VCA Inc at Stifel Healthcare Conference

Nov 15, 2016 AM EST
WOOF - VCA Inc
VCA Inc at Stifel Healthcare Conference
Nov 15, 2016 / 04:00PM GMT 

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

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Conference Call Participants
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   *  Jon Block
      Stifel Nicolaus & Company - Analyst

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Presentation
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 Jon Block,  Stifel Nicolaus & Company - Analyst   [1]
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 Thank you. Good morning. Jon Block with Stifel. We're going to get started with VCA. We have with us Tom Fuller, CFO of VCA. VCA is the largest standalone corporate animal hospital chain of over 750 practices. The Company is also one of the top two reference lab providers for the companion animal market in the US.

 I will do also a quick, shameless plug where we will also have VCA present at the Stifel West Coast med tech bus trip in mid-December.

 Maybe just to start off same way I actually began, the Abaxis meeting just before. Anything about trends, Tom? There is a lot of concerns about consumer. The concerns in the consumer were there earlier in 2016, around January, and they seemed to go away for several months, and now they're back. So maybe you can just speak to what you are seeing out there when we look across the US market.

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 Tom Fuller,  VCA Inc. - VP, CFO   [2]
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 I'm still focusing on this bus trip thing, and --

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [3]
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 We have all that information. We will get it.

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 Tom Fuller,  VCA Inc. - VP, CFO   [4]
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 I had bus ride [CAGR]. It sounds like a lot of fun. Again, I am not allowed on the bus this year, so it won't be too much fun.

 I think that last time people were talking about the consumer, I think it's probably true now, although I think with the election everyone is trying to figure out what the hell is going on and whether we're in a daze or we're going to stay where we are, but so far, so good, I guess.

 But I think from our perspective, the consumer is changing. It is no longer Nordstrom. It is online. It's no longer Michael Kors. It is practical buying. It is home stuff. And just like the elections, hug your dog; it is the economy. Cocoon and pets are part of the family, so I think -- I don't think we're seeing much impact from changes right now.

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [5]
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 From the uncertainty that's out there?

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 Tom Fuller,  VCA Inc. - VP, CFO   [6]
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 Yes, I am not going to comment on -- I'm not going to (multiple speakers) what we said post through October, but I think everyone is a little bit -- some people, I guess, are a little bit down, but I think we are not seeing that translate to the consumer at this point.

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [7]
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 Okay, great. Maybe just to start and I will try to go in some sort of order, hospital volume gains of 1%, which is positive, had been negative for a number of years. Is 1% the right place to be when we think about some of the new products that were brought into the marketplace that I think helped volumes a bit, and now we have lapped that contribution? Do you think 1%, 2% volume gains is the right area looking forward?

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 Tom Fuller,  VCA Inc. - VP, CFO   [8]
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 Yes, I think that if you even go back further, go back many, many years, what was driving growth in veterinary was certainly pet ownership, which is now increasing again. More knowledge, more awareness, more specialization, a big immature market, certainly more mature now than it was 10 years ago, but still quite immature in terms of how much medicine we do.

 And so based on that, I think as the consumer continues to be stronger or get stronger, more awareness, more knowledge, more products coming in the channel, so vet pharma continues to put new products, whether it is for itchy skin or the new one, which is great, I use actually (inaudible) for chihuahuas who are a little high strung. The gel, I think it is [pruritus] gel, (inaudible) works really well. I was going to take it myself last week, but ran out. Last year [I could comment].

 So I think there is opportunity for continued volume, which I don't know if it is 1%, 2%. It could be even more if things pick up. So I think certainly positive volumes, particularly after coming in (multiple speakers) negative ones because of the economy and those channel shift for the products was started back actually in 2000. We saw seepage of the flea products leaving the veterinary channel. Now there is products coming back in the channel and we bled out those who are going to buy online or other outlets had not been.

 So that part of the business, stable economy, not better and stable, improving, so I think positive volumes are very likely in the (multiple speakers) future.

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [9]
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 You well cycled through the online headwinds.

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 Tom Fuller,  VCA Inc. - VP, CFO   [10]
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 Absolutely.

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [11]
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 And innovation will determine whether the volume is maybe 1% to 3% (multiple speakers)

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 Tom Fuller,  VCA Inc. - VP, CFO   [12]
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 Good point, yes.

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [13]
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 Okay, okay, great.

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 Tom Fuller,  VCA Inc. - VP, CFO   [14]
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 It makes it sound coherent.

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [15]
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 And then just if you can deconstruct the 4% to 5% gain in ASP, I think that is well misunderstood, if that makes sense, in the marketplace. I'm thinking you're jamming through a lot of products, but clearly there is an intensity of services component, as you like to put it. And what's the true underlying price increase?

