fargo") prime rate in effect on such day, the Federal funds effective rate in effect on such day plus 0.5% and the adjusted Eurodollar rate for a one-month interest period commencing on such day plus 1.0%. The adjusted Eurodollar rate is defined as the rate per annum obtained by dividing (1) the rate of interest offered to Wells Fargo on the London interbank market by (2) a percentage equal to 100% minus the stated maximum rate of all reserve requirements applicable to any member bank of the Federal Reserve System in respect of “Eurocurrency liabilities.”
 



10


VCA Antech, Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
June 30, 2012
(Unaudited)


5.
 Long-Term Obligations, continued

Maturity and Principal Payments. The amended and restated senior term notes mature on August 19, 2016. Principal payments on the senior term notes are paid quarterly in the amount of $7.9 million for the first five quarters beginning on September 30, 2012, quarterly payments of $11.8 million for the two years following, and quarterly payments of $15.8 million for the three quarters prior to maturity at which time the remaining balance is due. The following table sets forth the remaining scheduled principal payments for our senior term notes (in thousands):
 
2012
(1) 
$
15,781

2013
 
35,508

2014
 
47,344

2015
 
51,289

2016
 
458,281

Total
$
608,203

 ____________________________
(1) 
Relates to the period from July 1, 2012 through December 31, 2012.
The revolving credit facility matures on August 19, 2016. Principal payments on the revolving credit facility are made at our discretion with the entire unpaid amount due at maturity.
Guarantees and Security. We and each of our wholly-owned subsidiaries guarantee the outstanding debt under our senior credit facility. These borrowings, along with the guarantees of the subsidiaries, are further secured by substantially all of our consolidated assets. In addition, these borrowings are secured by a pledge of substantially all of the capital stock, or similar equity interests, of our wholly-owned subsidiaries.

6.
Fair Value Measurements
Fair Value of Financial Instruments
The FASB accounting guidance requires disclosure of fair value information about financial instruments, whether or not recognized in the accompanying condensed, consolidated balance sheets. Fair value as defined by the guidance is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value estimates of financial instruments are not necessarily indicative of the amounts we might pay or receive in actual market transactions. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
Cash and Cash Equivalents. These balances include cash and cash equivalents with maturities of less than three months. The carrying amount approximates fair value due to the short-term maturities of these instruments.
Receivables, Less Allowance for Doubtful Accounts, Accounts Payable and Certain Other Accrued Liabilities. Due to their short-term nature, fair value approximates carrying value.
Long-Term Debt. The fair value of debt at June 30, 2012 and December 31, 2011 is based upon the ask price quoted from an external source, which is considered a Level 2 input.
 



11


VCA Antech, Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
June 30, 2012
(Unaudited)



6.
Fair Value Measurements, continued

The following table reflects the carrying value and fair value of our variable-rate long-term debt (in thousands):
 
 
As of June 30, 2012
 
As of December 31, 2011
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
Variable-rate long-term debt
$
608,203

 
$
608,203

 
$
573,984

 
$
573,984

At June 30, 2012 and December 31, 2011, we did not have any material applicable nonrecurring measurements of nonfinancial assets and nonfinancial liabilities.

7.
Share-Based Compensation
Stock Option Activity
A summary of our stock option activity for the six months ended June 30, 2012 is as follows (in thousands):
 
 
Stock
Options
 
Weighted-
Average
Exercise
Price
Outstanding at December 31, 2011
3,776

 
$
16.92

Granted

 
$

Exercised
(188
)
 
$
15.35

Canceled
(39
)
 
$
20.13

Outstanding at June 30, 2012
3,549

 
$
16.96

Exercisable at June 30, 2012
2,655

 
$
17.30

Vested and expected to vest at June 30, 2012
3,509

 
$
16.98

There were no stock options granted during the six months ended June 30, 2012. The aggregate intrinsic value of our stock options exercised during the three and six months ended June 30, 2012 was $97,000 and $1.2 million, respectively, and the actual tax benefit realized on options exercised during these periods was $38,000 and $488,000, respectively.
At June 30, 2012 there was $3.5 million of total unrecognized compensation cost related to our stock options. This cost is expected to be recognized over a weighted-average period of 3.3 years.
The compensation cost that has been charged against income for stock options for the three months ended June 30, 2012 and 2011 was $269,000 and $347,000, respectively. The corresponding income tax benefit recognized was $105,000 and $136,000 for the three months ended June 30, 2012 and 2011, respectively.
The compensation cost that has been charged against income for stock options for the six months ended June 30, 2012 and 2011 was $744,000 and $694,000, respectively. The corresponding income tax benefit recognized was $291,000 and $271,000 for the six months ended June 30, 2012 and 2011, respectively.
Nonvested Stock Activity
During the six months ended June 30, 2012, we granted 50,420 shares of nonvested common stock as incentives to certain employees, including 14,308 shares for the annual directors' grant. Assuming continued service through each vesting date, the majority of these awards will vest in four equal annual installments beginning February 2013 through April 2016.



