VCA Inc.
VCA INC (Form: 10-Q, Received: 11/07/2014 13:21:15)

 
 
 
 
 
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 September 30, 2014
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 001-16783
___________________________________________________ 
VCA 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, 84,124,955 shares as of November 3, 2014 .
 
 
 
 
 



VCA Inc. and Subsidiaries
Form 10-Q
September 30, 2014
Table of Contents

Page
Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



PART I.
FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS

VCA Inc. and Subsidiaries
Condensed, Consolidated Balance Sheets
(Unaudited)
(In thousands, except par value)
 
September 30, 2014
 
December 31, 2013
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
126,507

 
$
125,029

Trade accounts receivable, less allowance for uncollectible accounts of $18,292 and $17,702 at September 30, 2014 and December 31, 2013, respectively
65,603

 
59,900

Inventory
50,325

 
55,067

Prepaid expenses and other
32,830

 
25,417

Deferred income taxes
28,921

 
28,907

Prepaid income taxes

 
15,434

Total current assets
304,186

 
309,754

Property and equipment, net
450,617

 
448,366

Goodwill
1,368,230

 
1,330,917

Other intangible assets, net
78,611

 
86,671

Notes receivable
3,016

 
3,454

Deferred financing costs, net
8,308

 
2,987

Other
59,517

 
55,632

Total assets
$
2,272,485

 
$
2,237,781

Liabilities and Equity
 
 
 
Current liabilities:
 
 
 
Current portion of long-term debt
$
11,687

 
$
51,087

Accounts payable
38,858

 
36,962

Accrued payroll and related liabilities
72,221

 
57,337

Income tax payable
3,078

 

Other accrued liabilities
64,414

 
58,762

Total current liabilities
190,258

 
204,148

Long-term debt, less current portion
648,723

 
568,558

Deferred income taxes
90,428

 
100,099

Other liabilities
35,811

 
36,758

Total liabilities
965,220

 
909,563

Commitments and contingencies

 

Redeemable noncontrolling interests
11,014

 
10,678

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

 

VCA Inc. stockholders’ equity:
 
 
 
Common stock, par value $0.001, 175,000 shares authorized, 85,292 and 88,508 shares outstanding as of September 30, 2014 and December 31, 2013, respectively
85

 
89

Additional paid-in capital
261,812

 
384,721

Retained earnings
1,035,799

 
928,720

Accumulated other comprehensive loss
(12,581
)
 
(6,190
)
Total VCA Inc. stockholders’ equity
1,285,115

 
1,307,340

Noncontrolling interests
11,136

 
10,200

Total equity
1,296,251

 
1,317,540

Total liabilities and equity
$
2,272,485

 
$
2,237,781



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

1


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



 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2014
 
2013
 
2014
 
2013
Revenue
$
499,577

 
$
464,055

 
$
1,438,556

 
$
1,367,916

Direct costs
375,820

 
353,378

 
1,092,933

 
1,046,022

Gross profit
123,757

 
110,677

 
345,623

 
321,894

Selling, general and administrative expense
42,792

 
38,747

 
124,163

 
117,616

Impairment of goodwill and other long-lived assets
27,019

 

 
27,019

 

Net loss (gain) on sale or disposal of assets
470

 
(109
)
 
(173
)
 
1,187

Operating income
53,476

 
72,039

 
194,614

 
203,091

Interest expense, net
4,367

 
4,474

 
12,564

 
14,439

Debt retirement costs
1,709

 

 
1,709

 

Other expense (income)
188

 
(86
)
 
178

 
(113
)
Income before provision for income taxes
47,212

 
67,651

 
180,163

 
188,765

Provision for income taxes
18,261

 
25,740

 
69,389

 
71,571

Net income
28,951

 
41,911

 
110,774

 
117,194

Net income attributable to noncontrolling interests
1,499

 
1,264

 
3,695

 
4,400

Net income attributable to VCA Inc.
$
27,452

 
$
40,647

 
$
107,079

 
$
112,794

Basic earnings per share
$
0.32

 
$
0.46

 
$
1.22

 
$
1.27

Diluted earnings per share
$
0.31

 
$
0.45

 
$
1.21

 
$
1.26

Weighted-average shares outstanding for basic earnings per share
86,274

 
88,834

 
87,543

 
88,583

Weighted-average shares outstanding for diluted earnings per share
87,360

 
89,845

 
88,665

 
89,659



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

2


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

 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2014
 
2013
 
2014
 
2013
Net income (1)  
$
28,951

 
$
41,911

 
$
110,774

 
$
117,194

Other comprehensive income:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(6,207
)
 
2,633

 
(6,919
)
 
(3,708
)
Other comprehensive (loss) income
(6,207
)
 
2,633

 
(6,919
)
 
(3,708
)
Total comprehensive income
22,744

 
44,544

 
103,855

 
113,486

Comprehensive income attributable to noncontrolling interests (1) 
1,021

 
1,264

 
3,167

 
4,400

Comprehensive income attributable to VCA Inc.
$
21,723

 
$
43,280

 
$
100,688

 
$
109,086

 ____________________________
(1)  
Includes approximately $1.9 million and $2.6 million of net income related to redeemable and mandatorily redeemable noncontrolling interests combined for the nine months ended September 30, 2014 and 2013 , respectively.



































