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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

For the quarterly period ended June 30, 2010

OR

For the transition period from               to          

Commission File Number:  000-51468

MWI VETERINARY SUPPLY, INC.

(Exact name of registrant as specified in its Charter)

(208) 955-8930

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

The number of shares of the registrant’s common stock, $0.01 par value, outstanding as of July 26, 2010 was 12,339,353.

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MWI VETERINARY SUPPLY, INC.

INDEX

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PART I.  FINANCIAL INFORMATION

Item 1.    Financial Statements

MWI VETERINARY SUPPLY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

Dollars and shares in thousands, except per share data

(unaudited)

See Notes to Condensed Consolidated Financial Statements.

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MWI VETERINARY SUPPLY, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

Dollars and shares in thousands, except per share data

(unaudited)

See Notes to Condensed Consolidated Financial Statements.

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MWI VETERINARY SUPPLY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Dollars in thousands (unaudited)

See Notes to Condensed Consolidated Financial Statements.

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MWI VETERINARY SUPPLY, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Dollars in thousands, except per share data
(unaudited)

NOTE 1 — GENERAL

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the results of operations, financial position and cash flows of MWI Veterinary Supply, Inc. and its wholly-owned subsidiaries (collectively referred to as “we,” “us,” and “our” throughout this Form 10-Q).  All material intercompany balances have been eliminated.

In the opinion of our management, the accompanying unaudited condensed consolidated financial statements include all adjustments necessary to present fairly, in all material respects, our results for the periods presented. These condensed consolidated financial statements have been prepared by us pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations.  These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in our 2009 Annual Report on Form 10-K filed with the SEC on November 20, 2009.  The results of operations for the three and nine months ended June 30, 2010 are not necessarily indicative of results to be expected for the entire fiscal year.

Our unaudited condensed consolidated balance sheet as of September 30, 2009 has been derived from the audited consolidated balance sheet as of that date.

Use of Estimates

The accompanying unaudited condensed consolidated financial statements have been prepared on the accrual basis of accounting using accounting principles generally accepted in the United States. In preparing financial information, we use certain estimates and assumptions that may affect the reported amounts and disclosures. Some of these estimates require difficult, subjective and complex judgments about matters that are inherently uncertain. As a result, actual results could differ materially from these estimates. Estimates are used when accounting for, among other items, sales returns, allowance for doubtful accounts, customer incentives, vendor rebates, inventories, goodwill and intangible assets, income taxes, impairment of long-lived assets, depreciation and amortization, employee benefits, unearned income and contingencies. The estimates of fair value of assets and liabilities and the disclosure of contingent assets and liabilities as of the balance sheet date and reported amounts of revenue and expenses for the periods are based on assumptions that we believe to be reasonable.

Revenue Recognition

We sell products we source from vendors to our customers through either a “buy/sell” transaction or an agency relationship with our vendors. In a “buy/sell” transaction, we purchase or take inventory of products from the vendor. When a customer places an order with us, we pick, pack, ship and invoice the customer for the order. We recognize revenue from “buy/sell” transactions as product sales when the product is delivered to the customer. We accept product returns from our customers. We estimate returns based on historical experience and recognize these estimated returns as a reduction of product sales. Product returns have historically not been significant to our financial statements. We record revenues net of sales tax.  In an agency relationship, we generally do not purchase and take inventory of products from vendors. We receive an order from a customer, then transmit the order to the vendor, who picks, packs and ships the order to the customer. In some cases, the vendor invoices and collects payment from the customer, while in other cases we invoice and collect payment from the customer on behalf of the vendor. We receive a commission payment for soliciting the order from the customer and for providing other customer service activities. Commissions are recognized when the services upon which the commissions are based are complete. Gross billings from agency contracts were $92,504 and $72,960 for the three months ended June 30, 2010 and 2009, respectively, and generated commission revenue of $4,332 and $3,645, respectively.  Gross billings from agency contracts were $234,788 and $196,097 for the nine months ended June 30, 2010 and 2009, respectively, and generated commission revenue of $12,094 and $10,273, respectively.

