VCA Inc.
VCA INC (Form: 10-Q/A, Received: 05/09/2017 16:46:14)
 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________________________________ 
FORM 10-Q/A
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2017
 
¨
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 website, 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, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth 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)
  
Emerging growth company [ ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
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, 81,267,863 shares as of May 2, 2017 .
 
 
 
 
 



EXPLANATORY NOTE
This Form 10-Q/A (this “Amendment”) is VCA Inc.’s Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2017. On May 9, 2017, VCA Inc. inadvertently filed with the Securities and Exchange Commission the Form 10-Q for the fiscal quarter ended September 30, 2016, which was originally filed on November 7, 2016. This Amendment replaces the Form 10-Q filed on May 9, 2017 in its entirety.






VCA Inc. and Subsidiaries
Form 10-Q
March 31, 2017
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)
 
March 31, 2017
 
December 31, 2016
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
89,531

 
$
81,409

Trade accounts receivable, less allowance for uncollectible accounts of $22,730 and $23,440 at March 31, 2017 and December 31, 2016, respectively
85,611

 
85,593

Inventory
56,833

 
57,590

Prepaid expenses and other
38,432

 
44,752

Prepaid income taxes

 
11,705

Total current assets
270,407

 
281,049

Property and equipment, net
645,652

 
613,224

Goodwill
2,228,189

 
2,164,422

Other intangible assets, net
211,630

 
212,577

Notes receivable
2,136

 
2,147

Other
102,664

 
99,909

Total assets
$
3,460,678

 
$
3,373,328

Liabilities and Equity
 
 
 
Current liabilities:
 
 
 
Current portion of long-term obligations
$
43,877

 
$
38,320

Accounts payable
61,532

 
68,587

Accrued payroll and related liabilities
73,247

 
97,806

Income tax payable
15,874

 

Other accrued liabilities
95,045

 
91,783

Total current liabilities
289,575

 
296,496

Long-term obligations, net
1,342,607

 
1,309,397

Deferred income taxes, net
147,851

 
142,535

Other liabilities
43,913

 
44,560

Total liabilities
1,823,946

 
1,792,988

Commitments and contingencies

 

Redeemable noncontrolling interests
10,398

 
11,615

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, 81,262 and 81,231 shares outstanding as of March 31, 2017 and December 31, 2016, respectively
81

 
81

Additional paid-in capital
37,012

 
32,157

Retained earnings
1,535,484

 
1,484,391

Accumulated other comprehensive loss
(43,084
)
 
(45,406
)
Total VCA Inc. stockholders’ equity
1,529,493

 
1,471,223

Noncontrolling interests
96,841

 
97,502

Total equity
1,626,334

 
1,568,725

Total liabilities and equity
$
3,460,678

 
$
3,373,328



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

1



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



 
Three Months Ended
March 31,
 
2017
 
2016
Revenue
$
678,251

 
$
563,439

Direct costs
523,783

 
426,659

Gross profit
154,468

 
136,780

Selling, general and administrative expense
58,401

 
50,128

Net loss on sale or disposal of assets
250

 
563

Operating income
95,817

 
86,089

Interest expense, net
9,027

 
7,095

Other income
(302
)
 
(264
)
Income before provision for income taxes
87,092

 
79,258

Provision for income taxes
34,639

 
31,536

Net income
52,453

 
47,722

Net income attributable to noncontrolling interests
1,360

 
1,495

Net income attributable to VCA Inc.
$
51,093

 
$
46,227

Basic earnings per share
$
0.63

 
$
0.57

Diluted earnings per share
$
0.62

 
$
0.57

Weighted-average shares outstanding for basic earnings per share
81,245

 
80,776

Weighted-average shares outstanding for diluted earnings per share
82,179

 
81,523



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
March 31,
 
2017
 
2016
Net income (1)  
$
52,453

 
$
47,722

Other comprehensive income:
 
 
 
Foreign currency translation adjustments
2,381

 
12,598

Other comprehensive income
2,381

 
12,598

Total comprehensive income
54,834

 
60,320

Comprehensive income attributable to noncontrolling interests (1) 
1,419

 
1,848

Comprehensive income attributable to VCA Inc.
$
53,415

 
$
58,472

____________________________
(1)  
Includes approximately $0.8 million and $1 million of net income related to redeemable and mandatorily redeemable noncontrolling interests for the three months ended March 31, 2017 and 2016 , 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, 2015
80,764

 
$
81

 
$
19,708

 
$
1,275,207

 
$
(50,034
)
 
$
12,072

 
$
1,257,034

Net income (excludes $641 and $365 related to redeemable and mandatorily redeemable noncontrolling interests, respectively)

 

 

 
46,227

 

 
489

 
46,716

Other comprehensive income (excludes $167 related to mandatorily redeemable noncontrolling interests)

 

 

 

 
12,245

 
186

 
12,431

Distributions to noncontrolling interests

 

 

 

 

 
(637
)
 
(637
)
Purchase of noncontrolling interests

 

 
(1,821
)
 

 

 
(1,909
)
 
(3,730
)
Share-based compensation

 

 
4,906

 

 

 

 
4,906

Issuance of common stock under stock incentive plans
55

 

 
286

 

 

 

 
286

Stock repurchases
(18
)
 

 
(843
)
 

 

 

 
(843
)
Excess tax benefit from share-based compensation

 

 
445

 

 

 

 
445

Other

 

 

 

 

 
(107
)
 
(107
)
Balances, March 31, 2016
80,801

 
$
81

 
$
22,681

 
$
1,321,434

 
$
(37,789
)
 
$
10,094

 
$
1,316,501

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balances, December 31, 2016
81,231

 
$
81

 
$
32,157

 
$
1,484,391

 
$
(45,406
)
 
$
97,502

 
$
1,568,725

Net income (excludes $384 and $406 related to redeemable and mandatorily redeemable noncontrolling interests, respectively)

 

 

 
51,093

 

 
570

 
51,663

Other comprehensive income (excludes $21 related to mandatorily redeemable noncontrolling interests)

 

 

 

 
2,322

 
38

 
2,360

Formation of noncontrolling interests

 

 

 

 

 
335

 
335

Distributions to noncontrolling interests

 

 

 

 

 
(534
)
 
(534
)
Purchase of noncontrolling interests (excludes $1,210 related to redeemable noncontrolling interests)

 

 
(190
)
 

 

 

 
(190
)
Share-based compensation

 

 
3,962

 

 

 

 
3,962

Issuance of common stock under stock incentive plans
32

 

 
90

 

 

 

 
90

Stock repurchases
(1
)
 

 
(95
)
 

 

 

 
(95
)
Other

 

 
1,088

 

 

 
(1,070
)
 
18

Balances, March 31, 2017
81,262

 
$
81

 
$
37,012

 
$
1,535,484

 
$
(43,084
)
 
$
96,841

 
$
1,626,334


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)

 
Three Months Ended
March 31,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
52,453

 
$
47,722

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
30,401

 
21,289

Amortization of debt issue costs
383

 
433

Provision for uncollectible accounts
1,794

 
851

Net loss on sale or disposal of assets
250

 
563

Share-based compensation
3,962

 
4,906

Excess tax benefits from share-based compensation

 
(445
)
Other
884

 
4,489

Changes in operating assets and liabilities:
 
 
 
Trade accounts receivable
(1,594
)
 
(3,339
)
Inventory, prepaid expenses and other assets
5,507

 
(7,569
)
Accounts payable and other accrued liabilities
3,491

 
(4,801
)
Accrued payroll and related liabilities
(24,748
)
 
12,955

Income taxes
27,508

 
16,855

Net cash provided by operating activities
100,291

 
93,909

Cash flows from investing activities:
 
