VCA ANTECH INC - 10-Q Quarterly Report

UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549

FORM 10-Q


x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the quarterly period ended March 31, 2004

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-16783

VCA ANTECH, INC.

(Exact name of registrant as specified in its charter)


Delaware (State or other jurisdiction of incorporation or organization)		95-4097995 (I.R.S. Employer Identification No.)

12401 West Olympic Boulevard
Los Angeles, California 90064-1022
(Address of principal executive offices)

(310) 571-6500
(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 [ ].

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ].

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: common stock, $0.001 par value 40,775,396 shares as of May 7, 2004.

TABLE OF CONTENTS


PART I. FINANCIAL INFORMATION
	ITEM 1. FINANCIAL STATEMENTS
		CONDENSED, CONSOLIDATED BALANCE SHEETS
		CONDENSED, CONSOLIDATED INCOME STATEMENTS
		CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
	ITEM 4. CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
	ITEM 1. LEGAL PROCEEDINGS
	ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES
	ITEM 3. DEFAULTS UPON SENIOR SECURITIES
	ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
	ITEM 5. OTHER INFORMATION
	ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURE
EXHIBIT INDEX
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1

VCA ANTECH, INC.
FORM 10-Q
MARCH 31, 2004

TABLE OF CONTENTS


		Page
		Number

Part I	Financial Information
Item 1.	Financial Statements
	Condensed, Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003 (Unaudited)	1
	Condensed, Consolidated Income Statements for the Three Months Ended March 31, 2004 and 2003 (Unaudited)	2
	Condensed, Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003 (Unaudited)	3
	Notes to Condensed, Consolidated Financial Statements	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	38
Item 4.	Controls and Procedures	38
Part II	Other Information
Item 1.	Legal Proceedings	39
Item 2.	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities	39
Item 3.	Defaults Upon Senior Securities	39
Item 4.	Submission of Matters to a Vote of Security Holders	39
Item 5.	Other Information	39
Item 6.	Exhibits and Reports on Form 8-K	39
	Signature	40
	Exhibit Index	41

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VCA ANTECH, INC. AND SUBSIDIARIES
CONDENSED, CONSOLIDATED BALANCE SHEETS
As of March 31, 2004 and December 31, 2003
(Unaudited)
(In thousands, except par value)


				March 31,			December 31,
				2004			2003

ASSETS
Current assets:
	Cash and cash equivalents			$	29,361		$	17,237
	Trade accounts receivable, less allowance for uncollectible accounts of $6,850 and $6,681 at March 31, 2004 and December 31, 2003, respectively				26,141			22,335
	Inventory, prepaid expenses and other				9,378			9,432
	Deferred income taxes				11,433			11,040
	Prepaid income taxes				1,228			7,266

		Total current assets			77,541			67,310
Property and equipment, net					99,686			99,161
Other assets:
	Goodwill, net				386,748			373,238
	Covenants-not-to-compete, net				4,904			4,626
	Deferred financing costs, net				4,421			4,601
	Other				6,027			5,867

		Total assets		$	579,327		$	554,803

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Current portion of long-term obligations			$	2,356		$	2,403
	Accounts payable				8,854			9,208
	Accrued payroll and related liabilities				17,500			15,716
	Accrued interest				5,630			1,538
	Other accrued liabilities				16,416			15,006

		Total current liabilities			50,756			43,871
Long-term obligations, less current portion					314,719			315,066
Deferred income taxes					26,493			24,532
Other liabilities					3,544			3,216
Mandatorily redeemable partnership interests					2,176			2,176
Minority interest					4,227			4,019
Preferred stock, par value $0.001, 11,000 shares authorized, none outstanding					—			—
Stockholders’ equity:
	Common stock, par value $0.001, 75,000 shares authorized, and 40,762 and 40,715 shares outstanding as of March 31, 2004 and December 31, 2003, respectively				41			41
	Additional paid-in capital				245,056			244,311
	Accumulated deficit				(67,587	)		(82,331	)
	Accumulated other comprehensive loss — unrealized loss on hedging instruments				(82	)		(82	)
	Notes receivable from stockholders				(16	)		(16	)

			Total stockholders’ equity		177,412			161,923

			Total liabilities and stockholders’ equity	$	579,327		$	554,803

The accompanying notes are an integral part of these condensed, consolidated financial statements.

VCA ANTECH, INC. AND SUBSIDIARIES
CONDENSED, CONSOLIDATED INCOME STATEMENTS
For the Three Months Ended March 31, 2004 and 2003
(Unaudited)
(In thousands, except per share amounts)


		Three Months Ended
		March 31,

		2004		2003

				(Restated)
Revenue		$	144,350	$	125,579
Direct costs (excludes operating depreciation of $2,782 and $2,754 for the three months ended March 31, 2004 and 2003, respectively)			101,568		89,330
Selling, general and administrative			8,307		9,363
Depreciation and amortization			3,616		3,577
Loss (gain) on sale of assets			62		(238	)

	Operating income		30,797		23,547
Interest expense, net			5,985		6,992
Debt retirement costs			—		7,417
Other expense			111		127
Minority interest in income of subsidiaries			416		361

	Income before provision for income taxes		24,285		8,650
Provision for income taxes			9,541		3,467

	Net income	$	14,744	$	5,183

Basic earnings per common share		$	0.36	$	0.13

Diluted earnings per common share		$	0.36	$	0.13

Shares used for computing basic earnings per share			40,741		39,021

Shares used for computing diluted earnings per share			41,510		39,417

The accompanying notes are an integral part of these condensed, consolidated financial statements.

VCA ANTECH, INC. AND SUBSIDIARIES
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2004 and 2003
(Unaudited)
(In thousands)


			Three Months Ended
			March 31,

			2004			2003

Cash flows from operating activities:
	Net income		$	14,744		$	5,183
	Adjustments to reconcile net income to net cash provided by operating activities:
		Depreciation and amortization		3,616			3,577
		Amortization of deferred financing costs and debt discount		184			233
		Provision for uncollectible accounts		628			928
		Debt retirement costs		—			7,417
		Loss (gain) on sale of assets		62			(238	)
		Minority interest in income of subsidiaries		416			361
		Distributions to minority interest partners		(374	)		(409	)
		Increase in accounts receivable		(4,485	)		(3,986	)
		Decrease (increase) in inventory, prepaid expenses and other assets		42			(222	)
		Increase in accounts payable and other accrued liabilities		473			2,662
		Increase (decrease) in accrued payroll and related liabilities		1,784			(184	)
		Increase in accrued interest		4,092			4,216
		Decrease in prepaid income taxes		6,361			1,461
		Increase in deferred income tax assets		(393	)		(181	)
		Increase in deferred income tax liabilities		2,386			1,561

	Net cash provided by operating activities			29,536			22,379

Cash flows used in investing activities:
		Business acquisitions, net of cash acquired		(14,113	)		(6,011	)
		Real estate acquired in connection with business acquisitions		—			(88	)
		Property and equipment additions, net		(3,465	)		(2,825	)
		Proceeds from sale of assets		178			353
		Other		95			215

	Net cash used in investing activities			(17,305	)		(8,356	)

Cash flows provided by (used in) financing activities:
		Repayment of long-term obligations, including redemption fees		(529	)		(42,293	)
		Repayment of revolving credit facility		—			(7,500	)
		Payment of deferred financing costs		—			(382	)
		Proceeds from issuance of common stock under stock option plans		422			20
		Proceeds from issuance of common stock		—			54,345

	Net cash provided by (used in) financing activities			(107	)		4,190

Increase in cash and cash equivalents				12,124			18,213
Cash and cash equivalents at beginning of period				17,237			6,462

Cash and cash equivalents at end of period			$	29,361		$	24,675

The accompanying notes are an integral part of these condensed, consolidated financial statements.

VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004
(Unaudited)

1. General

The accompanying unaudited condensed, consolidated financial statements of VCA Antech, Inc. and subsidiaries (the “Company” or “VCA”) have been prepared in accordance with generally accepted accounting principles in the United States for interim financial information and in accordance with the rules and regulations of the United States Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States for complete financial statements as permitted under applicable rules and regulations. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. The results of operations for the three months ended March 31, 2004 are not necessarily indicative of the results to be expected for the full year. For further information, refer to the Company’s consolidated financial statements and footnotes thereto included in the Company’s 2003 Annual Report on Form 10-K.

2. Acquisitions

Primary Acquisitions

During the three months ended March 31, 2004, the Company purchased nine animal hospitals, two of which were merged into existing animal hospitals upon acquisition. During the three months ended March 31, 2003, the Company purchased five animal hospitals and one veterinary diagnostic laboratory.

The following table summarizes the aggregate consideration, including acquisition costs, paid by the Company for its acquisitions and the allocation of the purchase price (in thousands):


			Three Months Ended
			March 31,

			2004		2003

Consideration:
	Cash		$	13,777	$	5,561
	Obligations to sellers (1)			725		462
	Notes payable and other liabilities assumed			90		50

		Total	$	14,592	$	6,073

Purchase Price Allocation:
	Tangible assets (3)		$	515	$	206
	Identifiable intangible assets			710		414
	Goodwill (2)(3)(4)			13,367		5,453

		Total	$	14,592	$	6,073

(1)		Represents a portion of the purchase price withheld (the “holdback”) for offset of any amounts the Company may pay on behalf of the former owner for any liabilities the Company did not assume at the time of acquisition. The unused portion is paid to the seller after a designated period following the date of acquisition.




(2)		The Company expects that $11.9 million and $4.5 million of the goodwill recorded for the three months ended March 31, 2004 and 2003, respectively, will be fully deductible for income tax purposes.




(3)		Includes adjustments to purchase price allocation related to prior period acquisitions.

(4) The following table summarizes goodwill assigned to the animal hospital and laboratory segments (in thousands):


		Three Months Ended
		March 31,

		2004		2003

Laboratory		$	48	$	274
Animal hospital			13,319		5,179

	Total	$	13,367	$	5,453

Partnership Interests

In each of the three months ended March 31, 2004 and 2003, the Company purchased the total ownership interest of a partner in a partially-owned subsidiary of the Company. The following table summarizes the consideration paid by the Company and the amount of goodwill recorded (in thousands):


		Three Months Ended
		March 31,

		2004		2003

Consideration:
	Cash	$	56	$	—
	Notes payable		131		763

	Total	$	187	$	763

Goodwill recorded (1)		$	163	$	363

(1)

The Company expects that the goodwill recorded for both transactions will be fully deductible for income tax purposes.

Other Acquisition Payments

During the three months ended March 31, 2004 and 2003, the Company paid $280,000 and $450,000, respectively, of unused holdbacks to the respective sellers.

3. Goodwill and Other Intangible Assets

Goodwill represents the purchase price paid and the fair market value of liabilities assumed for animal hospital and laboratory acquisitions in excess of the fair market value of the net assets acquired. Other intangible assets represent covenants-not-to-compete and client lists, both of which are associated with acquisitions.

