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Executives

Tomas W. Fuller - CFO and VP

Bob L. Antin - Co-Founder, CEO, President and Chairman

Analysts

Dawn Brock - JPMorgan

Ryan Daniels - William Blair

Mark Arnold - Piper Jaffray

Arthur Henderson - Jefferies & Company

Robert Willoughby - Banc of America

Robert Mains - Morgan Keegan

Mitra Ramgopal - Sidoti & Company

VCA Antech Inc. (WOOF) Q3 FY08 Earnings Call October 23, 2008 4:30 PM ET

Operator

Good day, everyone, and welcome to the VCA Antech, Inc. Third Quarter 2008 Earnings Conference Call. Before we commence the discussion, I would like to preface the comments made today with a statement regarding forward-looking information. The information contained in this presentation includes forward-looking statements that involve risks and uncertainties. These statements appear in a number of places in this presentation and include statements regarding: One, our intent two, our belief or current expectations with respect to our revenues and operating results in future periods three, our expansion plans four, and our business strategy and abilities to successfully execute on that strategy. We caution you not to place undue reliance on these forward-looking statements. These statements are not guarantees of our future performance and involve risks and uncertainties. Our actual results may differ materially from those discussed in this presentation for the reasons, among others, discussed in our filings with the Securities and Exchange Commission. The information in this presentation concerning our forecasts for future periods represents our outlook only as of today's date, October 23, 2008, and we undertake no obligation to update or revise any forward-looking statements whether as a result of new developments or otherwise.

Our earnings and guidance releases are filed with the Securities and Exchange Commission and are available on our website. In addition, an audio file of this conference call will be available on our website for a period of three months at www.investor.vcaantech.com. As a reminder, today's call is being recorded.

I will now turn the conference over to our host, Mr. Tom Fuller. Please go ahead, sir.

Tomas W. Fuller - Chief Financial Officer and Vice President

Thank you, Jennifer, and thank you for joining us for the third quarter 2008 WOOF earnings call. It was a bit of a challenging quarter, but overall I think it was a very good quarter. With the weakness in the economy and the turbulent times we are in, we continue to see variability in our comps, and by and large our operating team did a really good job of holding margin, although I think we've had a bit of more difficulty maintaining margin than we have in the last couple of quarters, but overall this has been a pretty good quarter.

On an 8.3% revenue growth to $332 million, we increased earnings per share 10.5% to $0.42 per diluted share. Gross profit increased 2.9%, operating income was up 4.7%. Operating margins were down 150 basis points to 26.7%... operating margins were down by 70 points to 20.1% and we had a good quarter as we have in the past two quarters, a good strong quarter for acquisitions.

In Antech Diagnostics, revenue increased 3.8% to $77 million, driven primarily by internal growth of 3.1%. Gross profit decreased 1% and gross margins were down 220 basis points to 45.8%. Operating income decreased 2.2% and operating margins were down 240 basis points at 39%.

Much of that decrease were contribute to three things. One, we entered Canada in the first quarter of 2001 [ph] with an acquisition, opening a lab. It's a great platform to build on but it's basically in startup mode now and bringing down our margins.

Transportation costs, we all know are increasing at very high rates. A combination of that increase in our transportation costs and spreading that costs over a lower revenue base increased that cost percentage of revenues. And we initiated some R&D initiatives during the quarter affecting margins as well. So, overall 240 basis point decline in margins.

The components for internal growth, 3.1% total internal growth composed of a 4.9% increase in number of requisitions to 3,286,000 requisitions on a same-store basis and a decrease in the average revenue per requisition of 1.7% to $23.30. Much of that decrease is coming in a decrease in tests per requisition. Total requisitions for the quarter was 3,307,000.

Laboratory facilities, we started the quarter with 39 facilities. We acquired one, we built two STAT labs, and ended the quarter with 42 facilities.

In the hospital division, revenue increase 10.4% to $253 million, driven primarily through acquisitions and internal growth of 1.4%. I will also point out that Healthy Pet, which we acquired back on June 1, 2007 is now in the same-store base, effective in the beginning of the third quarter.

Gross profit margins increased 5.7% and gross profit margins were down 80 basis points with 19.9%. But I will point out that the same-store gross profit margins were actually down slightly, basically flat at down 30 basis points at 1.4% internal growth. So with the acquisitions coming in at lower margins, a 30 basis point reduction in same-store margins, but 80 basis point reduction in combined hospital gross profit margins because of the lower margins in the acquisitions which we historically have always seen. Operating margins were down 60 basis points compared to the 80 basis point reduction in gross profit due to a savings in SG&A. SG&A actually as a percentage of revenue, decreased 20 basis points from 20.4% last to 20… excuse me, 2.4% last year to 2.2% this year.