12


VCA Antech, Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
June 30, 2012
(Unaudited)


7.
Share-Based Compensation, continued
Total compensation cost charged against income related to nonvested stock awards was $3.3 million and $1.1 million for the three months ended June 30, 2012 and 2011, respectively. The corresponding income tax benefit recognized in the income statement was $1.3 million and $436,000 for the three months ended June 30, 2012 and 2011, respectively. Total compensation cost charged against income related to nonvested stock awards was $7.0 million and $1.8 million for the six months ended June 30, 2012 and 2011, respectively. The corresponding income tax benefit recognized in the income statement was $2.7 million and $717,000 for the six months ended June 30, 2012 and 2011, respectively.
At June 30, 2012, there was $16.5 million of unrecognized compensation cost related to these nonvested shares, which will be recognized over a weighted-average period of 2.9 years. A summary of our nonvested stock activity for the six months ended June 30, 2012 is as follows:
 
 
Shares    
 
Grant Date
Weighted-
Average Fair
Value
Per Share
Outstanding at December 31, 2011
1,516

 
$
20.76

Granted
50

 
$
22.32

Vested
(364
)
 
$
22.68

Forfeited/Canceled
2

 
$
25.10

Outstanding at June 30, 2012
1,204

 
$
20.25

 
8.
Calculation of Earnings per Share
Basic earnings per share is calculated by dividing net income by the weighted-average number of shares outstanding during the period. Diluted earnings per share is calculated by dividing net income attributable to VCA Antech, Inc. by the weighted-average number of common shares outstanding, after giving effect to all dilutive potential common shares outstanding during the period. Basic and diluted earnings per share were calculated as follows (in thousands, except per share amounts): 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2012
 
2011
 
2012
 
2011
Net income attributable to VCA Antech, Inc
$
34,320

 
$
39,612

 
$
69,565

 
$
68,451

Weighted-average common shares outstanding:
 
 
 
 
 
 
 
Basic
87,589

 
86,535

 
87,443

 
86,445

Effect of dilutive potential common shares:
 
 
 
 
 
 
 
Stock options
550

 
647

 
555

 
664

Nonvested shares
584

 
122

 
557

 
194

Diluted
88,723

 
87,304

 
88,555

 
87,303

Basic earnings per share
$
0.39

 
$
0.46

 
$
0.80

 
$
0.79

Diluted earnings per share
$
0.39

 
$
0.45

 
$
0.79

 
$
0.78

For the three months ended June 30, 2012 and 2011, potential common shares of 1,047,701 and 1,139,567, respectively, were excluded from the computation of diluted earnings per share because their inclusion would have had an antidilutive effect.
For the six months ended June 30, 2012 and 2011, potential common shares of 1,050,520 and 40,067, respectively, were excluded from the computation of diluted earnings per share because their inclusion would have had an antidilutive effect.
 







13


VCA Antech, Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
June 30, 2012
(Unaudited)




9.
Lines of Business
Our reportable segments are Animal Hospital and Laboratory. Our Animal Hospital segment provides veterinary services for companion animals and sells related retail and pharmaceutical products. Our Laboratory segment provides diagnostic laboratory testing services for veterinarians, both associated with our animal hospitals and those independent of us. Our other operating segments included in “All Other” in the following tables are our Medical Technology business, which sells digital radiography and ultrasound imaging equipment, related computer hardware, software and ancillary services to the veterinary market and our Vetstreet and ThinkPets businesses, which provides online communications, professional education, marketing solutions to the veterinary community and an ecommerce platform for independent animal hospitals. These operating segments do not meet the quantitative requirements for reportable segments. Our operating segments are strategic business units that have different services, products and/or functions. The segments are managed separately because each is a distinct and different business venture with unique challenges, risks and rewards. We also operate a corporate office that provides general and administrative support services for our other segments.
The accounting policies of our segments are essentially the same as those described in the summary of significant accounting policies included in our 2011 Annual Report on Form 10-K. We evaluate the performance of our segments based on gross profit and operating income. For purposes of reviewing the operating performance of our segments all intercompany sales and purchases are generally accounted for as if they were transactions with independent third parties at current market prices.
 