The following table presents the changes in the carrying amount of goodwill for the three months ended March 31, 2004 (in thousands):


			Animal
	Laboratory		Hospital			Total

Balance as of January 1, 2004	$	94,770	$	278,468		$	373,238
Goodwill acquired		48		13,482			13,530
Goodwill written off related to sale of animal hospital		—		(20	)		(20	)

Balance as of March 31, 2004	$	94,818	$	291,930		$	386,748

In addition to goodwill, the Company had other intangible assets as follows (in thousands):


		As of March 31, 2004							As of December 31, 2003

		Gross					Net		Gross					Net
		Carrying		Accumulated			Carrying		Carrying		Accumulated			Carrying
		Amount		Amortization			Amount		Amount		Amortization			Amount

Covenants-not-to-compete		$	10,844	$	(5,940	)	$	4,904	$	10,141	$	(5,515	)	$	4,626
Client lists			505		(447	)		58		498		(432	)		66

	Total	$	11,349	$	(6,387	)	$	4,962	$	10,639	$	(5,947	)	$	4,692

The aggregate amortization related to other intangible assets was as follows (in thousands):


	Three Months Ended
	March 31,

	2004		2003

Aggregate amortization expense	$	440	$	477

Based on balances at March 31, 2004, estimated amortization expense for other intangible assets for the current year and the next four fiscal years is as follows (in thousands):


2004	$	1,700
2005	$	1,328
2006	$	945
2007	$	742
2008	$	351

4. Calculation of Earnings per Common Share

Basic and diluted earnings per common share were computed as follows (in thousands, except per share amounts):


			Three Months Ended
			March 31,

			2004		2003

Net income			$	14,744	$	5,183

Weighted average common shares outstanding:
	Basic			40,741		39,021
	Effect of dilutive common shares:
		Stock options		698		396
		Contracts that may be settled in stock or cash		71		—

	Diluted			41,510		39,417

	Basic earnings per common share		$	0.36	$	0.13

	Diluted earnings per common share		$	0.36	$	0.13

5. Interest Rate Hedging Agreements

The Company entered into no-fee swap agreements (“Swap Agreements”), whereby the Company pays to the counter party amounts based on fixed interest rates and set notional amount in exchange for the receipt of payments from the counter party based on LIBOR and the same set notional principal amounts. A summary of these agreements is as follows:

Swap #1

Swap #2

Swap #3

Fixed interest rate

2.22%

1.72%

1.51%

Notional amount

$40.0 million

$20.0 million

Effective date

11/29/2002

5/30/2003

Expiration date

11/29/2004

5/31/2005

Counter party

Wells Fargo Bank

Goldman Sachs

Qualifies for hedge accounting (1)

Yes

(1)

Swap #1 and #2 were no longer considered effective as of May 2003 and March 2004, respectively.

Both Swap #1 and Swap #2 were initially considered to be cash-flow hedging instruments; however, management has determined that they are no longer effective tools for mitigating interest-rate risk within an acceptable degree of variance because the current interest rate environment is materially different than management’s projections at the inception of the contracts. As a result of this determination, Swap #1 and Swap #2 no longer qualify for hedge accounting and all changes in their market value are recognized as income or expense in the period of change.

The following table summarizes the Company’s payments and unrealized losses recognized under the Swap Agreements (in thousands):


	Three Months Ended
	March 31,

	2004		2003

Cash paid (1)	$	164	$	85
Unrealized losses (2)	$	111	$	127

(1)		These payments are included in interest expense in the condensed, consolidated income statements.

(2)		These unrealized losses are included in other expense in the condensed, consolidated income statements.

The valuations of the Swap Agreements were determined by the counter parties based on fair market valuations for similar agreements. At March 31, 2004 and December 31, 2003, the fair market values of the Swap Agreements resulted in a liability from interest rate hedging activities of $388,000 and $277,000, respectively. These amounts have been reported as part of other accrued liabilities.

6. Consolidation of Variable Interest Entities

Under the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 46R (“FIN No. 46R”), Consolidation of Variable Interest Entities, adopted by the Company in the fourth quarter of 2003, the veterinary medical groups for which the Company provides management services are variable interest entities. As a result of adopting FIN No. 46R, the Company consolidated the veterinary medical groups. The prior period presented has been restated to conform to the current period presentation. The restatement resulted in an increase in both revenue and direct costs in the amount of $9.6 million, thus there was no impact on operating income, net income, earnings per share or cash flows.

7. Lines of Business

During the three months ended March 31, 2004 and 2003, the Company had three reportable segments: Laboratory, Animal Hospital and Corporate. These segments are strategic business units that have different products, services and functions. The segments are managed separately because each is a distinct and different business venture with unique challenges, rewards and risks. The Laboratory segment provides testing services for veterinarians both associated with the Company and independent of the Company. The Animal Hospital segment provides veterinary services for companion animals and sells related retail and pharmaceutical products. Corporate provides selling, general and administrative support for the other two segments.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies as detailed in the Company’s consolidated financial statements and footnotes thereto included in the 2003 Annual Report on Form 10-K. The Company evaluates performance of segments based on operating income. For purposes of reviewing the operating performance of the segments, all intercompany sales and purchases are accounted for as if they were transactions with independent third parties at current market prices.

Below is a summary of certain financial data for each of the three segments (in thousands):


						Animal						Intercompany
			Laboratory			Hospital			Corporate			Eliminations			Total

Three Months Ended March 31, 2004
	Revenue		$	49,182		$	97,956		$	—		$	(2,788	)	$	144,350
	Direct costs (excluding operating depreciation)			26,894			77,462			—			(2,788	)		101,568
	Selling, general and administrative			3,173			2,748			2,386			—			8,307
	Depreciation and amortization			821			2,401			394			—			3,616
	Loss (gain) on sale of assets			(1	)		63			—			—			62

		Operating income (loss)	$	18,295		$	15,282		$	(2,780	)	$	—		$	30,797

	Capital expenditures		$	746		$	2,453		$	266		$	—		$	3,465

Three Months Ended March 31, 2003
	Revenue		$	41,698		$	86,307		$	—		$	(2,426	)	$	125,579
	Direct costs (excluding operating depreciation)			23,456			68,300			—			(2,426	)		89,330
	Selling, general and administrative			2,707			2,503			4,153			—			9,363
	Depreciation and amortization			754			2,477			346			—			3,577
	Gain on sale of assets			(2	)		(236	)		—			—			(238	)

		Operating income (loss)	$	14,783		$	13,263		$	(4,499	)	$	—		$	23,547

	Capital expenditures		$	1,174		$	1,193		$	458		$	—		$	2,825

At March 31, 2004
	Identifiable assets		$	135,556		$	390,025		$	53,746		$	—		$	579,327

At December 31, 2003
	Identifiable assets		$	130,799		$	374,940		$	49,064		$	—		$	554,803

Below is a reconciliation between total segment operating income after eliminations and consolidated income before provision for income taxes as reported on the condensed, consolidated income statements (in thousands):


	Three Months Ended
	March 31,

	2004		2003

Total segment operating income after eliminations	$	30,797	$	23,547
Interest expense, net		5,985		6,992
Debt retirement costs		—		7,417
Other expense		111		127
Minority interest in income of subsidiaries		416		361

Income before provision for income taxes	$	24,285	$	8,650

8. Common Stock Offering and Debt Retirement

In February 2003, the Company sold 3.8 million shares of its common stock in exchange for net proceeds of $54.3 million. The Company used $42.7 million of the net proceeds to voluntarily retire the remaining principal amount outstanding of its 15.5% senior notes due 2010 at a price of 110% of the principal amount plus accrued and unpaid interest. As a result of the debt retirement we incurred debt retirement costs of $7.4 million.

9. Stock-Based Compensation

The Company has granted stock options to various employees under multiple stock option plans and is accounting for those options under the intrinsic value method as prescribed in Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees. Under that method, when options are issued with a strike price equal to or greater than market price on date of issuance, there is no impact on earnings either on the date of issuance or thereafter, absent modification to the options. This method is not a fair-value-based method of accounting as defined by Statements of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation. Fair-value-based methods of accounting require compensation expense to be recognized annually equal to the fair market value of the options granted divided by their vesting period. The following table presents net income and earnings per common share for the three months ended March 31, 2004 and 2003 as if the Company accounted for its stock options under SFAS No. 123 and the fair-value-based method of accounting (in thousands, except per share amounts):


		Three Months Ended
		March 31,

		2004			2003

As reported		$	14,744		$	5,183
	Deduct: Total stock-based employee compensation expense determined under fair-value-based method for all awards, net of related tax effects		(222	)		(213	)

	Pro forma net income available to common stockholders	$	14,522		$	4,970

Earnings per common share:
	Basic — as reported	$	0.36		$	0.13
	Basic — pro forma	$	0.36		$	0.13
	Diluted — as reported	$	0.36		$	0.13
	Diluted — pro forma	$	0.35		$	0.13

10. Commitments and Contingencies

The Company has certain contingent liabilities resulting from litigation and claims incident to the ordinary course of its business. Management believes that the probable resolution of such contingencies will not have a material adverse effect on the Company’s consolidated financial position or results of operations.

11. Condensed, Consolidating Information

The Company has a legal structure comprised of a holding company and an operating company. VCA is the holding company. Vicar Operating, Inc. (“Vicar”) is the operating company and wholly-owned by VCA. Vicar owns the capital stock of all of the Company’s subsidiaries.

In connection with Vicar’s issuance in November 2001 of $170.0 million of 9.875% senior subordinated notes, VCA and each existing and future domestic wholly-owned restricted subsidiary of Vicar (the “Guarantor Subsidiaries”) have, jointly and severally, fully and unconditionally guaranteed the 9.875% senior subordinated notes. These guarantees are unsecured and subordinated in right of payment to all existing and future indebtedness outstanding under the Credit and Guaranty Agreement dated September 20, 2000 and any other indebtedness permitted to be incurred by Vicar under the terms of the indenture agreement for the 9.875% senior subordinated notes.

Vicar’s subsidiaries are composed of wholly-owned restricted subsidiaries and partnerships. The partnerships may elect to serve as guarantors of Vicar’s obligations, however, none of the partnerships have elected to do so (the “Non-Guarantor Subsidiaries”). Vicar conducts all of its business through and derives virtually all of its income from its subsidiaries. Therefore, Vicar’s ability to make required payments with respect to its indebtedness (including the 9.875% senior subordinated notes) and other obligations depends on the financial results and condition of its subsidiaries and its ability to receive funds from its subsidiaries.

Pursuant to Rule 3-10 of Regulation S-X, the following condensed, consolidating information is for VCA, Vicar, the Guarantor Subsidiaries and the Non-Guarantor Subsidiaries with respect to the 9.875% senior subordinated notes. This condensed financial information has been prepared from the books and records maintained by VCA, Vicar, the Guarantor Subsidiaries and the Non-Guarantor Subsidiaries. The condensed financial information may not necessarily be indicative of results of operations or financial position had the Guarantor Subsidiaries and the Non-Guarantor Subsidiaries operated as independent entities. The separate financial statements of the Guarantor Subsidiaries are not presented because management has determined they would not be material to investors.

VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

CONDENSED, CONSOLIDATING BALANCE SHEETS
As of March 31, 2004
(Unaudited)
(In thousands)


											Non-
									Guarantor		Guarantor
			VCA			Vicar			Subsidiaries		Subsidiaries			Elimination			Consolidated

Current assets:
	Cash and cash equivalents		$	—		$	25,682		$	3,559	$	120		$	—		$	29,361
	Trade accounts receivable, net			—			7			25,570		564			—			26,141
	Inventory, prepaid expenses and other			—			2,462			6,372		544			—			9,378
	Deferred income taxes			—			11,433			—		—			—			11,433
	Prepaid income taxes			—			1,228			—		—			—			1,228

		Total current assets		—			40,812			35,501		1,228			—			77,541
Property and equipment, net				—			6,556			91,245		1,885			—			99,686
Other assets:
	Goodwill, net			—			—			363,839		22,909			—			386,748
	Covenants-not-to-compete, net			—			—			4,378		526			—			4,904
	Deferred financing costs, net			—			4,421			—		—			—			4,421
	Other			30			1,927			3,009		2,476			(1,415	)		6,027
	Investment in subsidiaries			217,884			333,064			26,524		—			(577,472	)		—

		Total assets	$	217,914		$	386,780		$	524,496	$	29,024		$	(578,887	)	$	579,327

Current liabilities:
	Current portion of long-term obligations		$	—		$	1,546		$	810	$	—		$	—		$	2,356
	Accounts payable			—			6,735			2,119		—			—			8,854
	Accrued payroll and related liabilities			—			11,079			6,083		338			—			17,500
	Accrued interest			—			5,610			16		4			—			5,630
	Other accrued liabilities			—			11,079			5,337		—			—			16,416

		Total current liabilities		—			36,049			14,365		342			—			50,756
Long-term obligations, less current portion				—			315,479			655		—			(1,415	)		314,719
Deferred income taxes				—			26,493			—		—			—			26,493
Other liabilities				—			3,544			—		—			—			3,544
Mandatorily redeemable partnership interests				—			—			2,176		—			—			2,176
Intercompany payable/(receivable)				40,502			(212,669	)		174,236		(2,069	)		—			—
Minority interest				—			—			—		—			4,227			4,227
Preferred stock				—			—			—		—			—			—
Stockholders’ equity:
	Common stock			41			—			—		—			—			41
	Additional paid-in capital			245,056			—			—		—			—			245,056
	Accumulated equity (deficit)			(67,587	)		217,966			333,064		30,751			(581,781	)		(67,587	)
	Accumulated other comprehensive loss - unrealized loss on hedging instruments			(82	)		(82	)		—		—			82			(82	)
	Notes receivable from stockholders			(16	)		—			—		—			—			(16	)

		Total stockholders’ equity		177,412			217,884			333,064		30,751			(581,699	)		177,412

		Total liabilities and stockholders’ equity	$	217,914		$	386,780		$	524,496	$	29,024		$	(578,887	)	$	579,327

VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

CONDENSED, CONSOLIDATING BALANCE SHEETS
As of December 31, 2003
(In thousands)


											Non-
									Guarantor		Guarantor
			VCA			Vicar			Subsidiaries		Subsidiaries			Elimination			Consolidated

Current assets:
	Cash and cash equivalents		$	—		$	14,883		$	2,244	$	110		$	—		$	17,237
	Trade accounts receivable, net			—			6			21,790		539			—			22,335
	Inventory, prepaid expenses and other			—			2,607			6,228		597			—			9,432
	Deferred income taxes			—			11,040			—		—			—			11,040
	Prepaid income taxes			—			7,266			—		—			—			7,266

		Total current assets		—			35,802			30,262		1,246			—			67,310
Property and equipment, net				—			6,692			90,933		1,536			—			99,161
Other assets:
	Goodwill, net			—			—			351,130		22,108			—			373,238
	Covenants-not-to-compete, net			—			—			4,050		576			—			4,626
	Deferred financing costs, net			—			4,601			—		—			—			4,601
	Other			30			1,939			2,517		2,296			(915	)		5,867
	Investment in subsidiaries			203,141			313,565			25,109		—			(541,815	)		—

		Total assets	$	203,171		$	362,599		$	504,001	$	27,762		$	(542,730	)	$	554,803

Current liabilities:
	Current portion of long-term obligations		$	—		$	1,544		$	859	$	—		$	—		$	2,403
	Accounts payable			—			7,295			1,913		—			—			9,208
	Accrued payroll and related liabilities			—			7,837			7,541		338			—			15,716
	Accrued interest			—			1,517			16		5			—			1,538
	Other accrued liabilities			—			10,590			4,423		(7	)		—			15,006

		Total current liabilities		—			28,783			14,752		336			—			43,871
Long-term obligations, less current portion				—			314,451			1,530		—			(915	)		315,066
Deferred income taxes				—			24,532			—		—			—			24,532
Other liabilities				—			3,216			—		—			—			3,216
Mandatorily redeemable partnership interests				—			—			2,176		—			—			2,176
Intercompany payable/(receivable)				41,248			(211,524	)		171,978		(1,702	)		—			—
Minority interest				—			—			—		—			4,019			4,019
Preferred stock				—			—			—		—			—			—
Stockholders’ equity:
	Common stock			41			—			—		—			—			41
	Additional paid-in capital			244,311			—			—		—			—			244,311
	Accumulated equity (deficit)			(82,331	)		203,223			313,565		29,128			(545,916	)		(82,331	)
	Accumulated other comprehensive loss - unrealized loss on hedging instruments			(82	)		(82	)		—		—			82			(82	)
	Notes receivable from stockholders			(16	)		—			—		—			—			(16	)

		Total stockholders’ equity		161,923			203,141			313,565		29,128			(545,834	)		161,923

		Total liabilities and stockholders’ equity	$	203,171		$	362,599		$	504,001	$	27,762		$	(542,730	)	$	554,803

VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

CONDENSED, CONSOLIDATING INCOME STATEMENTS
For the Three Months Ended March 31, 2004
(Unaudited)
(In thousands)


										Non-
								Guarantor		Guarantor
		VCA			Vicar			Subsidiaries		Subsidiaries			Elimination			Consolidated

Revenue		$	—		$	—		$	133,862	$	10,745		$	(257	)	$	144,350
Direct costs			—			—			93,411		8,414			(257	)		101,568
Selling, general and administrative			—			2,386			5,556		365			—			8,307
Depreciation and amortization			—			394			3,061		161			—			3,616
Loss on sale of assets			—			—			62		—			—			62

	Operating income (loss)		—			(2,780	)		31,772		1,805			—			30,797
Interest expense, net			(1	)		5,983			40		(37	)		—			5,985
Other expense			—			111			—		—			—			111
Equity interest in income of subsidiaries			14,743			19,499			1,426		—			(35,668	)		—

	Income before minority interest and provision (benefit) for income taxes		14,744			10,625			33,158		1,842			(35,668	)		24,701
Minority interest in income of subsidiaries			—			—			—		—			416			416

	Income before provision (benefit) for income taxes		14,744			10,625			33,158		1,842			(36,084	)		24,285
Provision (benefit) for income taxes			—			(4,118	)		13,659		—			—			9,541

	Net income	$	14,744		$	14,743		$	19,499	$	1,842		$	(36,084	)	$	14,744

VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

CONDENSED, CONSOLIDATING INCOME STATEMENTS
For the Three Months Ended March 31, 2003
(Unaudited)
(In thousands)


											Non-
								Guarantor			Guarantor
		VCA			Vicar			Subsidiaries			Subsidiaries			Elimination			Consolidated

Revenue		$	—		$	—		$	116,167		$	9,638		$	(226	)	$	125,579
Direct costs			—			—			82,017			7,539			(226	)		89,330
Selling, general and administrative			—			4,153			4,867			343			—			9,363
Depreciation and amortization			—			346			3,077			154			—			3,577
Gain on sale of assets			—			—			(238	)		—			—			(238	)

	Operating income (loss)		—			(4,499	)		26,444			1,602			—			23,547
Interest expense, net			531			6,464			29			(32	)		—			6,992
Debt retirement costs			7,417			—			—			—			—			7,417
Other expense			—			127			—			—			—			127
Equity interest in income of subsidiaries			9,872			16,585			1,273			—			(27,730	)		—

	Income before minority interest and provision (benefit) for income taxes		1,924			5,495			27,688			1,634			(27,730	)		9,011
Minority interest in income of subsidiaries			—			—			—			—			361			361

	Income before provision (benefit) for income taxes		1,924			5,495			27,688			1,634			(28,091	)		8,650
Provision (benefit) for income taxes			(3,259	)		(4,377	)		11,103			—			—			3,467

	Net income	$	5,183		$	9,872		$	16,585		$	1,634		$	(28,091	)	$	5,183

VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

CONDENSED, CONSOLIDATING STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2004
(Unaudited)
(In thousands)


											Non-
								Guarantor			Guarantor
		VCA			Vicar			Subsidiaries			Subsidiaries			Elimination			Consolidated

Cash flows from operating activities:
	Net income	$	14,744		$	14,743		$	19,499		$	1,842		$	(36,084	)	$	14,744
	Adjustments to reconcile net income to net cash provided by (used in) operating activities:
	Equity interest in earnings of subsidiaries		(14,743	)		(19,499	)		(1,426	)		—			35,668			—
	Depreciation and amortization		—			394			3,061			161			—			3,616
	Amortization of deferred financing costs and debt discount		—			180			4			—			—			184
	Provision for uncollectible accounts		—			—			569			59			—			628
	Loss on sale of assets		—			—			62			—			—			62
	Minority interest in income of subsidiaries		—			—			—			—			416			416
	Distributions to minority interest partners		—			(374	)		—			—			—			(374	)
	Increase in accounts receivable		—			(1	)		(4,400	)		(84	)		—			(4,485	)
	Decrease (increase) in inventory, prepaid expenses and other assets		—			145			(156	)		53			—			42
	Increase (decrease) in accounts payable and other accrued liabilities		—			(71	)		537			7			—			473
	Increase (decrease) in accrued payroll and related liabilities		—			3,242			(1,458	)		—			—			1,784
	Increase (decrease) in accrued interest		—			4,093			—			(1	)		—			4,092
	Decrease in prepaid income taxes		—			6,361			—			—			—			6,361
	Increase in deferred income tax assets		—			(393	)		—			—			—			(393	)
	Increase in deferred income tax liabilities		—			2,386			—			—			—			2,386
	Increase in intercompany payable/(receivable)		(423	)		16,764			(14,314	)		(2,027	)		—			—

	Net cash provided by (used in) operating activities		(422	)		27,970			1,978			10			—			29,536

VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

CONDENSED, CONSOLIDATING STATEMENTS OF CASH FLOWS — (Continued)
For the Three Months Ended March 31, 2004
(Unaudited)
(In thousands)


											Non-
								Guarantor			Guarantor
			VCA		Vicar			Subsidiaries			Subsidiaries		Elimination		Consolidated

Cash flows used in investing activities:
	Business acquisitions, net of cash acquired		$	—	$	(14,113	)	$	—		$	—	$	—	$	(14,113	)
	Property and equipment additions, net			—		(2,719	)		(746	)		—		—		(3,465	)
	Proceeds from sale of assets			—		178			—			—		—		178
	Other			—		12			83			—		—		95

		Net cash used in investing activities		—		(16,642	)		(663	)		—		—		(17,305	)

Cash flows from financing activities:
	Repayment of long-term obligations			—		(529	)		—			—		—		(529	)
	Proceeds from issuance of common stock under stock option plans			422		—			—			—		—		422

		Net cash provided by (used in) financing activities		422		(529	)		—			—		—		(107	)

Increase in cash and cash equivalents				—		10,799			1,315			10		—		12,124
Cash and cash equivalents at beginning of period				—		14,883			2,244			110		—		17,237

Cash and cash equivalents at end of period			$	—	$	25,682		$	3,559		$	120	$	—	$	29,361

VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

CONDENSED, CONSOLIDATING STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2003
(Unaudited)
(In thousands)


												Non-
									Guarantor			Guarantor
			VCA			Vicar			Subsidiaries			Subsidiaries			Elimination			Consolidated

Cash flows from operating activities:
	Net income		$	5,183		$	9,872		$	16,585		$	1,634		$	(28,091	)	$	5,183
	Adjustments to reconcile net income to net cash provided by (used in) operating activities:
	Equity interest in earnings of subsidiaries			(9,872	)		(16,585	)		(1,273	)		—			27,730			—
	Depreciation and amortization			—			346			3,077			154			—			3,577
	Amortization of deferred financing costs and debt discount			14			219			—			—			—			233
	Provision for uncollectible accounts			—			—			848			80			—			928
	Debt retirement costs			7,417			—			—			—			—			7,417
	Gain on sale of assets			—			—			(238	)		—			—			(238	)
	Minority interest in income of subsidiaries			—			—			—			—			361			361
	Distributions to minority interest partners			—			(409	)		—			—			—			(409	)
	Increase in accounts receivable			—			(2	)		(3,937	)		(47	)		—			(3,986	)
	Decrease (increase) in inventory, prepaid expenses and other assets			17			106			(358	)		13			—			(222	)
	Increase in accounts payable and other accrued liabilities			—			1,739			879			44			—			2,662
	Increase (decrease) in accrued payroll and related liabilities			—			1,550			(1,737	)		3			—			(184	)
	Increase in accrued interest			—			4,200			16			—			—			4,216
	Decrease in prepaid income taxes			—			1,461			—			—			—			1,461
	Increase in deferred income tax assets			—			(181	)		—			—			—			(181	)
	Increase in deferred income tax liabilities			—			1,561			—			—			—			1,561
	Increase in intercompany payable/(receivable)			(14,932	)		28,626			(11,843	)		(1,851	)		—			—

		Net cash provided by (used in) operating activities		(12,173	)		32,503			2,019			30			—			22,379

VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

CONDENSED, CONSOLIDATING STATEMENTS OF CASH FLOWS — (Continued)
For the Three Months Ended March 31, 2003
(Unaudited)
(In thousands)


												Non-
									Guarantor			Guarantor
			VCA			Vicar			Subsidiaries			Subsidiaries		Elimination		Consolidated

Cash flows used in investing activities:
	Business acquisitions, net of cash acquired		$	—		$	(6,011	)	$	—		$	—	$	—	$	(6,011	)
	Real estate acquired in connection with business acquisitions			—			(88	)		—			—		—		(88	)
	Property and equipment additions, net			—			(1,651	)		(1,174	)		—		—		(2,825	)
	Proceeds from sale of assets			—			353			—			—		—		353
	Other			(2	)		38			179			—		—		215

		Net cash used in investing activities		(2	)		(7,359	)		(995	)		—		—		(8,356	)

Cash flows from financing activities:
	Repayment of long-term obligations, including redemption fees			(41,808	)		(485	)		—			—		—		(42,293	)
	Repayment of revolving credit facility			—			(7,500	)		—			—		—		(7,500	)
	Payment of deferred financing costs			(382	)		—			—			—		—		(382	)
	Proceeds from issuance of common stock under stock option plans			20			—			—			—		—		20
	Proceeds from issuance of common stock			54,345			—			—			—		—		54,345

		Net cash provided by (used in) financing activities		12,175			(7,985	)		—			—		—		4,190

Increase in cash and cash equivalents				—			17,159			1,024			30		—		18,213
Cash and cash equivalents at beginning of period				—			5,083			1,233			146		—		6,462

Cash and cash equivalents at end of period			$	—		$	22,242		$	2,257		$	176	$	—	$	24,675

12. Subsequent Events

From April 1, 2004 through May 10, 2004, the Company acquired five animal hospitals for an aggregate consideration of $11.8 million, consisting of $11.5 million in cash and the assumption of liabilities of $350,000.

On May 9, 2004, the Company entered into a merger agreement with National PetCare Centers, Inc. (“NPC”), pursuant to which the Company will acquire NPC for $76.5 million (less assumed debt), to be paid in cash. NPC operates 69 animal hospitals in 11 states with annual revenues for the year ended December 31, 2003 of $81.7 million. This merger agreement is subject to customary closing conditions, including approval of the stockholders of NPC.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our condensed, consolidated financial statements provided under Part I, Item I of this quarterly report on Form 10-Q. Certain statements contained herein may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve a number or risks, uncertainties and other factors that could cause actual results to differ materially, as discussed more fully herein.

The forward-looking information set forth in this quarterly report on Form 10-Q is as of May 10, 2004, and we undertake no duty to update this information. Shareholders and prospective investors can find information filed with the SEC after May 10, 2004 at our website at www.investor.vcaantech.com or at the SEC’s website at www.sec.gov. More information about potential factors that could affect our business and financial results is included in the section entitled “Risk Factors.”

Overview

We are a leading animal health care services company and operate the largest networks of veterinary diagnostic laboratories and freestanding, full-service animal hospitals in the United States. Our network of veterinary diagnostic laboratories provides sophisticated testing and consulting services used by veterinarians in the detection, diagnosis, evaluation, monitoring, treatment and prevention of diseases and other conditions affecting animals. Our animal hospitals offer a full range of general medical and surgical services for companion animals. We treat diseases and injuries, offer pharmaceutical products and perform a variety of pet wellness programs, including health examinations, diagnostic testing, routine vaccinations, spaying, neutering and dental care.

At March 31, 2004, our laboratory network consisted of 23 laboratories serving all 50 states and our animal hospital network consisted of 247 animal hospitals in 34 states. We primarily focus on generating internal growth to increase revenue and profitability. In order to augment internal growth, we may selectively acquire laboratories and intend to acquire 20 to 25 animal hospitals per year with aggregate annual revenues of approximately $25.0 million, depending upon the attractiveness of candidates and the strategic fit with our existing operations. In addition, if presented with a favorable opportunity, we may pursue acquisitions of additional animal hospitals or laboratories, including additional chains.

The following table summarizes our growth in facilities:


		Three Months Ended
		March 31,

		2004			2003

Laboratories:
	Beginning of period		23			19
	Acquisitions		—			1

	End of period		23			20

Animal hospitals:
	Beginning of period		241			229
	Acquisitions		9			5
	Relocated into hospitals operated by us		(2	)		—
	Sold or closed		(1	)		(1	)

	End of period		247			233

We adopted Financial Accounting Standards Board, FASB, Interpretation No. 46R, FIN No. 46R, Consolidation of Variable Interest Entities, in the fourth quarter of 2003 and accordingly, restated the prior period to conform to the current period presentation. Under FIN No. 46R we consolidate the operating results of the veterinary medical groups for which we provide management services. The result of the consolidation is an increase

in both revenue and direct costs by an equal amount, thus there is no impact on operating income, net income, earnings per share or cash flows. However, hospital and consolidated operating margins are lower than our historical reported margins because of the increase in revenue without a corresponding increase in operating income.

Subsequent Event

On May 9, 2004, we entered into a merger agreement with National PetCare Centers, Inc., which we refer to as NPC, pursuant to which we will acquire NPC for $76.5 million (less assumed debt), to be paid in cash. NPC operates 69 animal hospitals in 11 states with annual revenues for the year ended December 31, 2003 of $81.7 million. The merger will allow us to expand our animal hospital operations in nine states, particularly California and Texas, and to expand into two new states, Oregon and Oklahoma.

We expect to incur integration expenses during the remainder of 2004 as we integrate NPC's animal hospital operations into our existing animal hospital operations. Our integration plan includes eliminating duplicative overhead and the closure, sale or merger of those NPC animal hospitals that do not fit our model or which we expect cannot meet our operating goals. We believe that the combination of the two companies will be accretive to net income and diluted earnings per share, starting in the third quarter of 2004. We expect a positive impact (after integration costs) of between one and two cents per diluted earnings per share in 2004. The impact in the second quarter of 2004 is not expected to be material.

We expect to require approximately $80.0 million to $85.0 million in cash to fund merger consideration, assumed debt, transaction costs and integration costs. We intend to fund these requirements from cash on hand and increased borrowings. We will need to negotiate amendments to our existing credit facilities or enter into new facilities in order to provide for these requirements.

The NPC board of directors unanimously approved the merger agreement. The merger agreement is subject to customary closing conditions, including approval of the stockholders of NPC. Significant stockholders of NPC, representing over 36% of the vote required to approve the transaction, have agreed to vote in favor of the transaction while the merger agreement is in effect. VCA Antech's board of directors unanimously approved the merger. Closing is targeted for June 2004.

Basis of Reporting

General

Our discussion and analysis of our financial condition and results of operations are based upon our condensed, consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States of America, or GAAP. We report our operations in three segments: laboratory, animal hospital and corporate.

The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expense, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Our estimates form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates due to changes in future conditions.

Revenue Recognition

We recognize revenue only after the following criteria are met:

       •    there exists adequate evidence of the transaction;

       •    delivery of goods has occurred or services have been rendered; and

       •    the price is not contingent on future activity and collectibility is reasonably assured.

We report our revenue net of sales discounts.

Laboratory Revenue

Laboratory internal revenue growth was calculated using laboratory revenue as reported, adjusted to exclude revenue for the newly acquired laboratories that we did not own for the entire period presented and adjusted for the impact resulting from any differences in the number of billing days in comparable periods.

Approximately 6% of laboratory revenue is intercompany revenue that was generated by providing laboratory services to our animal hospitals. For purposes of reviewing the operating performance of the business segments, all intercompany revenue is accounted for as if the transaction was with an independent third-party at current market prices. For financial reporting purposes, intercompany revenue is eliminated as part of our consolidation.

Discounts, such as those given to clients for prompt payment, are given to clients in periods subsequent to the period the revenue was recognized. These discounts are estimated and deducted from revenue in the period the related revenue was recognized. These estimates are based upon historical experience. Errors in these estimates would not have a material effect on our condensed, consolidated financial statements.

Animal Hospital Revenue

Certain states prohibit business corporations from providing, or holding themselves out as providers of, veterinary medical care. In these states, we provide administrative and support services to veterinary medical groups pursuant to management agreements. The veterinary medical groups are each solely responsible for all aspects of the practice of veterinary medicine. In return for our services, the veterinary medical groups pay us management fees. We consolidate the financial results of these veterinary medical groups.

Same-facility revenue growth includes revenue generated by customers referred from our relocated or combined animal hospitals, including those combined upon acquisition and adjusted for the impact resulting from any differences in the number of business days in comparable periods.

Direct Costs

Laboratory direct costs are comprised of all costs of laboratory services, including salaries of veterinarians, specialists, technicians and other non-administrative, laboratory-based personnel, facilities rent, occupancy costs and supply costs.

Animal hospital direct costs are comprised of all costs of services and products at the animal hospitals, including salaries of veterinarians, technicians and all other animal hospital-based personnel, facilities rent, occupancy costs, supply costs, certain marketing and promotional expense and costs of goods sold associated with the retail sales of pet food and pet supplies.

