Annual Report

Item 1A.

Risk Factors.

 

In addition to the factors discussed elsewhere in this Form 10-K, the following are important factors which could cause actual results or events to differ materially from those contained in any forward-looking statements made by or on behalf of the Company.

 

Our operating results may fluctuate due to factors outside of management’s control.

 

Our future revenues and results of operations may significantly fluctuate due to a combination of factors, many of which are outside of management’s control. The most notable of these factors include:

 

·	the impact of vendor consolidation on our business;

 

·	changes in or availability of vendor contracts or rebate programs;

 

·	transitional challenges associated with acquisitions, including the failure to achieve anticipated synergies;

 

·	vendor rebates based upon attaining certain growth goals;

 

·	changes in the way vendors introduce/deliver products to market;

 

·	exclusivity requirements with certain vendors that may prohibit us from distributing competing products manufactured by other vendors;

 

·	risks associated with our international operations;

 

·	financial risks associated with acquisitions;

 

·	the impact of general economic trends on our business;

 

·	the recall of a significant product by one of our vendors;

 

·	extended shortage or backorder of a significant product by one of our vendors;

 

·	seasonality;

 

·	the timing and effectiveness of marketing programs or price changes offered by our vendors;

 

·	the timing of the introduction of new products and services by our vendors;

 

·	our intellectual property rights may be inadequate to protect our business;

 

·	the ability to borrow on our revolving credit facility, extend the terms of our revolving credit facility or obtain alternative financing on favorable terms or at all;

 

·	risks from potential increases in variable interest rates;

 

·	the impact of tightening credit standards and/or access to credit on behalf of our customers and suppliers;

 

·	unforeseen litigation;

 

·	a disruption caused by adverse weather or other natural conditions;

 

·	inability to ship products to the customer as a result of technological or shipping disruptions; and

 

·	competition.

 

These factors could adversely impact our results of operations and financial condition. We may be unable to reduce operating expenses quickly enough to offset any unexpected shortfall in revenues or gross profit. If we have a shortfall in revenues or gross profit without a corresponding reduction to expenses, operating results may suffer. Our operating results for any particular fiscal year or quarter may not be indicative of future operating results. You should not rely on year-to-year or quarter-to-quarter comparisons of results of operations as an indication of our future performance.

 

Consolidation among our vendors could be harmful to our business.

 

In the past two years, there have been two large acquisitions affecting our largest vendors.  In October 2009, Pfizer completed its acquisition of Wyeth.  Pfizer and Fort Dodge, a division of Wyeth, were our two largest vendors as measured by our revenues at the time of that acquisition.  In November 2009, Merck and Schering-Plough completed their merger under which Merck acquired all of the outstanding stock of Schering-Plough. These were two of our largest vendors at the time of the merger.  Additionally, on July 7, 2011, Pfizer, who is our largest vendor as measured by our revenues, issued a press release stating that they were considering a spin-off, sale or other transaction of their animal health business.

 

The surviving companies from these types of transactions could end up with higher 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 the companies individually while they were competing with each other. 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 products 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 business, financial condition and results of operations depend upon maintaining our relationships with vendors.

 

     We currently do not manufacture the vast majority of our products and are dependent on our vendors for our supply of products. Our ten largest vendors supplied products that accounted for approximately 71%, 71% and 74% of our revenues for the fiscal years ended September 30, 2011, 2010 and 2009, respectively. Pfizer supplied products that accounted for approximately 24%, 25% and 24% of our revenues for our fiscal years ended September 30, 2011, 2010 and 2009, respectively. Of the Pfizer supplied products, production animal products under a livestock agreement accounted for approximately 13%, 12% and 14% of our revenues for our fiscal years ended September 30, 2011, 2010 and 2009, respectively.  Merck, formerly known as Intervet/Schering-Plough, supplied products that accounted for approximately 11%, 10% and 11% of our revenues for our fiscal years ended September 30, 2011, 2010 and 2009, respectively.  Boehringer supplied products that accounted for approximately 9%, 10% and 4% of our revenues for our fiscal years ended September 30, 2011, 2010 and 2009, respectively. Merial, a subsidiary of Sanofi-Aventis, supplies the majority of their products under an agency relationship.  Commission revenue generated from Merial products accounted for approximately 47%, 49% and 56% of total commission revenues for our fiscal years ended September 30, 2011, 2010 and 2009, respectively.