The components of same-store growth; our average order increased 6.9% to $148.16. The number of orders was down 5.1% for a total of a 1.4% internal growth in same-store growth in the hospital division.

As I mentioned, we have continued a very aggressive streak on acquiring hospitals. During the quarter, we acquired seven hospitals with annual revenues of close to $12 million, bringing our total for the year to 43 hospitals with revenues of $87 million.

In terms of the hospital count, we started the quarter with 465 hospitals. We acquired seven, of which four we tucked into existing facilities. We closed one hospital, ending the quarter with 467 hospitals.

Medical Technologies; Sound Technologies had a very strong quarter, 13.1% increase in revenues to $12.5 million. Gross profit increased 32%, operating income increased 143%, operating margins up 510 basis points to 9.6%. So, a very strong quarter for Sound Technologies.

In terms of the balance sheet, we ended the quarter with $95 million in cash, which is up $19 million from the June quarter. We did draw $35 million on our revolver, which increased our cash balance. We did that not for need of cash, but given the uncertainty of the bank market, we thought back last month. It made sense to… prudent to put extra cash on the balance sheet, so we drew $35 million.

So that means we ended the quarter with $555 million in debt, which includes $524 million on our senior credit facility, including the revolver. Of that $524 million, we have interest rates swaps fixing the rate on $325 million of that debt at 4.5% plus the margin, gives us an on-line cost of 6%. The rest flows at LIBOR plus 150.

In terms of cash flows, operating cash flow for the quarter increased 4.4% to almost $43 million, bringing the year-to-date total to $143 million or a 5.6% increase. We are expecting for the year to have operating cash flow of somewhere in the $185 million to $190 million range, which brings us to I think an important topic, liquidity. We're very, very comfortable with that $185 million of cash where we could easily fund our capital expenditure and acquisition goals for this year and into next year.

In terms of CapEx, $14 million for the quarter brings us to a little less than $40 million for the year to date.

So I think all in all, we had a very good quarter considering the environment we're operating in. We continue to see weakness in the economy uncertainty. We believe we'll see more of it. Our revenue growth continues to be very volatile. I think we are doing a very good job of trying to hold margin, managing costs, cutting costs, other measures to hold margin. We believe it's prudent at this point to lower our guidance for the fourth quarter to revenues of $1.28 billion to $1.29 billion, diluted earnings per share of $1.47 to $1.51, which implies a fourth quarter earnings of $0.22 to $0.26 per share.

I'll quickly point out that, comparing to last year, we did report $0.29 per share in the fourth quarter 2007, but I'll remind everybody that number did include a $0.03 credit for workers' comp [inaudible] and a $0.01 credit for adjusting our tax reserves for the prior periods.

And now with that, we'll go back to Bob.

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

Thank you, Tom. I also believe that it is a very good quarter, but there were an awful lot of uncertainties. We experienced, on the hospital and on the lab side, a very up and down circumstance. Two out of the three months, the hospitals and the labs were doing very, very well and like everyone else, with the uncertainty in the news market, the bank market, we ended up feeling it and it made our results a little choppy.

I'd like to point out on the hospital side, the overwhelming majority of our hospitals are growing and our margins are growing. But because of the geographic dispersion and some of the issues that exist in different markets, we do feel those markets, and we have felt them. And the news media doesn't help. And the overall feeling out there does affect. We take surveys of our doctors, had our managers in, and do have the feeling that in certain markets, not all markets, but in certain markets we are certainly a reflection of what is going on.

But very, very positive is that our hospitals are up and they're doing a good job. The management on the hospital side, if you look, the margins have fallen slightly, which I think is an incredible achievement give the 1.3% same-store growth. So the hospital division has invested quite a bit in cutting back and managing expenses, and in the different markets where we have felt pressure, they're accelerating their efforts.

On the lab side, on the very positive, our comps are not impacted by the competition. We do believe we're serving the same amount of hospitals, no loss of hospitals. But we have seen the intensity of the orders go off a little bit and it's gone off in a very choppy, uneven manner. Several of the months, the intensity of the lab requisitions were up, and in another month, which coincided with the same impact that we had on the hospitals, we felt it down.

We've made great progress in two markets in Canada. We've opened up a lab, as Tom mentioned, which impacted the margins, in Calgary. We have also purchased a small-- and expanded a lab in Toronto in the suburbs, and we're making good progress, which has impacted the margins because of the expansion and some money that we're spending on R&D.

Medical Technologies did a great job. It's interesting because you would expect Medical Technologies, as I said on the last call, to face the first real strong winds, because it's a capital expenditure and one of the largest expenditures that's taking place, and they've done a good job.