Selling, General and Administrative Expense

Our selling, general and administrative expense is divided between our laboratory, animal hospital and corporate segments. Laboratory selling, general and administrative expense consists primarily of salary-related sales, administrative, accounting personnel, selling, marketing and promotional expense. Animal hospital selling, general and administrative expense consists primarily of field management, certain administrative and accounting personnel, recruiting and certain marketing expense. Corporate selling, general and administrative expense consists of administrative expense at our headquarters, including the salaries of corporate officers, rent, accounting, finance, legal and other professional expense and occupancy costs.

Software Development Costs

We frequently develop and implement new software to be used internally, or enhance our existing internal software. We develop the software using our own employees and/or outside consultants. Costs associated with the development of new software are expensed as incurred. Costs related directly to the software design, coding, testing and installation are capitalized and amortized over the expected life of the software, generally three years. Costs related to upgrades or enhancements of existing systems are capitalized if the modifications result in additional functionality.

Critical Accounting Policies and Significant Estimates

We are required to make significant accounting estimates that directly impact our consolidated financial statements and related disclosures. Significant estimates are estimates that meet two criteria: (1) the estimates require that we make assumptions about matters that are highly uncertain at the time the estimates are made; and (2) there exist different estimates that could reasonably be used in the current period, or changes in the estimates used are reasonably likely to occur from period to period, both of which would have a material impact on the presentation of the financial condition or results of operations. We base our assumptions and estimates on historical experience and on various other factors believed to be reasonable under the circumstances. We have discussed with our audit committee the critical accounting policies for our company, the basis for their underlying assumptions and estimates and the nature of our related disclosures herein. We believe the critical accounting policies for our company that are most affected by significant estimates and judgments are as follows:

Workers’ Compensation Expense

Workers’ compensation expense is the cost to insure our company against losses related to injuries incurred by our employees in the normal course of their duties. In 2001, we restructured our workers’ compensation insurance policies to a self-insurance retention program. The effect of this restructuring was a shift of the significant portion of the financial risk associated with claims losses from the insurance company to our company, while the insurance company bears only the financial risk of large individual losses and large aggregate losses.

We estimate the amount that we will ultimately pay for losses associated with workers’ compensation claims, or claims losses for the policy period. These estimated claims losses are recorded as expense during the policy period.

Claims losses can vary substantially and, because they can take years to develop fully, can be difficult to estimate. These estimates are based on complex judgments regarding the probable number of claims that will be filed and the nature of those claims. Both of those variables are highly uncertain and combine to form a factor referred to as the “loss pick.” The loss pick factor is multiplied by our payroll cost to determine what the projected costs for claims and our related expense will be.

We estimate the loss pick by reviewing a minimum of five years of our historical claims loss data and analyzing the trend of the development of claims over time. We also review and adjust the loss pick for other major factors such as the risk control environment and claims handling. We review our loss pick on a quarterly basis considering the current loss trend and any changes in the environment as indicated above. The loss pick is then applied to our actual payroll costs to estimate the claims loss portion of our workers’ compensation expense for the given period.

Our insurance carriers require us to pre-fund claims at a certain loss pick (the “low-end” in the following table), and give us a maximum loss pick (the “high-end” in the following table), above which the carrier is responsible for paying all claims. The ranges set forth by the insurance carrier reflect the most probable potential for our workers’ compensation claims losses. The increase in the insurance carriers’ range reflects the trend over the last several years toward increasing workers’ compensation costs. Based on these ranges, and the factors described above, we estimated our losses using a loss pick of 2.10% for the policy years ending September 30, 2004 and 2003. The increase in our loss pick reflects an increase in our claims loss trend during the previous years.

The following table reflects the loss pick percentages and total estimated claims expense recorded by us and the probable ranges for the ultimate realized loss picks and claims expense (in thousands):


				Claims Expense					Probable Claims Expense Range
				Recorded					Low-End					High-End

		Payroll		%			$		%			$		%			$

Policy year ending 9/30/04 (6 months of policy elapsed as of 3/31/04)		$	98,843		2.10	%	$	2,076		1.53	%	$	1,512		2.82	%	$	2,784
Policy year ended 9/30/03			185,907		2.10	%		3,904		1.59	%		2,931		2.55	%		4,741
Policy year ended 9/30/02			169,022		2.04	%		3,441		1.54	%		2,603		2.49	%		4,208

	Total	$	453,772		2.08	%	$	9,421		1.55	%	$	7,046		2.59	%	$	11,733

We recognize the claims expense as part of the overall workers’ compensation expense in direct costs and selling, general and administrative expense of our segments, based on their respective payroll cost and the loss pick percentage discussed and shown above, to calculate the claims loss portion of the expense. The difference between the minimum amount of claims losses pre-funded to the insurance carrier and the amount expensed is accrued and included in other liabilities. If our estimates prove to be incorrect as the losses develop over several years, we will either have to pay additional claims losses or will receive a refund from our insurance carrier. This could result in a need for us to recognize additional expense or have expense reduced in future periods within the range shown above.

The insurance policies in place prior to September 30, 2001 did not have large deductibles, and we have accrued for the maximum possible expense under these policies.

Impairment of Goodwill

Our goodwill represents the purchase price paid and liabilities assumed for animal hospital and laboratory acquisitions in excess of the fair market value of the net assets acquired. The total amount of our net goodwill at March 31, 2004 was $386.7 million, consisting of $94.8 million for our laboratory operating segment and $291.9 million for our animal hospital operating segment.

Annually, and upon material changes in our operating environment, we test our goodwill for impairment by comparing the fair market value of our reporting units, which equate to our laboratory and animal hospital operating segments, to their respective net book value. At December 31, 2003, we estimated the fair market value of each of our operating segments and determined that the estimated fair value of each exceeded their respective net book value, resulting in a conclusion that our goodwill was fairly stated.

For three months ended March 31, 2004, there have been no significant changes in the operating environment of our operating segments or in the other variables used in our estimates of fair value that would cause us to believe that the fair value of our operating segments might have materially changed since our evaluation at December 31, 2003. We will review our goodwill for impairment again at December 31, 2004 or upon material changes in our operating environment. We do not anticipate that there will be significant changes in our operations or operating environments in the near future.

Legal Settlements

We are a party to various legal proceedings. Although we cannot determine the ultimate disposition of these proceedings, we can use judgment to reasonably estimate our liability for legal settlement costs that may arise as a result of these proceedings. Significant changes in the proceedings of current claims or the occurrence of new claims could result in the need for additional accruals.

Allowance for Uncollectible Accounts

The allowance for uncollectible accounts is estimated based primarily upon age of accounts receivable and loss history. Accounts receivable balances are routinely reviewed in conjunction with collection efforts, historical collection rates and other economic conditions which might ultimately affect the collectibility of accounts when considering the adequacy of the amounts recorded as allowance for uncollectible accounts. Significant changes in client mix or economic conditions could affect our collection of accounts receivable, cash flows and results of operations.

Results of Operations

The following table sets forth components of our income statements expressed as a percentage of revenue:


			Three Months Ended
			March 31,

			2004			2003

Revenue:
	Laboratory			34.1	%		33.2	%
	Animal hospital			67.9			68.7
	Intercompany			(2.0	)		(1.9	)

		Total revenue		100.0			100.0
Direct costs (excluding operating depreciation)				70.4			71.1
Selling, general and administrative				5.8			7.5
Depreciation and amortization				2.5			2.8
Loss (gain) on sale of assets				—			(0.2	)

	Operating income			21.3			18.8
Interest expense, net				4.1			5.6
Debt retirement costs				—			5.9
Other expense				0.1			0.1
Minority interest in income of subsidiaries				0.3			0.3

	Income before provision for income taxes			16.8			6.9
Provision for income taxes				6.6			2.8

	Net income			10.2	%		4.1	%

The following is a summary of the components of operating income (loss) and operating margin by segment (in thousands):


												Inter-
						Animal						company
			Laboratory			Hospital			Corporate			Eliminations			Total

Three Months Ended March 31, 2004
	Revenue		$	49,182		$	97,956		$	—		$	(2,788	)	$	144,350
	Direct costs (excluding operating depreciation)			26,894			77,462			—			(2,788	)		101,568
	Selling, general and administrative			3,173			2,748			2,386			—			8,307
	Depreciation and amortization			821			2,401			394			—			3,616
	Loss (gain) on sale of assets			(1	)		63			—			—			62

		Operating income (loss)	$	18,295		$	15,282		$	(2,780	)	$	—		$	30,797

		Operating margin		37.2	%		15.6	%		(1.9	)%					21.3	%

Three Months Ended March 31, 2003
	Revenue		$	41,698		$	86,307		$	—		$	(2,426	)	$	125,579
	Direct costs (excluding operating depreciation)			23,456			68,300			—			(2,426	)		89,330
	Selling, general and administrative			2,707			2,503			4,153			—			9,363
	Depreciation and amortization			754			2,477			346			—			3,577
	Gain on sale of assets			(2	)		(236	)		—			—			(238	)

		Operating income (loss)	$	14,783		$	13,263		$	(4,499	)	$	—		$	23,547

		Operating margin		35.5	%		15.4	%		(3.6	)%					18.8	%

Revenue

The following table summarizes our revenue (in thousands):


		Three Months Ended March 31,

		2004			2003			% Change

Laboratory		$	49,182		$	41,698			17.9	%
Animal hospital			97,956			86,307			13.5	%
Intercompany			(2,788	)		(2,426	)

	Total revenue	$	144,350		$	125,579			14.9	%

Laboratory Revenue

Laboratory revenue increased $7.5 million for the three months ended March 31, 2004 compared to the same period in the prior year. The components of the increase in laboratory revenue are detailed below (in thousands, except average price per requisition):


		Three Months Ended March 31,

Laboratory Revenue:		2004		2003		% Change

Internal growth:
	Number of requisitions		1,999		1,846		8.3	%
	Average revenue per requisition (1)	$	23.22	$	22.59		2.8	%

Total internal revenue (2)		$	46,411	$	41,698		11.3	%
Billing day adjustment (3)			611		—
Acquired revenue			2,160		—

	Total	$	49,182	$	41,698		17.9	%

(1)		Computed by dividing total internal revenue by the number of requisitions.




(2)		Numbers may not calculate exactly due to rounding.




(3)		The 2004 billing day adjustment reflects the impact of one additional billing day for the three months ended March 31, 2004 as compared to the same period in the prior year.

The increases in requisitions from internal growth for the three months ended March 31, 2004 are the result of a continued trend in veterinary medicine to focus on the importance of laboratory diagnostic testing in the diagnosis and treatment of diseases. This trend is driven by an increase in the number of specialists in the veterinary industry relying on diagnostic testing, the increased focus on diagnostic testing in veterinary schools and general increased awareness through ongoing marketing and continuing education programs provided by ourselves, pharmaceutical companies and other service providers in the industry. In addition, we continue to see the impact from the recent migration of diagnostic testing from the human health care industry and the advent of medicine in the veterinary industry that requires diagnostic assessment and monitoring.

The increases in the average revenue per requisition for the three months ended March 31, 2004 is primarily attributable to price increases, which approximated 2% to 4% in February 2004 and 3% to 5% in February 2003. These price increases were partially offset by changes in the mix of tests performed per requisition.

As the result of our laboratory acquisitions subsequent to January 1, 2003, we generated an additional $2.2 million of revenue (referred to in the above table as “acquired revenue”) during the three months ended March 31, 2004 in comparison to the same period in the prior year.