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 Tom Fuller,  VCA Inc. - VP, CFO   [16]
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 So pure price is probably around 2%. As in the past, and I think now and even going in the future, much of the increase has come from intensity or mix, right? I would say intensity. There's more procedures. Imagine one more lab test per day per hospital, there's a lot of growth.

 And where it is coming from is just a continuation of more medicine, more awareness, more knowledge of the consumer, and frankly, it is a stronger consumer, which consumer confidence not just for the consumer, but for the veterinarian. The proper term in the industry is the doctors are patient advocates, so you think of the patient as the pet and -- no? Do you have a pet?

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [17]
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 Yes.

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 Tom Fuller,  VCA Inc. - VP, CFO   [18]
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 See, you get it. So the doctor is trying to help the client make the best medical decision for the pet when the pet doesn't talk. Shorthand in our world might just be salesmen, where they are basically -- everything we do, healthcare conference, the things you hate about human health care, reimbursement, contracts, and trying to figure out Obamacare, trying to figure out where Obamacare is going to go, is complicated.

 So the good news is we are fee for service. 98% of our revenue comes at time of service with cash or check or credit card. The bad news is we are fee for service, so everything they do, everything -- procedure the doctors do, they are ostensibly selling. I hate to use the word, but they are selling. When you may [trend], you're at resist. So, as you get -- as the consumer gets more confident, the doctor feels that and they get more confident offering more medicine and offering more, doing more, which drives more transactions per invoice. More laboratory, more testing, more diagnostics, more medicine drives the ASP up.

 So, that's probably the biggest part of the actual pure, pure price is the ability for the doctors to practice the higher-level medicine that they want to provide, and the market is still very immature. And the question you get a lot is price fatigue, whereas if your dog is getting one lab test per year, you have to get two lab tests per year. At some point, the dog owner says enough is enough. I don't need more lab testing. That's not the market.

 Both -- across the board, I think all the diagnostics people say the same thing, actually, is diagnostics is basic medicine. It is still very immature, so a fraction of the dogs that could be getting a lab test are getting a lab test. So it is not about getting you to get two lab tests. It's about getting that other person in the room who is not getting one to get one.

 That comes, again, from knowledge and awareness, knowing that -- even stupid things like one person, there is seven dog years, so you should bring your dog in once a year for an exam.

 As we get more wellness plans and more awareness and building veterinary into your lifestyle and your budget where you will come in for your annual exam, annual lab test, it will drive utilization and drives average transaction, so it is really about further penetration into what is a pretty underpenetrated, pretty immature market. Certainly more mature now than it was 15 years ago, but still I think there's a lot of room for more medicine for a lot of pet owners.

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [19]
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 So you sort of answered this next question, but I will quickly ask it anyway. In terms of if you think about intensity of services, 1% to 2% growth in a 5% growth environment is clearly a critical component. But you believe we're early days in terms of what inning we are with intensity of services. There is more diagnostic testing. There is a greater level of sophistication that can be brought to market.

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 Tom Fuller,  VCA Inc. - VP, CFO   [20]
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 We're certainly more mature now than we were 15 years ago, but I think it is still early. Interesting, even if you broaden that, I would say -- I was at a conference last week and somebody just got a dog, their first dog as an adult, and their first comment was they didn't know how expensive it was to take care of a dog.

 The second comment was, though, I don't even know what to do. I have got this dog; I don't know what I'm supposed to do with it, other than play with it.

 And it reminds me back, I remember years ago, I don't know if it was mommy and me or something, a good analogy might be -- if I knew the guy who did it -- actually, it was the calendar for young, new mothers. It basically said birth on this day, crawl on this day, walk on this day, feed them on this day, the first tooth [missing]. So you have at least a clear -- and bring in for this vaccine and this checkup, and so you have a clear with the progress what you're going to do with your baby.

 I think we're moving towards that in the profession, so there is wellness plans. We started a puppy plan. You graduate to an adult plan, a senior plan.

 You mentioned our websites, which is the first step in really being a much more -- night and day, they're good, actually. I have a really bad cold. I apologize. The websites are actually -- and even VCA changed its name to VCA from VCA Antech a couple years ago. That was as acknowledgment and recognition that we're a consumer-facing company.

 Websites, the first step in planning a much more consumer facing -- you will virtually serve up medical data from the database for that specific pet company. And so we can with one standard -- as a new pet owner, if you know you're going to come in for your puppy plan and get your vaccines and your spays and neuters, and you're going to come in for your vaccinations and your wellness exams and your lab testing as you age throughout the cycle, I think you build veterinary into your lifestyle and your budget. I think you're going to drive a lot of volume.