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Cost of Product Sales and Vendor Rebates

Cost of product sales consist of our inventory product cost, including shipping and delivery costs to and from our distribution centers.  Vendor rebates are recorded based on the terms of the contracts or programs with each vendor.  Many of our vendors’ rebate programs are based on a calendar year.  We may receive quarterly, semi-annual or annual performance-based rebates from third-party vendors based upon attainment of certain sales and/or purchase goals. Sales rebates are classified in the accompanying condensed consolidated statements of income as a reduction to cost of product sales at the time the sales performance measures are achieved. Purchase rebates are measured against inventory purchases from the vendors and are classified as a reduction of inventory until the product is sold. When the inventory is sold and purchase measures are achieved, purchase rebates are recognized as a reduction to cost of product sales.

Historically, actual results have not significantly deviated from those determined using the estimates described above. We expect that our estimates in the future will continue to be reasonable as our rebates are based on specific vendor program goals and are principally recorded upon achievement of sales or purchase performance measures. Vendors may change or eliminate rebate programs from year to year.

NOTE 2 — EFFECT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In June 2009, the Financial Accounting Standards Board issued authoritative guidance that amends the consolidation guidance applicable to variable interest entities and requires additional disclosures concerning an enterprise’s continuing involvement with variable interest entities. The guidance is effective for our fiscal year beginning October 1, 2010. We are currently evaluating the expected impact, if any, that this standard will have on our consolidated financial statements.

NOTE 3 — BUSINESS ACQUISITION

On February 8, 2010, MWI Veterinary Supply Co. (“MWI Co.”) purchased all of the outstanding share capital of Centaur Services Limited (“Centaur”), based in the United Kingdom for an initial purchase price of $44,053, consisting of $42,053 in cash and $2,000 in a note payable due in one year.  Subsequent to the acquisition of Centaur, we funded $2,047 to the pension plan as required by the terms of the share purchase agreement.  The purchase price was reduced during the three months ended June 30, 2010 by $1,868 as a result of a post-closing working capital and debt adjustment.  Centaur is a supplier of animal health products to veterinarians in the United Kingdom.  Centaur sells products to both the companion animal market and production animal market.  The acquisition of Centaur has allowed us to expand into the international markets.  We incurred $1,100 of direct acquisition-related expenses.  The intangible assets acquired in the acquisition have estimated useful lives between 1 and 20 years.  The amount recorded in goodwill will not be deductible for tax purposes.

The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of acquisition, which may be adjusted during the allocation period as defined in ASC 280.  These purchase price allocations are based on a combination of valuations and analyses.

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The following table presents information for Centaur that is included in our condensed consolidated statements of income from the acquisition date of February 8, 2010 through the three and nine months ended June 30, 2010:

The following table presents supplemental pro forma information as if the acquisition of Centaur had occurred on October 1, 2009 for the periods ended June 30, 2010 and on October 1, 2008 for the periods ended June 30, 2009 (unaudited):

For the pro forma calculation, we used an average foreign currency exchange rate for each of the periods presented and the annual net income as a percentage of revenues for purposes of determining the net income for interim periods.  The unaudited pro forma consolidated results are not necessarily indicative of what our consolidated results of operations would have been had we completed the acquisition on October 1, 2009 and on October 1, 2008.  Additionally, the unaudited pro forma consolidated results do not purport to project the future results of operations of the combined company.

NOTE 4 — RECEIVABLES

Product sales resulting from transactions with Banfield, The Pet Hospital (“Banfield”) were approximately 9% and 12% of total product sales during the three months ended June 30, 2010 and 2009, respectively. Product sales resulting from transactions with Banfield were approximately 10% of total product sales during each of the nine months ended June 30, 2010 and 2009.  Approximately 13% of our trade receivables resulted from transactions with Banfield as of June 30, 2010 and September 30, 2009.