The following is a summary of certain financial data for each of our segments (in thousands):



14


VCA Antech, Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
June 30, 2012
(Unaudited)



9.
Lines of Business, continued

 
Animal
Hospital
 
Laboratory
 
All Other
 
Corporate
 
Intercompany
Eliminations
 
Total
Three Months Ended
June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
External revenue
$
342,282

 
$
72,452

 
$
23,638

 
$

 
$

 
$
438,372

Intercompany revenue

 
14,168

 
3,780

 

 
(17,948
)
 

Total revenue
342,282

 
86,620

 
27,418

 

 
(17,948
)
 
438,372

Direct costs
292,902

 
44,324

 
17,624

 

 
(17,085
)
 
337,765

Gross profit
49,380

 
42,296

 
9,794

 

 
(863
)
 
100,607

Selling, general and administrative expense
7,995

 
7,510

 
9,029

 
14,463

 

 
38,997

Net (gain) loss on sale and disposal of assets
(112
)
 
(7
)
 
232

 
(1
)
 

 
112

Operating income (loss)
$
41,497

 
$
34,793

 
$
533

 
$
(14,462
)
 
$
(863
)
 
$
61,498

Depreciation and amortization
$
15,239

 
$
2,521

 
$
2,582

 
$
804

 
$
(345
)
 
$
20,801

Property and equipment additions
$
15,297

 
$
2,282

 
$
1,048

 
$
3,008

 
$
(542
)
 
$
21,093

Three Months Ended
June 30, 2011
 
 
 
 
 
 
 
 
 
 
 
External revenue
$
291,332

 
$
72,955

 
$
11,818

 
$

 
$

 
$
376,105

Intercompany revenue

 
11,430

 
4,391

 

 
(15,821
)
 

Total revenue
291,332

 
84,385

 
16,209

 

 
(15,821
)
 
376,105

Direct costs
238,392

 
43,716

 
11,419

 

 
(14,254
)
 
279,273

Gross profit
52,940

 
40,669

 
4,790

 

 
(1,567
)
 
96,832

Selling, general and administrative expense
6,044

 
6,853

 
3,584

 
10,182

 

 
26,663

Net loss on sale and disposal of assets
51

 
7

 
2

 

 

 
60

Operating income (loss)
$
46,845

 
$
33,809

 
$
1,204

 
$
(10,182
)
 
$
(1,567
)
 
$
70,109

Depreciation and amortization
$
9,533

 
$
2,508

 
$
668

 
$
685

 
$
(318
)
 
$
13,076

Property and equipment additions
$
13,236

 
$
1,728

 
$
258

 
$
1,627

 
$
(449
)
 
$
16,400




15


VCA Antech, Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
June 30, 2012
(Unaudited)



9.
 Lines of Business, continued
 
Animal
Hospital
 
Laboratory
 
All Other
 
Corporate
 
Intercompany
Eliminations
 
Total
Six Months Ended
June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
External revenue
$
658,407

 
$
144,423

 
$
45,007

 
$

 
$

 
$
847,837

Intercompany revenue

 
26,927

 
8,736

 

 
(35,663
)
 

Total revenue
658,407

 
171,350

 
53,743

 

 
(35,663
)
 
847,837

Direct costs
563,471

 
88,503

 
35,282

 

 
(33,405
)
 
653,851

Gross profit
94,936

 
82,847

 
18,461

 

 
(2,258
)
 
193,986

Selling, general and administrative expense
15,052

 
15,108

 
18,312

 
29,576

 

 
78,048

Net loss (gain) on sale and disposal of assets
393

 
(14
)
 
240

 
16

 

 
635

Operating income (loss)
$
79,491

 
$
67,753

 
$
(91
)
 
$
(29,592
)
 
$
(2,258
)
 
$
115,303

Depreciation and amortization
$
26,583

 
$
5,074

 
$
4,845

 
$
1,568

 
$
(707
)
 
$
37,363

Property and equipment additions
$
26,063

 
$
3,349

 
$
2,770

 
$
5,991

 
$
(1,008
)
 