 
 
Business acquisitions, net of cash acquired
(81,721
)
 
(160,385
)
Property and equipment additions
(28,919
)
 
(25,806
)
Proceeds from sale of assets
349

 
12

Other
(6,203
)
 
(7,346
)
Net cash used in investing activities
(116,494
)
 
(193,525
)
Cash flows from financing activities:
 
 
 
Repayment of long-term obligations
(17,813
)
 
(9,678
)
Proceeds from revolving credit facility
45,000

 
90,000

Distributions to noncontrolling interest partners
(1,138
)
 
(1,238
)
Proceeds from formation of noncontrolling interests
335

 

Purchase of noncontrolling interests
(1,400
)
 
(3,730
)
Proceeds from issuance of common stock under stock incentive plans
90

 
286

Excess tax benefits from share-based compensation

 
445

Stock repurchases
(95
)
 
(843
)
Other
(812
)
 
(333
)
Net cash provided by financing activities
24,167

 
74,909

Effect of currency exchange rate changes on cash and cash equivalents
158

 
299

Increase (decrease) in cash and cash equivalents
8,122

 
(24,408
)
Cash and cash equivalents at beginning of period
81,409

 
98,888

Cash and cash equivalents at end of period
$
89,531

 
$
74,480

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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)

 
 
 
 
 
 
 
 
 
Three Months Ended
March 31,
 
2017
 
2016
Supplemental disclosures of cash flow information:
 
 
 
Interest paid
$
7,875

 
$
5,173

Income taxes paid
$
7,081

 
$
14,213



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

6



VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements
March 31, 2017
(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 four operating segments: animal hospitals ("Animal Hospital"), veterinary diagnostic laboratories ("Laboratory"), veterinary medical technology ("Medical Technology"), 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 and Camp Bow Wow operating segments are combined in our All Other category. See Note 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 March 31, 2017 , we operated or managed 810 animal hospitals throughout 43 states and five 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 March 31, 2017 , we operated 61 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 Camp Bow Wow business 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 March 31, 2017 , there were 130 Camp Bow Wow franchise locations operating in 33 states and one Canadian province. 
On May 1, 2016 , we acquired an 80% ownership interest in Companion Animal Practices, North America ("CAPNA"). CAPNA, founded in 2010 , and at the time of acquisition, operated a network of 56 free standing animal hospitals in 18 states. Accordingly, CAPNA's results of operations are included in our Animal Hospital segment for the quarter ended March 31, 2017 .
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.

Merger Agreement
On January 7, 2017 , we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with MMI Holdings, Inc. (“Acquiror”), Venice Merger Sub Inc., a wholly owned subsidiary of Acquiror (“Merger Sub”), and, solely for purposes of Section 9.15 of the Merger Agreement, Mars, Incorporated (“Mars”), pursuant to which, among other things, at the closing of the merger, we will become a wholly-owned subsidiary of Acquiror (the “Merger”). The Merger is subject to satisfaction of a number of customary closing conditions contained in the Merger Agreement, including the receipt of the outstanding required regulatory approvals and discussed in detail in the definitive proxy statement filed with the U.S. Securities and Exchange Commission by VCA on February 15, 2017 (the “Definitive Proxy Statement”). The Merger Agreement and the Merger are described in greater detail in the Definitive Proxy Statement and other materials and documents filed with the SEC, all of which are available on the SEC’s website at www.sec.gov . The foregoing description of the Merger Agreement is qualified in its entirety by reference to the full text of the Merger Agreement attached as Exhibit 2.1 to our Current Report on Form 8-K filed with the SEC on January 9, 2017 .




7


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(Unaudited)

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 months ended March 31, 2017 are not necessarily indicative of the results to be expected for the full year ending December 31, 2017 . The year end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. For further information, refer to our audited consolidated financial statements and notes thereto included in our 2016 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.

3.
Goodwill and Other Long-Lived Assets
Goodwill
The following table presents the changes in the carrying amount of our goodwill for the three months ended March 31, 2017 (in thousands):
 
 
Animal
Hospital
 
Laboratory
 
All Other
 
Total
Balance as of December 31, 2016
 
 
 
 
 
 
 
Goodwill
$
2,047,894

 
$
101,283

 
$
145,302

 
$
2,294,479

Accumulated impairment losses

 

 
(130,057
)
 
(130,057
)
Subtotal
2,047,894

 
101,283

 
15,245

 
2,164,422

Goodwill acquired
75,884

 

 

 
75,884

Foreign translation adjustment
1,733

 
5

 

 
1,738

Other (1)
(13,855
)
 

 

 
(13,855
)
Balance as of March 31, 2017
 
 
 
 
 
 
 
Goodwill
2,111,656

 
101,288

 
145,302

 
2,358,246

Accumulated impairment losses

 

 
(130,057
)
 
(130,057
)
Subtotal
$
2,111,656

 
$
101,288

 
$
15,245

 
$
2,228,189

 ____________________________

(1)  
"Other" consists primarily of measurement period adjustments.















8


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(Unaudited)

3.
Goodwill and Other Long-Lived Assets, continued
Other Intangible Assets
Our acquisition related amortizable intangible assets as of March 31, 2017 and December 31, 2016 are as follows (in thousands):
 
As of March 31, 2017
 
As of December 31, 2016
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
Non-contractual customer relationships
$
228,148

 
$
(71,469
)
 
$
156,679

 
$
218,847

 
$
(62,331
)
 
$
156,516

Covenants not-to-compete
25,592

 
(8,776
)
 
16,816

 
23,990

 
(7,580
)
 
16,410

Favorable lease assets
6,503

 
(3,008
)
 
3,495

 
9,451

 
(5,855
)
 
3,596

Technology
1,377

 
(845
)
 
532

 
1,377

 
(795
)
 
582

Trademarks
30,314

 
(8,974
)
 
21,340

 
30,144

 
(7,713
)
 
22,431

Client lists
10

 
(1
)
 
9

 
10

 
(1
)
 
9

Franchise rights
11,730

 
(3,030
)
 
8,700

 
11,730

 
(2,737
)
 
8,993

Total
$
303,674

 
$
(96,103
)
 
$
207,571

 
$
295,549

 
$
(87,012
)
 
$
208,537


The following table summarizes our aggregate amortization expense related to other intangible assets (in thousands):
 
 
Three Months Ended
March 31,
 
2017
 
2016
Aggregate amortization expense
$
11,425

 
$
6,228

The estimated amortization expense related to other intangible assets for the remainder of 2017 and each of the succeeding years thereafter, as of March 31, 2017 , is as follows (in thousands):

Definite-lived intangible assets:
 
Remainder of 2017
$
33,413

2018
41,576

2019
38,461

2020
33,532

2021
23,264

Thereafter
37,325

Total
$
207,571

Indefinite-lived intangible assets:
 
Trademarks
4,059

Total intangible assets
$
211,630

 











9


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(Unaudited)

4.
Acquisitions

The table below reflects the activity related to the acquisitions and dispositions of our animal hospitals during the three months ended March 31, 2017 and 2016 , respectively. There were no laboratory acquisitions or dispositions during the three months ended March 31, 2017 and 2016 , respectively.