All in all, I am very, very pleased with the results of the quarter, especially given the circumstances. I think we've demonstrated, and we will continue to focus on costs, economizing and making sure in the markets where we feel the pressure, we respond, particularly on the cost side. I think we're also going to get some relief because I think we've been through the height of the transportation costs, which cost us 1 point on the margins for transportation and fuel. So I think we're responding.

And now we'll open it up for some questions.

Question And Answer

Operator

[Operator Instructions]. And we'll go first to Dawn Brock with JPMorgan.

Dawn Brock - JPMorgan

Good afternoon, guys. So I guess the first thing that I wanted to ask is whether or not you can quantify for us the impact that you saw from the hurricanes.

Tomas W. Fuller - Chief Financial Officer and Vice President

I think they were nominal. I think it cost us a little less than 1% on same-store, but there was dislocation. There was dislocation in Florida, Louisiana and certainly in Texas. I believe the number was about 50 hospital days in the South were closed. So the hurricane did play a role for us.

Dawn Brock - JPMorgan

Okay. Great. And then, Tom, did you guys quantify that at all from an earnings perspective? And the only reason I ask is simply because a lot of the other companies that have already reported have actually broken that out, so that we can try to figure out where the Street estimates were based on without the hurricane...

Tomas W. Fuller - Chief Financial Officer and Vice President

I wouldn't attribute... it's fairly de minimis. I wouldn't attribute there's something to it, but it's not a big part of our number.

Dawn Brock - JPMorgan

Okay. Great. The second thing is, Bob, you talked about geographically there was strength and weakness in certain markets. Would you be willing to give us some color on just... on that strength and weakness?

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

The ones that you would certainly guess, Riverside, San Bernardino, Las Vegas, we felt it. Some parts of New York we felt it, especially when there was the upset in Northern New Jersey when the banking crisis... I want to say was at its peak. We felt a little of it in Texas. But on the other hand, we felt strength in Hawaii, Alaska, Northern California, the Los Angeles area.

So it's all over the place. Washington, DC was strong, San Diego was strong. We felt some in Denver. Some if was felt certainly by the economy, but some is also a little fluctuation in the marketplace.

Dawn Brock - JPMorgan

Okay. Great. Is it fair to say that July and August were the two stronger months of the three?

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

Actually, not.

Dawn Brock - JPMorgan

Okay.

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

It's fair to say that July... we don't release the individual months, but August was probably of the three, the more challenging month. And it ran between the hospitals and the lab in a very, very similar fashion. August was the more challenging month. And September and July were actually on track.

The difficulty is that we're seeing, which led to the attention to the guidance, is we're seeing... I use the word choppy and everybody hates it... but such an uneven spiking going on, up and down, as we face it in the media, we're seeing people coming to the hospitals. We're in a wonderful place compared to the rest of the world because we're all positive. Every segment we have is positive. But we're feeling it.

So I think when you feel it on the TV, you feel it in the pet owners. But August was more challenging and there's just a little uneasiness all over the place. It makes it harder to forecast.

Dawn Brock - JPMorgan

Right. And on the hospital side, the order number was really strong. Do you attribute that to the fact that people are actually doing higher acuity... you're seeing higher acuity cases or procedures?

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

Dawn, it's really all over the place. Some of the most expensive procedures in the company were up and some of the most intensive hospitals, which I know you visited, have had very, very strong growth, while some of them in other markets, like the markets that depend on Riverside, as an example, is down. They refer... they rely on the referrals from less affluent marketplaces where they're having dramatic issues with subprime. So it's really-- a lot of it is market by market.

Dawn Brock - JPMorgan

Okay. Just one last question, then I'll jump back in. You talked a little bit about R&D initiatives. Can you provide any color around that?

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

On the lab side, we certainly buy an awful lot of reagents and we do make our own [inaudible]. We've taken on from Fair Isaac the PCR and we're looking at other ways of vertically integrating in the lab side and diagnostic side. So we're beginning to expense some of the R&D that we're doing.

But it just contributed. It contributed to the reduction in the margin, but primarily the biggest one in that reduction was opening up the two... and shortly a third location up in Canada. So that hit us a little bit.

Dawn Brock - JPMorgan

Okay. Great. Thank you very much.

Operator

And we'll go next to Ryan Daniels.

Ryan Daniels - William Blair

Yeah, Bob. You made some... good afternoon, guys, by the way. Bob, you made some commentary about potentially accelerating some of the cost savings initiatives as you head into the fourth quarter. Can you give us a little bit more color on what that is, is that actually some staff reductions that you're seeing or just more focus on what you've been doing in the past?

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

No, we're going after it. We're taking all of our large vendors. We've cut quite a bit through them. We have cut hours. In some areas, on the hospital side, they've reduced the full time equivalents. They're going after it both ways. One is not only managing the hours and the overtime, but they're actually now managing the full time equivalents, which, in our last call, I said I thought we could avoid.