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

3


VCA 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, 2012
88,372

 
$
88

 
$
390,359

 
$
791,209

 
$
1,847

 
$
10,890

 
$
1,194,393

Net income (excludes $1,152 and $1,475 related to redeemable and mandatorily redeemable noncontrolling interests, respectively).

 

 

 
112,794

 

 
1,773

 
114,567

Other comprehensive loss

 

 

 

 
(3,708
)
 

 
(3,708
)
Formation of noncontrolling interests

 

 

 

 

 
1,806

 
1,806

Distribution to noncontrolling interests

 

 

 

 

 
(1,175
)
 
(1,175
)
Purchase of noncontrolling interests

 

 
(976
)
 

 

 
(4,309
)
 
(5,285
)
Share-based compensation

 

 
10,340

 

 

 

 
10,340

Issuance of common stock under stock incentive plans
1,313

 
1

 
15,110

 

 

 

 
15,111

Stock repurchases
(737
)
 

 
(19,384
)
 

 

 

 
(19,384
)
Excess tax benefit from stock options

 

 
2,654

 

 

 

 
2,654

Tax benefit and other from stock options and awards

 

 
(4
)
 

 

 

 
(4
)
Other

 

 

 

 

 
163

 
163

Balances, September 30, 2013
88,948

 
89

 
398,099

 
904,003

 
(1,861
)
 
9,148

 
1,309,478

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balances, December 31, 2013
88,508

 
$
89

 
$
384,721

 
$
928,720

 
$
(6,190
)
 
$
10,200

 
$
1,317,540

Net income (excludes $723 and $1,172 related to redeemable and mandatorily redeemable noncontrolling interests, respectively).

 

 

 
107,079

 

 
1,800

 
108,879

Other comprehensive loss (excludes $358 related to mandatorily redeemable noncontrolling interests).

 

 

 

 
(6,391
)
 
(170
)
 
(6,561
)
Formation of noncontrolling interests

 

 

 

 

 
933

 
933

Distribution to noncontrolling interests

 

 

 

 

 
(1,627
)
 
(1,627
)
Purchase of noncontrolling interests

 

 
29

 

 

 

 
29

Share-based compensation

 

 
12,234

 

 

 

 
12,234

Issuance of common stock under stock incentive plans
614

 

 
926

 

 

 

 
926

Stock repurchases
(3,830
)
 
(4
)
 
(139,906
)
 

 

 

 
(139,910
)
Excess tax benefit from stock options

 

 
3,808

 

 

 

 
3,808

Balances, September 30, 2014
85,292

 
$
85

 
$
261,812

 
$
1,035,799

 
$
(12,581
)
 
$
11,136

 
$
1,296,251


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

4


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

 
Nine Months Ended
September 30,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income
$
110,774

 
$
117,194

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Impairment of goodwill and other long-lived assets
27,019

 

Depreciation and amortization
59,659

 
57,783

Amortization of debt issue costs
957

 
937

Provision for uncollectible accounts
4,388

 
5,380

Debt retirement costs
1,709

 

Net (gain) loss on sale or disposal of assets
(173
)
 
1,187

Share-based compensation
12,234

 
10,340

Deferred income taxes

 
2,868

Excess tax benefit from exercise of stock options
(3,808
)
 
(2,654
)
Other
381

 
(251
)
Changes in operating assets and liabilities:
 
 
 
Trade accounts receivable
(9,678
)
 
(9,986
)
Inventory, prepaid expense and other assets
(8,233
)
 
(1,634
)
Accounts payable and other accrued liabilities
2,920

 
4,941

Accrued payroll and related liabilities
14,761

 
11,408

Income taxes
12,137

 
21,492

Net cash provided by operating activities
225,047

 
219,005

Cash flows from investing activities:
 
 
 
Business acquisitions, net of cash acquired
(62,122
)
 
(39,640
)
Real estate acquired in connection with business acquisitions
(3,293
)
 
(1,208
)
Capital expenditures
(50,093
)
 
(52,682
)
Proceeds from sale or disposal of assets
4,464

 
905

Other
(202
)
 
(1,738
)
Net cash used in investing activities
(111,246
)
 
(94,363
)
Cash flows from financing activities:
 
 
 
Repayment of debt
(563,976
)
 
(28,507
)
Proceeds from issuance of long-term debt
600,000

 

Payment of financing costs
(7,987
)
 

Distributions to noncontrolling interest partners
(3,577
)
 
(3,324
)
Purchase of existing noncontrolling interests
(326
)
 
(5,727
)
Proceeds from issuance of common stock under stock option plans
926

 
15,111

Excess tax benefit from exercise of stock options
3,808

 
2,654

Repurchase of common stock
(139,910
)
 