 But it was away from that, but that's the direction we are going is we got awareness and knowledge [is] we will continue to grow.

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Questions and Answers
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 Jon Block,  Stifel Nicolaus & Company - Analyst   [1]
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 If we have anyone with any questions, just please raise your hand. Your questions will take precedent over mine. Just to continue down the hospital road, hospital margin expansion, 50 to 100 basis points. Is that the right place to be? And then, maybe it was us getting a little too aggressive. We were a bit more in the mindset of 100. Last quarter, it was around 50. Is there a part, Tom, when you take a step back?

 During the downturn, I think the Company did a much better job of holding margins when times were rough and maybe we are not seeing the upside now during better times where this just isn't as fixed of a business as it would seem. Maybe if you can comment on that.

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 Tom Fuller,  VCA Inc. - VP, CFO   [2]
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 I think I would love to figure out a way to condition that the margins are a little bit variable.

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [3]
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 So look at them over like LTM, last (multiple speakers)

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 Tom Fuller,  VCA Inc. - VP, CFO   [4]
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 Yes, but over time, which is why I think that -- I will get there in a second. So, they will bounce around a little bit. It is normal, this normal volatility, and we talked about this 2% to hold margin. You get above 2% comps, the margin should grow, but you have a portfolio of 600 hospitals with (inaudible) all over the board and margins all over the board, and sometimes they go in your favor. Sometimes they don't.

 So I imagine it is not much different than a stock portfolio with a bunch of stocks in the middle and three great stocks and three crummy stocks, and one great goes to crummy, you have a bad quarter, and the next quarter it comes back, which is why we all do one-, three-, five-year averages, sort of smooth some of that volatility.

 I like we have a little bit of that. And you saw that in Q1 and Q2 of 2014, I believe, on relatively low growth, 1%, 2% margin growth, over 100 basis points, [oddly], which was way too good based on that model of 2%, give or take.

 In Q1 and Q2 of this year -- or last year, rather, 2015, on reasonable growth, 5% margins were up only 50 basis points, and then, of course, terrific margin in Q1 and Q2 of this year and then a little bit weaker in Q3, which I think is a more sustainable margin, the 50 basis points.

 We did have a couple unusual items with healthcare spiking, self-insured health care. That one hospital, it is a perfect example of the portfolio. If the one hospital had a major downturn just because of some operational moving of the facility, temporary, so you adjust for that, we are over the 50 basis points.

 Lab, the business day, and a couple of other things, they would be somewhere in the 100 basis points as well. So I think we're in that target range of 50 to 100 for the hospitals and 100 to 150 for the lab. It could be better. Maybe it could do worse once in a while, but I think that the progression, I think they should consistently stay in that range.

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [5]
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 And when you made the analogy to a stock portfolio, then I guess in a perfect world in that stock portfolio everything would be green, not red, and you wouldn't have a crazy outlier that could then go (multiple speakers) the following quarter.

 Where are you when you look across your portfolio of 750 hospitals? Has the volatility diminished a little bit across them or are there still your wild outliers? Do you have a lot of guys -- now that we are two or three years into a growth environment for same-store sales, how -- has the left tail diminished, so to say?

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 Tom Fuller,  VCA Inc. - VP, CFO   [6]
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 Yes, probably, but again you can't -- not that you still can't have an outlier that can smack you, but the hope is that whether it is -- a lot of our issues on those are doctor turnover issues endemic in the industry, not just us. It is pretty common. And so, losing a large, producing doctor for a maternity leave or just moving community will affect your revenue. So our goal has always been to recognize you can't do a lot on reducing turnover.

 I like to think we are becoming an employer of choice, but even then it is probably a marginal impact on that. We're doing a better job of recruiting, so our residency programs that we train doctors, our internship, for instance, we train almost 200 interns per year in our intern programs, which allows us to recruit the better ones. I think that, hopefully, we can reduce that churn at the bottom of the tail and get closer to the mean.

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Unidentified Audience Member   [7]
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 You mentioned earlier that consumer confidence was an important part of the (multiple speakers) going. Some of the (inaudible) before the election. So I guess my question when you see (inaudible)

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 Tom Fuller,  VCA Inc. - VP, CFO   [8]
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 I think the -- I don't want to overemphasize the consumer confidence; I think it's clearly there. To the extent in the past we can measure it, it appears we were a little bit on the later side.

 It takes the doctors a while, I think, to glide into seeing that -- those grumpy faces from their clients before they start shutting down, and the converse is true as well. They take fewer grumpy faces and more smiling faces to be more comfortable selling.