 

Our ability to sustain our gross profits has been, and will continue to be, dependent in part upon our ability to obtain favorable terms and access to new and existing products from our vendors. These terms may be subject to changes from time to time by vendors, such as changing from a “buy/sell” to an agency relationship, or from an agency to a “buy/sell” relationship which could adversely affect our revenues and operating income. The loss of one or more of our large vendors, a material reduction in their supply of products to us or material changes in the terms we obtain from them could have a material adverse effect on our business, financial condition and results of operations.

 

Vendors may also choose to change the method in which products are taken to market.  For example, a vendor may change our relationship from a complete distribution provider, including logistics and sales support, to only a logistics provider or only a sales support provider.  Only doing one of these services would reduce our margin on any sale.  A change in the method in which products are taken to market caused by any vendor could have a material adverse effect on our business.

 

Some of our current and future vendors may decide to compete with us in the future by pursuing or increasing their efforts in direct marketing and sales of their products. These vendors could sell their products at lower prices and maintain a higher gross margin on their product sales than we can. In this event, veterinarians or animal owners may elect to purchase animal health products directly from these vendors.  As an example of this type of event, we were a sales agent for a pet food line for most of fiscal year 2011 that we will not represent in fiscal year 2012 because that manufacturer chose to sell their products direct and not through sales agents.  Increased competition from any vendor of animal health products could significantly reduce our market share and adversely impact our financial results.

 

 

An adverse change in vendor rebates could negatively affect our business.

 

The terms on which we purchase or sell products from many vendors of animal health products may entitle us to receive a rebate based on the attainment of certain growth goals. Vendors may adversely change the terms of or eliminate some or all of these rebate programs at any time without notice. Because the amount of rebates we earn is directly related to the attainment of pre-determined sales growth goals, and because the nature of the rebate programs and the amount of rebates available are determined by the vendors, there can be no assurance as to the amount of rebates that we will earn in any given year. Changes to or elimination of any rebate program initiated by our vendors may have a material effect on our gross profit and our operating results in any given quarter or year. Vendors may reduce or eliminate rebates offered under their programs, interpret the terms of their rebate programs in a way that is adverse to us or increase the growth goals or other conditions we must meet to earn rebates to levels that we cannot achieve. Additionally, factors outside of our control, such as customer preferences or vendor supply issues, can have a material impact on our ability to achieve the growth goals established by our vendors, which may reduce the amount of rebates we receive. The occurrence of any of these events could have an adverse impact on our results of operations.

 

Our quarterly operating results may fluctuate significantly, and these fluctuations may cause our stock price to fall.

 

Our quarterly revenues and operating results have varied significantly in the past, and may continue to do so in the future. While we accrue rebates from vendors as they are earned, our rebates have historically been highest during the quarter ended December 31, since most of our vendors’ rebate programs were designed to include targets to be achieved during the calendar year.  Historically, our revenues have been seasonal, with peak sales in the spring and fall months. The seasonal nature of our business is directly tied to the buying patterns of veterinarians for production animal health products used for certain medical procedures performed on production animals during the spring and fall months. These buying patterns can also be affected by vendors’ and distributors’ marketing programs or price increase announcements, which can cause veterinarians to purchase production animal health products earlier than those products are used. This kind of early purchasing may reduce our sales in the months these purchases would have otherwise been made. Additionally, the production animal market can be affected by volatility in commodity prices such as milk, corn, grain and feeder cattle, changes in weather patterns (e.g. droughts or seasons of higher precipitation that determine how long cattle will graze) or a change in the general economy, which can shift the timing of when animals are treated and to what extent they are treated.  This shift in treatment may have a significant impact on the timing of purchases.  While companion animal products tend to have a different product use cycle than production animal health products, and approximately two-thirds of our revenues have been generated from sales to the companion animal market, we cannot assure you that our revenues and operating results will not continue to fluctuate on a quarter-to-quarter basis. We believe period-to-period comparisons of our results of operations are not necessarily meaningful as our future revenue and results of operations may vary substantially. It is also possible that in future quarters our results of operations will be below the expectations of securities analysts and investors. In either case, the price of our common stock could decline, possibly materially.

 

Our market is highly competitive. Failure to compete successfully could have a material adverse effect on our business, financial condition and results of operations.

