VCA Inc at Piper Jaffray Healthcare Conference

Dec 02, 2015 AM EST
WOOF - VCA Inc
VCA Inc at Piper Jaffray Healthcare Conference
Dec 02, 2015 / 03:00PM GMT 

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Corporate Participants
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   *  Tom Fuller
      VCA Inc. - CFO and VP

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Conference Call Participants
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   *  Kevin Ellich
      Piper Jaffray & Co. - Analyst

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Presentation
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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [1]
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 Thank you all for joining us. This is the 10 AM presentation with VCA Inc., ticker WOOF. Tom Fuller, the Company's Vice President and Chief Financial Officer, is with us. There is a box over on the table to our left that has all of the WOOF hats, which they typically graciously bring to the conference, so please help yourself. I've got about half a dozen myself. So, with that, I will get into the fireside panel. If you guys have questions, feel free to jump in, but with that I'm going to hand it over to Tom to give him a quick overview of what's transpired for VCA this year.

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 Tom Fuller,  VCA Inc. - CFO and VP   [2]
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 Thank you. Thanks for having -- I am actually late because I was talking to Mike Cox, who I didn't realize was his boss. I have known Mike since he was a young banker pup traveling around with this guy, I think, through Edinburgh.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [3]
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 That's right.

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 Tom Fuller,  VCA Inc. - CFO and VP   [4]
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 Really, really love Piper Jaffray; do a great job and love Mike and love Kevin.

 It's interesting; I think the question of the day I have been getting a lot lately is why are you guys doing so well? And I think the follow-up to that, which is always you want to ask is, is it sustainable? And I think the quick, succinct answer to that is we are in an amazing industry, which is benefiting everybody in our industry, actually.

 Those I am sure that have pets know firsthand that we spend money on our pets. So, after a tough four or five years with a tough economy -- although amazing to me for the three years into 2011, our three-year comps were down a total of 6.5%, which I would maintain, given the discretionary consumer for what we do, is amazing.

 But now the consumer is getting better, the economy is getting better. Veterinarians are feeling better, doing more medicine. We're really seeing that natural demand that's been there forever come forward again in an environment where we do more. There is specializations exploding in medicine. All the -ologists you see in human medicine, you see in veterinary medicine: dermatology, oncology, radiology.

 Diagnostics is huge. Consumers, we're all -- when we are sick, doctor draws blood; makes sense for your pet. We go for surgery, draws blood; makes sense for your pet. So, I think as the consumer gets better, all this industry are seeing strength and the comps are improving, getting margin expansion.

 Laboratory, which -- I see [Dr. Marr] from the back, who actually runs our lab on the East Coast -- is exploding. Just because it is fundamental to how doctors practice more medicine in a time when we do more medicine through specialization and more knowledge and awareness.

 So, I'd like to think a lot of the things we're doing from client service and wellness plans and better communication through apps, bonding with our clients, appointment reminders is driving a lot of our success. I think in the future it will continue and even more so, but a lot of it is we're just in an amazing industry with a lot of natural growth.

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Questions and Answers
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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [1]
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 That make sense. Thanks, Tom. As for your comment about the comps, they have accelerated nicely, 6% to 7%, seeing some good volume growth and order growth. Where do you think that's going to normalize? Can comps actually accelerate to high single-digits, even double digits, do you think? Or are we at that peak?

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 Tom Fuller,  VCA Inc. - CFO and VP   [2]
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 Yes, think in the hospitals it is probably doable, but my guess is, if it stays in the 4% to 6% range that is probably more realistic. Price and increasing -- where I have seen increasing volumes now, positive volumes. Price is actually not just pure price per procedure; it is really intensity and mix. It is just doing an extra lab test per day, per hospital. As, again, as the consumer is getting stronger. Veterinarians who -- I hate saying this, but they are ostensibly salesman. They don't think of themselves as salesman. I would never call them a salesman, but they are unfortunately put in a position to be salesman.