 But, again, I think that -- I'm not sure the restaurant business -- I think those who have seen weakness with the consumer, it is spotty. Some places are still very, very strong; some places, very, very weak, and I think we tend to be in a stronger segment. And through October when we released earnings on the 26th, my birthday, actually, things were holding up and haven't seen much impact, so hope to see --

 The election is probably (inaudible). Everybody was (inaudible) by the time the elections rolled around. We were just cocooning and shellshocked and couldn't cope anymore. So now that the elections are done, maybe that is going to free some stuff up as well.

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Unidentified Audience Member   [9]
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 [Only] on the coast.

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 Tom Fuller,  VCA Inc. - VP, CFO   [10]
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 Only on the coast, yes.

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Unidentified Audience Member   [11]
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 (inaudible - microphone inaccessible)

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 Tom Fuller,  VCA Inc. - VP, CFO   [12]
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 There is. There is a -- one has been around for years called VPI, which is more of a DRG type reimbursement. Then there is a new one called Trupanion, a public company, actually, which is more of an indemnity plan.

 We love insurance. We support insurance. Now, Trupanion is our preferred venue. We help sell their product in our hospitals, particularly since it is a really good fit with our wellness plans. Wellness plans cover just well. They don't cover sick. Trupanion covers sick, not well, so if you really want to go the full spectrum, you can buy a wellness plan and then buy insurance on top of it.

 Much of the industry data, there has been much of the survey data, but veterinarians suggest that, not unexpectedly, that patients with insured pets spend more -- or consumers spend more.

 Again, that's even directly because, yes, either directly -- I think the doctors will -- our clinics that have insurance, but also the doctors want to do [cart] medicine, so that barrier to medicine goes away. They tend to do more medicine.

 The market so far, even though it is small, it is not like human health care, obviously, where you are buying through employers and group. We don't see it as any potential long-term harm of they'd be the gatekeeper on price or volume, so we fully support it. It does tend to -- think of the -- if revenues that grow the populating industry, then that will be another driver of utilization, both on the volume side and the price side.

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Unidentified Audience Member   [13]
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 Do you have any idea what percentage of your customers (multiple speakers)

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 Tom Fuller,  VCA Inc. - VP, CFO   [14]
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 Tiny, tiny is how you meant it because we don't take insurance directly. They pay and they get reimbursed.

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Unidentified Audience Member   [15]
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 Can you talk a little bit about the impact of the proposed corporate tax cut and capital gains? We have seen a slowdown in acquisition opportunities, and any reason why the corporate tax cut itself (inaudible) rate goes to [25% to 20%] (inaudible) flow through to your bottom line?

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 Tom Fuller,  VCA Inc. - VP, CFO   [16]
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 On the acquisition -- the other side, interestingly, I thought of it yesterday and I have not had a chance to check with the office. Obviously, a very -- a big -- be a very robust, very strong third quarter, strong partial fourth quarter. A lot of that was probably tax selling. There is probably a lot of guys now that are kicking themselves that they should have waited, I guess, but then we all make a bet and sometimes it doesn't work.

 So I don't know if we're going to see that dry up and be deferred into January or not. But if it does, it doesn't matter; it is just timing. So I would suspect -- my gut is that lower rates would probably increase sector selling. Having said that, most are going to sell in the rate of sell now, once the [bids] are locked in. So, they'll sell on the rate of sell based on their retirement needs and assets. So, you may see a little disruption of Q4 to Q1, but I don't think that's material.

 On these tax cut side, yes, it is basically going to turn into a a lot of cash flow, that would generate a lot of cash flow, so a lot more free cash flow, which -- I am not sure that cash flow is our biggest threat on acquisitions. It is really valuation.

 We have plenty of capital where we are now and have more capital. So I wouldn't necessarily see that having a huge impact on future acquisitions, other than what the doctors are willing to sell.

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [17]
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 But maybe just to follow up on that. Maybe I didn't understand the question. You are one of the few companies that I follow, in part it is because you are predominantly -- all your revenue is in the US and you are based in California, but your tax rate is 30% to 39%. I think for every 10 percentage points if your tax rate were to step down, that is about $0.50 on the bottom line.

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 Tom Fuller,  VCA Inc. - VP, CFO   [18]
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 It is huge.

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [19]
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 It is massive. So maybe just -- any miscalculation there or your thoughts if the corporate tax rate were to go down?

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 Tom Fuller,  VCA Inc. - VP, CFO   [20]
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 If you want to value us on free cash flow returns, then yes. It's huge, right? So there is the valuation piece I didn't address. You guys can figure that out. It's a lot. But in terms of free cash flow, it doesn't -- we'll have a lot of free cash flow. It is probably more than we need.

