VCA Inc at Credit Suisse Healthcare Conference

Nov 07, 2016 AM EST
WOOF - VCA Inc
VCA Inc at Credit Suisse Healthcare Conference
Nov 07, 2016 / 03:00PM GMT 

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

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Conference Call Participants
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   *  Erin Wilson
      Credit Suisse - Analyst

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Presentation
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 Erin Wilson,  Credit Suisse - Analyst   [1]
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 Good morning. Welcome to the 25th annual Credit Suisse conference. My name is Erin Wilson. I am the research analyst covering life science tools and diagnostics at Credit Suisse, with a unique focus also on animal health.

 We are happy to have VCA, the largest and leading provider of veterinary services and diagnostics here with us today. And with them, we have the Chief Financial Officer, Tom Fuller. And with that, I'll hand it over.

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 Tom Fuller,  VCA Inc. - CFO, VP and Secretary   [2]
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 Thank you, Erin. [Watch me] coming at you like Trump, we should all be basking in this great rally. It's exciting to have you all here. If anybody heckles -- you know if someone comes in and heckles me, what will do with them -- IDEXX or something, we'll take them out.

 It's really -- thank you Erin. Thank you, Bob, in the back. We do have the WOOF hats, and if you're lucky, you may catch Bob in a pink WOOF hat later today. Been great supporters.

 It's interesting -- this is the 25th year of this conference. And I think back, I think it was 15 years, actually, November of 2001, we -- the year began, I think, wrapped up a very successful road show for our second IPO after going public a year earlier, led by Credit Suisse -- CSFB back then, actually; CSFB and Goldman Sachs.

 And what's funny is I remember it was actually at the Biltmore in the hallway -- Bob and I were standing in the hall waiting to go in, and behind us this woman says, pet care, animal hospitals, who would invest in animal hospitals? And Bob turned around and said, well, I would, it's my Company. And he brought her into presentation, and her fund ended up being our largest shareholder for quite a while. Made a ton money, as we all did. I think the 15-year CAGR on WOOF after our $5 share. But adjust to that fuel price is in the high -- was actually almost 20% two weeks ago, but took a little bit out of that. So we are in the high teens.

 But it's interesting -- her comment is interesting, actually, because she was kind of right. It wasn't really an industry back then. It was sort of -- it wasn't really -- not much coverage. Not much focus on animal health. And with -- I think, Bob actually was -- came in after Peter at Credit Suisse and started following the Company.

 It really became an industry. We have distributors and we have lab companies. We have hospital companies. We have big pharma. Very involved in veterinary. So a lot of focus on the space and a lot of great coverage, including what Erin does at Credit Suisse. And so it's great to be here.

 So, this is our business. And I'm sure those of you who have a pet know firsthand how important pets are in our lives. The great thing about this slide is there's lots of data. People talk about birthday presents for pets and taking them on vacation, Christmas presents and singing happy birthday. And all the crazy things that are -- including sleeping with our pet.

 And I look at this slide -- while you're looking at me, I'm looking at you, and half of you are kind of, oh god, that's me. The other half of you are saying people sleep with their pets? That's disgusting. In fact, they do. Over half of households sleep with a pet. And fun little math for the conference -- and probably certainly not the most important thing you'll learn, but one of the coolest things you'll learn is if you take that 43% of pet owners are sleeping with a pet, and 65% of households own a pet. So a quarter of the people in this room sleep with a pet. So kind of a fun fact.

 That really is our business. And the question I get a lot lately, especially after coming out of the recession and having many great quarters, is why is your business doing so well. Because you're all forward-thinking the implied or explicit -- in that is it sustainable, which is obviously difficult to tell. But I can -- by looking at where we are in the industry, maybe I can shed some light on that.

 We are doing so well because we run a great business in a great market based on that human-animal bond, that love of pets. Based on a consumer where I think there's a lot of natural demand; within reason, you're going to spend money in your pet.

 Paired to the professional that continues to offer more capabilities and more medicine. So the consumer side, pet (inaudible) is growing. Erin does a lot of work on pet adoptions. They are growing again. We talk about the bonding, great demographics across all socioeconomic, demographic lines -- elderly, young kids. One of the fastest-growing, Millennials -- one of the fastest-growing segments is couples without children have a pet.

 And I heard recently there is supposed to be a correlation of getting engaged and getting a dog, and I think Erin might be one of those people. So it really does cut across.