Fortunately for us, we're in an industry that has turnover in the hospitals. So a lot of it has been painless. But we are now at the point, in some areas, where we're looking at more closely reducing the levels. But fortunately for us, we haven't had to do it, but we still had a 5... I think, its 5 percentage point reduction in the full time equivalents.

On the lab side, much the same. We've cut full time equivalents. We're cutting... we're looking in both areas of cutting any journals, advertising and related stuff the same things that most companies would do. And I think we can have a pretty good impact on it.

But, Ryan, I'll point out, two out of the three months that we had were very good. And in many, many of our hospitals, probably two thirds of our hospitals, the growth was at or above our targeted areas. So we are still amazingly fortunate in this world that all of our businesses are growing where we are doing the right thing, but it's hard it's difficult to catch up when you do have this choppiness on the expense side. Given the fact, when I look at the lab and we're down 2.5 points, but having opened up three markets in Canada, and having to take on that expense, which I would say the rest of the lab in the domestic market has done pretty well.

Ryan Daniels - William Blair

Sure. And Tom, have you actually looked at what that cost you in the quarter? Obviously, that was something we didn't have in our expectations to open the labs. It sounds like that might have cost a penny, penny and a half. Is that a reasonable thought?

Tomas W. Fuller - Chief Financial Officer and Vice President

No, it's more in the margins. Probably between transportation… between transportation and the Canadian open is probably 200 basis points. The opening is probably that.

Ryan Daniels - William Blair

Okay. So definitely some earnings impact. And then on the fuel side--

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

By the way we are making tremendous progress up there as well.

Ryan Daniels - William Blair

Has there been thoughts on that, I guess, just to continue about potentially converting that and taking that on the income statement and capturing ownership of the hospitals up there? Are you still happy with the arrangement you have at present?

Tomas W. Fuller - Chief Financial Officer and Vice President

We are still happy with the arrangement. To make it clear, Ryan, what I'm talking about is the ones we've opened there on the lab side. We have an investment in a group that owns approximately 28 hospitals now. But we're talking about the margin reduction on the lab side as a result of opening up the labs in Canada.

Ryan Daniels - William Blair

Okay, thank you for that clarification. And then last question, I'll hop back in the queue. We think about the transportation costs, obviously, fuel has been skyrocketing, Sensex plummeted. Is that something where you see a pretty quick impact from the reduction in fuel and diesel costs and perhaps in shipping costs from FedEx? Or is that something that's likely to spill in the fourth quarter that you did not see much in the third quarter?

Tomas W. Fuller - Chief Financial Officer and Vice President

Well, I think FedEx in particular, besides us cutting our use of FedEx across the board I think you begin to see it because they had their own calculus in there… in their billing. So I think we'll see that. We'll also see it because I think one of the things we have a fairly standard application of mileage reimbursement across the company, and that mileage reimbursement's going to fall just by virtue of the fuel. So, I believe in the fourth quarter, we'll start to see it.

Ryan Daniels - William Blair

Okay, fair enough. Thanks a lot, guys.

Operator

We'll take our next question from Mark Arnold.

Mark Arnold - Piper Jaffray

Good afternoon, guys. I guess you kind of answered this already, talking about the trends in traffic through the months, but can you give us a sense… I think everybody probably would like to get a sense as to kind of what you felt at the end of the quarter, just the last few weeks? And maybe any color on the first few weeks of October?

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

Sure. I think, Dawn, had asked about the months and September was actually stronger on the lab side. And I think what we felt is coming into October is with all the upset that take place in the market, it's going up and down. There's a lot of gyrating, the spikes are going up and down. So September, I don't know whether it's a reflection on the first three weeks of October, but we're still seeing ups and downs in different areas, more so than we have seen in years past. That's why it's a little bit choppy.

Mark Arnold - Piper Jaffray

Is it fair to say, then there, that you've adjusted your guidance here for the rest of the year, that it's as much related to the uncertainty as it is to your feeling as to how the quarter is kind of go? It's just that that choppiness has made it harder to predict so you are being more cautious? Or do you guys really feel that the quarter here is going to probably be a little bit weaker than what you maybe earlier expected?

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

Well, to begin with, we have always been very conservative and our numbers have always been very, very transparent. I think the clarity is hard. I think we are having a hard time seeing and that's what led us to the guidance. In terms of the market feedback we get, and even some of the analysts have actually done research on the expectation of pet owners, I think we're in a great place. I just think right now is that the choppiness is very, very hard to forecast.