 
Three Months Ended
March 31,
 
2017
 
2016
Animal Hospitals:
 
 
 
Acquisitions
15

 
24

Acquisitions, merged

 
(1
)
Sold, closed or merged

 
(2
)
Net increase
15

 
21


Animal Hospital Acquisitions
The purchase price allocations for some of the 2017 animal hospital acquisitions included 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 and the allocation of the purchase price for our independent animal hospitals acquired during the three months ended March 31, 2017 and 2016 , respectively (in thousands):

 
Three Months Ended
March 31,
 
2017
 
2016
Consideration:
 
 
 
  Cash, net of cash acquired
$
81,721

 
$
157,325

  Assumed debt
8,374

 
1,361

  Holdbacks
1,600

 
3,508

  Earn-outs

 
3,437

      Fair value of total consideration transferred
$
91,695

 
$
165,631

 
 
 
 
Allocation of the Purchase Price:
 
 
 
  Tangible assets
$
5,395

 
$
17,541

  Identifiable intangible assets (1)
10,303

 
18,844

  Goodwill (2)
75,884

 
129,246

  Other liabilities assumed
113

 

      Fair value of assets acquired and liabilities assumed
$
91,695

 
$
165,631

____________________________

(1)  
Identifiable intangible assets include customer relationships, trademarks and covenants-not-to-compete. The weighted-average amortization period for the total identifiable intangible assets is approximately five years. The weighted-average amortization period for customer relationships, trademarks and covenants-not-to-compete is approximately five , two and five years, respectively.
(2)  
We expect that $75.9 million and $129.2 million of the goodwill recorded for these acquisitions, as of March 31, 2017 and 2016 , respectively, will be fully deductible for income tax purposes.




10


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(Unaudited)

5.
Other Accrued Liabilities
Other accrued liabilities consisted of the following at March 31, 2017 and December 31, 2016 (in thousands):

 
March 31, 2017
 
December 31, 2016
Deferred revenue
$
24,037

 
$
21,400

Holdbacks and earn-outs
14,403

 
20,823

Accrued other insurance
6,380

 
6,169

Deferred rent
5,492

 
5,347

Accrued health insurance
5,012

 
4,818

Miscellaneous accrued taxes (1)
4,407

 
2,966

Accrued worker's compensation
3,938

 
3,733

Accrued accounting and legal fees
3,822

 
2,508

Customer deposits
2,236

 
3,168

Accrued lease payments
1,355

 
1,409

Other
23,963

 
19,442

 
$
95,045

 
$
91,783

____________________________
(1)     Includes property, sales and use taxes.
6.
Long-Term Obligations
Senior Credit Facility

On June 29, 2016 , we entered into a New Senior Credit Facility with various lenders for approximately $1.7 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., Barclays Bank PLC, Suntrust Bank, and Wells Fargo Bank, N.A. as co-syndication agents (the "New Senior Credit Facility"). The New Senior Credit Facility replaced our previous senior credit facility which provided for $600 million of term notes and an $800 million revolving credit facility. The New Senior Credit Facility provides for $880 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 previous senior credit facility, borrowings under our New Senior Credit Facility may be used for general corporate purchases, including permitted share repurchases. At June 30, 2016 , we had $375 million in outstanding borrowings under the new senior secured revolving facility, which funds were used together with the proceeds from the $880 million of new senior secured term notes to refinance amounts outstanding under our previous senior credit facility.

In connection with the New Senior Credit Facility, we incurred $3.8 million in financing costs, of which approximately $3.2 million were capitalized as deferred financing costs. The remaining $0.6 million of financing costs were expensed as debt retirement costs, along with an additional $1.0 million of previously capitalized deferred financing costs associated with lenders under our previous senior credit facility who are not lenders under our New Senior Credit Facility.

In 2016, ASU 2015-03 and ASU 2015-15 were adopted. In accordance with ASU 2015-03, the table below presents debt issuance costs as a direct deduction from the face amount of the corresponding notes in the current period and retrospectively in the prior fiscal year end.









11


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(Unaudited)

6.
Long-Term Obligations, continued

Long-term obligations consisted of the following at March 31, 2017 and December 31, 2016 (in thousands):
 
 
 
 
March 31, 2017
 
December 31, 2016
Senior term notes
 
Principal amount
 
$
863,500

 
$
869,000

 
 
Less unamortized debt issuance costs
 
(2,448
)
 
(2,605
)
 
 
Senior term notes less unamortized debt issuance costs, secured by assets, variable interest rate (2.51% and 2.28% at March 31, 2017 and December 31, 2016, respectively) (1)
 
$
861,052

 
$
866,395

Revolving credit
 
Principal amount
 
$
445,000

 
$
400,000

 
 
Less unamortized debt issuance costs
 
(3,866
)
 
(4,093
)
 
 
Revolving line of credit less unamortized debt issuance costs, secured by assets, variable interest rate (2.49% and 2.28% at March 31, 2017 and December 31, 2016, respectively) (1)
 
$
441,134

 
$
395,907

Secured seller note
 
Notes payable matures in 2017, secured by assets and stock of certain subsidiaries, with interest rate of 10.0%
 
230

 
230

 
 
Other Debt
 
1,819

 
1,801

 
 
Total debt obligations
 
1,304,235

 
1,264,333

 
 
Capital lease obligations
 
82,249

 
83,384

 
 
 
 
1,386,484

 
1,347,717

 
 
Less — current portion
 
(43,877
)
 
(38,320
)
 
 
 
 
$
1,342,607

 
$
1,309,397

____________________________
(1)  
Notes payable and the revolving line of credit at March 31, 2017 will mature in 2021 under the New Senior Credit Facility.

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 0.50% (Pricing Tier 3, see table below) per annum; or

the Eurodollar rate (as defined below), plus a margin of 1.50% (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 March 31, 2017 , 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:












12


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(Unaudited)

6.
Long-Term Obligations, continued
Pricing Tier
 
Consolidated Leverage Ratio
 
Applicable Margin for Eurodollar Loans/Letter of Credit Fees
 
Applicable Margin for Base Rate Loans
 
Commitment Fee
1
 
≥ 3.50:1.00
 
2.00
%
 
1.00
%
 
0.40
%
2
 
< 3.50:1.00 and ≥ 2.75:1.00
 
1.75
%
 
0.75
%
 
0.35
%
3
 
< 2.75:1.00 and ≥ 1.75:1.00
 
1.50
%
 
0.50
%
 
0.30
%
4
 
< 1.75:1.00 and ≥ 1.00:1.00
 
1.25
%
 
0.25
%
 
0.25
%
5
 
< 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 June 29, 2021 . Principal payments on the senior term notes are due in the amount of $5.5 million on June 30, 2017 , $11.0 million due each calendar quarter from September 30, 2017 to and including June 30, 2019 , $16.5 million due each calendar quarter from September 30, 2019 to and including June 30, 2020 and $22.0 million due each calendar quarter thereafter with a final payment of the outstanding principal balance due upon maturity.
 
The revolving credit facility has a per annum commitment fee determined by reference to the Leverage Ratio in effect from time to time and is applied to the unused portion of the commitment. The revolving credit facility matures on June 29, 2021 . Principal payments on the revolving credit facility are made at our discretion with the entire unpaid amount due at maturity. At March 31, 2017 , we had borrowings of $445.0 million under our revolving credit facility.

The following table sets forth the scheduled principal payments for our senior credit facility (in thousands):
 
 
2017
 
2018
 
2019
 
2020
 
2021
 
Thereafter
Senior term notes
 
$
27,500

 
$
44,000

 
$
55,000

 
$
77,000

 
$
660,000

 
$

Revolving loans
 

 

 

 

 
445,000

 

 
 
$
27,500

 
$
44,000

 
$
55,000

 
$
77,000

 
$
1,105,000

 
$


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.