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [21]
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 Okay. And maybe just to continue down the road, the only one we have seen the past couple of weeks is obviously (inaudible) yield curve. Can you talk to your debt outstanding and any change there? When you're marked to LIBOR, does that hurt you in any way?

 And then to take a step back from the immediate term, your competitors in the hospital arena have probably benefited from the ability to borrow cheap, and it is maybe hospital acquisition side, pretty intense, and you see multiples. Could that help you out where all of a sudden that becomes less competitive going forward?

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 Tom Fuller,  VCA Inc. - VP, CFO   [22]
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 It's a great point. So, yes, on that two edge, right? So, all of our debt is floating-rate debt, which -- close to $1 billion, I guess, over $1 billion. That's floating-rate debt, LIBOR plus [175]. If we get our leverage down, we drop to 150 again.

 I was debating of how much -- once you fix that, I think our belief is since we are in crazy times and we don't know what's going to happen right now, but we think that [rate] still is probably a function of the economy heating up, which is a function of the economy, and our business will benefit from that so we can make -- believe there is a natural match there.

 On the flip side is, yes, the private equity model is obviously very, very hot. Lot of money chasing assets, and as rates environment changes, then obviously their models will change, and I would suspect that will end up resulting in valuation changes, so in theory help us.

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [23]
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 Maybe just a couple more at the hospital. You've had several initiatives over the past couple years that I believe has helped spearhead growth. There was workwear, the wellness programs, and text reminders, online appointments. Where are we? Maybe let's just start with the wellness programs, and that takes a while to work its way through your portfolio of hospitals. Where are we with your initiatives and how they have positively impacted revenue (multiple speakers)

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 Tom Fuller,  VCA Inc. - VP, CFO   [24]
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 I alluded to it a second ago. All of them individually -- or none of them individually are moving the needle necessarily. Cumulatively, they're probably moving the needle a little bit, but I think all of them are very early in the development stage and really -- well, things like missed appointments.

 If you talk to the guys to do the programming and manage that program, they can give you a chart showing this gigantic decrease in missed appointments because of their app. But you have to be cynical about it because you don't know if they would have come anyway.

 But clearly there has got to be some benefits, and every business shows benefits. On that appointment booking, making it much more streamlined, the conversion rate goes up when you can put the print right online. I think on our websites now you can actually book an appointment online, where if you are an existing client, you can book an appointment online, rather than pick up the phone and get put on hold and lose interest. You can Google us or (multiple speakers) paid search and better search optimization, hit our websites, and Jon said we just redid them. And as part of that process of getting information, medical information, the hospital location, you can book an appointment to the fun stuff like -- well, practical. Pick up Fluffy at 5 o'clock. His surgery is done.

 And [the find] in the queue, like Fluffy got a bath and taking a picture of a wet dog. Ours is a business of love, and people love their pet, and if you feel like we love your pet, that's bonding for us and our clients, and we want your doctor to think your pet is the cutest pet, and I certainly do. It is related to me and it works great (inaudible) dog lover and I love it.

 And so, I think all those things are the framework, as I tried to elude to a while ago, is a framework that is really changing how, probably not just as we sit with the profession, but I think we're leading that and we are -- what we're doing is differentiating of changing that how you relate to your vet. So whether it is getting text messages on keeping abreast of what is going on with your pet, whether it is booking appointments, whether it is getting a website that you can drill down and get a medical record on that, and with that I would hit the regulations to do much better education (inaudible) marketing.

 I think all those things are putting things in place, and then you put wellness plans on top of that. Soon there will be an app that goes over the wellness (inaudible). If you are a wellness plan participant, then you get an app that has your medical records on it, shows you where you are in your program, what you had done, what you need to be done, and even potentially allow you to talk to a doctor and get some quick [sits], just like we see in human health care. People Google doctors now where you -- really, you're interested in self diagnosing, but we feel that as well, so we always wanted to for years to do a better job controlling the message. So in our network, we can do that now with apps.

 So I think all those programs are really just fundamental building blocks of creating a whole chain in how consumers and veterinarians relate to each other. Specifically, again, it would be difficult to point to any one thing that is moving the needles. Wellness plans are -- did a couple of years, and where the hospitals embraced it and selling them, they are doing quite well, but we need new -- like any organization with 600 hospitals getting out and doing the same thing, spreading the best practices takes a lot of time.

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [25]
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 But if you look at the hospitals that were the first to roll out and deploy wellness, so those are further along, is that hospital portfolio going with the corporate?