NOTE 5 — PROPERTY AND EQUIPMENT

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Depreciation expense was $1,046 and $640 for the three months ended June 30, 2010 and 2009, respectively.  Depreciation expense was $2,659 and $1,931 for the nine months ended June 30, 2010 and 2009, respectively.

NOTE 6 — GOODWILL AND INTANGIBLES

The changes in the carrying value of goodwill for the nine months ended June 30, 2010 are as follows:

Balances of other intangible assets excluding goodwill are as follows:

Amortization expense was $395 and $207 for the three months ended June 30, 2010 and 2009, respectively.  Amortization expense was $909 and $624 for the nine months ended June 30, 2010 and 2009, respectively.  Estimated future annual amortization expense related to intangible assets as of June 30, 2010 follows:

The above projection of amortization expense includes preliminary estimates of intangible assets and lives associated with the acquisition of Centaur.  These amounts may be adjusted during the allocation period as defined in ASC 805.

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NOTE 7 — CREDIT FACILITY AND LONG-TERM DEBT

The following table presents the outstanding debt and capital lease obligations as of June 30, 2010:

(1) Note payable is related to the acquisition of Centaur and is due one year from the date of the acquisition, which was February 8, 2010.

(2) Term note and capital lease obligations were assumed as a result of the acquisition of Centaur.  The term note matures in March 2011 and the capital lease obligations have varying maturity dates.

Revolving credit facility—On February 8, 2010, MWI Co., our wholly-owned subsidiary as borrower, entered into a First Amendment to its Credit Agreement (the “First Amendment”) with us and Memorial Pet Care, Inc., as guarantors, and Bank of America, N.A. and Wells Fargo Bank, N.A., (collectively, the “lenders”) amending the Credit Agreement dated December 13, 2006 among MWI Co., MWI Veterinary Supply, Inc., Memorial Pet Care, Inc. and the lenders a party thereto (the “facility”).  The First Amendment increased the aggregate revolving commitment of the lenders under the facility from $70,000 to $100,000.  The First Amendment also extended the maturity date of the loans under the facility from December 1, 2011 to March 1, 2013.  The variable interest rate is now equal to the Daily LIBOR Floating Rate or the LIBOR 1-month fixed rate (at MWI Co.’s option) plus a margin ranging from 1.75% to 2.50%, which was previously 0.7% to 1.25% under the facility prior to the First Amendment.  The lenders also receive an unused line fee and letter of credit fee which is now equal to 0.2% of the unused amount of the facility, which was previously 0.125%. Our outstanding balance on the facility was $13,400 and $0 at June 30, 2010 and September 30, 2009, respectively, and the interest rate for the facility was 2.06% as of June 30, 2010.    The facility contains financial covenants, including a fixed charge ratio and a funded debt to EBITDA calculation.  We were in compliance with both of these covenants as of June 30, 2010.

Fortis credit facility—Centaur operates with a credit facility (“Fortis facility”) with Fortis Bank as the lender.  The Centaur facility allows for borrowings in the aggregate of £12,000.  The Fortis facility has a variable interest rate equal to a base rate of 0.50% plus GBP one-month LIBOR plus a margin of 0.85%.  It is our intent to replace the Fortis facility within the next six months.  The outstanding balance at June 30, 2010 on the Fortis facility was £1,649, or $2,485 using the exchange rate on June 30, 2010.  The interest rate for the Fortis facility was 1.90% as of June 30, 2010.

NOTE 8 — FAIR VALUE OF FINANCIAL INSTRUMENTS

Current fair value accounting guidance includes a hierarchy that is intended to increase consistency and comparability in fair value measurements and disclosures.  This hierarchy prioritizes inputs to valuation techniques based on observable and unobservable data.  The guidance categorizes these inputs used in measuring fair value into three levels which include the following:

·                  Level 1 — observable inputs such as quoted prices in active markets;

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

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

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For certain of our financial instruments, including cash and cash equivalents, receivables and accounts payable, the fair values approximate book values due to their short maturities.