$
37,165

Six Months Ended
June 30, 2011
 
 
 
 
 
 
 
 
 
 
 
External revenue
$
561,273

 
$
142,051

 
$
27,904

 
$

 
$

 
$
731,228

Intercompany revenue

 
21,883

 
7,401

 

 
(29,284
)
 

Total revenue
561,273

 
163,934

 
35,305

 

 
(29,284
)
 
731,228

Direct costs
468,780

 
86,535

 
26,057

 

 
(26,754
)
 
554,618

Gross profit
92,493

 
77,399

 
9,248

 

 
(2,530
)
 
176,610

Selling, general and administrative expense
12,127

 
13,489

 
7,140

 
20,090

 

 
52,846

Net loss on sale and disposal of assets
129

 
18

 
2

 

 

 
149

Operating income (loss)
$
80,237

 
$
63,892

 
$
2,106

 
$
(20,090
)
 
$
(2,530
)
 
$
123,615

Depreciation and amortization
$
19,406

 
$
4,979

 
$
1,325

 
$
1,365

 
$
(619
)
 
$
26,456

Property and equipment additions
$
22,771

 
$
2,964

 
$
1,017

 
$
2,585

 
$
(903
)
 
$
28,434

 
 
 
 
 
 
 
 
 
 
 
 
At June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
1,578,725

 
$
244,360

 
$
219,390

 
$
132,700

 
$
(23,980
)
 
$
2,151,195

At December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
1,439,103

 
$
232,423

 
$
202,187

 
$
142,793

 
$
(21,138
)
 
$
1,995,368











16


VCA Antech, Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
June 30, 2012
(Unaudited)



10.
Commitments and Contingencies
We have certain commitments, including operating leases and acquisition agreements. These items are discussed in detail in our consolidated financial statements and notes thereto included in our 2011 Annual Report on Form 10-K. We also have contingencies as follows:
 
a.
Earn-Out Payments
We have contractual arrangements in connection with certain acquisitions that were accounted for under previous business combinations accounting guidance, whereby additional cash may be paid to former owners of acquired companies upon attainment of specified financial criteria as set forth in the respective agreements. The amount to be paid cannot be determined until the earn-out periods expire and the attainment of criteria is established. If the specified financial criteria are attained, we will be obligated to pay approximately, an additional $925,000. Under the current business combination accounting guidance, contingent consideration, such as earn-out liabilities, is recognized as part of the consideration transferred on the acquisition date. A corresponding liability is recorded based on the fair value of the liability if the fair value is known or determinable. The changes in fair value are recognized in earnings where applicable for each reporting period.
 
b.
Other Contingencies
We have certain contingent liabilities resulting from litigation and claims incident to the ordinary course of our business. We believe that the probable resolution of such contingencies will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

11.
Income Taxes
The effective rates for the three and six months ended June 30, 2012, were 38.5% and 37.0%, as compared to the three and six months ended June 30, 2011, of 39.2% and 39.4%, respectively. The decreases in rates are in part due to the non-taxable gain of $5.7 million related to the increase in value of our historic noncontrolling interest in AVC realized upon the acquisition of the remaining equity interest in addition to lower tax rates in Canada.


12.
Noncontrolling Interests
We own some of our animal hospitals in partnerships with noncontrolling interest holders. We consolidate our partnerships in our consolidated financial statements because our ownership interest in these partnerships is equal to or greater than 50.1% and we control these entities. We record noncontrolling interest in income of subsidiaries equal to our partners’ percentage ownership of the partnerships’ income. We also record changes in the redemption value of our redeemable noncontrolling interests in net income attributable to noncontrolling interests in our condensed, consolidated income statements. We reflect our noncontrolling partners’ cumulative share in the equity of the respective partnerships as either noncontrolling interests in equity, mandatorily redeemable noncontrolling interests in other liabilities, or redeemable noncontrolling interests in temporary equity (mezzanine).
 
a.
Mandatorily Redeemable Noncontrolling Interests
The terms of some of our partnership agreements require us to purchase the partner’s equity in the partnership in the event of the partner’s death. We report these redeemable noncontrolling interests at their estimated redemption value and classify them as liabilities due to the certainty of the related event. We recognize redemption value changes in the obligation in interest expense. At June 30, 2012 and December 31, 2011, these liabilities were $11.3 million and $3.1 million, respectively, and are included in other liabilities in our consolidated balance sheets.
 
b.
Redeemable Noncontrolling Interests
We also enter into partnership agreements whereby the minority partner is issued certain “put” rights. These rights are normally exercisable at the sole discretion of the minority partner. We report these redeemable noncontrolling interests at their estimated redemption value and classify them in temporary equity (mezzanine). We recognize changes in the obligation in net income attributable to noncontrolling interests.