Debt Covenants. The New Senior Credit Facility contains certain financial covenants pertaining to interest coverage and leverage ratios. In addition, the New Senior Credit Facility has restrictions pertaining to the payment of cash dividends on all classes of stock. At March 31, 2017 , we had a interest coverage ratio of 15.45 to 1.00, which was in compliance with the required ratio of no less than 3.00 to 1.00, and a leverage ratio of 2.65 to 1.00, which was in compliance with the required ratio of no more than 3.75 to 1.00.
7.
Fair Value

Current fair value accounting guidance includes a hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques that are used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs





13


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(Unaudited)

7.
Fair Value, continued

reflect a reporting entity’s pricing based upon their own market assumptions. The current guidance establishes a three-tiered fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:

Level 1.     Observable inputs such as quoted prices in active markets;

Level 2.     Inputs, other than quoted prices, that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active; and

Level 3.     Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

Non-Recurring Financial Measurements

Non-financial assets such as property, plant and equipment, land, goodwill and intangible assets are 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 March 31, 2017 , there were no changes to our non-recurring 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 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 March 31, 2017 and December 31, 2016 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 March 31,
 
As of December 31,
 
 
2017
 
2016
 
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
Variable-rate long-term debt
 
$
1,308,500

 
$
1,308,500

 
$
1,269,000

 
$
1,269,000












14


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(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
March 31,
 
2017
 
2016
Net income attributable to VCA Inc.
$
51,093

 
$
46,227

Weighted-average common shares outstanding:
 
 
 
Basic
81,245

 
80,776

Effect of dilutive potential common shares:
 
 
 
Stock options
360

 
284

Non-vested shares and units
574

 
463

Diluted
82,179

 
81,523

Basic earnings per common share
$
0.63

 
$
0.57

Diluted earnings per common share
$
0.62

 
$
0.57

For the three months ended March 31, 2017 and 2016 , potential common shares of 72,225 and 40,193 , respectively, were excluded from the computation of diluted earnings per share.
In March 2016, the FASB issued ASU 2016-09, “ Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, ”, requiring all tax benefits and tax deficiencies be recognized as income tax
expense or benefit in the income statement. Since excess tax benefits are no longer recognized in additional paid-in capital, we amended our calculation of earnings per share to exclude the excess tax benefits that would be included in additional paid-in capital under the treasury stock method. We elected to adopt this standard prospectively effective January 1, 2017. The adoption of this standard did not have a material impact on the weighted average number of diluted shares outstanding during the period.





15


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(Unaudited)

9.
Lines of Business

Our Animal Hospital and Laboratory business segments are each considered reportable segments in accordance with the FASB's guidance related to Segment Reporting. 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 the “All Other” category 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 Camp Bow Wow business, which primarily franchises a premier provider of pet services including dog day care, overnight boarding, grooming and other ancillary services at specially designed pet care facilities. 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 each of our segments.
The accounting policies of our segments are the same as those described in the summary of significant accounting policies included in our 2016 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)
March 31, 2017
(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
March 31, 2017
 
 
 
 
 
 
 
 
 
 
 
External revenue
$
568,181

 
$
90,549

 
$
18,639

 
$

 
$
882

 
$
678,251

Intercompany revenue

 
20,599

 
3,930

 

 
(24,529
)
 

Total revenue
568,181

 
111,148

 
22,569

 

 
(23,647
)
 
678,251

Direct costs
481,871

 
51,555

 
13,883

 

 
(23,526
)
 
523,783

Gross profit
86,310

 
59,593

 
8,686

 

 
(121
)
 
154,468

Selling, general and administrative expense
17,611

 
9,906

 
6,640

 
24,244

 

 
58,401

Operating income (loss) before sale or disposal of assets
68,699

 
49,687

 
2,046

 
(24,244
)
 
(121
)
 
96,067

Net loss on sale or disposal of assets
211

 
38

 
1

 

 

 
250

Operating income (loss)
$
68,488

 
$
49,649

 
$
2,045

 
$
(24,244
)
 
$
(121
)
 
$
95,817

Depreciation and amortization
$
26,658

 
$
2,908

 
$
829

 
$
692

 
$
(686
)
 
$
30,401

Property and equipment additions
$
19,603

 
$
7,640

 
$
1,118

 
$
1,621

 
$
(1,063
)
 
$
28,919

Three Months Ended
March 31, 2016
 
 
 
 
 
 
 
 
 
 
 
External revenue
$
458,623

 
$
89,240

 
$
14,454

 
$

 
$
1,122

 
$
563,439

Intercompany revenue

 
17,487

 
4,959

 

 
(22,446
)
 

Total revenue
458,623

 
106,727

 
19,413

 

 
(21,324
)
 
563,439

Direct costs
385,206

 
50,011

 
12,503

 

 
(21,061
)
 
426,659

Gross profit
73,417

 
56,716

 
6,910

 

 
(263
)
 
136,780

Selling, general and administrative expense
12,085

 
10,296

 
5,299

 
22,448

 

 
50,128

Operating income (loss) before sale or disposal of assets
61,332

 
46,420

 
1,611

 
(22,448
)
 
(263
)
 
86,652

Net loss (gain) on sale or disposal of assets
575

 

 

 
(12
)
 

 
563

Operating income (loss)
$
60,757

 
$
46,420

 
$
1,611

 
$
(22,436
)
 
$
(263
)
 
$
86,089

Depreciation and amortization
$
17,573

 
$
2,781

 
$
883

 
$
638

 
$
(586
)
 
$
21,289

Property and equipment additions
$
18,544

 
$
4,652

 
$
607

 
$
2,851

 
$
(848
)
 
$
25,806

 
 
 
 
 
 
 
 
 
 
 
 
At March 31, 2017
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
3,229,297

 
$
344,355

 
$
74,078

 
$
1,587,845

 
$
(1,774,897
)
 
$
3,460,678

At December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
Total assets
$
3,137,177

 
$
331,484

 
$
74,752

 
$
1,502,150

 
$
(1,672,235
)
 
$
3,373,328





17


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(Unaudited)

10.
Commitments and Contingencies

We have certain commitments including operating leases, purchase agreements and acquisition agreements. These items are discussed in detail in our consolidated financial statements and notes thereto included in our 2016 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, whereby additional cash may be paid to former owners of acquired companies upon fulfillment of specified financial criteria as set forth in the respective agreements. The amount to be paid cannot be determined until the earn-out periods have expired. If the specified financial criteria are satisfied, we will be obligated to pay an additional $ 9.2 million .
In accordance with business combination accounting guidance, contingent consideration, such as earn-outs, are recognized as part of the consideration transferred on the acquisition date. A liability is initially recorded based upon its acquisition date fair value. The changes in fair value are recognized in earnings where applicable for each reporting period. The fair value is determined using a contractually stated formula using either a multiple of revenue or Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA"). The formulas used to determine the estimated fair value are Level 3 inputs. The changes in fair value were immaterial to our condensed, consolidated financial statements taken as a whole. We recorded $8.6 million and $ 9.2 million in earn-out liabilities as of March 31, 2017 and December 31, 2016 , respectively, which are included in other accrued liabilities in our condensed, consolidated balance sheets.