(19,384
)
Other
(838
)
 
(160
)
Net cash used in financing activities
(111,880
)
 
(39,337
)
Effect of currency exchange rate changes on cash and cash equivalents
(443
)
 
(566
)
Increase in cash and cash equivalents
1,478

 
84,739

Cash and cash equivalents at beginning of period
125,029

 
68,435

Cash and cash equivalents at end of period
$
126,507

 
$
153,174

 
 
 
 
 
 
 
 

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

5


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

 
 
 
 
 
 
 
 
 
Nine Months Ended
September 30,
 
2014
 
2013
Supplemental disclosures of cash flow information:
 
 
 
Interest paid
$
10,633

 
$
9,487

Income taxes paid
$
57,108

 
$
47,305

 
 
 
 
Supplemental schedule of noncash investing and financing activities:
 
 
 
Detail of acquisitions:
 
 
 
Fair value of assets acquired
$
76,686

 
$
58,825

Fair value of pre-existing investment
(2,014
)
 

Noncontrolling interest
(1,705
)
 
(5,406
)
Cash paid for acquisitions, net of acquired cash
(62,122
)
 
(39,640
)
Assumed debt
(4,483
)
 
(2,360
)
Contingent consideration
(2,531
)
 
(1,120
)
Holdbacks
(2,900
)
 
(892
)
Other liabilities assumed
$
931

 
$
9,407

 
 
 
 
Other noncash items:
 
 
 
Capital lease additions
$

 
$
21,668



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

6


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements
September 30, 2014
(Unaudited)

 
1.
Nature of Operations
Our company, VCA 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 five operating segments: animal hospitals (“Animal Hospital”), veterinary diagnostic laboratories (“Laboratory”), veterinary medical technology (“Medical Technology”), Vetstreet, and Camp Bow Wow Franchising, Inc. (f/k/a D.O.G. Enterprises, LLC) ("Camp Bow Wow"). Our operating segments are aggregated into two reportable segments “Animal Hospital” and “Laboratory.” Our Medical Technology, Vetstreet and Camp Bow Wow operating segments are combined in our “All Other” category. See Footnote 9, “ Lines of Business within these notes to unaudited condensed, consolidated financial statements.
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 September 30, 2014 , we operated or managed 622 animal hospitals throughout 41 states and four Canadian provinces.
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 September 30, 2014 , we operated 59 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 several different services to the veterinary community including, online communications, professional education, marketing solutions and a home delivery platform for independent animal hospitals.
Our Camp Bow Wow business operates and franchises a premier provider of pet services including dog day care, overnight boarding, grooming and other ancillary services at specially designed pet care facilities, principally under the trademark Camp Bow Wow ® .  As of September 30, 2014 , there were 125 Camp Bow Wow® franchise locations operating in 37 states and one Canadian province. 
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 disclosures 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 nine months ended September 30, 2014 are not necessarily indicative of the results to be expected for the full year ending December 31, 2014 . For further information, refer to our audited consolidated financial statements and notes thereto included in our 2013 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 Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
September 30, 2014
(Unaudited)


3.
Goodwill and Other Long-Lived Assets
Goodwill
The following table presents the changes in the carrying amount of our goodwill for the nine months ended September 30, 2014 (in thousands):
 
 
Animal
Hospital
 
Laboratory
 
All Other
 
Total
Balance as of December 31, 2013
 
 
 
 
 
 
 
Goodwill
$
1,216,581

 
$
96,871

 
$
138,276

 
$
1,451,728

Accumulated impairment losses

 

 
(120,811
)
 
(120,811
)
Subtotal
1,216,581

 
96,871

 
17,465

 
1,330,917

Goodwill acquired
46,475

 
27

 
6,669

 
53,171

Goodwill impairment

 

 
(9,246
)
 
(9,246
)
Foreign translation adjustment
(5,176
)
 
(28
)
 

 
(5,204
)
Other (1)
(1,408
)
 

 

 
(1,408
)
Balance as of September 30, 2014
 
 
 
 
 
 
 
Goodwill
1,256,472

 
96,870

 
144,945

 
1,498,287

Accumulated impairment losses

 

 
(130,057
)
 
(130,057
)
Subtotal
$
1,256,472

 
$
96,870

 
$
14,888

 
$
1,368,230

 ____________________________

(1)  
"Other" primarily includes immaterial measurement period adjustments and an immaterial write-off related to the sale of an animal hospital.
Vetstreet Goodwill Impairment Charge

Impairment testing for goodwill is performed at least annually at the reporting unit level. A reporting unit is an operating segment or one level below an operating segment (also known as a component). We perform our annual impairment test as of October 31st. Goodwill is also tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value.