 We are fee for service, which those of you who do healthcare you hate about healthcare reimbursement contracting. We don't see that. We are fee-for-service. 95% of our revenue comes at point of -- at time of service. That's the good news. The bad news is the doctors are put in a position to deal with client resistance. And so the consumer is getting better. They are getting less of it. They are slowly doing more medicine.

 So, I think 4% to 6% is probably not unrealistic. Lab continues to be a faster growing segment of veterinary as it becomes more medical intensive, and diagnostics is the leading edge of that. So, I think short term, 5% to 6%, 7% is not unreasonable. Longer-term it could be a little higher than that.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [3]
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 And are vets ordering more tests because they need to? because the tests are available? What is really driving the --?

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 Tom Fuller,  VCA Inc. - CFO and VP   [4]
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 Yes, I think it is a little of both. I think it's as much -- it's a good question. A lot of times you get the questions on price fatigue. At some point do the clients say enough testing? My dog got tested already, no more testing. It is not about more testing per client. It is really about more clients getting tested. There is still a lot, a lot of pets -- a lot, a lot of vets who don't do as much testing. If you graph how much testing vets do, you get a bell curve of some doctors are just phenomenal testing. Maybe a younger vet. Kids coming out of school now are much highly trained when they were 20 years ago.

 Typically, doctors in a large practice do more laboratory testing than sole practitioners. There is a trend in the industry that the one-man shop is going away. Kids coming out of school don't want to work retail-type hours, so they are joining -- particularly women now. Profession is usually dominated by women. They want more lifestyle choices and hours. Not just at your business; I mean working groups, you tend to do a higher level of work, so they tend to do more lab testing. So, I think it's really the growth comes from further penetration, as opposed to more tests per pet.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [5]
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 Got it. And then we have seen a nice improvement in your hospital margins. You guys have done a nice job of expanding margins. I guess how much more (multiple speakers)?

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 Tom Fuller,  VCA Inc. - CFO and VP   [6]
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 Until last quarter.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [7]
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 Right, until last quarter. But a head, we hit a ceiling. Or, how much more expansion could we see? And what are the main drivers?

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 Tom Fuller,  VCA Inc. - CFO and VP   [8]
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 I think the hospital -- the lab business is phenomenal. Fixed costs; think of our margin business. So, last quarter over 200 basis points on the 6% growth, which is probably not sustainable. Mid-hundreds is probably a more realistic target, which is still awesome.

 Hospital business is lesser so, but still a fairly high fixed cost, high incremental margin business. You can actually see the margins in the hospital, but if you look sequentially -- the business is a bit seasonal, so Q2 and Q3, purely based on weather -- daylight, parasites, less snow -- are busier than Q4 and Q1. The margins go up pretty dramatically in Q2 compared to Q1, so you can see the margin potential.

 Historically, on 4% to 5% gross margins we have anywhere from 30, 40, 50 basis points improvement. Last quarter a little bit of weakness; margins were actually down 40 basis points on 5.4% growth, I think. Which I think much of that is just the portfolio affect of 600 hospitals with revenue growth that's all over the place and margins up, down, all over the place. Which tend to average out; sometimes if you get a couple of stinkers, it goes against you. A little bit of that going on.

 Cost variances, which normally net out. We did have a couple unusual cost or maybe we got ahead of ourselves on some spending. Our labor hours were a little bit high in the hospitals, which we can ratchet back. Some marketing programs, which we can ratchet back a little bit. So, I think if the growth rates continue -- which, again, given the macro appears that they could -- the margins could expand anywhere from 40, 50 basis points on 4% to 6% growth.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [9]
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 Is that the target for the Company, 40 to 50 basis points (multiple speakers)?