So I think we're taking in a conservative way. But I think our guidance, in pointing down a little bit, is probably realistic… is realistic. But I think the lack of real clear vision out in the marketplace right now and trying to forecast what's going to happen through November and the holidays is different this year than next year. So I think it's a clarity issue, not a confidence issue.

Mark Arnold - Piper Jaffray

Okay. Any change in the types of treatments that might be getting deferred in your practice? I think our research would say that clinics that we've surveyed are all seeing… that they are seeing deferral of treatments. I'm sure you guys have talked about it too, but any change in terms of the types of treatments that are being deferred by customers?

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

I think there's one thing that's real clear, even by the reflection of the lab. Diagnostics has been pressed a little bit at the local hospitals. So I think you can see a little cutback on that, a little bit more sensitivity to it. But in the larger hospitals in the areas where we don't feel it as much, we don't feel it. We still see the same growth, but there is absolutely sensitivity. I think I mentioned in the last call, you probably found this in your research, when pet owners are coming into the hospitals, they're expressing more like the veterinarians, they're priests or rabbi. So they absolutely feel it.

So the intensity is changing ever so slightly. Because again, we're talking about same-store growth of 1.3 versus 3 or 3.5. I mean, it's tiny, but you can feel it you can feel the sensitivity.

Mark Arnold - Piper Jaffray

Okay. Then on the acquisition front, your pace slowed down a bit in Q3 from the first half of the year. I guess that shouldn't be completely unexpected. But can you give us a sense as to what you've built into your guidance for the full year? And I guess to any extent, whether you think it will continue at that pace for 2008 into 2009? Or has this change in the landscape here in the last few months caused you guys to look at acquisitions differently?

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

No. Actually our pipeline is great. The opportunities are great. And as Tom mentioned in his opening, we have very strong cash flow that we fund acquisitions. And this year, I think our acquisition base is some place between $75 million and $100 million. So we're very lucky. We have great opportunities out there. We hit it at a sweet spot. And some of the hospitals, we're buying are just great. So we are continuing very aggressively to do it. In terms of what we've built in for the numbers, Tom can address that.

Tomas W. Fuller - Chief Financial Officer and Vice President

You are right, Mark. Q3 was a little slowdown from the prior two quarters, but we expect a pretty strong fourth quarter, something more what we saw in the first two quarters. And going into 2009, I think we have said that the phenomenal pace in… [inaudible] pace in 2008 really [inaudible] and we may not see that high level of acquisitions, but still see something pretty strong for 2009.

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

Certainly not in the beginning of the year, because so many people are wanting to do towards the end of the year, but the pipeline for acquisitions are phenomenal.

Mark Arnold - Piper Jaffray

Okay. And then, I just have one last question. Are there any one-time costs that we should look at here in Q3 associated with the integration of the facilities you acquired… the tuck-in of the four facilities and the one you closed? And then also the lab you opened in Canada?

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

No not at all.

Mark Arnold - Piper Jaffray

Okay. And the ramp-up of that lab, in terms of the costs you absorbed here, the drag that that's having on the lab margins. How quickly can we expect to see that kind of ramp up and change the… how quickly can we see a ramp up and impact margins on the positive side?

Tomas W. Fuller - Chief Financial Officer and Vice President

I think we'll feel some positive impact in the first quarter.

Mark Arnold - Piper Jaffray

Okay, great. Thank you, guys.

Operator

Next to Art Henderson.

Arthur Henderson - Jefferies & Company

Hi thanks for taking the question. Tom, you had briefly touched on operating cash flow for the year, and I think you said $185 million to $190 million, was that what you said?

Tomas W. Fuller - Chief Financial Officer and Vice President

Yes.

Arthur Henderson - Jefferies & Company

Okay. And then, did you highlight what the CapEx expectations were for the year?

Tomas W. Fuller - Chief Financial Officer and Vice President

I think we'll end up somewhere around $60 million.

Arthur Henderson - Jefferies & Company

Okay, $60 million. Okay. Very good. And then as far as the… obviously you've drawn some like $35 million down on your revolver. Could we get some perspective on sort of how you're thinking about managing the balance sheet now going forward? Are you going to just keep that? Are you going to try and build a bigger cash balance? What are your plans there? Are you going to pay down the debt?

Tomas W. Fuller - Chief Financial Officer and Vice President

I think we're just watching, you know watching what's going on in the credit market and the banks. And my guess is, a very good chance, we could end up paying that down once we get more comfort that the... a lot of companies were reporting having difficulty drawing on their revolvers and as I said, even though we don't need the cash, we thought it was a prudent idea to go ahead and take some. I think as we get more comfort out in the market that that situation is no longer around and you could perceive paying off... paying that back.