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 Tom Fuller,  VCA Inc. - VP, CFO   [26]
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 Yes, but not -- and I am not sure, again, there is a lot of other moving parts that could not --

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [27]
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 The geography with --

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 Tom Fuller,  VCA Inc. - VP, CFO   [28]
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 The geography, doctors in, doctor coming and going. But the general, yes, they are growing. They are contributing to the central comps and more so than most hospitals where wellness has been actively pursued.

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [29]
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 Maybe one more in hospital before just moving into lab. Trying to decipher whether margin expansion is going to be 50 bps or 80 bps is pretty difficult, especially from where I sit. So when we go about your portfolio, what percentage of your portfolio is specialty hospitals? And I ask that because I think there can be more moving parts to the margin with a specialty. You got to hire a specialist. Sometimes you got to pay them a lot of money upfront to get them in the door. Then there is a higher return on the back end, too. Can you dial to your portfolio what percent is specialty, and is that a headwind near term?

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 Tom Fuller,  VCA Inc. - VP, CFO   [30]
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 I think it is around 20% of our revenue, but maybe a little more volatile. Hard to say. But your point is a good one.

 Even you look at -- there has been -- I am getting in the weeds here, but that is going to age all of you, running a business in a public environment and even listening to budget calls where hospitals are saying I want to hire a specialist, it's going to cost me a $200,000 finder's fee. (inaudible) unproductive, so he builds up his referral base that is going to drive our margins for six months.

 Then some of you are going to feel at least tuning up the environment we live in, but for me all four of these upcoming, maybe I should space them out one every six months. And my answer has been screw it. No, if it's a good investment, it is a good investment. We will deal with the margin impact and it is typically small, but they could accumulate to a larger number. But we're going to run the business.

 If it makes sense to do it, why would you wait, because you may not get that opportunity to hire that guy. So, that's always there and you may get a little bit more of that in specialty, but I think those cut across both segments.

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 Jon Block,  Stifel Nicolaus & Company - Analyst   [31]
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 Okay. Overall competitive environment, maybe just the (inaudible) I'll never be able to figure out, which is you have a duopoly. You have one player saying SG&A matters; the other saying it is not. So maybe before we go down to SG&A route, which I got to hit on, right, just the competitive environment and what you're seeing there.

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 Tom Fuller,  VCA Inc. - VP, CFO   [32]
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 I would be crushed if you didn't. It is very competitive. I think we are probably moving a little closer to what we were 10-plus years ago, a duopoly. We both compete furiously, but the good news is we are in a market that is growing. It would be a way different conversation if we were in a shrinking market.

 In fact, I was actually talking to somebody this morning. I found a great graph and it appears it is in [attics's] presentation, so I was going to use it, but (inaudible). I love it, because it is a graph that has been around for years showing general consumer spending like this and then pet spending like that and vet spending like this in all economies for about 35 years. I think it is back to 1985. What is that? 35, 30 years.

 All economies, good economy, bad economy, different economies, vet spending was dramatically growing faster than the general, which gets us to the first conversation about just the consumer and the maturity of the marketplace.

 So, lots of great markets to compete in, number one. Why are we doing in this kind of market? I think after years of competing over share, it is a little bit more rational now. Obviously, we have a very dominant share in the primary business.

 But we compete. But with the changes I think in the distribution channels and distributors, we're a much more level playing field than we were, but that's not to say it is still a very competitive market.

------------------------------
 Jon Block,  Stifel Nicolaus & Company - Analyst   [33]
------------------------------
 Okay, and your thoughts on SG&A (multiple speakers)

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [34]
------------------------------
 SG&A? I mean (multiple speakers)

------------------------------
 Jon Block,  Stifel Nicolaus & Company - Analyst   [35]
------------------------------
 The science is there, but there (multiple speakers)

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [36]
------------------------------
 The science is a great thing. And it's funny. If we were not in the lab business, you would have been calling us all along as the largest employer of vet medicine in the country, largest employer of specialists in the country, largest operator of specialty hospitals in the country. We have textbook writing, lecturer. We are the opinion leaders among them in the space asking us for SG&A, and you have an opinion, but you have to constantly -- and we saw at the elections, right? You can get in a bubble and get surprised.

 So, we take it seriously. We certainly don't see any significant issue there, but you still have to go back and double check and see what you're missing. And we go back to our salesmen and ask them are they losing and they are not. Are they not getting because of it? No.

 We talk to our medical professionals who practice medicine, highest quality medicine in the country, day in and day out, and they don't see it significantly better than the existing technology. So, there we are.

------------------------------
 Jon Block,  Stifel Nicolaus & Company - Analyst   [37]
------------------------------
 So, I am going to conclude that, hey, we saw 9% lab growth in 1Q and it stepped down to right around 5.5% in 2Q, 3Q. What is the right number, then? [More] than 5%, if the step down wasn't because of share losses to SG&A, how do we view that long-term growth rate around lab?