17


VCA Antech, Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
June 30, 2012
(Unaudited)



12.
Noncontrolling Interests, continued
The following table provides a summary of redeemable noncontrolling interests (in thousands):
 
 
Income
Statement
Impact
 
Redeemable
Noncontrolling
Interests
Balance as of December 31, 2010
 
 
$
5,799

Noncontrolling interest
$
428

 
 
Redemption value change
402

 
830

Distribution to noncontrolling interests
 
 
(372
)
Balance as of June 30, 2011
 
 
$
6,257

 
 
 
 
Balance as of December 31, 2011
 
 
$
6,964

Noncontrolling interest
$
446

 
 
Redemption value change
17

 
463

Distribution to noncontrolling interests
 
 
(442
)
Balance as of June 30, 2012
 
 
$
6,985

 
13.
Recent Accounting Pronouncements

In June 2011, the FASB finalized the accounting guidance for the Presentation of Comprehensive Income. The objective of the new guidance is to improve the comparability, consistency, and transparency of financial reporting, to increase the prominence of the items reported in other comprehensive income and to facilitate convergence of GAAP and IFRS. The guidance eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholder's equity and requires that all nonowner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. Regardless of which option is chosen, it is required that reclassification adjustments for items that are reclassified from other comprehensive income to net income be presented on the face of the financial statements.

The new guidance does not change the following: the items that must be reported in other comprehensive income; when an item of other comprehensive income must be reclassified to net income; the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects with a single amount shown for aggregate income tax expense; and does not affect how earnings per share is calculated or presented.
 
The guidance was effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and should be applied retrospectively. Early adoption was permitted. We adopted the new accounting guidance on January 1, 2012. The adoption did not significantly impact our consolidated financial statements other than the changes to presentation outlined.

In December 2011, the FASB deferred the effective date for amendments to the presentation of reclassifications of items out of accumulated other comprehensive income. The effective date deferral is to allow the FASB to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income.




18


VCA Antech, Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
June 30, 2012
(Unaudited)



13.
Recent Accounting Pronouncements, continued

In September 2011, the FASB amended the accounting guidance on Intangibles--Goodwill and Other - Testing Goodwill for Impairment. The objective of this guidance is to reduce the cost and complexity of performing the annual goodwill impairment test and to improve the previous guidance by expanding the examples of events and circumstances that an entity should consider in the qualitative evaluation about the likelihood of goodwill impairment. The amendments allow an entity the option of first assessing qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount.

The examples of events and circumstances included in the amendment that an entity should consider in performing its qualitative assessment about whether to proceed to the first step of the goodwill impairment test supersede the examples in the existing guidance. If it is determined that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. Under the amendments, an entity has the option to bypass the qualitative assessment for any reporting unit in any period and may resume performing the qualitative assessment in any subsequent period. An entity is no longer permitted to carry forward its detailed calculation of a reporting unit's fair value from a prior year as previously permitted under the existing guidance. The amended guidance is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 with early adoption permitted. We adopted the amended goodwill impairment testing procedures on January 1, 2012. The adoption does not significantly impact our consolidated financial statements.

In July 2012, the FASB issued accounting guidance on testing indefinite-lived intangible assets for impairment. The objective of this guidance is to reduce the cost and complexity of performing an impairment test for indefinite-lived intangible assets by simplifying how an entity tests those assets for impairment and to improve consistency in impairment testing guidance among long-lived asset categories. The amendments permit an entity first to assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test. An entity will have an option not to calculate annually the fair value of an indefinite-lived intangible asset if the entity determines that it is not more likely than not that the asset is impaired. Permitting an entity to assess qualitative factors when testing indefinite-lived intangible assets for impairment results in guidance that is similar to the goodwill impairment testing guidance, as mentioned above. The amended guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. We currently do not have any indefinite-lived intangible assets.