And again, getting back to the cash flow... on the low-end, $185 million, upper end cash flow is $60 million, let's say $85 million of CapEx next year gives us plenty of capital to buy something close to what we'll buy this year or something well above what we've bought in the last few years. So plenty of capital to continue our acquisition plan.

Arthur Henderson - Jefferies & Company

Okay, great. And then, on the... Bob or Tom, whichever one. Your pricing strategy, going forward, I know you typically put price increases in February. With the change in the environment, does that change your perspective on that at all?

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

No, it doesn't.

Arthur Henderson - Jefferies & Company

Okay. And then lastly, on the acquisitions that you've done, I realize that there's some margin drag relative to your core business, how long do you... first of all, how much do you sort of quantify, at this juncture, the difference being between where the acquisitions are today versus your core numbers? And how long do you think it would be before you got them up to the levels where your core business is?

Tomas W. Fuller - Chief Financial Officer and Vice President

They're a couple hundred to 300 basis points lower than our same-store base, which is really always been the case. And it takes anywhere from... some improvements we get [ph] immediately, but it can take as much as six or nine months to get them up. But then what happens is in that six-month period, you buy more hospitals with lower margins. So we've always had the situation where acquisitions have a impact on margins. But the hospitals in and of themselves are typically always accretive, always additive, always a good return on investment, but they do lower the margins slightly. So we always focus on same-store margins. I think, on the 1.4% sales, a slight decrease of 30 basis points is pretty good. But we'll always have some impact from acquisitions as we continue to buy hospitals.

Arthur Henderson - Jefferies & Company

Okay, that's helpful. Last question, when are you planning on issuing '09 guidance?

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

I believe it'll be with the first quarter results or, fourth quarter.

Arthur Henderson - Jefferies & Company

Okay. Fourth quarter okay, great. Thank you very much.

Operator

And our next question will come from Robert Willoughby.

Robert Willoughby - Banc of America

Bob or Tom, I just... can you just speak to how maybe the strategy has evolved over time here? I guess, its... I'm less certain buying hospitals, that you guys are getting the bang for your buck there. You did mention vertically integrating in Diagnostics a bit Medical Technology's had a good quarter, but still small. I mean, is there anything over the next couple of years that is really going to step up more than just hospital acquisitions here?

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

Well, I'll start with the lab side. I think Diagnostics is still the backbone to how much we love our pets. I think what you're going to see, you have a characterization now of wellness, which I think is going to transition to early detection, like we have in human healthcare. I think with all the education and the graduating specialists in the universities and the effort, I think Diagnostics is the backbone. So I see Diagnostics for us continuing.

I know that it's the... the growth has flattened a little bit just because... and we believe because we have been vigilant about it, mostly because of the economy. It's very competitive but we're pretty comfortable that even in the quarter, it's really just the economy. So I think the future on the Diagnostics is still very, very great.

On the hospital side, on top of all of the turbulence that's out there and the uncertainty, and the news and the market and everything else, and the people losing jobs, we're still positive. And the overwhelming majority of our hospitals are still growing nicely. So I still see a continuation on the hospital side. I think people love their pets, they're spending money even in tough times. And some of the hospitals we're buying now are really the stars in the community. They're marquee hospitals in the areas where we're looking to do business and I think they're great. You're right Sound Technology's on the small side, but it is strategic. It provides a connection.

Going back to your last part of the question, yes, we are looking at different segments. We are looking to Diagnostics. I think you're aware of that we're investigating how to vertically integrate, not only on the reference lab diagnostic side for our own reagents, but also what our own hospitals do. We're one of the largest buyers of in-house diagnostics in the country, maybe the world. We're looking to develop our own strategy on our own in-house diagnostics. So I think that future's pretty good.

Robert Willoughby - Banc of America

And I would agree with you on the Diagnostics business. I mean, if the hospital trajectory is something other than temporary, why wouldn't investors be better served here with VCA just putting in a dividend policy here? I wonder if the returns there over the last year, and the coming year, might be a little bit higher with some sort of policy out there now.

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

I know you're asking, and it's hard to answer in an environment like this. But I'm watching the same news programs you are and we poll, as you well are aware... we poll our clients pretty frequently. And there's a sense out in this country right now with an election, with the banks, and the rest of it. I think we're pretty good holding our steady course. We feel little comfortable, and especially given the fact that all of our businesses are positive.

Tomas W. Fuller - Chief Financial Officer and Vice President

That's right. I just want to quickly add, our hospital acquisition plan is still very, very good. We're still paying a similar valuation we paid for 20 years. Hospitals have a similar margin we've seen for many, many years, so they all have positive return on investment, which is higher than our existing return on investment. So I'm not sure that the... receiving less bang for the buck is really totally true.