With respect to our Vetstreet reporting unit, during 2013 we established a Fiscal 2014 Operating and Financial Performance - Turnaround Plan. The Plan anticipated the launch of numerous product enhancements designed to restore our competitive advantage in the marketplace. Although certain of these product enhancements were delivered in a timely fashion, others were not. In addition, increasing competition created the need for additional product enhancements to those already planned. Given the less than anticipated impact of new product offerings combined with the the impact of increased competition, we determined that a triggering event had occurred with respect to goodwill and long-lived assets of our Vetstreet reporting unit. Accordingly, we established revised multi-year projections and performed an interim test of Vetstreet’s recorded goodwill and long-lived assets for impairment in the third quarter of 2014, prior to our annual October 31, 2014 test. As a result of our review, we determined that goodwill related to our Vetstreet reporting unit was impaired.

The impairment test for goodwill uses a two-step approach. Step one compares the fair value of the reporting unit to its carrying value including goodwill. If the carrying value exceeds the fair value, there is a potential impairment and step two must be performed. Step two compares the carrying value of the reporting unit's goodwill to its implied fair value (i.e., the fair value of the reporting unit less the fair value of the unit's assets and liabilities, including identifiable intangible assets). If the carrying value of goodwill exceeds its implied fair value, the excess is recorded as an impairment.








8


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
September 30, 2014
(Unaudited)


3.
Goodwill and Other Long-Lived Assets, continued

We calculate the implied fair value of the reporting unit utilizing the income approach. The income approach is based on a discounted cash flow analysis and calculates the fair value of the reporting unit by estimating the after-tax cash flows attributable to the reporting unit and then discounting the after-tax cash flows to a present value, using a weighted average cost of capital ("WACC"). The WACC utilized in our analysis using the income approach was 14.0% . The WACC is an estimate of the overall after-tax rate of return required for equity and debt holders of a business enterprise. The reporting unit's cost of equity and debt was developed based on data and factors relevant to the economy, the industry and the reporting unit. The cost of equity was estimated using the capital asset pricing model ("CAPM"). The CAPM uses a risk-free rate of return and an appropriate market risk premium for equity investments and the specific risks of the investment. The analysis also included comparisons to a group of guideline companies engaged in the same or similar businesses. The cost of debt was estimated using the current after-tax average borrowing cost that a market participant would expect to pay to obtain its debt financing assuming a target capital structure.

Based on the above analysis, it was determined that the carrying value of the Vetstreet reporting unit including goodwill exceeded the fair value of the reporting unit, requiring us to perform step two of the goodwill impairment test to measure the amount of impairment loss, if any.

In performing step two of the goodwill impairment test, we compared the implied fair value of the reporting unit's goodwill to its carrying value. As the carrying value of Vetstreet's goodwill exceeded its implied fair value we recognized a non-cash, goodwill impairment charge of $9.2 million , representing the entire balance of Vetstreet's goodwill. The impairment charge was recognized during the quarter ended September 30, 2014.

The fair value estimates used in the goodwill impairment analysis required significant judgment. The Company's fair value estimates for purposes of determining the goodwill impairment charge are considered Level 3 fair value measurements.

Other Intangible Assets
Our acquisition related amortizable intangible assets at September 30, 2014 and December 31, 2013 are as follows (in thousands):
 
 
As of September 30, 2014
 
As of December 31, 2013
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
Non-contractual customer relationships
$
98,904

 
$
(50,033
)
 
$
48,871

 
$
109,842

 
$
(41,895
)
 
$
67,947

Covenants not-to-compete
9,170

 
(4,383
)
 
4,787

 
8,843

 
(4,661
)
 
4,182

Favorable lease assets
9,591

 
(4,844
)
 
4,747

 
7,458

 
(4,373
)
 
3,085

Trademarks
13,104

 
(4,608
)
 
8,496

 
13,115

 
(4,194
)
 
8,921

Contracts
460

 
(363
)
 
97

 
608

 
(305
)
 
303

Technology
2,913

 
(1,613
)
 
1,300

 
5,240

 
(3,015
)
 
2,225

Client lists

 

 

 
50

 
(42
)
 
8

Franchise rights
10,400

 
(87
)
 
10,313

 

 

 

Total
$
144,542

 
$
(65,931
)
 
$
78,611

 
$
145,156

 
$
(58,485
)
 
$
86,671




9


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
September 30, 2014
(Unaudited)


3.
Goodwill and Other Long-Lived Assets, continued

The recoverability of the carrying values of all fixed assets and intangible assets with finite lives are re-evaluated when events or changes in circumstances indicate an asset's value may be impaired. We perform a quarterly review of fixed assets and identified intangible assets to determine if facts and circumstances indicate that the useful life is shorter than we had originally estimated or that the carrying amount of assets may not be recoverable. If such facts and circumstances exist, we assess recoverability by comparing the projected undiscounted net cash flows associated with the related asset or group of assets over their remaining lives against their respective carrying amounts. Impairments, if any, are based on the excess of the carrying amount over the fair value of those assets. If the useful life is shorter than originally estimated, we accelerate the rate of amortization and amortize the remaining carrying value over the new shorter useful life.