 

The market for veterinary distribution services is highly competitive, continually evolving and subject to technological change. We compete with numerous vendors and distributors based on customer relationships, service and delivery, product selection, price and e-commerce capabilities.  Our primary competitors in the United States, excluding vendors, include the following:

 

·

Animal Health International, Inc;

 

·

Butler Schein Animal Health;

 

·

IVESCO;

 

·

Midwest Veterinary Supply;

 

·

Webster Veterinary Supply, a division of Patterson Companies, Inc.; and

 

·

other national, regional, local and specialty distributors.

 

Some of our competitors may have more customers, stronger brand recognition or greater financial and other resources than we do. Most of our products are available from several sources, including other distributors and vendors, and our customers typically have relationships with several distributors and vendors. Many of our competitors have comparable product lines, technical expertise or distribution strategies that directly compete with us. Our competitors could obtain exclusive rights to distribute certain products, eliminating our ability to distribute those products. The entry of new or additional distributors in the industry could also have a material adverse effect on our ability to compete. Additionally, some of our vendors may decide to compete with us by selling their products directly to our customers. If we do not compete successfully against these organizations, it could have a material and adverse effect on our business, financial condition and results of operations.

 

Consolidation in the veterinary distribution business and veterinary practices may decrease our revenues and profitability.

 

Consolidation in the veterinary distribution business could result in existing competitors increasing their market share, which could give them greater pricing power, decrease our revenues and profitability, and increase the competition for customers. Consolidation of the many small, privately-held veterinary practices would result in an increasing number of larger veterinary practices, which could have increased purchasing leverage and the ability to negotiate lower product costs. This could reduce our operating margins and negatively impact our revenues and profitability. Any of these developments could result in increased marketing expenses and have a material adverse effect on our business, financial condition and results of operations.

 

Exclusivity requirements and failures to continue relationships with vendors may cause us to lose access to certain products and erode our market share.

 

We may not be able to establish or maintain relationships with key vendors in the animal health industry if we have established relationships with competitors of these key vendors. We have written agreements with approximately 50 of our vendors. Some of our agreements with vendors are for one-year periods. Upon expiration, we may not be able to renew our existing agreements on favorable terms, or at all.

 

In addition, vendors may require us to distribute their products on an exclusive basis, which would cause us to forego distributing competing products that may also be profitable, including generic products that may gain increased market share.  In this situation we are often forced to project future sales of competing products so that we can elect to distribute the product that we believe will be more profitable.  Our projections may not be correct, and we may be contractually prohibited from distributing products that gain market share, including generic products, at the expense of the products that we distribute.  Competitors of ours could also obtain exclusive rights to market particular products, which we would be unable to market. If we lose the right to distribute products under such agreements, or are required to exclusively distribute certain products at the expense of others that may be more profitable, we may lose access to certain products and lose a competitive advantage. Potential competitors could sell products from vendors that we fail to continue with and erode our market share.

 

An economic downturn could materially adversely affect our business.

 

Our business may be materially adversely affected by negative trends in the general economy that could reduce consumer discretionary spending on animal health products and reduce or eliminate sources of credit available to our customers. Levels of consumer spending have recently deteriorated significantly in the United States and may remain depressed for the foreseeable future.  Some of the factors that could influence the levels of consumer spending include continuing increases in fuel and other energy costs, conditions in the residential real estate and mortgage markets, unemployment levels, healthcare costs, access to credit, consumer confidence and other macroeconomic factors affecting consumer spending behavior.  In addition, volatility in commodity prices such as milk, corn, grain and feeder cattle, changes in weather patterns (e.g. droughts or seasons of higher precipitation that determine how long cattle will graze) and changes in the general economy may adversely impact the amount spent by animal owners in the production animal market.  Such volatility and/or tightening of credit available to our customers could further deteriorate the financial condition of our customers, and may ultimately lead our customers to reduce their working capital available to purchase our products.

 

Our business ultimately depends on the ability and willingness of animal owners to pay for our products. This dependence could make us more vulnerable to any reduction in consumer confidence or disposable income than companies in other industries that are less reliant on consumer spending, such as the human health care industry, in which a large portion of payments are made by insurance programs.  Additionally, any cost-cutting measures taken to offset the effects of an economic downturn could materially impact our ability to generate future revenue growth.  For all of these reasons, an economic downturn could materially affect our business.

 

Any inability of our customers to pay us for our products and services due to their deteriorating financial condition or otherwise may adversely affect our results of operations and financial condition.