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 Tom Fuller,  VCA Inc. - CFO and VP   [10]
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 Yes, it could be higher. Again, on a unit economics of one store, four-wall basis, in theory it could be a lot higher than that. But if you average all the margins together with the portfolio I think somewhere in that range is probably not unreasonable.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [11]
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 And now have you put all of your hospitals on the same system, so you can monitor the cost (multiple speakers)?

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 Tom Fuller,  VCA Inc. - CFO and VP   [12]
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 Yes, they have always been. We do all the accounting, all the revenue is all centralized.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [13]
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 Got it. Great. And then you made a comment about specialization exploding in vet medicine. We are clearly seeing a lot of new companies come to market, trying to come up with innovative therapeutics. Wondering what sort of effect that could have on your business. And is VCA -- are you guys embracing the new products that could be coming to market?

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 Tom Fuller,  VCA Inc. - CFO and VP   [14]
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 Absolutely. So, any of which, though -- again, everything is cumulative and probably small in and of itself -- but cumulatively maybe they will add a little here and there. Whether it is pharma bringing new drugs into the channel. For many years, we saw pressure on our -- this is not quite the answer you're looking for -- I will get there in a second. But even in the flea products, which went from veterinary exclusive to over-the-counter, lost some traffic for that, and then the vet [pharma] comes in and has a new -- product which drives traffic back.

 Specialization; everything from CTs to MRIs to -- we have a couple of CyberKnifes in the Company. Advanced diagnostics, advanced treatments in our largest specialty hospitals, which 95% of our revenue in our specialty hospitals come from non-VCA referrals. So they get the vast, vast [majority] of the revenue comes from non-VCA hospitals. And those are cutting-edge hospitals with cutting-edge technology. Which, again, will grow, but is -- will grow revenue as well as just more utilization of existing technologies.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [15]
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 And what -- have you had conversations with some of these new companies? They have mentioned to me that they have had meetings with (multiple speakers)?

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 Tom Fuller,  VCA Inc. - CFO and VP   [16]
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 Yes, I am sure there are in my Company, but I'm not (multiple speakers) with any of them.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [17]
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 Sure. Let's switch over into the competitive landscape. You guys have continued to do acquisitions, maybe a little bit more discipline with your capital allocation. Wondering what your thoughts are on the M&A environment. Recently I think BluePearl was sold to Banfield?

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 Tom Fuller,  VCA Inc. - CFO and VP   [18]
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 Right.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [19]
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 Was that an asset you were interested in?

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 Tom Fuller,  VCA Inc. - CFO and VP   [20]
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 Yes. So, you mentioned discipline on price. I think our latest evolution thinking's maybe we have been too disciplined on price. Since we pioneered the space and historically paid 5 times EBITDA, and then it got more competitive with private equity entering the space, a lot of little start-ups entering the space. During the recession, the supply of hospitals for sale was a little less robust than it had been previously. I think due to, A, doctors feeling poor. Their income was down, their assets were down. Retirement assets were down. Didn't feel comfortable retiring. They felt like they had to go to work and make a living; couldn't afford to retire.

 Here we are now with -- and maybe also thinking, realize they sell their practice on multiples of revenues, EBITDA, so they could get their revenue up to make a little more money. So, here we are now in a better macro, and doctors are -- and, frankly, they're all six, seven years older, and they're all baby boomer generation anyway. So, the supply of hospitals for sale is picking up. Very large hospitals; so as I mentioned there is a sub-consolidation going on in the industry with the one-man shop is going away, so the three-man unit, the four-man unit, the five-man unit, the 10-man practice are being -- seeing larger hospitals we are buying.

 That's the good news. The bad news, it's still very competitive. Private equity is very aggressive. Banfield bought BluePearl and NVA traded a couple of quarters ago to Ares at a very high multiple. So, having said that, we have tons of capital: $0.25 billion in free cash flow. And as I suggested you were being a little more -- I think our goal for the year -- beginning of year, was roughly $80 million to $90 million of acquired revenue. We did $42 million in Q3, $90 million for the first nine months. And so your outlook, how much you could buy is somewhat predicated on your assumptions on valuations. And moving up a little bit, you could buy a little more.