b.
Legal Proceedings

On May 29, 2013, a former veterinary assistant at one of our animal hospitals filed a purported class action lawsuit against us in the Superior Court of the State of California for the County of Los Angeles, titled Jorge Duran vs. VCA Animal Hospitals, Inc., et. al. The lawsuit seeks to assert claims on behalf of current and former veterinary assistants employed by us in California, and alleges, among other allegations, that we improperly failed to pay regular and overtime wages, improperly failed to provide proper meal and rest periods, and engaged in unfair business practices. The lawsuit seeks damages, statutory penalties, and other relief, including attorneys’ fees and costs. Plaintiff Duran moved to certify a meal period premium class, a rest period premium class and a class under California’s Business and Professions Code §§17200 et seq., on January 9, 2014. On May 7, 2014, we obtained partial summary judgment, dismissing four of eight claims of the complaint, including the claims for failure to pay regular and overtime wages. On June 24, 2015, the Court denied Plaintiff’s Motion. The plaintiff continues to have a Private Attorney Generals Act ("PAGA") claim. On or about January 10, 2017, VCA filed a motion to prevent Duran from pursuing his PAGA action. That motion is currently pending before the court. We intend to continue to vigorously defend against the remaining claim in this action. At this time, we are unable to estimate the reasonably possible loss or range of possible loss, but do not believe losses, if any, would have a material effect on our results of operations or financial position taken as a whole.
On July 16, 2014, two additional former veterinary assistants filed a purported class action lawsuit against VCA in the Superior Court of the State of California for the County of Los Angeles, titled La Kimba Bradsbery and Cheri Brakensiek vs. Vicar Operating, Inc., et. al. The lawsuit seeks to assert claims on behalf of current and former veterinary assistants, kennel assistants, and client service representatives employed by us in California, and alleges, among other allegations, that VCA improperly failed to pay regular and overtime wages, improperly failed to provide proper meal and rest periods, improperly failed to pay reporting time pay, improperly failed to reimburse for certain business-related expenses, and engaged in unfair business practices. The lawsuit seeks damages, statutory penalties, and other relief, including attorneys’ fees and costs. This lawsuit and the Duran case above are related and are before the same Judge. In September 2014, the court issued an order staying the La Kimba Bradsbery lawsuit. On or about August 23, 2016, the Court lifted the stay and discovery is proceeding. We intend to vigorously defend against the Bradsbery action. At this time, we are unable to estimate the reasonably possible loss or range of possible loss, but do not believe losses, if any, would have a material effect on our results of operations or financial position taken as a whole.
On March 12, 2014, an individual client who purchased goods and services from one of our animal hospitals filed a purported class action lawsuit against us in the United States District Court for the Northern District of California, titled Tony M. Graham vs. VCA Antech, Inc. and VCA Animal Hospitals, Inc. The lawsuit sought to assert claims on behalf of the plaintiff and other individuals who purchased similar goods and services from our animal hospitals and alleged, among other allegations,



18


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(Unaudited)

10.
Commitments and Contingencies, continued

that we improperly charged such individuals for “biohazard waste management” in connection with the services performed. The lawsuit sought compensatory and punitive damages in unspecified amounts, and other relief, including attorneys' fees and costs. VCA successfully had the venue transferred to the Southern District of California. Plaintiffs filed their motion for class certification on February 12, 2016. On May 16, 2016, VCA filed its opposition to plaintiffs’ motion for class certification. On June 10, 2016, VCA filed a motion for summary judgment as to all of plaintiffs’ individual claims. The Honorable Christina Snyder issued her decision on September 12, 2016, granting Defendants’ summary judgment motion and denying Plaintiffs' motion for class certification as moot. On October 13, 2016, Defendants filed a Notice to Appeal. We intend to continue to vigorously defend this action. At this time, we are unable to estimate the reasonably possible loss or range of possible loss, but do not believe losses, if any, would have a material effect on our results of operations or financial position taken as a whole.
Following the announcement of the execution of the Merger Agreement, three putative stockholder class action complaints were filed in the United States District Court for the Central District of California relating to the proposed Merger with Mars: (1) Hight vs. VCA Inc., et al., Case No. 5:14-cv-00289, filed February 15, 2017, which named the Company, the Company’s Board of Directors, Mars, Merger Sub and Acquiror, as defendants, and which alleges, among other allegations, that (a) the consideration to be paid to the Company’s stockholders in connection with the proposed Merger is inadequate, (b) the Company’s Board of Directors and management have a conflict of interest due to continued employment and/or change in control payments, (c) the proposed Merger contains deal protection devices that preclude other bidders from making successful competing offers for the Company, and (d) the disclosures included in the proxy statement filed by the Company contain materially false or misleading statements or omissions; (2) Moran vs. VCA Inc., et al., Case No. 2:17-cv-01502, filed February 23, 2017, which named the Company and the Company’s Board of Directors as defendants, and which alleges, among other allegations, that the disclosures included in the proxy statement filed by the Company contain materially false or misleading statements or omissions; and (3) Krieger vs. VCA Inc., et al., Case No. 2:17-cv-01790, filed March 6, 2017, which named the Company and the Company’s Board of Directors as defendants, and which alleges, among other allegations, that the disclosures included in the proxy statement filed by the Company contain materially false or misleading statements or omissions. Each of the actions assert claims under Sections 14(a) and 20(a) of the Securities Exchange Act of 1934 and Rule 14a-9 promulgated thereunder.
The actions seek, among other things, (a) to enjoin the defendants from proceeding with the shareholder vote on the Merger or completing the Merger on the agreed upon terms, (b) rescission of the Merger or an award of rescissory damages, to the extent the proposed Merger has already been consummated, and (c) an award of plaintiff’s costs, including attorneys’ and experts’ fees, and other equitable relief as the court deems proper. 
  On March 6, 2017, the plaintiff in the Krieger action filed a motion for preliminary injunction seeking to enjoin the shareholder vote on the merger, which motion was withdrawn after the Company filed a supplement to the proxy statement on March 13, 2017 addressing the alleged disclosure claims in these actions, without admitting any liability or wrongdoing and specifically denying that any additional disclosures were required under applicable law. On March 28, 2017, our stockholders voted to approve the Merger. Subsequent to the filing of the supplement to the proxy statement and the stockholder vote, the plaintiffs in the actions agreed to file a stipulation of dismissal with prejudice, acknowledging that the claims arising from the Merger identified in their complaints have become moot. As the plaintiffs in actions assert that the prosecution of the actions caused VCA to file the supplemental proxy statement plaintiffs’ counsel may assert a claim for attorneys’ fees and expenses in connection with the common benefit provided to our stockholders as a result of the filing of the supplemental proxy statement, plaintiffs’ counsel intend to petition the court for such fees and expenses if their claims for fees cannot be resolved through negotiations. If and when the stipulation of dismissal is filed, the plaintiffs will voluntarily dismiss their complaints, with prejudice, and the actions shall be so dismissed. Until such time, the Company will continue to vigorously defend against all claims asserted.
In addition to the lawsuits described above, we are party to ordinary routine legal proceedings and claims incidental to our business, but we are not currently a party to any legal proceeding that we believe would have a material adverse effect on our financial position, results of operations, or cash flows.




19


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(Unaudited)

11.
Noncontrolling Interests
We own some of our animal hospitals in partnerships with noncontrolling interest holders. We consolidate our partnerships in our condensed, 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 statements of income. 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) in our condensed, consolidated balance sheets.

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, which approximates fair value, and classify them as liabilities due to the certainty of the related event. Estimated redemption value is determined using either a contractually stated formula or a discounted cash flow technique, both of which are used as an approximation of fair value. The discounted cash flow inputs used to determine the redemption value are Level 3 and include forecasted growth rates, valuation multiples, and the weighted average cost of capital. We recognize changes in the obligation as interest cost in our condensed, consolidated statements of income.