In February 2010, we amended our facility.  Because this amendment was done in the quarter ended March 31, 2010 and includes interest rates based on current market conditions, we believe that the estimated fair value of our long-term debt (including current maturities) was materially the same as our carrying value.

We have been reviewing market prices related to the refinance of the Fortis credit facility.  Based on this pricing, we believe that the estimated fair value  for the Fortis credit facility was materially the same as our carrying value.

NOTE 9 — COMMON STOCK AND STOCK-BASED AWARDS

2002 Stock Plan

We have a 2002 Stock Plan (the “2002 Plan”) to provide our directors, executives and other key employees with additional incentives by allowing them to acquire an ownership interest in us and, as a result, encouraging them to contribute to our success. As of June 30, 2010 and 2009, we had 244,304 and 402,220 shares, respectively, of our common stock available for issuance under the 2002 Plan. The options granted under the 2002 Plan are nonqualified stock options that have an exercise price per share equal to fair market value of the common stock at the time of grant. The term of each option is determined by our board of directors or by a designated committee of the board.  The term of any option may not exceed ten years from the date of grant.  As of June 30, 2010, 183,864 options to purchase common stock were outstanding with a weighted average exercise price of $0.18 per share and expiring through June 2012.

2005 Stock Plan

In July 2005, we adopted the 2005 Stock-Based Award and Incentive Compensation Plan (the “2005 Plan”). Under the 2005 Plan as amended, we may offer restricted and unrestricted shares of our common stock and grant options to purchase shares of our common stock to selected employees and non-employee directors. The purpose of the 2005 Plan is to promote our long-term financial success by attracting, retaining and rewarding eligible participants. As of June 30, 2010 and 2009 we had 1,038,852 and 1,081,404 shares, respectively, of our common stock available for issuance under the 2005 Plan. As of June 30, 2010, 36,578 options to purchase common stock were outstanding with a weighted average exercise price of $17.88 per share and expiring through September 2015.

The 2005 Plan permits us to grant stock options (both incentive stock options and non-qualified stock options), restricted  and unrestricted stock and deferred stock. The compensation committee will determine the number and type of stock-based awards to each participant, the exercise price of each award, the duration of the award (not to exceed ten years), vesting provisions and all other terms and conditions of such award in individual award agreements. The 2005 Plan provides that upon termination of employment with us, unless determined otherwise by the compensation committee at the time options are granted, the exercise period for vested awards will generally be limited, provided that vested awards will be canceled immediately upon a termination for cause or voluntary termination. The 2005 Plan provides for the cancellation of all unvested awards upon termination of employment with us, unless determined otherwise by the compensation committee at the time awards are granted.

We granted no common stock options during each of the nine months ended June 30, 2010 and 2009.  During the nine months ended June 30, 2010 and 2009, we issued 2,000 and 0 shares of restricted stock under the 2005 Plan.  We also granted 6,000 and 0 of unrestricted stock to non-employee directors during the nine months ended June 30, 2010 and 2009, respectively.  During the three months ended June 30, 2010 and 2009, we recognized $98 and $86 of compensation expense related to stock grants, respectively.  During the nine months ended June 30, 2010 and 2009, we recognized $528 and $265 of compensation expense related to stock grants, respectively.

We also have an employee stock purchase plan (“ESPP”) that allows substantially all employees to purchase shares of our common stock at 95% of the fair market value on the date of purchase.  The purchase date is the last trading date of the purchase periods, which begin in March, June, September and December.  Employees accumulate amounts through payroll deductions during the purchase period of between 1% and 10% but no more than $20 annually.  An employee is allowed to purchase a maximum of 200 shares per purchase period.  During the three months ended June 30, 2010 and 2009, we issued 1,408 and 2,211 shares, respectively, of our common stock under the ESPP.  During the nine months ended June 30, 2010 and 2009, we issued 4,454 and 7,537 shares, respectively, of our common stock under the ESPP.  As of June 30, 2010, there were 484,977 shares available to be issued under the ESPP.