Animal Hospital Revenue

Animal hospital revenue increased $11.6 million for the three months ended March 31, 2004 compared to the same period in the prior year. The components of the increase are summarized in the following table (in thousands, except average price per order):


		Three Months Ended March 31,

Animal Hospital Revenue:		2004		2003		% Change

Same-facility:
	Orders		809		812		(0.4	)%
	Average revenue per order (1)	$	109.94	$	104.14		5.6	%

Same-facility revenue (2)		$	88,948	$	84,519		5.2	%
Business day adjustment (3)			1,191		—
Net acquired revenue			7,817		1,788

	Total	$	97,956	$	86,307		13.5	%

(1)		Computed by dividing same-facility revenue by same-facility orders.




(2)		Numbers may not calculate exactly due to rounding.




(3)		The 2004 business day adjustment reflects the impact of one additional business day for the three months ended March 31, 2004 as compared to the same period in the prior year.

Over the last few years, certain pet-related products traditionally sold at animal hospitals have become more widely available in retail stores and other distribution channels, and, as a result, we have fewer customers coming to our animal hospitals solely to purchase such items. In addition, there has been a decline in the number of vaccinations as some recent professional literature and research has suggested that vaccinations can be given to pets less frequently. Orders for these pet-related products and vaccinations generally generate revenue that is less than the average revenue for all orders. In addition, the Company’s business strategy has placed greater emphasis on high-quality veterinary care and wellness programs, which are higher priced orders. These trends have resulted in a decrease in the number of orders and an increase in the average revenue per order.

Price increases also contributed to the increase in the average revenue per order, which approximated 2.5% to 5% on services at most hospitals in both February 2004 and 2003. Prices are reviewed on an annual basis for each hospital and adjustments are made based on market considerations, demographics and our costs.

Net acquired revenue represents the revenue from those hospitals acquired, sold or closed on or subsequent to January 1, 2003. Fluctuations in net acquired revenue occur due to the volume, size, and timing of acquisitions and disposals during the periods compared.

Direct Costs (Excluding Operating Depreciation)

The following table summarizes our direct costs as a percentage of applicable revenue (in thousands):


		Three Months Ended March 31,

		2004						2003

					% of						% of			%
		$			Revenue			$			Revenue			Change

Laboratory		$	26,894			54.7	%	$	23,456			56.3	%		14.7	%
Animal hospital			77,462			79.1	%		68,300			79.1	%		13.4	%
Intercompany			(2,788	)					(2,426	)

	Total direct costs	$	101,568			70.4	%	$	89,330			71.1	%		13.7	%

Laboratory Direct Costs

The decrease in laboratory direct costs as a percentage of laboratory revenue during these periods was primarily attributable to increases in laboratory revenue combined with operating leverage associated with our laboratory business. Our operating leverage comes from the incremental margins we realize on additional tests ordered by the same client, as well as when more comprehensive tests are ordered. We are able to benefit from these incremental margins due to the relative fixed cost nature of our laboratory business.

Animal Hospital Direct Costs

Animal hospital direct costs as a percentage of applicable revenue was consistent with the same period in the prior year.

Selling, General and Administrative Expense

The following table summarizes our selling, general and administrative expense, or SG&A, and our expense as a percentage of applicable revenue (in thousands):


		Three Months Ended March 31,

		2004					2003

				% of					% of			%
		$		Revenue			$		Revenue			Change

Laboratory		$	3,173		6.5	%	$	2,707		6.5	%		17.2	%
Animal hospital			2,748		2.8	%		2,503		2.9	%		9.8	%
Corporate			2,386		1.7	%		4,153		3.3	%		(42.5	)%

	Total SG&A	$	8,307		5.8	%	$	9,363		7.5	%		(11.3	)%

Laboratory SG&A

Laboratory SG&A as a percentage of laboratory revenue was consistent with the same period in the prior year. The increase in Laboratory SG&A was primarily the result of hiring additional sales persons.

Animal Hospital SG&A

The decrease in animal hospital SG&A as a percentage of animal hospital revenue was primarily attributable to increases in animal hospital revenue combined with operating leverage associated with our animal hospital business.

Corporate SG&A

During the three months ended March 31, 2004, a claim with our insurance company was settled that provided for the partial reimbursement of the Zoasis Corporation litigation settlement incurred in 2002 and related legal fees. The following table reconciles corporate SG&A as reported to corporate SG&A excluding the insurance claim settlement (in thousands):


		Three Months Ended March 31,

		2004						2003

					% of					% of			%
		$			Revenue			$		Revenue			Change

Corporate SG&A as reported		$	2,386			1.7	%	$	4,153		3.3	%		(42.5	)%
Impact of insurance claim settlement:
	Litigation settlement reimbursement		(1,124	)					—
	Legal fees reimbursement		(801	)					—

Corporate SG&A excluding the insurance claim settlement		$	4,311			3.0	%	$	4,153		3.3	%		3.8	%

Excluding the impact of the insurance claim settlement, corporate SG&A as a percentage of total revenue decreased due to an increase in total revenue combined with operating leverage.

Interest Expense, Net

The following table summarizes our interest expense, net of interest income (in thousands):


			Three Months Ended
			March 31,

			2004		2003

Interest expense:
	Revolving credit facility		$	—	$	27
	Senior term C notes			—		1,839
	Senior term D notes			1,342		—
	9.875% senior subordinated notes			4,197		4,197
	15.5% senior notes			—		522
	Interest rate hedging agreements			164		85
	Amortization of deferred financing costs and debt discount			184		233
	Secured seller notes & other			188		182

				6,075		7,085
Interest income				90		93

		Total interest expense, net of interest income	$	5,985	$	6,992

The decrease in net interest expense was primarily attributable to a decrease in the average debt balances outstanding and a decrease in the weighted average interest rate.

Debt Retirement Costs

On February 4, 2003, we voluntarily retired the entire principal amount of our 15.5% senior notes with net proceeds received from the sale of our common stock. In conjunction with that transaction, we recorded debt retirement costs of $7.4 million.

Provision for Income Taxes

We recognized a litigation settlement reimbursement of $1.1 million during the three months ended March 31, 2004, which we discuss above in “Corporate SG&A.” This reimbursement had no related tax expense reducing our effective tax rate to 39.3% for the three months ended March 31, 2004. This reimbursement will not impact our effective tax rate for quarters subsequent to the quarter ended March 31, 2004.

Liquidity and Capital Resources

Cash and Cash Equivalents

Cash and cash equivalents at March 31, 2004 totaled $29.4 million up from $17.2 million at December 31, 2003. The increase is a result of net cash provided by operations exceeding net cash used in investing and financing activities.

Cash Flows from Operating Activities

Net cash provided by operating activities increased $7.2 million for the three months ended March 31, 2004 compared to the same period in the prior year. This increase is primarily due to: (a) improved operating performance; (b) acquisitions; and (c) an $837,000 decrease in interest paid as a result of a reduction in the weighted average debt balances outstanding and a reduction in the weighted average interest rate. This increase was partially offset by: (a) a $561,000 increase in taxes paid; and (b) a use of $1.6 million from changes in working capital.

Cash Flows used in Investing Activities

In each of the three months ended March 31, 2004 and 2003, net cash used in investing activities was primarily comprised of cash used for the acquisition of animal hospitals and laboratories and expenditures for property and equipment.

We anticipate spending approximately $25.0 to $30.0 million for acquisitions and $18.0 million for property and equipment in 2004. Of these amounts, approximately $14.1 million and $3.5 million was used in the first quarter of 2004. The remaining amounts are intended to be spent over the last three quarters of the year. However, we may purchase either a fewer or greater number of animal hospital facilities, including additional chains, than we are planning depending upon opportunities that present themselves and our cash requirements may change accordingly. In addition, there may be acquisition opportunities in the laboratory field that may impose additional cash requirements. We intend to primarily use cash in our acquisitions but, depending upon the timing and amount of our acquisitions, we may use stock or debt to the extent we deem it appropriate. Our covenants under our senior credit facility allow us to spend $40.0 million per year on acquisitions, and we would require a waiver or amendment to the covenant to exceed this amount.

See “Subsequent Event” for a discussion of additional requirements that may arise in connection with a planned merger.

Cash flows from Financing Activities

During the three months ended March 31, 2003, we completed an offering of common stock at an issue price of $15.25 per share, in which we sold 3.8 million shares of our common stock in exchange for net proceeds of $54.3 million. Approximately $42.7 million of the net proceeds received were used to redeem the entire principal amount of our 15.5% senior notes due 2010 at a redemption price of 110% of the principal amount, plus accrued and unpaid interest.

Borrowings and repayments under our revolving credit facility are the result of normal working capital shifts created by the seasonality of our business and the timing of acquisition activity. In the fourth quarter of 2002 we borrowed $7.5 million, and in early 2003 we repaid the full amount. At March 31, 2004, we had no borrowings under our revolving credit facility.

See “Subsequent Event” for a discussion of additional financing needs we may have in connection with a planned merger.

Future Cash Requirements

The following table sets forth the scheduled principal, interest and other contractual cash obligations due by us for each of the years indicated (in thousands):


	Total			2004 (1)			2005			2006		2007		2008		Thereafter

Long-term debt	$	316,918		$	1,761		$	1,925		$	18,944	$	71,128	$	53,153	$	170,007
Capital lease obligations		157			135			22			—		—		—		—
Operating leases		240,403			12,027			15,861			15,642		15,481		15,172		166,220
Fixed cash interest expense		101,948			17,156			17,246			17,124		16,823		16,812		16,787
Variable cash interest expense (2)		31,736			5,165			7,902			9,242		7,303		2,124		—
Deferred income tax liabilities		26,493			—			—			—		—		—		26,493
Mandatorily redeemable partnership interests		2,176			—			—			—		—		—		2,176
Swap agreements (2)		(431	)		(200	)		(231	)		—		—		—		—

	$	719,400		$	36,044		$	42,725		$	60,952	$	110,735	$	87,261	$	381,683

(1)		Consists of the period April 1 through December 31, 2004.




(2)		We have both fixed-rate and variable-rate debt. The interest payments on our variable-rate debt are based on a variable rate component plus a fixed 2.5%. Including the fixed 2.5%, we estimate that the interest rate on our variable rate debt will be 4.8%, 5.5%, 6.5%, 7.5%, and 8.0% for years 2004 through 2008, respectively. These estimates are based on interest rate projections used to price our interest rate swap agreements. Our consolidated financial statements included in our 2003 Annual Report on Form 10-K discuss these variable-rate notes in more detail.

We anticipate that our cash on hand, cash from operations and, if needed, our revolving credit facility will provide sufficient cash resources to fund our contractual obligations and other cash needs for more than the next 12 months.

See “Subsequent Event” for a discussion of additional cash requirements we may have in connection with a planned merger.

Debt Related Covenants

The senior credit facility contains certain financial covenants pertaining to interest coverage, fixed charge coverage and leverage ratios. In addition, the senior credit facility has restrictions pertaining to capital expenditures, acquisitions and the payment of dividends. We currently believe the most restrictive covenant is the fixed charge coverage ratio. The senior credit facility defines the fixed charge coverage ratio as that ratio which is calculated on a last twelve-month basis by dividing pro forma earnings before interest, taxes, depreciation and amortization, as defined by the agreement, by fixed charges. Fixed charges are defined as cash interest expense, scheduled principal payments on debt obligations, capital expenditures, and provision for income taxes. At March 31, 2004, we had a fixed charge coverage ratio of 1.67 to 1.00, which was in compliance with the required ratio of no less than 1.10 to 1.00.