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [38]
------------------------------
 In spite -- evidently on the last quarter call, we suggested we could accelerate off what we saw in Q2 into Q3 and it didn't. It stuck out in the mid-5s, so that's probably the number. It could be higher. But I wouldn't expect it to continue to drop to below. I think we are leveling out both businesses, sure at leveling off into a more sustainable growth rate.

------------------------------
 Jon Block,  Stifel Nicolaus & Company - Analyst   [39]
------------------------------
 Okay. And one thing and maybe I will throw this out there and you can clarify, but in your 10-Q, you have a lot of detail on external revenue. I think there was some noise -- or at least I believe there was some noise. You have your lab number, you report, and you back out the intercompany to get external lab, and if you did that in the most recent quarter, the external lab growth rate stepped down meaningfully, which some people were concerned about. However, that is [catchment].

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [40]
------------------------------
 Catchment.

------------------------------
 Jon Block,  Stifel Nicolaus & Company - Analyst   [41]
------------------------------
 Going from external to internal, fair?

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [42]
------------------------------
 Correct. The revenues -- the total is the same, so what was sitting in external revenue popped down into internal revenue, so the total of it didn't change. That's why the comps are at 4 something today, adjusted 5 something. The total of them didn't change, but if it is internal, it is external, that changed because now we own it.

------------------------------
 Jon Block,  Stifel Nicolaus & Company - Analyst   [43]
------------------------------
 Okay.

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [44]
------------------------------
 So actually in fee on a consolidated basis, we actually lost revenue on that deal. It went away.

------------------------------
 Jon Block,  Stifel Nicolaus & Company - Analyst   [45]
------------------------------
 Okay. Got it. And then just maybe on the margin side, I think earlier you alluded to 100 to 150 basis points of lab. That's where you feel -- because I think that -- and I have to run through the model -- I think that actually implies that the incrementals which have been running around 55% would have to step up a little bit. Can you get there? You can get there around 100 basis points with the incrementals running 55%?

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [46]
------------------------------
 55% to 60% is what we have been seeing.

------------------------------
 Jon Block,  Stifel Nicolaus & Company - Analyst   [47]
------------------------------
 Okay, and that would allow you to get there, got you.

 All right, let me just move it to [plant] forward. Capital allocation, it has been a massive year this year. The mom-and-pops, as well as CAPNA. I'm not asking for 2017 guidance. You can provide it if you want, but on 2017, how do we think about hospital -- dollars being deployed for hospitals just (multiple speakers)

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [48]
------------------------------
 I wouldn't -- as I said that it really -- I apologize. I need to go just double check what happened with the latest tax stuff, but we had, as I said, a very strong year so far. In the last call, we said we were going to do over $200 million this year of revenue acquired. That will cost us roughly $300 million.

 That could change a little bit with the taxes. To assume that it does is probably just timing. My guess is they have historically been somewhere in the [100 to 120]. I think last year we were 120, but for the big chains, which are a [separate part]. My guess is we will guide to somewhere in the 100 to 120 range. Haven't come out yet, maybe a little higher.

------------------------------
 Jon Block,  Stifel Nicolaus & Company - Analyst   [49]
------------------------------
 So you'll get part of (inaudible) as well with the taxes?

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [50]
------------------------------
 Because that 200 does include some lumpiness or some fairly large hospitals, a $20 million hospital comes along that is pinching that total, so that may or may not happen again. If we did turn [it on], would it surprise me? No, but -- and we tend to be pretty conservative on guidance in general, and guidance in acquisitions because it is unpredictable.

------------------------------
 Jon Block,  Stifel Nicolaus & Company - Analyst   [51]
------------------------------
 CAPNA seemed to go well on the integration. Is there anything that would preclude you guys from doing another -- when I look back at VCA and covering you guys over a number of years, the big hospital chains have been every third year or so, roughly. Anything that would preclude you from doing another big chain from an integration standpoint in 2017?

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [52]
------------------------------
 Certainly not integration and probably not capital, but valuations, valuations and, frankly, being invited to the party.

 One thing that -- many things Bob is good at, but one thing he is great at is he's very -- did a good job working with them and bringing them along in an environment they wanted to go private equity. And I think they saw the benefits of going with VCA after a lot of handholding. It made sense to them.

 So, the other chains out there, the big ones, anyway, the big ones are probably out of our league on valuation. Frankly, the private equity market purposely excludes strategic buys anyway, so it is hard to even get invited to those parties, which is why I think doing CAPNA was a pretty great feat that we pulled off because we were able to get them to the party.