 

We generally extend some level of credit to our customers without requiring collateral, which exposes us to credit risk.  For example, milk price declines in the dairy market could have a significant impact on dairy farmers, which would create cash-flow challenges for these farmers and, in turn, impact the time it takes for us to collect on outstanding accounts receivable from these customers.  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. The financial difficulties of a customer could cause us to curtail business with that customer or the customer to reduce its business with us and cancel orders.  Any inability of current and/or potential customers to pay us for our products and/or services due to their deteriorating financial condition or otherwise may adversely affect our results of operations and financial condition.

 

Difficulties with the integration of acquisitions or the improvement of the performance of acquired companies may impose substantial costs and delays and cause other unanticipated problems for us.

 

Acquisitions involve a number of risks relating to our ability to integrate an acquired business into our existing operations. The process of integrating or improving the performance of the operations of an acquired business, particularly its personnel, could cause interruptions to our business. Some of the risks we face include:

 

·

the need to spend substantial operational, financial and management resources in integrating new businesses, technologies and products, and difficulties management may encounter in integrating or improving the performance of the operations, personnel or systems of the acquired business;

 

·

retention of key personnel, customers and vendors of the acquired business;

 

·

the occurrence of a material adverse effect on our existing business relationships with customers or vendors, or both, resulting from future acquisitions or business combinations could lead to a termination of or otherwise affect our relationships with such customers or vendors;

 

·

impairments of goodwill and other intangible assets; and

 

·

contingent and latent risks associated with the past operations of, and other unanticipated costs and problems arising in, an acquired business.

 

If we are unable to successfully integrate the operations of an acquired business into our operations, we could be required to undertake unanticipated changes. These changes could have a material adverse effect on our business.

 

In addition, it may be difficult to manage rapid growth from our acquired companies in the future, and the future success of our acquisitions depends on our ability to implement and/or maintain:

 

·

sales and marketing programs;

 

·

customer service levels;

 

·

current and new product and service lines and vendor relationships;

 

·

technological support which equals or exceeds our competitors;

 

·

recruitment and training of new personnel; and

 

·

operational and financial control systems.

 

If we are not able to manage our rapid growth from our acquisitions, there is a risk our customer service quality could deteriorate which may in turn lead to decreased sales or profitability. Also, due to acquisitions the cost of our operations could increase faster than growth in our revenues, negatively impacting our profitability.

 

 

Risks associated with our international operations.

 

On February 8, 2010, we acquired the outstanding share capital of Centaur.  Centaur is based in the United Kingdom and uses the British pound as its functional currency.  Prior to this acquisition, we had very limited exposure to international risks. International operations are subject to risks that may materially adversely affect our business, results of operations and financial condition.  The risks that our international operations are subject to include, among other things:

 

·	difficulties and costs relating to staffing and managing foreign operations;

 

·	difficulties in establishing channels of distribution;

 

·	fluctuations in the value of foreign currencies;

 

·	repatriation of cash from our foreign operations to the United States;

 

·	regulatory requirements;

 

·	foreign countries may impose additional withholding taxes or otherwise tax our foreign income;

 

·	separate operating and financial systems;

 

·	disaster recovery;

 

·	unexpected difficulties in importing or exporting our products;

 

·	imposition of import/export duties, quotas, sanctions or penalties;

 

·	liability related to the defined benefit plan; and

 

·	unexpected regulatory, economic and political changes in foreign markets.

 

Our financial results could be adversely affected by foreign exchange fluctuations.

 

We operate in both the United States and the United Kingdom, but report revenues, costs and earnings in U.S. dollars. Exchange rates between the U.S. dollar and the British pound sterling are likely to fluctuate from period to period. Because our financial results are reported in U.S. dollars, we are subject to the risk of translation losses for reporting purposes. If we continue to expand our international operations, we will conduct more transactions in currencies other than the U.S. dollar. To the extent that foreign revenue and expense transactions are not denominated in the local currency, we are also subject to the risk of transaction losses. Given the volatility of exchange rates, there is no assurance that we will be able to effectively manage currency transaction and/or translation risks. We have not entered into derivative instruments to offset the impact of foreign exchange fluctuations. Fluctuations in foreign currency exchange rates could have a material adverse affect on our results of operations and financial condition.

 

We only have one distribution center in the United Kingdom and any catastrophic event could materially impact our results.