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NOTE 10 — EMPLOYEE BENEFIT PLANS

As a result of the acquisition of Centaur, we assumed a defined benefit pension plan for United Kingdom employees.  This plan was frozen prior to the acquisition of Centaur to future participants.  We recorded the liability at the estimated fair value at the date of the acquisition.  Subsequent to the acquisition of Centaur, we funded $2,047 to the pension plan as required by the terms of the share purchase agreement.  The liability recorded as of June 30, 2010 was £741, or $1,117 using the exchange rate on June 30, 2010.

NOTE 11 — INCOME TAXES

Our effective tax rate for the three months ended June 30, 2010 and 2009 was 39.1% and 39.9%, respectively.  Our effective tax rate for the nine months ended June 30, 2010 and 2009 was 39.2% and 39.3%, respectively.  The decrease in the effective tax rate is primarily due to the impact of the Centaur acquisition.

As of June 30, 2010, we had $205 of unrecognized tax benefits, of which $15 would impact our effective rate if recognized. Our policy for classifying interest and penalties associated with unrecognized tax benefits is to include such items in income tax expense.  The amount of interest and penalties recognized during the three and nine months ended June 30, 2010 and 2009 was not material.

We filed Form 3115 Application of Change in Accounting Method with the Internal Revenue Service during the fiscal year ended September 30, 2008.  We filed an advance consent request for a non-automatic account method change for tax purposes for which we had not received approval prior to our reporting period end.  The method change will make revenue recognition for tax purposes the same as revenue recognized for book purposes. We expect resolution within the next twelve months, which would decrease the liability for unrecognized tax benefits by approximately $182.

With few exceptions, we are no longer subject to income tax examination for years before 2004 in the U.S. and significant state and local jurisdictions.  We are no longer subject to income tax examination for years before 2008 in significant foreign jurisdictions.

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NOTE 12 — COMPUTATION OF EARNINGS PER SHARE (In thousands, except per share data)

NOTE 13 — RELATED PARTIES

MWI Co. holds a 50.0% membership interest in Feeders’ Advantage LLC (“Feeders’ Advantage”).  MWI Co. charged Feeders’ Advantage for certain operating and administrative services in the amounts of $172 and $189 for the three months ended June 30, 2010 and 2009, respectively, and $563 and $562 for the nine months ended June 30, 2010 and 2009, respectively.  Sales of products to Feeders’ Advantage were $9,113 and $12,075 for the three months ended June 30, 2010 and 2009, respectively, which represented 3% and 5% of total product sales for the three months ended June 30, 2010 and 2009, respectively.  Sales of products to Feeders’ Advantage were $30,687 and $35,542 for the nine months ended June 30, 2010 and 2009, respectively, which represented 4% and 5% of total product sales for the nine months ended June 30, 2010 and 2009, respectively.

MWI Co. provides Feeders’ Advantage with a line-of-credit to finance its day-to-day operations. This line-of-credit bears interest at the prime rate. The interest due on the line-of-credit is calculated and charged to Feeders’ Advantage on the last day of each month. Conversely, to the extent MWI Co. has a payable balance due to Feeders’ Advantage, the payable balance accrues interest in favor of Feeders’ Advantage at the average federal funds rates in effect for that month. MWI Co. had a payable balance to Feeders’ Advantage of $1,567 and $210 as of June 30, 2010 and September 30, 2009, respectively.

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NOTE 14 —  STATEMENTS OF CASH FLOWS — SUPPLEMENTAL AND NON-CASH DISCLOSURES

Restatement of Statements of Cash Flows — We have restated the presentation of borrowings on the credit facility for the nine months ended June 30, 2009. Related amounts had previously been presented on a net basis, rather than on a gross basis in accordance with ASC 230. The correction had no effect on net cash used in financing activities.