 The more you are aware, the more you'll typically do. So we go in for -- if we are sick, the doctor draws blood; it makes sense for our pet. When we go in for surgery, the doctor draws blood; that makes sense for our pet. When you are my age, you go in for your annual lab screen; that makes sense for your pet.

 So we're all used to getting more medicine. And as the professional can just offer more med and increased specialization. Specialization is exploding in veterinary across all [arms] which we're a leader in actually. All of the [ologies] you see in human health care from radiology, dermatology, ophthalmology, oncology, cataract surgery, CJ/CL surgery is huge. (inaudible) itself grows, but because we are specialization makes the general practitioner, of which most doctors are, practice a much higher level of medicine.

 Of course pharma, very active in this space, (inaudible). And then technology and emerging markets. And telemedicine as we rolled out did (inaudible) across the industry.

 So a lot of new medicine, a lot of awareness on the professional side and with the consumer within reason wants to spend money. So as we come out of the recession, what we're seeing is those (inaudible) versus health care conference.

 So the things you hate about health care -- reimbursement, contracting -- that's not us. 97% of our revenue comes at the time of service. So it's a cash business, which is the good news. But that is a cash business. So our doctors are ostensibly salesmen. I would never call them that. Any doctor out listening out on the net -- the real term is patient advocate. So they're advocating for the patient to the client, provide the best quality of medicine.

 But there's resistance, obviously. You're paying out-of-pocket. And with the economy, more consumers were sort of flinching. Doctors walked in the room thinking the world is [expletive]. They see their friends unemployed, watch the news. They just weren't providing a higher level of medicine. So as they've seen the economy improve, the consumer improve, we're getting back to providing medicine, which grows revenue and obviously profitability.

 So, great industry built on a strong consumer. Doctors getting more confident. But just not the industry; it's also things that we are doing. Been investing a lot in people services. I'll talk about in a second, technology. So I think the combined of those two, we are a GDP-plus grower.

 There's a great graph, it's been around for years -- I think Erin has it in one of her reports -- showing consumer spending or in the economy pet spending, and then animal hospital -- or veterinary spending. The vet spending line is like a hockey stick well above the others. We obviously benefit from that. But I think we're doing a lot internally to help us either grow faster or do a better job weathering the flickers in the economic environment.

 So, we are in four business. VCA (inaudible) is the largest owner-operator of animal hospitals in the country. Antech Diagnostics is the largest veterinary reference lab in the country. Sound is a leading seller of digital radiology and ultrasound solutions to veterinary. And then very, very small at the bottom is Camp Bow Wow, which is a relatively recent addition. It's a leading franchisor of -- we don't call them kennels; we call them boarding and day care, I believe.

 So it's a fun little business, a lot of synergies with the hospitals. And a lot of passion and excitement by that management to help us and develop that side of our business.

 Great market, $35 billion. As I said, across all socioeconomic lines. I said over half the households in the country own a pet. Even in our franchise results, we're not going anywhere. We've been here for 30 years. Pets are part of our lives, and they are not going anywhere. So the future is very, very bright for us.

 In that market, the great thing about it -- very predictable business, very stable, repetitive revenues. No health care, all reimbursement -- the things you don't like, we don't have. And it continues to have a lot of opportunities to continue to consolidate the market through acquisitions. Very, very fragmented animal hospital market, which we started doing a little over 30 years ago, and we continue to buy hospitals.

 As I said, VCA Animal Hospitals is the largest animal hospital network in the country. In terms of investing people, we have the largest post-graduate training in the country with residency and internship programs. Specialty medicine and great (inaudible) technology set.

 The residency program is actually really important. Those future specialists -- we are training over 50 doctors per year in specialists, which go out into the veterinary community and become ambassadors for VCA. Maybe work for us.

 Internship programs, post-graduate, unlike human health care, where you are required -- your internship is voluntary in veterinary. We train almost 200 interns a year and then externship programs as well.

 We are also the leading provider of specialty medicine. Important to note on that: 95% of our revenue in our specialty hospitals come from non-VCA hospitals. So it's not a model of hub and spoke and capturing -- we like that, capturing term referrals, but that's a standalone business and very ingrained in the veterinary community, getting 95% of our clients from non-VCA hospital referrals.