We recorded a $13.1 million intangible asset impairment charge related to non-contractual customer relationships, technology, trademarks and contracts related to our above noted interim impairment test of Vetstreet. We also recorded a fixed asset impairment of $4.7 million . Our determination during interim testing that the fair value of the intangible assets was less than carrying value was based upon changes in our estimate of forecasted cash flows. The fair values of the impaired intangibles were calculated utilizing valuation methods consisting primarily of discounted cash flow techniques, and market comparables, where applicable. The impairment charges are included under the caption "Impairment of goodwill and other long-lived assets" in our consolidated income statement.

The following table summarizes our aggregate amortization expense related to acquisition related intangible assets (in thousands):
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2014
 
2013
 
2014
 
2013
Aggregate amortization expense
$
5,231

 
$
5,588

 
$
15,605

 
$
16,153

The estimated amortization expense related to acquisition related intangible assets for the remainder of 2014 and each of the succeeding years thereafter, as of September 30, 2014 , is as follows (in thousands):

Definite-lived intangible assets:
 
Remainder of 2014
$
5,147

2015
19,232

2016
16,321

2017
10,114

2018
6,677

Thereafter
20,250

Total
$
77,741

Indefinite-lived intangible assets:
 
Trademarks
870

Total intangible assets
$
78,611

 






10


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
September 30, 2014
(Unaudited)


4.
Acquisitions

The table below reflects the activity related to the acquisitions and dispositions of our animal hospitals and laboratories during the nine months ended September 30, 2014 and 2013, respectively:

 
Nine Months Ended
September 30,
 
2014
 
2013
Animal Hospitals:
 
 
 
Acquisitions
23

 
14

Acquisitions, merged
(4
)
 
(2
)
Sold, closed or merged
(6
)
 
(15
)
Net increase (decrease)
13

 
(3
)
 
 
 
 
Laboratories:
 
 
 
Acquisitions

 
1

Created
3

 

Net increase
3

 
1

Animal Hospital Acquisitions
The purchase price allocations for the acquisitions in the table below are preliminary. However, adjustments, if any, are not expected to be material. The measurement periods for purchase price allocations do not exceed 12 months from the acquisition date. The following table summarizes the aggregate consideration for our independent animal hospitals acquired during the nine months ended September 30, 2014 and 2013, respectively, (in thousands):

 
Nine Months Ended
September 30,
 
2014
 
2013
Consideration:
 
 
 
  Cash, net of cash acquired
$
46,948

 
$
39,640

  Assumed debt
4,160

 
2,360

  Holdbacks
1,400

 
892

  Earn-out contingent consideration
721

 
1,120

      Fair value of total consideration transferred
$
53,229

 
$
44,012

 
 
 
 
Allocation of the Purchase Price:
 
 
 
  Tangible assets
$
2,317

 
$
13,494

  Identifiable intangible assets
8,176

 
12,774

  Goodwill (1)
46,502

 
32,557

  Other liabilities assumed
(47
)
 
(9,407
)
      Fair value of assets acquired
$
56,948

 
$
49,418

Noncontrolling interest
(1,705
)
 
(5,406
)
Fair value of pre-existing investment
(2,014
)
 

Total
$
53,229

 
$
44,012

____________________________




11


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
September 30, 2014
(Unaudited)


4.
Acquisitions, continued

(1)  
We expect that $36.6 million and $12.9 million of the goodwill recorded for these acquisitions, as of September 30, 2014 and 2013 , respectively, will be fully deductible for income tax purposes.

In addition to the purchase price listed above, we made cash payments for real estate acquired in connection with our purchase of animal hospitals totaling $3.3 million for the nine months ended September 30, 2014 . There were $1.2 million in cash payments made for real estate for the nine months ended September 30, 2013 .
Camp Bow Wow
On August 15, 2014, we acquired D.O.G. Enterprises, LLC for $17.0 million with up to an additional $3.0 million that may be earned over the next three years . Camp Bow Wow primarily operates and franchises a premier provider of pet services including dog day care, overnight boarding, grooming and other ancillary services at specially designed pet care facilities, principally under the trademark Camp Bow Wow ® .  As of September 30, 2014 , there were 125 Camp Bow Wow ® franchise locations operating in 37 states and one Canadian province. 

The following table summarizes the preliminary purchase price allocation (in thousands):

Consideration:
 
  Cash, net of cash acquired
$
15,174

  Assumed debt
323

  Holdbacks
1,500

  Earn-out contingent consideration
1,810

      Fair value of total consideration transferred
$
18,807

 
 
Allocation of the Purchase Price:
 
  Tangible assets
$
942

  Identifiable intangible assets
12,080

  Goodwill (1)
6,669

  Other liabilities assumed
(884
)
Total
$
18,807

____________________________

(1)  
As of September 30, 2014 , we expect that the full amount of goodwill recorded for this acquisition will be deductible for income tax purposes.

The purchase price allocation for Camp Bow Wow is preliminary and is pending the completion of tangible and intangible asset valuations.