NOTE 15 — COMMITMENTS AND CONTINGENCIES

From time to time, in the normal course of business, we may become a party to legal proceedings that may have an adverse effect on our financial position, results of operations and cash flows. At June 30, 2010, we were not a party to any material pending legal proceedings and were not aware of any claims that could have a material adverse effect on our financial position, results of operations or cash flows.

NOTE 16 — OTHER COMPREHENSIVE INCOME

The components of comprehensive income (loss) were as follows:

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

MWI Veterinary Supply, Inc.

Meridian, Idaho

We have reviewed the accompanying condensed consolidated balance sheet of MWI Veterinary Supply, Inc. and subsidiaries (the “Corporation”) as of June 30, 2010, and the related condensed consolidated statements of income for the three-month and nine-month periods ended June 30, 2010 and 2009, and of cash flows for the nine-month periods ended June 30, 2010 and 2009. These interim financial statements are the responsibility of the Corporation’s management.

We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of MWI Veterinary Supply, Inc. and subsidiaries as of September 30, 2009, and the related consolidated statements of income, stockholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated November 20, 2009, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of September 30, 2009 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ DELOITTE & TOUCHE LLP

Boise, Idaho

July 29, 2010

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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

All dollar amounts are presented in thousands, except for per share amounts.

Overview

We are a distributor of animal health products to veterinarians across the United States and in the United Kingdom. We market our products to veterinarians in both the companion and production animal markets. Our growth has primarily been from internal growth initiatives and, to a lesser extent, selective acquisitions.  On February 8, 2010, we acquired the outstanding share capital of Centaur Services Limited (“Centaur”), which is a supplier of animal health products in the United Kingdom.  We operate under a single reporting segment.

Historically, we estimate that approximately two-thirds of our revenues have been generated from sales to the companion animal market and one-third from sales to the production animal market. The state of the overall economy and consumer spending have impacted both markets, with tightening credit markets, volatile commodity prices in milk, grain, corn and feeder cattle, and changes in weather patterns also affecting demand in the production animal market.  Both markets have been integral to our financial results and we intend to continue supporting both markets.

Industry

We believe that the companion animal market has slowed as a result of a decrease in consumer spending.  Historically, growth in the companion animal market has been due to the increasing number of households with companion animals, increased expenditures on animal health and preventative care, an aging pet population, advancements in pharmaceuticals and diagnostic testing and extensive marketing programs sponsored by companion animal nutrition and pharmaceutical companies. While the average order size for companion animal health products is often smaller than production animal health products, companion animal health products typically have higher margins. We intend to continue to penetrate this market through internal growth initiatives and selective acquisitions.

Product sales in the production animal market have been negatively impacted by volatility in commodity prices such as milk, corn, grain and feeder cattle, changes in weather patterns that allow cattle to graze for longer periods and changes in the general economy.  Milk price declines in the dairy market over the last two years have had a significant impact on dairy farmers.  This has created cash-flow challenges for these farmers and in turn, has impacted the time it takes for us to collect our outstanding accounts receivable from these customers.  However, we still believe that it is important to our business to service this market and we intend to continue to support production animal veterinarians with a broad range of products and value-added services. Historically, sales in this market have been largely driven by spending on animal health products to improve productivity, weight gain and disease prevention, as well as a growing focus on food safety.

We generally extend some level of credit to our customers without requiring collateral, which exposes us to credit risk.  If customers’ cash flow or operating and financial performance deteriorates, or if they are unable to make scheduled payments or obtain other sources of credit, they may not be able to pay or may delay payment to us, or in some cases may return products to us. We continually assess our customers’ ability to pay us and adjust our allowance for doubtful accounts, as necessary.

Our quarterly sales and operating results have varied significantly in the past, and will likely continue to do so in the future. Historically, our total revenues have typically been higher during the spring and fall months due to increased sales of production animal products. Product use cycles for production animal products are directly related to medical procedures performed by veterinarians on production animals during the spring and fall months. These buying patterns can also be affected by the marketing programs or price increase announcements of vendors and distributors, which can cause veterinarians to purchase production animal health products earlier than those products are needed. This kind of early purchasing may reduce our sales in the months these purchases would have otherwise been made.