 This is the part I'm excited about, actually, is we are all going mobile now. Our life revolves around our phone. There's some great things I think that -- over the next 10 years, 15 years, I think the whole profession coming through wellness plans, which you pay your annual monthly fee and you get your basic wellness services, and you get sort of calendar when you're going to do things. Really changing how we think about veterinary and building veterinary into your life and your lifestyle and your budget.

 Similarly, apps do the same thing. So things like online booking. It's going to get brought online whether you're a new client or existing client. Two-way texting is great. Any main hospital can -- it's fun stuff. It's taking a picture of your dog after a bath.

 I have four Chihuahuas, actually, and one of them is small -- that small, I guess. Even I go to the vet and the doctor comes up, oh, your dog is so cute. This is the best dog ever. I'm like, oh come on, man, you say that to all of your clients. But I buy it, I love it. Everyone wants to think they are special and their dog is the best dog in the world.

 People want to send pictures, send pictures out of surgery. Surgery went great, pick him up at 5 o'clock. So, much more efficient, and that's how we are used to communicating. And then appointment reminders obviously are terrific; as you remind automatically people the next day, the missed appointment rate goes down significantly and that drives --.

 So those are three examples of many things, all sitting on our proprietary WOOFware product information system platform. So, great data we can manipulate and communicate, bond with our clients.

 In addition to the internal set, we also grow through acquisitions, which you can see 145 year-to-date, we are on track to do over [$20 million] for the year. The environment is getting better. I think it's a function of the economy getting better. So doctors are selling in a better environment versus a slower environment. I think multiples are probably, from their perspective, at all time highs. Probably some tax selling. But very, very active; 2016 and 2017 looks pretty good. My guess is we'll guide next year to somewhere in the $120 million range. We typically guide low and beat it.

 Great thing is we internally fund all of our acquisitions with internally generated cash flow. We've done it for many, many years. Very sort of just plug-and-play, integrating into our existing networks.

 Just a quick five-year look back -- or four years and three quarters. You see margins recovering after deleveraging different -- after the recession. And then comps -- same-store growth is just picking up.

 Antech Diagnostics is the leading, largest veterinary referral lab in the country. Really it's a margin machine with a very expensive cost structure -- fixed cost structure; 60% incremental margin. Picking up samples in all 50 states and Canada and running them through a platform. So, picking up samples and running them through. So with those little triangles, most people think of it as capacity. It really allows us to do quick turnaround and delivery of results. So Boston, for example, pick up between 12 and 1 in the afternoon. Do the simple chemistries, hematologies locally and get the results back by 5 or 6 that afternoon. And pick up again at night and fly that down to New York and get the results out the next morning. So it allows us to compete with the (inaudible) capabilities at a much better quality, accuracy and, many times, same or lower price than doing the work in-house.

 All of our hospitals actually do in-clinic testing, so there's a place for both. But the reference lab continues to be a very important part of the practice for veterinarians.

 How did Antech grow? Again, it's part of that -- it's part of actually benefiting from -- it's also part driving that trend towards more medicine. Even things like wellness plans which we are adopting and doing more of, not just us but the industry, those typically include annual wellness tests. A lot of pharma products require annual lab testing. And again, as I said, the consumer is very aware of and used to getting lab testing. So it becomes ingrained in what we do.

 And then communicating better -- Antech Online allows doctors to do all their lab results on their handhelds, so they can practice anywhere they are. It's actually (inaudible) quickly here. That map actually, so you know -- education, knowledge is how we grow the business. So that map, for example, if you are in San Bernardino, which if you are it's too bad. It's not a great place. But that is by brightly blue shows incidence of parasites, or I think the many host of different things we can accumulate data for and get back to the doctors. So if you are a doctor practicing in a community, you see the positives for giardia is high. It makes sense to screen all your pets. So giving the doctors actionable information makes sense, helps grow that business and provides a higher quality of medicine in the hospital.

 Three, you can see that the great leverage on that. I think it's $23 million of revenue. 2013 goes to -- is that right, $26 million, whatever it is. $13 million goes to operating and about 60% incremental margin. And margin of that business growing nicely coming out of the lows in 2009 and 2010.

 So in summary, we had a terrific first quarter, over 5% comps in both hospital and lab on positive volumes. Adjusted operating margins in hospital up 30 basis points. Lab up 60 basis points. A little bit of pressure in the lab with one less business day. (inaudible) with health care. So not as robust as we would like to see, but I think still very, very strong.