Interest Rate Hedging Agreements

We entered into certain no-fee swap agreements whereby we pay to the counter party amounts based on fixed interest rates and set notional principal amounts in exchange for the receipt of payments from the counter party based on London interbank offer rates, LIBOR, and the same set notional principal amounts. A summary of these agreements is as follows:

Swap #1

Swap #2

Swap #3

Fixed interest rate

2.22%

1.72%

1.51%

Notional amount

$40.0 million

$20.0 million

Effective date

11/29/2002

5/30/2003

Expiration date

11/29/2004

5/31/2005

Counter party

Wells Fargo Bank

Goldman Sachs

We entered into the swap agreements to hedge against the risk of increasing interest rates. The contracts effectively convert a certain amount of our variable-rate debt under our senior credit facility to fixed-rate debt for purposes of controlling cash paid for interest. That amount is equal to the notional amount of the swap agreements and the fixed rate conversion period is equal to the terms of the contract. The impact of the swap agreements has been factored into our future contractual cash requirements table above.

In the future, we may enter into additional interest rate strategies to take advantage of favorable current rate environments. We have not yet determined what those strategies will be or their possible impact.

Description of Indebtedness

Senior Credit Facility

At March 31, 2004, we had $145.3 million principal amount outstanding under our senior term D notes and no borrowings outstanding under our revolving credit facility.

Borrowings under the senior credit facility bear interest, at our option, on either the base rate, which is the higher of the administrative agent’s prime rate or the Federal Funds Rate plus 0.5% plus a base rate margin, or the adjusted eurodollar rate, which is the rate per annum obtained by dividing (1) the rate of interest offered to the administrative agent on the London interbank market by (2) a percentage equal to 100% minus the stated maximum rate of all reserve requirements applicable to any member bank of the Federal Reserve System in respect of “eurocurrency liabilities” plus a eurodollar rate margin. The base rate margins for the revolving credit facility range from 1.00% to 2.25% per annum and the margin for the senior term D notes is 1.50% per annum. The eurodollar rate margins for the revolving credit facility range from 2.00% to 3.25% per annum and the margin for the senior term D notes is 2.50% per annum.

The senior term D notes mature in September 2008 and the revolving credit facility matures in September 2006.

9.875% Senior Subordinated Notes

On November 27, 2001, Vicar Operating, Inc., our wholly-owned subsidiary, issued $170.0 million in principal amount of senior subordinated notes due December 1, 2009, which were exchanged on June 13, 2002 for substantially similar securities that are registered under the Securities Act. Interest on these senior subordinated notes is 9.875% per annum, payable semi-annually in arrears in cash. At March 31, 2004, the outstanding principal balance of these senior subordinated notes was $170.0 million. We and each existing and future domestic wholly-owned subsidiary of Vicar have jointly and severally, fully and unconditionally guaranteed these notes. These guarantees are unsecured and subordinated in right of payment to all existing and future indebtedness outstanding under the credit and guaranty agreement and any other indebtedness permitted to be incurred by Vicar under the terms of the indenture agreement governing these notes.

Before December 1, 2004, we can redeem up to $59.5 million of principal on our 9.875% senior subordinated notes at a redemption price of 109.9% of the principal amount with proceeds from an equity offering. The remaining

portion may be paid off at our discretion beginning December 1, 2005 at a redemption price of 104.9% of the principal amount.

Other Debt

At March 31, 2004, we had seller notes secured by assets of animal hospitals, unsecured debt and capital leases that totaled $1.7 million.

Risk Factors

This Form 10-Q, including Risk Factors set forth below, contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they materialize or prove incorrect, could cause our results and the results of our consolidated subsidiaries to differ materially from those expressed or implied by these forward-looking statements. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including any projections of earnings, revenue or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statement concerning proposed new services or developments; any statements regarding the future economic conditions or performance; any statements of belief; and any statements of assumptions underlying any of the foregoing. The risks, uncertainties and assumptions referred to above include difficulty of managing our growth and integrating our new acquisitions and other risks that are described from time to time in our SEC reports, including but not limited to the items discussed below.

We recently entered into a merger agreement to acquire National PetCare Centers, Inc. The planned merger entails risks about which our investors should be aware.

On May 9, 2004, we entered into a merger agreement with NPC pursuant to which we will acquire NPC for $76.5 million (less assumed debt), to be paid in cash. Although we have targeted the closing of this merger for June 1, 2004, the merger is subject to significant conditions, some of which are outside of our control. Accordingly, the closing of the merger may be delayed beyond June 1, 2004 or may not occur at all.

We have entered into a merger agreement with NPC with the expectation that the merger will result in beneficial synergies. These include the potential to realize improved operating margins at animal hospitals through a strategy of centralizing various corporate and administrative functions and leveraging fixed costs.

Achieving these anticipated business benefits will depend on whether our operations and NPC’s operations can be integrated with each other in an efficient, effective and timely manner. Any delays in the integration process or unanticipated costs or results, could negatively impact our combined revenues, operating margins and net income. The combination of our two companies will require, among other things, the integration of the companies’ management staffs, the retention and expansion of the companies’ veterinarian and other professional staff and the identification and elimination of unnecessary overhead and non-performing hospitals. The success of this process will be significantly influenced by our ability to retain key management and professional personnel. If we are unsuccessful in accomplishing this, it may have a negative impact on our combined revenues, operating margins and net income.

The integration of operations of the two companies will require the dedication of management resources, which may temporarily detract attention from the day-to-day business of the combined companies. In addition, the employees of the combined company may be less productive as a result of uncertainty during the integration process, which also may disrupt our business. Our inability to successfully integrate the operations of NPC could have an adverse effect on the business and results of the combined companies. In addition, even if the integration is successfully accomplished, it is anticipated that the integration will be accomplished over time and, in the interim, the combination may have an adverse effect on the business and results of operations of the combined companies.

In addition, the present and potential customers of NPC may not continue their current utilization patterns or the proposed merger may have an adverse impact on the relationships with veterinarians and other animal health care professionals currently employed by NPC. Any significant reduction in utilization patterns or any significant adverse impact on relationships with the veterinarians or other animal health care professionals currently employed by NPC, could have an adverse effect on the business and results of operations of the combined companies.

If we are unable to effectively execute our growth strategy, we may not achieve our desired economies of scale and our margins and profitability may decline.

Our success depends in part on our ability to build on our position as a leading animal health care services company through a balanced program of internal growth initiatives and selective acquisitions of established animal hospitals and laboratories. If we cannot implement or effectively execute these initiatives and acquisitions, our results of operations will be adversely affected. Even if we effectively implement our growth strategy, we may not achieve the economies of scale that we have experienced in the past or that we anticipate having in the future. Our internal growth rate may decline and could become negative. Our laboratory internal revenue growth has fluctuated between 11.9% and 14.1% for each fiscal year from 2001 through 2003. Similarly, our animal hospital adjusted same-facility revenue growth rate has fluctuated between 3.6% and 5.0% over the same fiscal years. Our internal growth may continue to fluctuate and may be below our historical rates. Any reductions in the rate of our internal growth may cause our revenues and margins to decrease. Our historical growth rates and margins are not necessarily indicative of future results.

Demand for certain products could decline as their product life cycle matures and the products become available in other channels of distribution such as retail-oriented locations and through internet service providers. This cycle could affect the frequency of veterinary visits and may result in a reduction in revenue. Demand for vaccinations may also be impacted in the future as protocols for vaccinations change. Vaccinations have been recommended by some in the profession to be given less frequently. This may result in fewer visits and potentially less revenue. Vaccine protocols for our company are currently established by our veterinarians. Some of our veterinarians have changed their protocols and others may change their protocol in light of recent literature.

Due to the fixed cost nature of our business, fluctuations in our revenue could adversely affect our operating income.

Approximately 56% of our expense for the year ended December 31, 2003, particularly rent and personnel costs, are fixed costs and are based in part on expectations of revenue. We may be unable to reduce spending in a timely manner to compensate for any significant fluctuations in our revenue. Accordingly, shortfalls in revenue may adversely affect our operating income.

Difficulties integrating new acquisitions may impose substantial costs and cause other problems for us.

Our success depends on our ability to timely and cost-effectively acquire, and integrate into our business, additional animal hospitals and laboratories. Any difficulties in the integration process may result in increased

expense, loss of customers and a decline in profitability. We expect to acquire in the ordinary course of business 20 to 25 animal hospitals per year with aggregate annual revenues of approximately $25.0 million. In some cases, we have experienced delays and increased costs in integrating some hospitals, particularly where we acquire a large number of hospitals in a single region at or about the same time. In these cases, our field management may spend a predominant amount of time integrating these new hospitals and less time managing our existing hospitals in those regions. During these periods, there may be less attention directed to marketing efforts or staffing issues. In these circumstances, we also have experienced delays in converting the systems of acquired hospitals into our systems, which results in increased payroll expense to collect our results and delays in reporting our results, both for a particular region and on a consolidated basis. If this were to occur in the future, it could result in decreased revenue, increased costs or lower margins.

We continue to face risks in connection with our acquisitions including:

       •    negative effects on our operating results;

       •    impairments of goodwill and other intangible assets;

       •    dependence on retention, hiring and training of key personnel, including specialists; and

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

The process of integration may require a disproportionate amount of the time and attention of our management, which may distract management’s attention from its day-to-day responsibilities. In addition, any interruption or deterioration in service resulting from an acquisition may result in a customer’s decision to stop using us. For these reasons, we may not realize the anticipated benefits of an acquisition, either at all or in a timely manner. If that happens and we incur significant costs, it could have a material adverse impact on our business.

The carrying value of our goodwill could be subject to impairment write-down.

At March 31, 2004, our balance sheet reflected $386.7 million of goodwill, which is a substantial portion of our total assets of $579.3 million at that date. We expect that the aggregate amount of goodwill on our balance sheet will increase as a result of future acquisitions. We continually evaluate whether events or circumstances have occurred that suggest that the fair market value of each of our reporting units is below their carrying values. If we determine that the fair market value of one of our reporting units is less than its carrying value, this may result in an impairment write-down of the goodwill for that reporting unit. The impairment write-down would be reflected as expense and could have a material adverse effect on our results of operations during the period in which we recognize the expense. At December 31, 2003, we concluded that the fair value of our reporting units exceeded their carrying value and accordingly, as of that date, our net goodwill was not impaired in our consolidated financial statements. However, in the future we may incur impairment charges related to the goodwill already recorded or arising out of future acquisitions.

We require a significant amount of cash to service our debt and expand our business as planned.

We have, and will continue to have, a substantial amount of debt. Our substantial amount of debt requires us to dedicate a significant portion of our cash flow from operations to pay down our indebtedness and related interest, thereby reducing the funds available to use for working capital, capital expenditures, acquisitions and general corporate purposes.

At March 31, 2004, our debt consisted of:

       •    $145.3 million in principal amount outstanding under our senior credit facility;

       •    $170.0 million in principal amount outstanding under our 9.875% senior subordinated notes; and

       •    $1.7 million in principal amount outstanding under our other debt.