12


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
September 30, 2014
(Unaudited)


5.
Other Accrued Liabilities
Other accrued liabilities consisted of the following (in thousands):
 
 
As of September 30, 2014
 
As of December 31, 2013
Deferred revenue
$
11,399

 
$
11,190

Accrued health insurance
4,439

 
5,479

Deferred rent
4,125

 
4,331

Accrued other insurance
4,200

 
4,381

Miscellaneous accrued taxes (1)
4,270

 
2,804

Accrued workers' compensation
6,828

 
3,267

Holdbacks and earn-outs
3,629

 
3,040

Customer deposits
3,314

 
3,075

Accrued consulting fees
3,312

 
3,028

Accrued lease payments
1,744

 
2,547

Other
17,154

 
15,620

 
$
64,414

 
$
58,762

____________________________
(1)     Includes property, sales and use taxes.

 
6.
Long-Term Obligations
New Senior Credit Facility

On August 27, 2014, we entered into a new senior credit facility with various lenders for $1.4 billion of senior secured credit facilities with Bank of America, N.A., as the administrative agent, swingline lender and Letter of Credit issuer, and JPMorgan Chase Bank, N.A., and Suntrust Bank as co-syndication agents (the "New Senior Credit Facility). The New Senior Credit Facility replaced our existing senior credit facility providing for $534 million of term notes and a $125 million revolving credit facility. The New Senior Credit Facility which provided for $600 million of senior secured term notes and an $800 million senior secured revolving facility, which may be used to borrow, on a same-day notice under a swing line, the lesser of $25 million and the aggregate unused amount of the revolving credit facility then in effect. In addition to refinancing all outstanding amounts under our existing credit agreement, borrowings under our New Senior Credit Facility may be used for general corporate purchases, including permitted share repurchases.

In connection with the New Senior Credit Facility, we incurred $8.0 million in financing costs, of which approximately $6.5 million were capitalized as deferred financing costs and $1.5 million were recognized as part of net income. In addition, we expensed $0.2 million of previously capitalized deferred financing costs associated with lenders under our existing senior credit facility who are not lenders under our New Senior Credit Facility.
















13


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
September 30, 2014
(Unaudited)


6.
Long-Term Obligations, continued

The following table summarizes our long-term obligations at September 30, 2014 and December 31, 2013 (in thousands):

 
 
 
 
September 30, 2014
 
December 31, 2013
Senior term notes
 
Notes payable, maturing in 2019, secured by assets, variable interest rate (1.91% and 1.92% at September 30, 2014 and December 31, 2013, respectively)
 
600,000

 
556,914

Revolving credit
 
Revolving line of credit, maturing in 2019, secured by assets, variable interest rate
 

 

Secured seller notes
 
Notes payable matures in 2014, secured by assets and stock of certain subsidiaries, with interest rate of 10.0%
 
230

 
230

 
 
Total debt obligations
 
600,230

 
557,144

 
 
Capital lease obligations
 
60,180

 
62,501

 
 
 
 
660,410

 
619,645

 
 
Less — current portion
 
(11,687
)
 
(51,087
)
 
 
 
 
$
648,723

 
$
568,558


Interest Rate. In general, borrowings under the New Senior Credit Facility (including swing line borrowings) bear interest, at our option, on either:

the base rate (as defined below) plus the applicable margin of 0.75% (Pricing Tier 3, see table below) per annum; or

the Eurodollar rate (as defined below), plus a margin of 1.75% (Pricing Tier 3, see table below) per annum

Each of the aforementioned margins remain applicable until the date of delivery of the compliance certificate and the financial statements, for the period ended September 30, 2014 , 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:

Pricing Tier
 
Consolidated Leverage Ratio
 
Applicable Margin for Eurodollar Loans/Letter of Credit Fees
 
Applicable Margin for Base Rate Loans
 
Commitment Fee
1
 
≥ 4.00:1.00
 
2.25
%
 
1.25
%
 
0.45
%
2
 
< 4.00:1.00 and ≥ 3.25:1.00
 
2.00
%
 
1.00
%
 
0.40
%
3
 
< 3.25:1.00 and ≥ 2.50:1.00
 
1.75
%
 
0.75
%
 
0.35
%
4
 
< 2.50:1.00 and ≥ 1.75:1.00
 
1.50
%
 
0.50
%
 
0.30
%
5
 
< 1.75:1.00 and ≥ 1.00:1.00
 
1.25
%
 
0.25
%
 
0.25
%
6
 
< 1.00:1.00
 
1.00
%
 
%
 
0.25
%

The base rate for the senior term notes is a rate per annum equal to the highest of the (a) Federal Funds Rate plus 0.5%, (b) Bank of America, N.A.'s ("Bank of America") prime rate in effect on such day, and (c) the Eurodollar rate plus 1.0%. The Eurodollar rate is defined as the rate per annum equal to the London Interbank Offered Rate ("LIBOR"), or a comparable or successor rate which is approved by Bank of America.