The following table provides a summary of mandatorily redeemable noncontrolling interests included in other liabilities in our condensed, consolidated balance sheets (in thousands):
 
Income
Statement
Impact
 
Mandatorily Redeemable
Noncontrolling
Interests
Balance as of December 31, 2015
 
 
$
8,588

Noncontrolling interest expense
$
365

 
 
Redemption value change
(116
)
 
249

Distributions to noncontrolling interest partners
 
 
(312
)
Currency translation adjustment
 
 
167

Balance as of March 31, 2016
 
 
$
8,692

 
 
 
 
Balance as of December 31, 2016
 
 
$
10,379

Noncontrolling interest expense
$
406

 
 
Redemption value change
(39
)
 
367

Distributions to noncontrolling interest partners
 
 
(270
)
Currency translation adjustment
 
 
21

Balance as of March 31, 2017
 
 
$
10,497




20


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(Unaudited)

11.
Noncontrolling Interests, continued

b.
Redeemable Noncontrolling Interests
We also enter into partnership agreements whereby the noncontrolling interest partner is issued certain “put” rights. These rights are normally exercisable at the sole discretion of the noncontrolling interest 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 in our condensed, consolidated statements of income.
The following table provides a summary of redeemable noncontrolling interests (in thousands):

 
Income
Statement
Impact
 
Redeemable
Noncontrolling
Interests
Balance as of December 31, 2015
 
 
$
11,511

Noncontrolling interest expense
$
387

 
 
Redemption value change
254

 
641

Distributions to noncontrolling interest partners
 
 
(365
)
Balance as of March 31, 2016
 
 
$
11,787

 
 
 
 
Balance as of December 31, 2016
 
 
$
11,615

Noncontrolling interest expense
$
369

 
 
Redemption value change
15

 
384

Purchase of noncontrolling interests
 
 
(1,210
)
Distributions to noncontrolling interest partners
 
 
(391
)
Balance as of March 31, 2017
 
 
$
10,398

 



21


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(Unaudited)

12.
Recent Accounting Pronouncements

In January 2017, the FASB issued Accounting Standards Update (ASU) 2017-04, “Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment,” to simplify how an entity is required to test goodwill for impairment. The Board has eliminated Step 2, where an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. An entity will no longer determine goodwill impairment by calculating the implied fair value of goodwill by assigning the fair value of a reporting unit to all of its assets and liabilities as if that reporting unit had been acquired in a business combination. Instead, an entity should perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, any loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. These amendments should reduce the cost and complexity of evaluating goodwill for impairment. The effective date and transition requirements of this ASU for public entities are effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. We do not expect the adoption of this standard to have a material impact on our consolidated financial statements.

In January 2017, the FASB issued ASU 2017-03, “ Accounting Changes and Error Corrections (Topic 250) and Investments-Equity Method and Joint Ventures (Topic 323): Amendments to SEC Paragraphs Pursuant to Staff Announcements at the September 22, 2016 and November 17, 2016 EITF Meetings  (SEC Update). ” The SEC Staff Announcement applies to ASU 2014- 09 , Revenue from Contracts with Customers (Topic 606) ; ASU 2016-02, Leases (Topic 842) ; and ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The effective dates and transition requirements of this Update are different for each Topic included. We are currently evaluating the impact of the adoption of this ASU on our consolidated financial statements.
    
In January 2017, the FASB issued ASU 2017-01, “ Business Combination (Topic 805) Clarifying the Definition of a Business, ” to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This clarification is needed since the definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The effective date and transition requirements of this ASU for public entities are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. We do not expect the adoption of this standard to have a material impact on our consolidated financial statements.
    
In December 2016, the FASB issued Accounting Standards Update ("ASU") 2016-20, “ Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers,” as part of the Board’s ongoing project on its agenda about Technical Corrections and Improvements to clarify the Codification or to correct unintended application of guidance. A separate Update for technical corrections and improvements to Topic 606 and other Topics amended by Update 2014-09 was issued to increase awareness of the proposals and to expedite improvements to Update 2014-09. This Update affects various areas of ASU 2014-09 including: Loan Guarantee Fees, Contract Costs-Impairment Testing, Contract Costs-Interaction of Impairment Testing with Guidance in Other Topics, Scope of Topic 606, Disclosure of Remaining Performance Obligations, Disclosure of Prior-Period Performance Obligations, Contract Modifications Example, Contract Asset versus Receivable, Refund Liability, and Advertising Costs. The effective date and transition requirements of this ASU for public entities would be the same as the effective date for ASU 2014-09 as amended by ASU 2015-04, which are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. We are currently evaluating the impact of the adoption of this ASU on our consolidated financial statements.

In December 2016, the FASB issued ASU 2016-19, “ Technical Corrections and Improvements ,” that affect a wide variety of Topics in the Accounting Standards Codification (ASC) including amendments to Subtopic 350-40, Intangibles-Goodwill and Other- Internal-Use Software, Subtopic 360-20, Property, Plant, and Equipment- Real Estate Sales, Topic 820, Fair Value Measurement, Subtopic 405-40, Liabilities-Obligations Resulting from Joint and Several Liability Arrangements, Subtopic 860-20, Transfers and Servicing-Sales of Financial Assets, Subtopic 860-50, Transfers and Servicing-Servicing Assets and Liabilities . The amendments in this Update represent changes to clarify, correct errors, or make minor improvements to the



22


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(Unaudited)

12.
Recent Accounting Pronouncements, continued

ASC, making it easier to understand and easier to apply by eliminating inconsistencies and providing clarifications. Most of the amendments in this Update do not require transition guidance and are effective upon issuance of this Update. For the six amendments mentioned above, early adoption is permitted. We are currently evaluating the impact of the adoption of this ASU on our consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18, “ Statement of Cash Flows (Topic 230): Restricted Cash ,” to address the diversity that exists on how entities classify and present changes in restricted cash or restricted cash equivalents on the statement of cash flows. Other than limited guidance for not-for-profit entities, current GAAP does not include specific guidance on the cash flow classification and presentation of changes in restricted cash or restricted cash equivalents. The amendments in this update now provide guidance on the presentation of restricted cash or restricted cash equivalents in the statement of cash flows. This ASU is effective for public entities for annual periods beginning after December 15, 2017, including interim periods within that reporting period, with early adoption permitted. The amendments should be applied using a retrospective transition method to each period presented. We do not believe that the adoption of this ASU will have a significant impact on our consolidated financial statements.

In October 2016, the FASB issued ASU 2016-16, “ Income Taxes (Topic 710) Intra-Entity Transfers of Assets Other Than Inventory, ” to improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. While current GAAP prohibits the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset has been sold to an outside party, this ASU requires the entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The amendments in this Update are part of the Board’s Simplification initiative and align the recognition of income tax consequences for intra-entity transfers of assets other than inventory with International Financial Reporting Standards (IFRS). The effective date and transition requirements of this ASU for public entities are effective for annual reporting periods beginning after December 15, 2017, including interim periods within those reporting periods, with early adoption permitted. The amendments should be applied using a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. We are currently evaluating the impact of the adoption of this ASU on our consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, “ Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, ” to provide guidance on eight specific cash flow issues where current GAAP is unclear or does not have specific guidance. The cash flow issues covered by this ASU are: 1) debt prepayment or debt extinguishment costs; 2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; 3) contingent consideration payments made after a business combination; 4) proceeds from the settlement of insurance claims; 5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; 6) distributions received from equity method investees; 7) beneficial interests in securitization transactions; and 8) separately identifiable cash flows and application of the predominance principle. The effective date and transition requirements of this ASU for public entities are effective for annual periods beginning after December 15, 2017, including interim periods within that reporting period, with early adoption permitted. The amendments should be applied using a retrospective transition method to each period presented. If it is impracticable to apply the amendments retrospectively for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date practicable. We are currently evaluating the impact of the adoption of this ASU on our consolidated financial statements, however, we do not believe that the adoption of this ASU will have a significant impact on our consolidated financial statements.

In May 2016, the FASB issued ASU 2016-12, “ Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, ” to improve the guidance on Topic 606 in assessing collectibility, presentation of sales taxes, noncash consideration, and completed contracts and contract modifications at transition. The effective date and transition requirements of this ASU are the same as ASU 2014-09. Since the effective date of ASU 2014-09 was deferred by ASU 2015-14 by one year, ASU 2014-09 and ASU 2016-10 are effective for annual periods beginning after December 15, 2017, including interim periods within that reporting period, with early adoption permitted only as of annual periods beginning after December 15, 2016, including interim periods within that reporting period. We are currently evaluating the impact of the adoption of this ASU on our consolidated financial statements.