Sales

We sell products that we source from our vendors to our customers through either a “buy/sell” transaction or an agency relationship with our vendors. In a “buy/sell” transaction, we purchase or take inventory of products from our vendors. When a customer places an order with us, we pick, pack, ship and invoice the customer for the order. We record sales from “buy/sell” transactions, which account for the vast majority of our business, as revenues in conformity with generally accepted accounting principles in the United States. In an agency relationship, we generally do not purchase and take inventory of products from our vendors. When we receive an order from our customer, we transmit the order to our vendor,

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who picks, packs and ships the order to our customer. In some cases, our vendor invoices and collects payment from our customer, while in other cases we invoice and collect payment from our customer on behalf of our vendor. We receive a commission payment for soliciting the order from our customer and for providing other customer service activities. The aggregate revenues we receive in agency transactions constitute the “commissions” line item on our consolidated statements of income and are recorded in conformity with accounting principles generally accepted in the United States. Our vendors determine the method we use to sell our products. Historically, vendors have occasionally switched between the “buy/sell” and agency models for particular products in response to market conditions related to that particular product. A switch between models can impact our revenues and our operating income. We cannot know in advance when a vendor will switch between the “buy/sell” and agency models or what impact, if any, such a change may have. A switch can occur even with vendors with whom we have written agreements because most of our agreements with vendors have relatively short terms and are terminable with or without cause on short notice, normally 30 to 90 days. The impact of any individual change from a “buy/sell” to an agency model depends on the costs and expenses associated with a particular product, and can have either a positive or a negative effect on our profitability.

Historically, our contract with Merial to sell their flea, tick and heartworm products included an exclusivity requirement.  This requirement did not permit us to sell or distribute other competing flea, tick and heartworm products.  For calendar year 2010, we agreed with Merial to begin a non-exclusive arrangement where we are permitted to sell and distribute other competing products.  Some of these competing products will be sold under buy-sell arrangements, while others will be sold under agency arrangements.  Merial’s flea, tick and heartworm products are primarily sold under an agency arrangement.  This addition of buy-sell arrangements for certain flea, tick and heartworm products will have an impact on how our revenues are reported, since under agency sales, only commissions are reported as revenues, while for buy-sell products the total sale price of the product is reported as revenue.

Vendor Consolidation

On October 15, 2009, Pfizer completed its acquisition of Wyeth.  Prior to this acquisition, Pfizer and Fort Dodge, a division of Wyeth, were our two largest vendors as measured by our revenues.  In connection with this acquisition, Pfizer divested certain animal health products to Boehringer Ingelheim.  Fort Dodge supplied products that accounted for approximately 11% of our revenues for fiscal year 2009.  Of this amount, based on information received from the Federal Trade Commission, Pfizer and Boehringer Ingelheim, we estimate that approximately 43% of such revenues were attributable to products now owned by Pfizer and approximately 57% of such revenues were attributable to products now owned by Boehringer Ingelheim.  We have received contracts for calendar year 2010 from these vendors.  Based on these contracts, we do not believe that these changes described will have a material impact on our results for fiscal year 2010.

On November 3, 2009, Merck and Schering-Plough completed their merger under which Merck acquired all of the outstanding stock of Schering-Plough.  Merial was a joint venture between Merck and Sanofi-Aventis, and Sanofi-Aventis acquired Merck’s interest in Merial shortly before Merck and Schering-Plough completed their merger.  Merck has announced that Sanofi-Aventis has an option to combine the Intervet/Schering-Plough Animal Health business with Merial to form an animal health joint venture that would be equally owned by the new Merck and Sanofi-Aventis.  On March 9, 2010, Sanofi-Aventis and Merck announced that Sanofi-Aventis exercised its option to combine Merial with Intervet/Schering-Plough, Merck’s animal health business.  The completion of the transaction is expected to occur in the next twelve months.  Merial and Intervet-Schering are also two of our larger vendors.  We have received contracts for calendar year 2010 from these vendors.  Based on these contracts, we do not believe that these changes described will have a material impact on our results for fiscal year 2010.