Maturity and Principal Payments. The senior term notes mature on August 27, 2019 . Principal payments on the senior term notes of $7.5 million are due each calendar quarter from September 30, 2015 to and including June 30, 2017, $11.3 million are due each calendar quarter from September 30, 2017 to and including June 30, 2018 and $15.0 million are due each calendar quarter thereafter with a final payment of the outstanding principal balance due upon maturity. The following table sets forth the scheduled principal payments for our senior term notes (in thousands):




14


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
September 30, 2014
(Unaudited)


6.
Long-Term Obligations, continued

 
 
2014
 
2015
 
2016
 
2017
 
2018
 
Thereafter
Senior term notes
 
$

 
$
15,000

 
$
30,000

 
$
37,500

 
$
52,500

 
$
465,000


The revolving credit facility matures on August 27, 2019 . Principal payments under the revolving credit facility portion are made at our discretion with the entire unpaid amount due at maturity. As of September 30, 2014, no amounts have been borrowed under our revolving credit facility.

Guarantees and Security. We and each of our wholly-owned domestic subsidiaries guarantee the outstanding indebtedness under the New Senior Credit Facility. Any borrowings, along with the guarantees of the domestic subsidiaries, are further secured by a pledge of substantially all of our consolidated assets, including 65% of the voting equity and 100% of the non-voting equity interest in each of our foreign subsidiaries.


7. Fair Value Measurements
Fair Value of Financial Instruments
The FASB accounting guidance requires disclosure of fair value information about financial instruments, whether or not they are 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 September 30, 2014 and December 31, 2013 is based upon the ask price quoted from an external source, which is considered a Level 2 input.
The following table reflects the carrying value and fair value of our variable-rate long-term debt (in thousands):

 
As of September 30, 2014
 
As of December 31, 2013
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
Variable-rate long-term debt
$
600,000

 
$
600,000

 
$
556,914

 
$
556,914

Non-Recurring Assets
Non-financial assets such as property, plant and equipment, land, goodwill and intangible assets are also subject to non-recurring fair value measurements if they are deemed to be impaired. The impairment models used for nonfinancial assets depend on the type of asset and are accounted for in accordance with FASB’s guidance on fair value measurement.
During the quarter ended September 30, 2014 , the entire balance of $9.2 million of our Vetstreet goodwill was written off in an impairment charge which was included in earnings in the period. Additionally, during the quarter ended September 30, 2014 , our Vetstreet long-lived assets were written down to their estimated fair value resulting in an impairment charge of $17.8 million , which was included in earnings in the period. Our Vetstreet long-lived assets balance as of September 30, 2014 was $5.0 million . Both the implied fair value of goodwill and the estimated fair value of long-lived assets were calculated using Level 3 inputs which are described in Note 3.



15


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
September 30, 2014
(Unaudited)



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 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
September 30,
 
Nine Months Ended
September 30,
 
2014
 
2013
 
2014
 
2013
Net income attributable to VCA Inc.
$
27,452

 
$
40,647

 
$
107,079

 
$
112,794

Weighted-average common shares outstanding:
 
 
 
 
 
 
 
Basic
86,274

 
88,834

 
87,543

 
88,583

Effect of dilutive potential common shares:
 
 
 
 
 
 
 
Stock options
324

 
310

 
285

 
318

Nonvested shares and units
762

 
701

 
837

 
758

Diluted
87,360

 
89,845

 
88,665

 
89,659

Basic earnings per share
$
0.32

 
$
0.46

 
$
1.22

 
$
1.27

Diluted earnings per share
$
0.31

 
$
0.45

 
$
1.21

 
$
1.26


For the three months ended September 30, 2014 and September 30, 2013 , there were no potential common shares excluded from the computation of diluted earnings per share.
There were no potential common shares excluded from the computation of diluted earnings per share for the nine months ended September 30, 2014 . For the nine months ended September 30, 2013 , potential common shares of 23,538 were excluded from the computation of diluted earnings per share because their inclusion would have had an antidilutive effect.

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, our Vetstreet business, which provides online and printed communications, professional education, marketing solutions to the veterinary community and an ecommerce platform for independent animal hospitals, and our Camp Bow Wow business, which primarily franchises the right to operate dog day care, overnight boarding and grooming services. 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 2013 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.