23


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(Unaudited)

12.
Recent Accounting Pronouncements, continued

In April 2016, the FASB issued ASU 2016-10, “ Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, ” to clarify some issues on Topic 606 that arose on the identifying performance obligations and the licensing implementation guidance. The effective date and transition requirements of this ASU are the same as ASU 2014-09. Since the effective date of ASU 2014-09 was deferred by ASU 2015-14 by one year, ASU 2014-09 and ASU 2016-10 are effective for annual periods beginning after December 15, 2017, including interim periods within that reporting period, with early adoption permitted only as of annual periods beginning after December 15, 2016, including interim periods within that reporting period. We are currently evaluating the impact of the adoption of this ASU on our consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, “ Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,” as part of the Board’s Simplification Initiative. The Update requires that all excess tax benefits and tax deficiencies be recognized in the income statement as discrete tax items in the interim period in which they occur, clarifies that employee taxes paid when an employer withholds shares for tax purposes should be presented on the statement of cash flows as a financing activity, and changes the presentation of excess tax benefits on the statement of cash flows to be classified along with other income tax cash flows as an operating activity. It also provides for a policy election to either estimate the number of awards expected to vest or account for forfeitures when they occur. This new accounting guidance is effective for public companies for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. We adopted the applicable provisions of ASU 2016-09 effective January 1, 2017 as follows:

The amendment requiring excess tax benefits to be recorded in the income statement has been applied prospectively effective January 1, 2017. Amounts previously recorded to additional paid in capital related to windfall tax benefits prior to January 1, 2017 remain in equity, and the December 31, 2016 balance sheet has not been adjusted.
The amendment eliminating the requirement that excess tax benefits must be realized (through a reduction in income taxes payable) prior to recognition has been applied prospectively. As of January 1, 2017, we do not have unrecognized excess tax benefits.
The amendment requiring exclusion of excess tax benefits from the computation of assumed proceeds under the treasury stock method when calculating earnings per share has been applied prospectively effective January 1, 2017. Earnings per share for the prior quarter ended March 31, 2016 has not been adjusted.
The amendment requiring presentation of excess tax benefits to be classified along with other income tax cash flows as an operating activity on the statement of cash flows rather than as a financing activity has been applied prospectively effective January 1, 2017. The statement of cash flows for the prior quarter ended March 31, 2016 has not been adjusted.
We have elected not to change our policy to estimate the number of forfeitures expected to occur.

The adoption of this ASU did not have a significant impact on our consolidated financial statements.

In March 2016, the FASB issued ASU 2016-08, “ Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net). ” The amendments in this Update affect the guidance in Accounting Standards Update 2014-09 , "Revenue from Contracts with Customers (Topic 606)," which is not yet effective. The effective date and transition requirements for the amendments in this Update are the same as the effective date and transition requirements of Update 2014-09.
    
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842) Section A-Leases: Amendments to the FASB Accounting Standards Codification®; Section B-Conforming Amendments Related to Leases: Amendments to the FASB Accounting Standards Codification®; Section C-Background Information and Basis for Conclusions.” The amendments in this Update affect any entity that enters into a lease with some specified scope exemptions and supersedes Topic 840, Leases. The main difference between previous GAAP and Topic 842 is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP which did not require lease assets and lease liabilities to be recognized for most leases. The lease assets and lease liabilities arising from operating leases should be recognized in the statement of financial position. A lessee should recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. When measuring assets and liabilities arising from




24


VCA Inc. and Subsidiaries
Notes to Condensed, Consolidated Financial Statements (Continued)
March 31, 2017
(Unaudited)

12.
Recent Accounting Pronouncements, continued

a lease, a lessee (and a lessor) should include payments to be made in optional periods only if the lessee is reasonably certain to exercise an option to extend the lease or not to exercise an option to terminate the lease. The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. We have made progress toward completing our evaluation of potential changes from adopting the new standard on our leasing activities and continue to evaluate the impact of the adoption of this new guidance on our consolidated financial statements. We expect to have our evaluation completed by the end of 2017.

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” An entity should present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk if the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. For public business entities, this Update is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. We do not expect this adoption to have a significant impact on our consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers." This new standard will replace most existing revenue recognition guidance in U.S. GAAP. The core principle of the ASU is the recognition of revenue for the transfer of goods or services equal to the amount an entity expects to receive for those goods and services. This ASU requires additional disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and estimates and changes in those estimates. In August 2015, the FASB issued ASU 2015-14, " Revenue from Contracts with Customers: Deferral of the Effective Date" that delayed the effective date of ASU 2014-09 by one year to January 1, 2018, as the Company’s annual reporting period begins after December 15, 2017.
 
The Company has begun to analyze the impact of the new standard on its financial results based on an inventory of the Company’s current contracts with customers. The Company has obtained an understanding of the new standard and currently believes that it will retain much of the same accounting treatment as used to recognize revenue under current standards. Revenue on a significant portion of our contracts is currently recognized at the time the related services are rendered. Under the new standard the Company will continue to recognize revenue on these contracts using a similar approach as the performance obligations, transaction prices and related allocations are not expected to differ in comparison to the new standard.

In certain other cases we defer revenue related to multiple element arrangements. Based on the contracts currently in place, the Company does not anticipate a significant acceleration of revenue upon applying the new standard to its current contracts under these fact patterns.

The Company continues to evaluate the impact of ASU 2014-09 on our financial results and prepare for the adoption of the standard on January 1, 2018, including readying its internal processes and control environment for new requirements, particularly around enhanced disclosures, under the new standard. The standard allows for both retrospective and modified retrospective methods of adoption. The Company is in the process of determining the method of adoption it will elect and the impact on our consolidated financial statements and footnote disclosures, and will continue to provide enhanced disclosures as we continue our assessment.

13.    Subsequent Events

Subsequent to March 31, 2017, we acquired 7 hospitals for an estimated total consideration of $33.6 million , with acquired revenues of $17.4 million ; the total consideration includes $4.3 million for the purchase of real property in connection with two of the acquisitions.




25


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

 
Page
 
 
 
 
 
 
 
 
 
 
 
 




26


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 incorrect. 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 May 9, 2017 , 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 May 9, 2017 at our website at http://investor.vca.com or at the SEC’s website at www.sec.gov .
We are a leading North American animal healthcare company. We provide veterinary services and diagnostic testing services to support veterinary care and we sell diagnostic imaging equipment and other medical technology products and related services to veterinarians. We also franchise a premier provider of pet services including dog day care, overnight boarding, grooming and other ancillary services at specially designed pet care facilities.
Our reportable segments are as follows:  
Our Animal Hospital segment operates the largest network of freestanding, full-service animal hospitals in the nation. 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 March 31, 2017 , our animal hospital network consisted of 810 animal hospitals in 43 states and in five 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 March 31, 2017 , our laboratory network consisted of 61 laboratories serving all 50 states and certain areas in Canada.
For the three months ended March 31, 2017 , our “All Other” category includes the results of our Medical Technology and Camp Bow Wow operating segments. Each of these segments did not meet the materiality thresholds to be considered reportable segments.
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.