The surviving companies from these transactions will have high market shares with respect to certain animal health products, and they could use their increased leverage in the channel to negotiate terms with distributors that are materially worse to the distributor than the terms that we have been able to negotiate with Pfizer, Fort Dodge, Boehringer Ingelheim, Merial and Intervet-Schering individually while they were competing with each other. There also remains uncertainty related to any changes to the terms that may be included in the vendor contracts we negotiate for the upcoming year as a result of these transactions.  There is also a possibility of product disruption as these companies integrate their operations which could adversely impact our financial results.  Further consolidation among animal health product vendors could result in our vendors further increasing their market share, which could give vendors greater pricing power and make it easier for such vendors to sell their products directly to animal health customers, both of which could decrease our net sales and profitability.

Our top ten vendors supplied products that accounted for approximately 68% and 74% of our revenues for the nine months ended June 30, 2010 and 2009, respectively, and 74% of our revenues for the fiscal year ended September 30, 2009.  Pfizer supplied products that accounted for approximately 25% and 24% of our revenues during the nine months ended June 30,

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2010 and 2009, respectively, and  24% of our revenues for our fiscal year ended September 30, 2009.  Of the Pfizer supplied products, production animal products under a livestock agreement accounted for approximately 11% and 14% of our revenues during the nine months ended June 30, 2010 and 2009, respectively, and approximately 14% of our revenues for our fiscal year ended September 30, 2009.  Fort Dodge supplied products that accounted for 11% of our revenues during the nine months ended June 30, 2009, and 11% of our revenues for our fiscal year ended September 30, 2009.  Intervet-Schering, a subsidiary of Schering Plough, supplied products that accounted for approximately 10% and 11% of our revenues during the nine months ended June 30, 2010 and 2009, respectively, and 11% of our revenues for our fiscal year ended September 30, 2009.  Boehringer Ingelheim supplied products that accounted for approximately 10% and 4% of our revenues during the nine months ended June 30, 2010 and 2009, respectively, and 4% of our revenues for our fiscal year ended September 30, 2009.  Merial, a subsidiary of Sanofi-Aventis,  supplies the majority of their products to us under an agency relationship.  Commission revenue generated from Merial products accounted for approximately 50% and 55% of total commission revenues for each of the nine months ended June 30, 2010 and 2009, and 56% of total commission revenues for our fiscal year ended September 30, 2009.

Vendor Rebates

We typically renegotiate vendor contracts annually.  These vendor contracts may include terms defining rebates, commissions and exclusivity requirements. Vendor rebates based on sales are classified in our accompanying consolidated statements of income as a reduction to cost of product sales at the time the sales performance measures are achieved.  Purchase rebates are measured against inventory purchases from the vendors and are a reduction of inventory until the product is sold.  When the inventory is sold, purchase rebates are recognized as a reduction to cost of product sales. Many of our vendors’ rebate programs are based on a calendar year.

Acquisitions

In February 2010, we acquired the outstanding share capital of Centaur.  Based in Castle Cary, England, Centaur is a supplier of animal health products to veterinarians in the United Kingdom.  Centaur sells products to both the companion animal market and production animal market.

In July 2008, we acquired substantially all of the assets of AAHA MARKETLink.  Based near Denver, Colorado, AAHA MARKETLink was a distributor of animal health products to members of American Animal Hospital Association.

For more information on our business, see our Annual Report on Form 10-K filed with the SEC on November 20, 2009.

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Results of Operations

The following table summarizes our results of operations for the three and nine months ended June 30, 2010 and 2009, in dollars and as a percentage of total revenues.