Particularly, we're acquiring 7, 8% of our revenue from... as always, from acquisitions on accretive and additive acquisitions. And we do have the planned capital to continue to buy them. I think our approach is that given this environment, we are still investing in our business, still buying hospitals, in which when we do see improvement in the economy and revenue starts to grow again. We have a much bigger base to grow from. So we're still very excited about buying hospitals they are still very additive and good return.

Robert Willoughby - Banc of America

Well, I guess, I'd leave it... certainly you've been pretty clear with the answers, but I mean, you are clearly diversifying more rapidly each year into the slower growth, lower profit, and more asset-intensive business. And ultimately that does dilute that Diagnostic franchise, which is a crown jewel here. And I'm just wondering if you did not do $100 million in deals a year, and paid out a special dividend, I would wonder if that stock is higher than it is currently.

Tomas W. Fuller - Chief Financial Officer and Vice President

The other part, if you look at... we have stepped out of the country and have opened up two, and shortly a third, location in Canada. So we're beginning to look outside the footprint.

Robert Willoughby - Banc of America

Okay. That's it, thank you.

Operator

And we'll take our next question from Rob Mains.

Robert Mains - Morgan Keegan

Hey, good afternoon. Looking at the fourth quarter, it'll be busy and we can interpolate from the guidance. Lapping... obviously, by the fourth quarter, you've lapped up pet food recall, as you did in the third quarter. You're kind of lapping the NVA and Vet Corp defection. You're starting to lap the slowdown in the economy. I was curious as to why that's going to be the quarter where it looks like, if I take the midpoint of your suggested guidance that you'd be down year-over-year. Is it because the margin impacts that you saw in the current quarter you see carrying forward in the next quarter, as this is on lower revenue basis, it's more exaggerated? Or is it because you're seeing some continued slowing in the revenue growth? I know you've kind of touched on this, but kind of putting it together, it doesn't sound like, given what you saw in the third quarter, that the fourth quarter should be a down one, year over year.

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

Well, the loss of clients will actually anniversary sometime in December, because while they began, the majority of the loss was probably felt towards the latter part of the first quarter, November/December, if I recall. I think we are seasoning. And I think we do just feel a little bit uncertain. I think, I answered a question before about the spikes up and down. But I feel pretty comfortable in what we put out.

Robert Mains - Morgan Keegan

So, I guess from a modeling perspective then you wouldn't be, particularly or internally, it sounds like you're saying that things... we shouldn't be looking for any particular improvement in the fourth quarter compared to the third.

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

I think that's accurate.

Robert Mains - Morgan Keegan

Okay. The losses... because it sounds like you said, couple hundred basis points, that would exactly be about $0.01 a share. Do the losses on the labs that you're opening in Canada, do they get bigger in the first quarter, because you're adding a third, or do they get smaller because the other ones just seasoned?

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

No, I think basically, between the amount of resources we put up there, opening, investing, developing the market... I think we're going to begin to see the benefits. I think we're seeing them right now. So I don't think that'll be a tremendous drag.

Robert Mains - Morgan Keegan

Okay. And then, when you talk about the acquisition environment, maybe a little bit slower in '09. Just curious about the feedback that there's some capital gains tax anticipation related to selling in '08 and you are not expecting, necessarily, that volume in '09. Is that... are you getting that from... in the marketplace, or is that just kind of anecdotally? I'm just curious where that thought comes from.

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

Well, the capital gains, I think, it's... all of us think of that. But in terms of Tom has answered Bob, in terms of the pipeline. We are going to see in the fourth quarter, we are seeing right now, we're closing deals ahead of the capital gains question. Whether or not the capital gains comes in January, I could ask you that question. But I think we've seen, towards the end of the year, an acceleration of trying to get it done, because it takes away the uncertainty for a seller who's selling to us.

In spite of that, I still think that there is a real good pipeline that's there, especially when you consider... when you're on the acquisitive side, you look for reasons. People's 401(k)s have gotten crushed, people's pensions have gotten crushed. And they're looking to secure their own futures. And those who have thought about selling, more and more have actually stepped up in the plate. And VCA has been a phenomenal acquirer because we have a staying power. And most of the sellers don't want to leave, they want to continue to work. So I think that's been another... and I think that will be a good incentive in 2009.

Robert Mains - Morgan Keegan

Okay. And last question for Tom, and you might not have this in front of you. Given the average interest rate that you incurred in the third quarter versus second?

Tomas W. Fuller - Chief Financial Officer and Vice President

I do not.

Robert Mains - Morgan Keegan

Okay, I'll call you later for that. Thank you.

Operator

And we'll go next to Mitra Ramgopal.

Mitra Ramgopal - Sidoti & Company

Yes. Hi, guys. My questions have pretty much been answered, but I'm just wondering if on the margin side, on animal hospital and lab, the same story that we've been seeing. If there's anything in particular you might be able to do to improve those or just do much of the deal with, given the over-all economy?