 So I think with the free cash flow we have, we're willing to pay. Particularly if you build -- having built a company and looking forward to building a company, there are hospitals if you don't buy you're going to look back five years from now and be -- kick yourself for not buying it. So, as Bob said on the call, within reason we will pay up for a good hospital. So, I think you can see the -- I think, given that the supply appears to be getting better, I think you could see us -- we mentioned on the call, the fourth quarter pipeline was very strong: $90 million for the first nine months. Q1 looks pretty good, so I think you could see the acquisition pace accelerate a little bit.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [21]
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 And when you say pay up, are you willing to -- are we talking 8, 9 times, or --?

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 Tom Fuller,  VCA Inc. - CFO and VP   [22]
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 No, I think 7, 8 is probably standard now. So, I'm not saying we have done it or would do it, but 8, 9, 10 times, if you had to, no. Again, if I have $0.25 billion of free cash flow, I can buy WOOF at 12 trailing, or buy a hospital at 10 times. It doesn't -- now, realize you can't play the arbitrage game forever. But we have the capital and, within reason, we will do it.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [23]
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 Are there any sizable assets left? I mean, clearly there's some private equity, and Banfield is (multiple speakers)?

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 Tom Fuller,  VCA Inc. - CFO and VP   [24]
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 There are. There are, but unfortunately those particular assets are much -- valuations are way higher and that would be a -- I am not saying we wouldn't do it, but it would be a much tougher analysis.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [25]
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 Sure. What about international? You have had good success in Canada. We are still -- are you still interested in maybe expanding overseas to Europe or maybe Australia/New Zealand?

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 Tom Fuller,  VCA Inc. - CFO and VP   [26]
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 Yes, I think there is opportunity. The vets consolidating as well as there is actually a public company in UK known as CVS, like the pharmacy here, CVS. There is one in Australia, which again, same situation, very high valuations. The market is still little more fragmented there; smaller hospitals, but it is getting -- it is consolidating as well. Bigger hospitals, so there is -- eventually there will be opportunity there. Particularly that, and then maybe with the lab as well.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [27]
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 We never talk about Latin America. Are there any chains down there?

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 Tom Fuller,  VCA Inc. - CFO and VP   [28]
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 Not to my knowledge. Brazil is a huge market, but doing business in Latin America can be tough sometimes, so I think it would be a ways off.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [29]
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 Okay. And then recently I believe you sold VetStreet to Henry Schein. Just wondering what the thought process was behind that, strategic reaction. You had VetStreet for, what, a couple of years?

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 Tom Fuller,  VCA Inc. - CFO and VP   [30]
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 Yes, a few years. A little bit of a distraction, a little bit frankly I think for the management team at VetStreet who do a pretty good job, very good job. So that be kind of, like, be free, set them free. Subsequent to our buying them, the space phenomenally competitive. IDEXX got very involved doing similar products. A lot of little startups came in. To this day, VetStreet's products are probably -- some of the things they do are actually still leading-edge and better than what the competition can do, but it's hard to get veterinarians to focus, use the different products, see the value. So when someone comes in with a little start-up dotcom or comes in with a freebie, it's easy to switch. So, very competitive.

 I think under Schein they will have obviously the support of their huge sales force. And Schein is the leading provider of IT for hospitals, so whether they marry the two, embed it, make it much more -- communicate better. I think they can run with it a lot further than we could, because they have access to the veterinarian and the IT system, so I think they will thrive under Schein. We still have a 20% ownership, which is our -- because we believe that they probably will grow faster with Schein and have value. But also the business is very -- the vet business is very small and collegial. And so, being partners with our largest distributor I think makes a lot of sense as well.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [31]
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 And speaking of distributors, just wondering if you could give us an update on the relationships with the distributors? Are they helping to push volume to your reference lab business now that they don't -- they are not partnered up with IDEXX?