 If there's one complaint with the quarter is it's follow two -- specifically two but actually probably six or seven, but two spectacular quarters. 32% increase in earnings in Q1 and 24% in Q2. So 16% -- which I think anyone of us would love our company growing at 5% comps and 16% EPS. It looked a little light in comparison to that, but it really is within our expectation. I think is our longer-term, what we can do is make probably 7% of that rate.

 So I think we had a very strong, positive quarter. Balance sheet is great. We generated about $225 million in free cash to fund acquisitions plus lot of liquidity on the revolver.

 So I'll end by looking forward. We are in a great market. I think the market is obviously improving, and things that we are doing within VCA, I think, will help us even more. Very stable revenue growth. Growth (inaudible) through acquisitions. As I said, the acquisition environment is getting better as more doctors are selling.

 There's an interesting trend going on in the profession, actually, where there's actually a sub-consolidation going on below us. So of those 20,000 hospitals, probably 3,000 want to buy the multi-doctor, larger facilities.

 Like a lot of professions, kids are not coming out of school and hanging out a shingle or buying as a sole practitioner. They are joining established group practices. And you could do that 30 years ago in a hospital space -- neuter, shots, and exams and not a lot of medicine. But now with the technology and the knowledge and clients' expectations of a nice medical-looking facility, they are joining group practices.

 So we are seeing practices get bigger and bigger and bigger. So that 3,000 hospitals is seeing more of them and in that population are actually getting bigger. So we'll be buying fewer but larger hospitals over the next 10 or 15 years.

 I think Erin has questions. There are some balls back there, too, by the way, if you have maybe a dog.

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Questions and Answers
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 Erin Wilson,  Credit Suisse - Analyst   [1]
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 Thanks, Tom. I guess you mentioned on the earnings call that you were seeing 5% growth in October. Can you give us an update on fundamental demand trends in the current quarter and the sustainability of sort of higher same-store sales across the hospital businesses (inaudible)?

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 Tom Fuller,  VCA Inc. - CFO, VP and Secretary   [2]
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 We don't -- post the quarter call, we don't comment on growth. But, again, we did see plus-5% -- which, don't read anything into that, but just our habit. We did see plus-5%. And I think everyone hasn't seen may -- other than the outlook in the stock market recently (inaudible) elections, hopefully tomorrow you'll all be in the mood to buy stocks again.

 I think that all the macro continues to look very, very good. So I don't really expect that change.

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 Erin Wilson,  Credit Suisse - Analyst   [3]
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 And one of the questions during the quarter was on the hospital margin trends. Can you outline some of those one-time factors, and kind of should we anticipate any of those factors impacting the fourth-quarter trend?

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 Tom Fuller,  VCA Inc. - CFO, VP and Secretary   [4]
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 I hate parsing out adjustments because it sounds like you're making excuses. But there were some things that did hit the quarter. So we did have -- we self-insured health care, for example, which you just kind of go along and have a trend and all of a sudden it just pops. It happened a couple of years ago actually. So we had a very rough quarter on self-insured health care this quarter. Which could happen again, but my guess is it comes back to trend. That hit margins by about 20 basis points.

 On the lab side we had one less -- one-half fewer business days, which hits margins a little bit. We opened a lab -- we converted a lab to full-service. That hit margins a little bit.

 So I think adjusted for all of that, the lab margins are close to or above 100%. The hospital margins are close to or above 50%, which is sort of what we've been saying -- 50 to 100 basis points margin -- or same-store gross profit in the hospitals and 100-plus basis points for lab operating margins.

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 Erin Wilson,  Credit Suisse - Analyst   [5]
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 And then --

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 Tom Fuller,  VCA Inc. - CFO, VP and Secretary   [6]
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 Will that happen again? It's hard to say. But things always come up. Then we also had -- one thing I'll point to is there is one -- I've been saying for a long time -- and Erin asked the question on the call about the 2% growth to hold margin, which I've been saying for a couple of years. And that is that, give or take you probably need something in the 2% range on hospital growth to hold margins.

 Because I'd always caveat that with there is sort of a -- I'd call it a portfolio effect of 600 hospitals with growth that's all over the board and margins all over the board which may or may not offset. I think Bob gave a great example about this quarter with a very large specialty hospital in Southern California that we moved. And that went from being profitable to have losses, and that swung margins by 10 or 20 basis points.