 

We conduct all of our fulfillment operations in the United Kingdom from our distribution center in Castle Cary, England. This facility contains all of our product inventory. A natural disaster or other catastrophic event, such as an earthquake, fire, flood, severe storm, break-in, server or systems failure, terrorist attack, or other comparable event at this facility would cause interruptions or delays in our business and loss of inventory and could render us unable to process or fulfill customer orders in a timely manner, or at all. Further, we have a limited disaster recovery plan, and our business interruption insurance may not adequately compensate us for losses that may occur, including with respect to any lost profits for any period in which the business is not able to operate.  In the event that a significant part of this facility was destroyed or our operations were interrupted for any extended period of time, our business, financial condition, and operating results would be harmed.

 

We rely substantially on third-party vendors, and the loss of products or delays in product availability from one or more third-party vendors could substantially harm our business.

 

We must contract for the supply of current and future products of appropriate quantity, quality and cost. These products must be available on a timely basis and be in compliance with any regulatory requirements. Failure to do so could substantially harm our business.

 

We often purchase products from our vendors under agreements that typically have a term of one year and can be terminated on a periodic basis. There can be no assurance, however, that our vendors will be able to meet their obligations under these agreements or that we will be able to compel them to do so. Risks of relying on vendors include:

 

- If an existing agreement expires or a certain product line is discontinued or recalled, then we would not be able to continue to offer our customers the same breadth of products and our sales and operating results would likely suffer unless we are able to find an alternate supply of a similar product.

 

- If market demand for our products increases suddenly, our current vendors might not be able to fulfill our commercial needs, which would require us to seek new manufacturing arrangements or find new sources of supply, and may result in substantial delays in meeting market demand. If we consistently generate more demand for a product than a given vendor is capable of handling, it could lead to large backorders and potentially lost sales to competitive products that are more readily available.

 

- We may not be able to control or adequately monitor the quality of products we receive from our vendors. Poor quality products could damage our reputation with our customers.

 

- Some of our third party vendors are subject to ongoing periodic unannounced inspection by regulatory authorities, including the FDA, the USDA, the EPA, the DEA and the PDMA, as well as other federal and state agencies for compliance with strictly enforced regulations. We do not have control over our vendors’ compliance with these regulations and standards. Violations could potentially lead to interruptions in supply that could lead to lost sales to competitive products that are more readily available.

 

- If a vendor is unable to obtain the necessary credit to manage their business, they may not be able to deliver their products to us.

 

Potential problems with vendors such as those discussed above could substantially decrease sales of our products, lead to higher costs and damage our reputation with our customers.

 

We rely upon third parties to ship products to our customers and interruptions in their operations could harm our business, financial condition and results of operations.

 

We use UPS as our primary delivery service for our air and ground domestic shipments of products to our customers. If there were any significant service interruptions, there can be no assurance that we could engage alternative service providers to deliver these products in either a timely or cost-efficient manner, particularly in rural areas where many of our customers are located. Any labor disputes, slowdowns, transportation disruptions or other adverse conditions in the transportation industry experienced by UPS could impair or disrupt our ability to deliver our products to our customers on a timely basis, and could have a material adverse effect upon our customer relationships, business, financial condition and results of operations. In addition, rising fuel costs may result in continued increases in shipping costs charged by UPS, or other delivery service providers, and could have an adverse effect on our financial condition and results of operations.

 

The loss of one or more significant customers could adversely affect our profitability.

 

Our two largest customers, Banfield and Feeders’ Advantage (a related party), accounted for approximately 6% and 4%, respectively, of our product sales for our fiscal year ended September 30, 2011, 9% and 4%, respectively, of our product sales for our fiscal years ended September 30, 2010 and 11% and 5%, respectively, of our product sales for our fiscal years ended September 30, 2009. Our ten largest customers, excluding Banfield and Feeders’ Advantage, accounted for approximately 3%, 5% and 5% of our product sales for our fiscal years ended September 30, 2011, 2010 and 2009, respectively. Our business and results of operations could be adversely affected if the business of these customers was lost. We cannot guarantee that we will maintain or improve our relationships with these customers or that we will continue to supply these customers at current levels. Banfield, Feeders’ Advantage and other customers may seek to purchase some of the products that we currently sell directly from the vendors or from one or more of our competitors. Furthermore, our customers are not required to purchase any minimum amount of products from us. The loss of Banfield or Feeders’ Advantage or deterioration in our relations with either of them could significantly affect our financial condition and results of operations. Additionally, deterioration in the financial condition of one or more of our customers could have a material adverse effect on our results of operations.

 

Increases in over-the-counter sales of animal health products could adversely affect our business.