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 Tom Fuller,  VCA Inc. - CFO and VP   [32]
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 Yes, and as Bob -- no one is expecting -- no one is expecting -- we aren't, anyway, -- gigantic share gains with the change in the landscape with distributors and IDEXX and now supporting us. But if we can do a better job holding share at a better price, that's a huge win. Or the way Bob says it, the win for us is having distributors sell with us, not against us. So instead of being at the door with blockades, now they're opening the door for us.

 But distributors sell a book of thousands of products. They have their interests, we have our interests; so keeping everyone aligned and focused on what we want them to sell versus what -- everything they have to sell, is always a challenge. But they are doing a great job. We can continue to work to do a better job, but thus far, been great. And we just need to continue to work at making it better, but thus far it has been very, very, very good.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [33]
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 And then what about the strategic partnership with Abaxis? How is that going and could we see further expansion in that? Or is it kind of tapped out at this point?

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 Tom Fuller,  VCA Inc. - CFO and VP   [34]
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 I think that, again, Abaxis, as to distributors, as does Antech, we have different priorities. We are selling different things, so getting everybody on the same page and marching together is always a challenge. But incrementally anything helps. I think we are more focused on working with distributors than we are with Abaxis at this point, but we're still getting leads and still have opportunities. Anybody -- I think all of us realize the three of us together are more powerful than individually. So, when we can work together, we do, and when it makes sense to do our own thing we do that.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [35]
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 And when you acquired their lab, AVRL, have you kept that open, or did you consolidate?

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 Tom Fuller,  VCA Inc. - CFO and VP   [36]
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 No, it was closed within a quarter. So, all of the work was routed. We already have a big lab near the FedEx center in Memphis. So rather than getting on a second plane, it just gets off in Memphis; do their work locally there.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [37]
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 Understood. I think I'm going to pause now to see if there is any questions in the audience. Anything? Okay, we will keep going. Just wondering, now, I think you implemented a new wellness programs at your vet clinics. Wondering how that is going, what the penetration is, how many hospitals actually are offering this wellness plan?

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 Tom Fuller,  VCA Inc. - CFO and VP   [38]
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 So, wellness, is -- from my perspective, it is really about changing -- building veterinary into your lifestyle and your budget. So, a wellness plan at VCA would be $30 to $50 to $60 a month on your credit card, automatic billing. And for that you get office calls, you get an annual. You get annual wellness tests, which includes an annual lab, wellness screening. Which, by the way, one of the drivers for lab is not -- that's just not VCA; most of the wellness plans in the industry include annual lab testing, so that's a driver for the lab.

 So, it's still very in start-up phase. You need to be in front of the client to sell it. Because clients only come in a couple of times a year, so it is going to take many, many years to get full penetration. Ultimately it should improve revenue, and everyone does it -- and we have seen bits and pieces of it. Improve revenue based on client retention; it reduces a certain amount of your client doesn't churn every year, because they renew.

 By breaking down that barrier of the office cost fee, it -- people come in more. A lot of our business -- and you see it seasonally -- a lot of our visits are, frankly -- I actually met with somebody I have known for years who has two kids now. She says, yes, I get it. A lot of our visits are worried mommies and daddies that the dog is sick, lethargic, and you run to the vet. If it is a (expletive) day, you don't, and they get better. Just like pediatricians, vets will say that a lot of illness will resolve itself. If not -- I'm a hypochondriac; I went to the doctor 10 times a year when I was a kid, so I get it.

 So, wellness erases that barrier, so you get more traffic. And then when they are there you get more diagnostics, you get (inaudible). So, it's a great program, but it's still very, very early and it's -- but all the things you would measure from here: do we sign people up? Yes. Is the average transaction as good, where the wellness visit is not wellness? Yes. We are just trying to get some renewals now. They are renewing, yes. Are you cannibalizing high-value clients? No. So, all the metrics we look at our all going in the right direction, but it will be quite a ways before we are fully there.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [39]
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 Do all 600 hospitals offer wellness?