 Those things happen, or you invest in adding a couple of doctors at specialty hospitals, and you have some start-up costs associated with that. So probably not like what you guys do. You have a lot of stocks in the middle and three great ones and three not-so-great ones. And if one of the great ones goes to bad, you have a bad quarter, which is why we are all (inaudible) you guys' peer group by the minute now. But it's why we do our three-month, six-month, one year, five-year, 10-year -- to omit some of that fluctuation. We have a little bit of that too.

 So I think if the growth rates continue where they are, our margins flicker a little bit. But if we can get them in that 50 to 100 and 150 for the labs, then I think we'll be in good shape.

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Unidentified Audience Member   [7]
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 Tom, you do hear some of the health care providers talk about their vendor partners or distributors, that it's a competitive advantage that they are intertwined and that there's a real partnership there. What do you get with your vendor? What can you get from them? Or is it a contract that we could seek them out for bids at some point?

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 Tom Fuller,  VCA Inc. - CFO, VP and Secretary   [8]
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 That's a great question. There's two sides to that, actually, because we do view our vendors as partners. So our major shipper now is Schein. We monitor the pricing, and we are not constantly poking them for price. We do review it periodically to make sure we are being treated fair.

 We have good reconnaissance as we buy hospitals. Even including buying cat (inaudible) which has some scale. If you want to compare our prices and their pricing, we are always better. So we feel pretty good about our pricing.

 We are also -- because we are very close to our distributors, we are able to do a lot of work with them on kind of cross-selling, co-selling with Antech. And as that whole change in distribution and sales and our competitor, we are able to take advantage of that and work a little closer with our major distributors to place lab services.

 So it's a very, very positive environment. We are not constantly sticking it to them. We're very much partners, actually. But there's always opportunity to obviously improve.

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 Erin Wilson,  Credit Suisse - Analyst   [9]
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 A question?

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Unidentified Audience Member   [10]
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 Can you speak to -- you spoke briefly to the M&A environment and the pipeline and $120 million, I think, in 2017. I guess what's out there from a chain perspective versus standalone hospitals, and what are you specifically targeting?

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 Tom Fuller,  VCA Inc. - CFO, VP and Secretary   [11]
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 The vast majority of our acquisitions -- although dollar-wise, I guess -- but the vast majority are single hospitals, or one or two hospitals owned by one person. In addition -- which is the market which I referred to a second ago.

 In addition to that, there's phenomenal amount of private equity involvement in this space. There's three very large NDA pet corp -- pet partners, which was the partners, are fairly large. And then a lot of little companies backed by venture capitals/private equity which could be available for acquisitions.

 The problem with those is that those chains do get closer to private equity valuations and trade 12, 13, 14 times. So it's a little out of our -- big on price. But if something that came on that made sense strategically, we'd look at it. Those are more of an off than usual circumstance.

 So our focus with the individual hospital is there's a lot of hospitals for sale. That population is actually growing. Valuations are holding somewhere in 8 times. And even though it's competitive for acquisitions, I think we can continue at some rate above $100 million and $20 million.

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 Erin Wilson,  Credit Suisse - Analyst   [12]
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 So that wouldn't include any sort of (inaudible).

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 Tom Fuller,  VCA Inc. - CFO, VP and Secretary   [13]
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 That would not include, yes. The $20 million actually included a couple of big, fairly large hospitals, which could happen. So it wouldn't surprise me if we did well above $120 million, but I think conservatively somewhere in that range makes sense.

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 Erin Wilson,  Credit Suisse - Analyst   [14]
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 And we have about a minute, but we'll follow up in the breakout session. But the competitive landscape on the laboratory side of the business, can you speak to how that's changed even within the past year?

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 Tom Fuller,  VCA Inc. - CFO, VP and Secretary   [15]
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 I think we came out of a period of phenomenal, aggressive period with some share losses. And the past five or six quarters, it appears to have sort of settled down. Still phenomenally competitive. (inaudible) this is a terrific company, great competitor.

 But there's room for both of us. And the last couple of quarters, few quarters I guess, our share gain loss has been fairly close to neutral. Doing a good job on price, you saw last quarter.

 So I think that, again, the good news is we are both in a great market that's growing. We're not fighting over a shrinking pie. So I think we're going to continue to see growth there.

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 Erin Wilson,  Credit Suisse - Analyst   [16]
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 Okay, great.

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 Tom Fuller,  VCA Inc. - CFO, VP and Secretary   [17]
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 One second -- thank you all for coming in. Grab a hat, grab a ball, go vote, buy WOOF. I shouldn't say that, sorry.




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