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

Well, let me be real clear. On the lab side, I think some of the drag on the lab side, which Tom mentioned were transportation, little bit of R&D, and some of the drag from the lab will improve by itself.

I also think that we will see, hopefully, continued cost reduction on the laboratory side because there is a program in place to reduce the expenses. So I would hope, there.

On the hospital side, much the same. I mean, the fall-off on the margin in the hospital side was small. And I think they've done a good job in containing their expenses with the hospital side. So I don't see it as a major hurdle.

I think the underlying issue that we're facing is revenue. In just the... as I mentioned earlier in the call, two out of the last three months were very good. And because we're a company that is very open in its presentation, we're a little bit uncertain in terms of the revenue. I think we're very, very good on the expense side and I think we're very focused, and we're getting better at it. But I think just the uncertainty of the revenue and the consumer right now is... makes it hard for us to forecast what'll happen. We think we have a real good handle on it, but we don't see the growth at 5% and 6% or 7% on the hospitals like we did a year ago. That's the concern on the guidance.

Mitra Ramgopal - Sidoti & Company

Okay, thanks again. And just Tom, one follow-up question on the credit facilities. How much do you have available, again, for acquisitions?

Tomas W. Fuller - Chief Financial Officer and Vice President

The credit facility's $75 million, we've drawn $35 million so there's $40 million still available. But again, we don't draw on that for acquisitions; we've virtually never drawn on the credit facility. We've always funded acquisitions through internally generated cash flow.

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

And we finished the quarter with about $95 million in cash.

Mitra Ramgopal - Sidoti & Company

Okay, so you don't anticipate any real difficulty if you should need additional capital in terms of being able to go to the bank.

Tomas W. Fuller - Chief Financial Officer and Vice President

No.

Mitra Ramgopal - Sidoti & Company

Okay

Tomas W. Fuller - Chief Financial Officer and Vice President

And fortunately we have enough cash flow for all the opportunities we have, and some.

Mitra Ramgopal - Sidoti & Company

Okay. Thanks.

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

Jennifer?

Operator

Yes we will take a follow-up from Mark Arnold.

Mark Arnold - Piper Jaffray

Thank you, guys. I just had one last question. On the debt, can you guys give us a sense as to when your tranches have reset or are going to reset on your senior debt? And how you're managing that in terms of LIBOR rates? Or are you using your alternative option based off of prime? Can you just give us a sense as to how you guys are managing that?

Tomas W. Fuller - Chief Financial Officer and Vice President

The tranches on the swaps?

Mark Arnold - Piper Jaffray

No, just the tranches on your debt. And I know you guys have an alternative base-rate option to price the interest rates when those things come due at a spread-over-prime versus a spread-over-LIBOR. And I'm just curious if you've had any of those tranches on your term loan come due over the last month, when LIBOR has spiked, and kind of how you guys are managing refinancing?

Tomas W. Fuller - Chief Financial Officer and Vice President

The floating piece... the swap piece are fixed through the middle of 2009 into 2010. The floating piece resets monthly. So with simple [ph] that LIBOR spike, we lived [ph] with that for a month. But we do watch the difference in LIBOR versus the prime and make adjustments accordingly, but right now we're all LIBOR.

Mark Arnold - Piper Jaffray

Okay thank you.

Tomas W. Fuller - Chief Financial Officer and Vice President

It's coming down, obviously.

Operator

And that does conclude the question-and-answer session today. At this time, Mr. Antin, I will turn the conference back over to you for any additional or closing remarks.

Bob L. Antin - Co-Founder, Chief Executive Officer, President and Chairman

Thank you very much. At the sake of being redundant, I want to be real clear. We have three business segments and all three of them are positive. We are vigilant in maintaining control over the expenses of the company. And probably more important in this environment, people are still looking to their animals as part of their family and are spending money. And we see it in other sectors, complementary sectors, as well.

So I think we're still in a great place. We're the leader in our profession and in our industry and while we did provide the guidance because of the lack of clear visibility in the fourth quarter, it is a conservative approach to looking at our business. But the one thing we can't forecast is what's going on in these times. We don't view this as a recession. We view this as an incredible disturbance in the marketplace, which likes... which we haven't seen. But in spite of all that, our business is still growing and it grew at a record pace on an earnings basis and on a revenue basis.

So I'd like to thank you. The management of the company feels incredibly confident about what we do, and in the future of the company. So thank you very much. Good bye.

Operator

Ladies and gentlemen, this does conclude today's presentation. We thank you for your participation. You may now disconnect .

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Source: VCA Antech Inc. Q3 2008 Earnings Conference Call Transcript
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