27


Use of Supplemental Non-GAAP Financial Measures

In this management's discussion and analysis, we use supplemental measures of our performance, which are derived from our consolidated financial information, but which are not presented in our consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). These financial measures, which are considered “Non-GAAP financial measures” under SEC rules, include our Non-GAAP gross profit and our Non-GAAP gross margin on a consolidated basis for our Animal Hospital segment, and the same measures expressed on a same-store basis. Additionally, our Non-GAAP financial measures also include our Non-GAAP SG&A, our Non-GAAP operating income and Non-GAAP operating margin on a consolidated basis. Lastly, our Non-GAAP financial measures also include our Non-GAAP consolidated interest expense, Non-GAAP consolidated net income and Non-GAAP diluted earnings per share. See Consolidated Results of Operations - Non-GAAP Financial Measures below for information about our use of these Non-GAAP financial measures, including our reasons for including the measures, material limitations with respect to the usefulness of the measures, and a reconciliation of each Non-GAAP financial measure to the most directly comparable GAAP financial measure.
Executive Overview
During the three months ended March 31, 2017 , we experienced increases in consolidated revenue, gross profit and operating income. The increases were primarily driven by revenue from our acquisitions and organic growth in our Animal Hospital and Laboratory segments. Our Animal Hospital same-store revenue increased 3.7% for the three months ended March 31, 2017 , as compared to the same period in the prior year. Our Laboratory internal revenue increased 5.5% for the three months ended March 31, 2017 as compared to the same period in the prior year. Our consolidated operating income increased 11.3% for the three months ended March 31, 2017 , as compared to the same period in the prior year. Our consolidated operating margin decreased by 120 basis points to 14.1% for the three months ended March 31, 2017 , as compared to the same period in the prior year. Our Non-GAAP consolidated operating income, which excludes the impact of intangible asset amortization associated with acquisitions, transaction costs and other discrete items, increased 16.2% for the three months ended March 31, 2017 , as compared to the same period in the prior year. Our Non-GAAP consolidated operating margin decreased by 60 basis points for the three months ended March 31, 2017 , as compared to the same period in the prior year. The increase in Non-GAAP consolidated operating income was primarily due to improved results from our Animal Hospital and Laboratory business segments.
Recent Developments
On January 7, 2017, we entered into the Merger Agreement with MMI Holdings, Inc. (“Acquiror”), Venice Merger Sub Inc., a wholly owned subsidiary of Acquiror ("Merger Sub"), and, solely for purposes of Section 9.15 of the Merger Agreement, Mars, Incorporated (“Mars”), pursuant to which, among other things, at the closing of the merger, we will become a wholly-owned subsidiary of Acquiror. The Merger is subject to satisfaction of a number of customary closing conditions contained in the Merger Agreement, including the receipt of the outstanding required regulatory approvals. The Merger Agreement and the Merger are described in greater detail in the Company’s definitive proxy statement for the special meeting filed on February 15, 2017 with the SEC, and other materials and documents filed with the SEC, all of which are available on the SEC’s website at www.sec.gov. The foregoing description of the Merger Agreement is qualified in its entirety by reference to the full text of the Merger Agreement attached as Exhibit 2.1 to the Current Report on Form 8-K filed with the SEC on January 9, 2017.
Share Repurchase Program
In April 2013, our Board of Directors authorized a share repurchase for up to $125 million of our common shares, which was completed in August 2014. In August 2014, our Board of Directors authorized the continuance of that share repurchase program, authorizing us to repurchase up to an additional $400 million of our common shares.  These repurchases may be made from time to time in open market transactions, pursuant to trading plans established in accordance with SEC rules, through privately negotiated transactions, block trades or accelerated share repurchases.  The timing and number of shares repurchased will depend on a variety of factors, including price, capital availability, legal requirements and economic and market conditions. As of March 31, 2017 , we had repurchased $298.9 million of our common shares pursuant to our current share repurchase program. Accordingly, $101.1 million remains available for future repurchases. The Company is not obligated to purchase any shares under the repurchase program, and repurchases may be suspended or discontinued at any time without prior notice.  During the three months ended March 31, 2017 , no share repurchases were made since we elected to deploy our capital to fund acquisitions. Our share repurchase program has no expiration date. The repurchases have been and will continue to be funded by existing cash balances and by our revolving credit facility. The Merger Agreement limits our ability to repurchase shares of our Common Stock, subject to certain exceptions, and the share repurchases under the share repurchase program will not



28


continue so long as the Merger Agreement is in effect and has not been terminated. Refer to Item 2. Unregistered Sales of Equity Securities and the Use of Proceeds in Part II of this report.
Acquisitions
Our annual growth strategy includes the acquisition of independent animal hospitals. We also evaluate the acquisition of animal hospital chains, laboratories and related businesses if favorable opportunities are presented. For the three months ended March 31, 2017 , we acquired $54.4 million of annualized Animal Hospital revenue.
The following table summarizes the changes in the number of facilities operated by our Animal Hospital and Laboratory segments during the three months ended March 31, 2017 and 2016 , respectively:

 
Three Months Ended
March 31,
 
2017
 
2016
Animal Hospitals:
 
 
 
Beginning of period
795

 
682

Acquisitions
15

 
24

Acquisitions, merged

 
(1
)
Sold, closed or merged

 
(2
)
End of period
810

 
703

 
 
 
 
Laboratories:
 
 
 
Beginning of period
61

 
60

Acquisitions

 

Acquisitions, merged

 

End of period
61

 
60


Critical Accounting Policies
Our condensed, consolidated financial statements have been prepared in accordance with 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 condensed, consolidated financial statements. A discussion of such critical accounting policies, which include revenue recognition, goodwill, other intangible assets, and income taxes, can be found in our 2016 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 March 31, 2017 .

Recent Accounting Pronouncements Adopted

In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-09, “ Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,” as part of the Board’s Simplification Initiative. The Update requires that all excess tax benefits and tax deficiencies be recognized in the income statement as discrete tax items in the interim period in which they occur, clarifies that employee taxes paid when an employer withholds shares for tax purposes should be presented on the statement of cash flows as a financing activity, and changes the presentation of excess tax benefits on the statement of cash flows to be classified along with other income tax cash flows as an operating activity. It also provides for a policy election to either estimate the number of awards expected to vest or account for forfeitures when they occur. This new accounting guidance is effective for public companies for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. We adopted the applicable provisions of ASU 2016-09 effective January 1, 2017 as follows:
The amendment requiring excess tax benefits to be recorded in the income statement has been applied prospectively effective January 1, 2017. Amounts previously recorded to additional paid in capital related to windfall tax benefits prior to January 1, 2017 remain in equity, and the December 31, 2016 balance sheet has not been adjusted.



29


The amendment eliminating the requirement that excess tax benefits must be realized (through a reduction in income taxes payable) prior to recognition has been applied prospectively. As of January 1, 2017, we do not have unrecognized excess tax benefits.
The amendment requiring exclusion of excess tax benefits from the computation of assumed proceeds under the treasury stock method when calculating earnings per share has been applied prospectively effective January 1, 2017. Earnings per share for the prior quarter ended March 31, 2016 has not been adjusted.
The amendment requiring presentation of excess tax benefits to be classified along with other income tax cash flows as an operating activity on the statement of cash flows rather than as a financing activity has been applied prospectively effective January 1, 2017. The statement of cash flows for the prior quarter ended March 31, 2016 has not been adjusted.
We have elected not to change our policy to estimate the number of forfeitures expected to occur.
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
March 31,
 
2017
 
2016
Revenue:
 
 
 
Animal Hospital
83.8
 %
 
81.4
 %
Laboratory
16.4

 
18.9

All Other
3.3

 
3.5

Intercompany
(3.5
)
 
(3.8
)
Total revenue
100.0

 
100.0

Direct costs
77.2

 
75.7

Gross profit
22.8

 
24.3

Selling, general and administrative expense
8.6

 
8.9

Net loss on sale or disposal of assets
0.1

 
0.1

Operating income
14.1

 
15.3

Interest expense, net
1.3

 
1.2