Our ability to make payments on our debt, and to fund acquisitions, will depend upon our ability to generate cash in the future. Insufficient cash flow could place us at risk of default under our debt agreements or could prevent us from expanding our business as planned. Our ability to generate cash is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Our business may not generate sufficient cash flow from operations, our strategy to increase operating efficiencies may not be realized and future borrowings may not be available to us under our senior credit facility in an amount sufficient to enable us to service our debt or to fund our other liquidity needs. In order to meet our debt obligations, we may need to refinance all or a portion of our debt. We may not be able to refinance any of our debt on commercially reasonable terms or at all.

Our debt instruments may adversely affect our ability to run our business.

Our substantial amount of debt, as well as the guarantees of our subsidiaries and the security interests in our assets and those of our subsidiaries, could impair our ability to operate our business effectively and may limit our ability to take advantage of business opportunities. For example, our indenture and senior credit facility:

       •    limit our funds available to repay the 9.875% senior subordinated notes;

       •    limit our ability to borrow additional funds or to obtain other financing in the future for working capital, capital expenditures, acquisitions, investments and general corporate purposes;

       •    limit our ability to dispose of our assets, create liens on our assets or to extend credit;

       •    make us more vulnerable to economic downturns and reduce our flexibility in responding to changing business and economic conditions;

       •    limit our flexibility in planning for, or reacting to, changes in our business or industry;

       •    place us at a competitive disadvantage to our competitors with less debt; and

       •    restrict our ability to pay dividends, repurchase or redeem our capital stock or debt, or merge or consolidate with another entity.

The terms of our indenture and senior credit facility allow us, under specified conditions, to incur further indebtedness, which would heighten the foregoing risks. If compliance with our debt obligations materially hinders our ability to operate our business and adapt to changing industry conditions, we may lose market share, our revenue may decline and our operating results may suffer.

Our failure to satisfy covenants in our debt instruments will cause a default under those instruments.

In addition to imposing restrictions on our business and operations, our debt instruments include a number of covenants relating to financial ratios and tests. Our ability to comply with these covenants may be affected by events beyond our control, including prevailing economic, financial and industry conditions. The breach of any of these covenants would result in a default under these instruments. An event of default would permit our lenders and other debtholders to declare all amounts borrowed from them to be due and payable, together with accrued and unpaid interest. Moreover, these lenders and other debtholders would have the option to terminate any obligation to make further extensions of credit under these instruments. If we are unable to repay debt to our senior lenders, these lenders and other debtholders could proceed against our assets.

The significant competition in the companion animal health care services industry could cause us to reduce prices or lose market share.

The companion animal health care services industry is highly competitive with few barriers to entry. To compete successfully, we may be required to reduce prices, increase our operating costs or take other measures that could have an adverse effect on our financial condition, results of operations, margins and cash flow. If we are unable to compete successfully, we may lose market share.

There are many clinical laboratory companies that provide a broad range of laboratory testing services in the same markets we service. Our largest competitor for outsourced laboratory testing services is Idexx Laboratories, Inc., which currently competes or intends to compete in most of the same markets in which we operate. Also, Idexx and several other national companies provide on-site diagnostic equipment that allows veterinarians to perform their own laboratory tests.

Our primary competitors for our animal hospitals in most markets are individual practitioners or small, regional, multi-clinic practices. Also, regional pet care companies and some national companies, including operators of super-stores, are developing multi-regional networks of animal hospitals in markets in which we operate. Historically, when a competing animal hospital opens in close proximity to one of our hospitals, we have reduced prices, expanded our facility, retained additional qualified personnel, increased our marketing efforts or taken other actions designed to retain and expand our client base. As a result, our revenue may decline and our costs may increase.

We may experience difficulties hiring skilled veterinarians due to shortages that could disrupt our business.

As the pet population continues to grow, the need for skilled veterinarians continues to increase. If we are unable to retain an adequate number of skilled veterinarians, we may lose customers, our revenue may decline and we may need to sell or close animal hospitals. As of March 31, 2004, there were 28 veterinary schools in the country accredited by the American Veterinary Medical Association. These schools graduate approximately 2,100 veterinarians per year. There is a shortage of skilled veterinarians in some regional markets in which we operate animal hospitals. During shortages in these regions, we may be unable to hire enough qualified veterinarians to adequately staff our animal hospitals, in which event we may lose market share and our revenues and profitability may decline.

If we fail to comply with governmental regulations applicable to our business, various governmental agencies may impose fines, institute litigation or preclude us from operating in certain states.

The laws of many states prohibit business corporations from providing, or holding themselves out as providers of, veterinary medical care. These laws vary from state to state and are enforced by the courts and by regulatory authorities with broad discretion. As of March 31, 2004, we operated 68 animal hospitals in 11 states with these laws, including 21 in New York. We may experience difficulty in expanding our operations into other states with similar laws. Given varying and uncertain interpretations of the veterinary laws of each state, we may not be in compliance with restrictions on the corporate practice of veterinary medicine in all states. A determination that we are in violation of applicable restrictions on the practice of veterinary medicine in any state in which we operate could have a material adverse effect on us, particularly if we were unable to restructure our operations to comply with the requirements of that state.

All of the states in which we operate impose various registration requirements. To fulfill these requirements, we have registered each of our facilities with appropriate governmental agencies and, where required, have appointed a licensed veterinarian to act on behalf of each facility. All veterinarians practicing in our clinics are required to maintain valid state licenses to practice.

Any failure in our information technology systems or disruption in our transportation network (including disruption resulting from terrorist activities) could significantly increase testing turn-around time, reduce our production capacity and otherwise disrupt our operations.

Our laboratory operations depend, in part, on the continued and uninterrupted performance of our information technology systems and transportation network. Our growth has necessitated continued expansion and upgrade of our information technology systems and transportation network. Sustained system failures or interruption in our transportation network or in one or more of our laboratory operations could disrupt our ability to process laboratory requisitions, perform testing, provide test results in a timely manner and/or bill the appropriate party. We could lose customers and revenue as a result of a system or transportation network failure.

Our computer systems are vulnerable to damage or interruption from a variety of sources, including telecommunications failures, electricity brownouts or blackouts, malicious human acts and natural disasters. Moreover, despite network security measures, some of our servers are potentially vulnerable to physical or electrical break-ins, computer viruses and similar disruptive problems. Despite the precautions we have taken, unanticipated

problems affecting our systems could cause interruptions in our information technology systems. Our insurance policies may not adequately compensate us for any losses that may occur due to any failures in our systems.

In addition, over time we have significantly customized the computer systems in our laboratory business. We rely on a limited number of employees to upgrade and maintain these systems. If we were to lose the services of some or all of these employees, it may be time-consuming for new employees to become familiar with our systems, and we may experience disruptions in service during these periods.

Any substantial reduction in the number of available flights or delays in the departure of flights, whether as a result of severe weather conditions, as we recently experienced in the eastern United States, a terrorist attack or any other type of disruption, will disrupt our transportation network and our ability to provide test results in a timely manner. Any change in government regulation related to transporting samples or specimens could also have an impact on our business. In addition, our Test Express service, which services customers outside of major metropolitan areas, is dependent on flight services in and out of Memphis and the transportation network of Federal Express. Any sustained interruption in either flight services in Memphis or the transportation network of Federal Express would result in increased turn-around time for the reporting of test results to customers serviced by our Test Express service.

The loss of Mr. Robert Antin, our Chairman, President and Chief Executive Officer, could materially and adversely affect our business.

We are dependent upon the management and leadership of our Chairman, President and Chief Executive Officer, Robert Antin. We have an employment contract with Mr. Antin which may be terminated at the option of Mr. Antin. We do not maintain any key man life insurance coverage for Mr. Antin. The loss of Mr. Antin could materially adversely affect our business.

Concentration of ownership among our existing executive officers, directors and principal stockholders may prevent new investors from influencing significant corporate decisions.

Our executive officers, directors and principal stockholders beneficially own, in the aggregate, 23.1% of our outstanding common stock. As a result, these stockholders are able to significantly affect our management, our policies and all matters requiring stockholder approval. Our largest stockholder is Leonard Green & Partners, L.P., which owns 16.8% of our common stock. Three of the partners of Leonard Green & Partners, L.P. sit on our eight member board of directors. These directors, along with the two management directors, will be able to significantly affect decisions relating to our capital structure, including decisions to issue additional capital stock, implement stock repurchase programs and incur indebtedness. This concentration of ownership may have the effect of deterring hostile takeovers, delaying or preventing changes in control or changes in management, or limiting the ability of our other stockholders to approve transactions that they may deem to be in their best interests.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As of March 31, 2004, we had borrowings of $145.3 million under our senior credit facility with fluctuating interest rates based on market benchmarks such as LIBOR. To reduce the risk of increasing interest rates, we have entered into three separate no-fee interest rate swap agreements. The first agreement is for $40.0 million and commenced on November 29, 2002 and expires November 29, 2004. The second agreement is for $20.0 million and commenced on May 30, 2003 and expires May 31, 2005. The third agreement is for $20.0 million and commenced on May 30, 2003 and expires May 31, 2005. These swap agreements have the effect of reducing the amount of our debt exposed to variable interest rates from $145.3 million to $65.3 million. Accordingly, for the twelve month period ending March 31, 2005, for every 1.0% increase in LIBOR we will pay an additional $781,000 in interest expense and for every 1.0% decrease in LIBOR we will save $781,000 in interest expense.

We are considering entering into additional interest rate strategies to take advantage of the current rate environment. We have not yet determined what those strategies may be or their possible impact.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, we have carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic reports with the SEC.

In accordance with the requirements of the SEC, our Chief Executive Officer and Chief Financial Officer note that, since the date of the most recent evaluation of our disclosure controls and procedures to the date of this quarterly report on Form 10-Q, there have been no significant changes in our internal controls or in other factors that could significantly affect internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses.

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are not subject to any legal proceedings other than ordinarily routine litigation incidental to the conduct of our business.

ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits:


31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b) Reports on Form 8-K:


(1)		Report on Form 8-K, filed February 24, 2004, reporting under Item 5, financial guidance for fiscal year 2004 and under Item 12, financial information for the fourth quarter and fiscal year 2003.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the City of Los Angeles, State of California.


Date: May 10, 2004	By:	/s/ Tomas W. Fuller

		Tomas W. Fuller Chief Financial Officer

EXHIBIT INDEX


Exhibit No.		Description

31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

	•		there exists adequate evidence of the transaction;

	•		delivery of goods has occurred or services have been rendered; and

	•		the price is not contingent on future activity and collectibility is reasonably assured.

	•		negative effects on our operating results;

	•		impairments of goodwill and other intangible assets;

	•		dependence on retention, hiring and training of key personnel, including specialists; and

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

	•		$145.3 million in principal amount outstanding under our senior credit facility;

	•		$170.0 million in principal amount outstanding under our 9.875% senior subordinated notes; and

	•		$1.7 million in principal amount outstanding under our other debt.

	•		limit our funds available to repay the 9.875% senior subordinated notes;

	•		limit our ability to borrow additional funds or to obtain other financing in the future for working capital, capital expenditures, acquisitions, investments and general corporate purposes;

	•		limit our ability to dispose of our assets, create liens on our assets or to extend credit;

	•		make us more vulnerable to economic downturns and reduce our flexibility in responding to changing business and economic conditions;

	•		limit our flexibility in planning for, or reacting to, changes in our business or industry;

	•		place us at a competitive disadvantage to our competitors with less debt; and

	•		restrict our ability to pay dividends, repurchase or redeem our capital stock or debt, or merge or consolidate with another entity.