 

We rely, and will continue to rely, on animal owners who purchase their animal health products directly from veterinarians, which we refer to as the ethical channel. There can be no assurance that animal owners will continue to use the ethical channel with the same frequency as they have in the past, and will not increasingly purchase animal health products from sources other than veterinarians, such as the Internet, human or Internet pharmacies and other over-the-counter channels. Increased competition from any distributor of animal health products making use of an over-the-counter channel could significantly reduce our market share and adversely impact our financial results.

 

If we fail to comply with or become subject to more onerous government regulations, our business could be adversely affected.

 

The veterinary distribution industry is subject to changing political and regulatory influences. Both state and federal government agencies regulate the distribution of certain animal health products and we are subject to regulation, either directly or indirectly, by the FDA, the USDA, the EPA, the DEA and comparable state agencies. As a distributor of prescription pharmaceutical products, we are also subject to the PDMA, which provides for minimum standards, terms and conditions to be maintained for licensing as a distributor.  The regulatory stance these agencies take could change. Our vendors are subject to regulation by the FDA, the USDA, the EPA, the DEA, and the PDMA, as well as other federal and state agencies, and material changes to the applicable regulations could affect our vendors’ ability to manufacture certain products, which could adversely impact our product supply. In addition, some of our customers may rely, in part, on farm and agricultural subsidy programs. Changes in the regulatory positions that impact the availability of funding for such programs could have an adverse impact on our customers’ financial positions, which could lead to decreased sales.

 

We strive to maintain compliance with these and all other applicable laws and regulations. We retain a Manager of Regulatory Compliance and have engaged outside consultants as needed to assist us in meeting and complying with the various state licensure requirements to which we are subject. If we are unable to maintain or achieve compliance with these laws and regulations, however, we could be subject to substantial fines or other restrictions on our ability to provide competitive distribution services, which could have an adverse impact on our financial condition.

 

We cannot assure you that existing laws and regulations will not be revised or that new, more restrictive laws will not be adopted or become applicable to us or the products that we distribute or dispense. The federal pedigree regulations of the FDA under the PDMA require tracking human labeled prescription products through the entire distribution chain and are enforceable for distributors that do not have a written agreement with the manufacturer granting the wholesale distributor status as an “Authorized Distributor of Record.”  We cannot assure you that the vendors of products that may become subject to more stringent laws will not try to recover any or all increased costs of compliance from us by increasing the prices at which we purchase products from them, or, that we will be able to recover any such increased prices from our customers. We also cannot assure you that our business and financial condition will not be materially and adversely affected by future changes in applicable laws and regulations.

 

Loss of key management or sales representatives could harm our business.

 

Our future success depends to a significant extent on the skills, experience and efforts of management, including our President and Chief Executive Officer, Mr. James F. Cleary, Jr. While we have not experienced problems in the past attracting and maintaining members of our management team, the loss of any or all of these individuals could adversely impact our business. We do not carry key-man life insurance on any member of management. In addition we do not have employment agreements with key members of our senior management team. We must continue to develop and retain a core group of individuals if we are to realize our goal of continued expansion and growth. We cannot assure you that we will be able to do so in the future.

 

Also, due to the specialized nature of our products and services, generally only highly qualified and trained sales representatives have the necessary skills to market our products and provide our services. These individuals develop relationships with our customers that could be damaged if these employees are not retained. We face intense competition for the hiring of these professionals, and many professionals in the field that may otherwise be attractive candidates for us to hire may be bound by non-competition agreements with our competitors. Any failure on our part to hire, train and retain a sufficient number of qualified professionals would damage our business. We do not generally enter into agreements that contain non-competition provisions with our employees, other than with members of our senior management team, former owners of acquired companies and certain other employees.

 

Failure of, or security problems with, our information systems could damage our business.

 

Our information systems are dependent on third party software, global communications providers, telephone systems and other aspects of technology and Internet infrastructure that are susceptible to failure. Though we have implemented security measures and some redundant systems, our customer satisfaction and our business could be harmed if we or our vendors experience any system delays, failures, loss of data, power outages, computer viruses, break-ins, unauthorized access by competitors or similar disruptions. We currently process all customer transactions and data at our facilities in Boise, Idaho. Although we have safeguards for emergencies, including, without limitation, sophisticated back-up systems, the occurrence of a major catastrophic event or other system failure at any of our distribution facilities could interrupt data processing or result in the loss of stored data. This may result in the loss of customers or a reduction in demand for our services. Only some of our systems are fully redundant and although we do carry business interruption insurance, it may not be sufficient to compensate us for losses that may occur as a result of system failures. If a disruption occurs, our profitability and results of operations may suffer.