16


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
September 30, 2014
(Unaudited)


9.
Lines of Business, continued

The following is a summary of certain financial data for each of our segments (in thousands):

 
Animal
Hospital
 
Laboratory
 
All Other
 
Corporate
 

Eliminations
 
Total
Three Months Ended
September 30, 2014
 
 
 
 
 
 
 
 
 
 
 
External revenue
$
395,820

 
$
77,394

 
$
25,397

 
$

 
$
966

 
$
499,577

Intercompany revenue

 
14,509

 
4,684

 

 
(19,193
)
 

Total revenue
395,820

 
91,903

 
30,081

 

 
(18,227
)
 
499,577

Direct costs
327,283

 
46,879

 
19,945

 

 
(18,287
)
 
375,820

Gross profit
68,537

 
45,024

 
10,136

 

 
60

 
123,757

Selling, general and administrative expense
9,269

 
8,610

 
8,023

 
16,890

 

 
42,792

Operating income (loss) before charges
59,268

 
36,414

 
2,113

 
(16,890
)
 
60

 
80,965

Impairment of goodwill and other long-lived assets

 

 
27,019

 

 

 
27,019

Net loss (gain) on sale or disposal of assets
598

 
7

 

 
(135
)
 

 
470

Operating income (loss)
$
58,670

 
$
36,407

 
$
(24,906
)
 
$
(16,755
)
 
$
60

 
$
53,476

Depreciation and amortization
$
15,201

 
$
2,671

 
$
1,781

 
$
688

 
$
(479
)
 
$
19,862

Capital expenditures
$
17,224

 
$
2,391

 
$
1,123

 
$
2,025

 
$
(649
)
 
$
22,114

Three Months Ended
September 30, 2013
 
 
 
 
 
 
 
 
 
 
 
External revenue
$
368,868

 
$
72,877

 
$
21,482

 
$

 
$
828

 
$
464,055

Intercompany revenue

 
13,583

 
5,980

 

 
(19,563
)
 

Total revenue
368,868

 
86,460

 
27,462

 

 
(18,735
)
 
464,055

Direct costs
308,029

 
45,650

 
17,456

 

 
(17,757
)
 
353,378

Gross profit
60,839

 
40,810

 
10,006

 

 
(978
)
 
110,677

Selling, general and administrative expense
8,678

 
7,921

 
7,618

 
14,530

 

 
38,747

Operating income (loss) before charges
52,161

 
32,889

 
2,388

 
(14,530
)
 
(978
)
 
71,930

Net (gain) loss on sale or disposal of assets
(110
)
 
11

 

 
(10
)
 

 
(109
)
Operating income (loss)
$
52,271


$
32,878

 
$
2,388

 
$
(14,520
)
 
$
(978
)
 
$
72,039

Depreciation and amortization
$
15,037

 
$
2,554

 
$
2,087

 
$
816

 
$
(450
)
 
$
20,044

Capital expenditures
$
15,915

 
$
1,905

 
$
872

 
$
1,795

 
$
(900
)
 
$
19,587




17


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
September 30, 2014
(Unaudited)


9.
Lines of Business, continued

<
 
Animal
Hospital
 
Laboratory
 
All Other
 
Corporate
 

Eliminations
 
Total
Nine Months Ended
September 30, 2014
 
 
 
 
 
 
 
 
 
 
 
External revenue
$
1,134,184

 
$
233,497

 
$
68,055

 
$

 
$
2,820

 
$
1,438,556

Intercompany revenue

 
42,895

 
13,859

 

 
(56,754
)
 

Total revenue
1,134,184

 
276,392

 
81,914

 

 
(53,934
)
 
1,438,556

Direct costs
953,511

 
139,245

 
54,161

 

 
(53,984
)
 
1,092,933

Gross profit
180,673

 
137,147

 
27,753

 

 
50

 
345,623

Selling, general and administrative expense
28,261

 
24,909

 
23,782

 
47,211

 

 
124,163

Operating income (loss) before charges
152,412

 
112,238

 
3,971

 
(47,211
)
 
50

 
221,460

Impairment of goodwill and other long-lived assets

 

 
27,019

 

 

 
27,019

Net loss (gain) on sale and disposal of assets
1,180

 
(71
)
 
(1,087
)
 
(195
)
 

 
(173
)
Operating income (loss)
$
151,232

 
$
112,309

 
$
(21,961
)
 
$
(47,016
)
 
$
50

 
$
194,614

Depreciation and amortization
$
45,053

 
$
7,769

 
$
5,921

 
$
2,333

 
$
(1,417
)
 
$
59,659

Capital expenditures
$
38,411

 
$
5,676

 
$
2,801

 
$
4,769

 
$
(1,564
)
 
$
50,093

Nine Months Ended
September 30, 2013
 
 
 
 
 
 
 
 
 
 
 
External revenue
$
1,074,688

 
$
223,466

 
$
67,339

 
$

 
$
2,423

 
$
1,367,916

Intercompany revenue

 
41,559

 
16,118

 

 
(57,677
)
 

Total revenue
1,074,688

 
265,025

 
83,457

 

 
(55,254
)
 
1,367,916

Direct costs
908,537

 
136,524

 
54,394

 

 
(53,433
)
 
1,046,022

Gross profit
166,151

 
128,501

 
29,063

 

 
(1,821
)
 
321,894

Selling, general and administrative expense
25,723

 
23,891

 
24,573

 
43,429

 

 
117,616

Operating income (loss) before charges
140,428

 
104,610

 
4,490

 
(43,429
)
 
(1,821
)
 
204,278

Net loss (gain) on sale and disposal of assets
1,459

 
5