19


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




20


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 August 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 August 9, 2012 at our website at http://investor.vcaantech.com or at the SEC’s website at www.sec.gov.
We are a leading international 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 June 30, 2012, our animal hospital network consisted of 592 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 June 30, 2012, our laboratory network consisted of 54 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 fluctuating and slow pace of the economic recovery and continued competition predominantly in the laboratory business, continues to impact our revenue. We are unable to forecast the timing or degree of any 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 six months ended June 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 0.2% for the three months ended June 30, 2012 and our Animal Hospital same-store revenue, adjusted for one additional business day, increased 1.2% for the six months ended June 30, 2012. Our Laboratory internal revenue increased 2.6% and 3.8% for the three and six months ended June 30, 2012, respectively. Our



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overall operating income declined as compared to the prior-year comparable periods. 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, a $2.7 million out-of-period adjustment to depreciation expense related to our acquired capital leases 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 Associate Veterinary Clinics (1981) LTD ("AVC"), detailed below.
Acquisitions
Our growth strategy includes the acquisition of independent animal hospitals. We currently anticipate that we will acquire $90 million to $120 million of annualized Animal Hospital revenue in 2012, in addition to 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 six months ended June 30, 2012:
 
 
 
Animal Hospitals:
 
Beginning of period
541

Acquisitions, excluding AVC
14

Acquisitions, merged
(3
)
AVC
44

Sold, closed or merged
(4
)
End of period
592

 
 
Laboratories:
 
Beginning of period
53

Created
1

End of period
54

The following table summarizes the aggregate consideration for the 14 independent animal hospitals acquired during the six months ended June 30, 2012 , and the allocation of the acquisition price (in thousands):
Consideration:
 
  Cash
$
19,193

  Holdback
475

      Fair value of total consideration transferred
$
19,668

 
 
Allocation of the Purchase Price:
 
  Tangible assets
$
780

  Identifiable intangible assets
3,134

  Goodwill (1)
15,754

      Total
$
19,668

____________________________

(1)     We expect that $11.8 million of the goodwill recorded for these acquisitions, as of June 30, 2012, will be deductible for income tax purposes.



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Associate Veterinary Clinics (1981) LTD Investment
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
$
48,891

  Cash paid to debt holders
25,915

      Fair value of total consideration transferred
$
74,806

 
 
Allocation of the Purchase Price:
 
  Tangible assets
$
11,744

  Identifiable intangible assets
14,124

  Goodwill (1)
87,073

  Other liabilities assumed
(18,124
)
 
94,817

  Noncontrolling interest
(8,161
)
  Fair value of pre-existing investment in AVC
(11,850
)
      Total
$
74,806

____________________________
(1)     As of June 30, 2012, we have not finalized the determination of the amount of goodwill that will be deductible for income tax purposes.
The allocation of the additional investment is preliminary, because certain events have not occurred or have not been completed or finalized, including but not limited to, the valuation of assets, including intangible assets, and liabilities.
The pro forma impacts on revenue and earnings have not been disclosed as the amounts were immaterial to the financial statements as a whole.
ThinkPets Inc. (“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.



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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
$
2,573

  Identifiable intangible assets
7,350

  Goodwill (1)
10,569

  Other liabilities assumed
(1,474
)
      Total
$
19,018

____________________________

(1)     As of June 30, 2012, we have not finalized the determination of the amount of goodwill that will be deductible for income tax purposes.
The allocation of the purchase price is preliminary because certain events have not occurred or have not been completed or finalized, including but not limited to, the valuation of assets, including intangible assets, and liabilities.
The pro forma impacts 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 June 30, 2012. A summary of our valuation of goodwill accounting policy is discussed below.

Valuation of Goodwill

At June 30, 2012, we had $1.3 million of goodwill, accounting for 63% of our total assets. Our goodwill represents the excess of the cost of an acquired entity 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 currently involves a two-step process:

First we identify 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.



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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 would be done 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 reporting unit.
Our Animal Hospital reporting unit, which has approximately $1.1 billion of goodwill as of June 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.

Consolidated Results of Operations
The following table sets forth components of our condensed, consolidated income statements expressed as a percentage of revenue:
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2012
 
2011
 
2012
 
2011
Revenue:
 
 
 
 
 
 
 
Animal Hospital
78.1
 %
 
77.5
 %
 
77.7
 %
 
76.8
 %
Laboratory
19.8

 
22.4

 
20.2

 
22.4

All Other
6.2

 
4.3

 
6.3

 
4.8