 

The outbreak of an infectious disease within either the production animal or companion animal population could have a significant adverse effect on our business and our results of operations.

 

An outbreak of disease affecting animals, such as foot-and-mouth disease, various forms of influenza or bovine spongiform encephalopathy, commonly referred to as “mad cow disease,” could result in the widespread destruction of affected animals and consequently result in a reduction in demand for animal health products. In addition, outbreaks of these or other diseases or concerns of such diseases could create adverse publicity that may have a material adverse effect on consumer demand for meat, dairy and poultry products, and, as a result, on our customers’ demand for the products we distribute. The outbreak of a disease among the companion animal population which could cause a reduction in the demand for companion animals could also adversely affect our business. Although we have not been adversely impacted by the outbreak of a disease in the past, there can be no assurance that a future outbreak of an infectious disease will not have an adverse effect on our business.

 

Our acquired technology or developed technology may not be successful in gaining new customers or the technology may fail to produce its intended results.

The process of acquiring or developing new technology products and solutions is inherently complex and uncertain. It requires accurate anticipation of customers’ changing needs and emerging technological trends. We must make long-term investments and commit significant resources before knowing whether these investments will eventually result in products or services that achieve customer acceptance and generate the revenues required to provide desired returns. If we fail to accurately anticipate and meet our customers’ needs through the development of new products and technologies and service offerings or if we fail to adequately protect our intellectual property rights or if our new products are not widely accepted or if our current or future products fail to meet applicable worldwide regulatory requirements, we could lose market share and customers to our competitors and that could materially adversely affect our results of operations and financial condition.  Additionally, we face the risk of claims from system users that the systems failed to produce the intended result and/or that the systems caused negative performance of the customer’s animals or overall operation of the customer’s business.  Any such claims, even those without merit, could be expensive and  time consuming to defend, cause us to lose a customer and the associated revenue, divert management’s attention and resources or require us to pay damages.

 

If third parties claim that we infringe upon their intellectual property rights, our financial results could be adversely affected.  

 

We face the risk of claims that we have infringed third parties’ intellectual property rights, including trademarks, trade names, and patents. Third parties may claim that our proprietary branded products infringe their trademarks and/or trade names; that our consultative services infringe a patented machine, process, or business method; and/or that our products infringe such third parties’ patented animal health products.  We have not conducted an independent review of trademarks or patents issued to third parties. The large number of trademarks and patents, the rapid rate of new trademark and patent issuances, the complexities of the technology involved in patents and uncertainty of litigation increase the risk of business assets and management’s attention being diverted to intellectual property litigation.

 

Any claims of patent or other intellectual property infringement, even those without merit, could:

 

	•		be expensive and time consuming to defend;
	•		cause us to cease making, licensing or using products or services that incorporate the challenged intellectual property;
	•		require us to redesign, reengineer, or rebrand our products or packaging, if feasible;
	•		divert management’s attention and resources; or
	•		require us to enter into royalty or licensing agreements in order to obtain the right to use a third party’s intellectual property.

 

Any royalty or licensing agreements, if required, may not be available to us on acceptable terms or at all. A successful claim of infringement against us could result in our being required to pay significant damages, enter into costly license or royalty agreements, or stop the sale of certain products, any of which could have a negative impact on our financial results and harm our future prospects.

 

Our intellectual property rights may be inadequate to protect our business.  

 

We attempt to protect our intellectual property rights through a combination of patent, trademark, copyright and trade secret laws, as well as licensing agreements and third-party nondisclosure and assignment agreements. Our failure to obtain or maintain adequate protection of our intellectual property rights for any reason could have a material adverse effect on our business.

 

           We rely on our trademarks, trade names, service marks and brand names to distinguish our proprietary branded products and services from the products and services of our competitors, and have registered or applied to register many of these trademarks and servicemarks. We cannot assure you that our trademark and servicemark applications will be approved. Third parties may also oppose our trademark and servicemark applications, or otherwise challenge our use of the trademarks and servicemarks. In the event that our marks are successfully challenged, we could be forced to rebrand our proprietary branded products and services, which could result in loss of brand recognition, and could require us to devote resources to advertise and market new brands. Further, we cannot assure you that competitors will not infringe upon our marks, or that we will have adequate resources to enforce our marks.