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 Tom Fuller,  VCA Inc. - CFO and VP   [40]
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 No. The target would never be -- the specialty hospitals wouldn't have it, which is a fair amount of our hospitals. And plus those hospitals are growing at 10%, 20% in great markets that just are running on all cylinders. It wouldn't make sense. And that particular market may not -- is it differentiated where they want that? So, it will be a subset of our hospitals and a subset of the clients at those hospitals. It wouldn't be like a Banfield, with all wellness all the time.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [41]
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 Understood. What about pet insurance? Obviously different product than wellness. I don't think you guys have your own captive insurance, but are you seeing an increase, especially at the specialty hospitals for insurance?

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 Tom Fuller,  VCA Inc. - CFO and VP   [42]
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 Marginally. Pet insurance has been -- I mean, there's companies that have been doing it for 30 years, and it is a tough business. It is a low premium, low benefit, hard to sell, hard to commission it -- but we like it, we support it. We actually just changed relationships and now we support Trupanion, which went public last year. Trupanion was actually a good fit for us, particularly as we rolled out wellness, is because the wellness plans cover just wellness, not sick. Trupanion covers sick, not well.

 So, now, if you are in front of a client, once they buy the wellness you can then say, geez, if you want to now cover the sick stuff as well, you can buy insurance for that. So, we love it. The good news is I will never be in a position like the human healthcare where they're the gatekeeper on price or volume, so it is all additive. There is actually an article in the Vet Journal two months ago that doctors saying that, yes, clients that have insurance spend more. Which makes sense. So, we love it. But it is still a very, very small part of the business.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [43]
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 Got it. And then going back to -- one thing I forgot to ask with your comments on acquisitions and maybe getting a little bit more aggressive in terms of the valuations, will that change your ability to buy back stock? And can you give us an update as to where the share repurchase (multiple speakers)?

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 Tom Fuller,  VCA Inc. - CFO and VP   [44]
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 Again, and we have a lot of free cash flow, almost $0.25 billion. So whether we buy $80 million or $100 million or $120 million, there is still a lot of excess capital of that. Plus there is -- we are currently levered about 2 times EBITDA on debt, so there's also a couple -- not a couple, I shouldn't say it that way. There is also capital available on the balance sheet as well, which -- our focus is really just the free cash flow. I don't see leverage changing much, short-term. We like the flexibility to have a balance sheet that is -- could accommodate a larger acquisition, should something occur in the future. But, yes, with the $0.25 billion in free cash flow I think there is enough to do both.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [45]
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 Understood. What is your target leverage? You said you're about 2 times now?

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 Tom Fuller,  VCA Inc. - CFO and VP   [46]
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 Yes, 2 feels good. And, again, we like the flexibility, the optionality, is that the new word? Of having the ability to write a big check if we needed to for a large, platform-type acquisition. so I think you would see it probably stick around where it is.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [47]
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 Okay, great. One more poll for questions in the audience. And then my last question is, so you are in this amazing industry, people are spending more money on their pets, lifestyles have changed. What could derail this?

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 Tom Fuller,  VCA Inc. - CFO and VP   [48]
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 Economy. But, again, it is amazing to me, even when it was derailed, where a lot of retailers got demolished, we were down -- worst year was down 2%. Now, having said that, it is a fairly high fixed cost, incremental margins business, so those revenue variations would fall to the bottom line. But there is no disaster; it is just a little bit of weakness. But thus far things look very bright.

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 Kevin Ellich,  Piper Jaffray & Co. - Analyst   [49]
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 Great. Well, I think we will wrap it up then and thank you all for joining us and thanks to Tom.

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 Tom Fuller,  VCA Inc. - CFO and VP   [50]
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 [Where is a] pet? Yes.




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