 Now there are a lot of -- someone told me last week that there is 50 private equity players in this space, which I didn't even know they were 50 private equity guys. A lot of little, teeny roll-ups, none of which will gain scale, be meaningful, but it is just a cottage industry of playing the arbitrage game of buying their friends and neighbors in the community at 7, 8 times of the amount and then clipping one of us for 10 times to make a little bit of money. So the three large ones, it would be hard to imagine those coming along, but you never know.

------------------------------
Unidentified Audience Member   [53]
------------------------------
 I just wanted to ask about (inaudible). What is the differential (inaudible) expenses? Where are you comfortable (multiple speakers)

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [54]
------------------------------
 Yes, that's a good point. So we pay -- on the individual hospitals, we will pay anywhere from 6 to in some cases as much as 10 times, which sounds high, but average around 8 times, which is up from where they were 10 years ago [then] because we're competing with private equity.

------------------------------
 Jon Block,  Stifel Nicolaus & Company - Analyst   [55]
------------------------------
 Just to be clear, that's next 12 months post synergy?

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [56]
------------------------------
 That's part of that trailing post synergy.

------------------------------
 Jon Block,  Stifel Nicolaus & Company - Analyst   [57]
------------------------------
 Trailing post synergy, okay.

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [58]
------------------------------
 And that's a good point, though, because we went through the recession and were very price disciplined. Stuck to our old 6 times model and lost a lot of good opportunities, and we realized that a company our size, investing a little bit of capital at the higher multiples, and you look back and (inaudible) down to one turn on this [that] really good hospital within reason.

 So if it is going to be really, really, really good, we may pay as much as 10 times. But we're averaging around 8 times. The private equity NVA traded hands last year at somewhere around 13 plus, 14 times. NVA, we paid somewhere in the 13 times.

------------------------------
 Jon Block,  Stifel Nicolaus & Company - Analyst   [59]
------------------------------
 CAPNA.

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [60]
------------------------------
 CAPNA, sorry -- trailing, and I think one of the things that has given us some more confidence to pay a little more is in the recession where you are buying -- following [nas] in a weak economic environment, revenue wasn't -- not just us, but the industry, now industry is growing. Margins are holding, so we may have to look at a combination of trailing and forward multiples and with our synergies, which we always have, but also just better than historical operating performance, you can memorize the valuations down again relatively quickly, so pick a little bit.

------------------------------
 Jon Block,  Stifel Nicolaus & Company - Analyst   [61]
------------------------------
 Maybe just one more on CAPNA. You mentioned, hey, they wanted to go the private equity route. We are able to get them, sort of a big win. Was the deal structure part of that? In other words, they retained 20% ownership? Is that something that you were pleased with in the early days that you would be willing to apply to other potential larger deals?

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [62]
------------------------------
 Yes, and they are sort of incubated, right? You give them -- give a small company a little more -- either with all the controls you need -- what I need, the controls and financial and all that stuff. Given a little more nimble, there to do some acquisitions, run a little bit different, try with different things.

 So we are very -- the bad news is we build a separate G&A, so if you look at our hospital SG&A, which is a good point, but I would point out that our hospital SG&A number went the (inaudible) $3 million in the quarter, which looks like it is out of control, but that is (inaudible) SG&A, which is offset by a higher hospital gross profit.

 And so, they are highly engaged. That's the good news. The owners are still there and trying to create value in that 20%. So, would we do that again? If it made sense, of course.

------------------------------
 Jon Block,  Stifel Nicolaus & Company - Analyst   [63]
------------------------------
 And where are you on the integration, with half a minute to go -- I think they were pretty far along the (inaudible)

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [64]
------------------------------
 It is -- the part we know -- the mechanical part is mostly done. And so, they are using our systems. In the process of starting a workflow, which is our price information system as we speak. They did the first couple installations a couple weeks ago. So it is going very well, and from my perspective, it is going well on both sides.

 Now I am no risk manager, so I care about the risk of screw-ups and you have to put your arms around it to do that, and the trick is to get your arms around it tight enough to do that, but not squeeze them to death.

 So I think they would say that from their perspective, it went very well as well because they feel like they have that latitude and independence that they want and need to thrive, while we have the control we need. So I think it's been both -- been very good integration from both sides, actually.

------------------------------
 Jon Block,  Stifel Nicolaus & Company - Analyst   [65]
------------------------------
 Any last-minute questions? Okay, good. Tom, thank you very much.

------------------------------
 Tom Fuller,  VCA Inc. - VP, CFO   [66]
------------------------------
 Thank you for coming in. I have a cold. I won't do that.




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