 

         The pursuit and assertion of patent rights involve complex legal and factual determinations and, therefore, are characterized by some uncertainty.  In addition, the laws governing patentability and the scope of patent coverage continue to evolve.  As a result, we cannot assure you patents will be issued from any of our patent applications.  The scope of any of our patents, if issued, may not be sufficiently broad to offer meaningful protection. In addition, our patents, if they are issued, may be successfully challenged, invalidated, circumvented or rendered unenforceable so that our patent rights might not create an effective competitive barrier for certain of our niche products. Further, we cannot assure you that competitors will not infringe upon our patent, or that we will have adequate resources to enforce our patent.

 

We also rely on unpatented proprietary technology. It is possible that others will independently develop the same or similar technology or otherwise obtain access to our unpatented technology. To protect our trade secrets and other proprietary information, we require employees, consultants, advisors and collaborators to enter into confidentiality agreements. We cannot assure you that these agreements will provide meaningful protection for our trade secrets, know-how or other proprietary information in the event of any unauthorized use, misappropriation or disclosure of such trade secrets, know-how or other proprietary information.  Our inability to maintain the proprietary nature of our technologies for any reason could have a material adverse effect on our business.

 

If our proprietary branded products infringe on the intellectual property rights of others, we may be required to indemnify our customers for any damages they suffer.  

 

Third parties may assert infringement claims against our customers. These claims may require us to initiate or defend protracted and costly litigation on behalf of our customers, regardless of the merits of these claims. If any of these claims succeed, we may be forced to pay damages on behalf of our customers or may be required to obtain licenses for the products they use. If we cannot obtain all necessary licenses on commercially reasonable terms, our customers may be forced to stop using our products.

 

We may be subject to product liability and other claims in the ordinary course of business.

 

Our business involves a risk of product liability and other claims in the ordinary course of business, for example arising from shipping mislabeled or outdated product, product recalls or disputes among competing vendors. We maintain general liability insurance with policy limits of $1.0 million per incident and $2.0 million in the aggregate, and in many cases we have indemnification rights against such claims from the manufacturers of the products we distribute. We do not maintain a separate product liability insurance policy because we do not currently manufacture the vast majority of the products that we sell. Our ability to recover under insurance or indemnification arrangements is subject to the financial viability of the insurers and manufacturers. We cannot assure you that our insurance coverage or the manufacturers’ indemnity will be available or sufficient in any future cases brought against us.

 

We may not be able to raise needed capital in the future on favorable terms or at all.

 

We expect that our existing sources of cash, together with any funds generated from operations, will be sufficient to meet our anticipated capital needs for at least the next twelve months. However, we may require additional capital to finance our growth strategies or other activities in the future. Our capital requirements will depend on many factors, including the costs associated with our growth and expansion. Additional financing may not be available when needed and, if such financing is available, it may not be available on terms favorable to us. Our failure to raise capital when needed could have an adverse effect on our business, financial condition and results of operations.

 

Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.

 

Any borrowings on the revolving credit facility will be at variable rates of interest and expose us to interest rate risk based on market rates. If interest rates increase, our debt service obligations on any future variable rate indebtedness that we may incur on our revolving credit facility would increase even if the amount borrowed remained the same, and our net income and cash available for servicing our indebtedness would decrease. Our variable rate debt as of September 30, 2011 was $2.9 million (comprised of revolving credit facilities). As of October 31, 2011, our variable rate debt on our revolving credit facilities was $46.9 million, primarily due to the funding of the Micro acquisition. Our interest expense for fiscal year 2011 was approximately $0.7 million and was approximately $0.5 million for fiscal year 2010. A 1% increase in the average interest rate would not have a material impact on our operations assuming our current level of debt.  However, if we had to borrow additional funds to operate our business, the change in interest rates could affect our operations.   See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

 

Our lenders may have suffered losses related to the weakening economy and may not be able to fund our borrowings.

 

Our lenders, including the lenders participating in our revolving credit facility, may have suffered losses related to their lending and other financial relationships, especially because of the general weakening of the national economy and increased financial instability of many borrowers.  As a result, lenders may become insolvent or tighten their lending standards, which could make it more difficult for us to borrow under our revolving credit facility or to obtain other financing on favorable terms or at all.  Our financial condition and results of operations would be adversely affected if we were unable to draw funds under our revolving credit facility because of a lender default or to obtain other cost-effective financing.