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 June 30, 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 o.

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

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 40,957,118 shares as of August 3, 2004.

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VCA ANTECH, INC. AND SUBSIDIARIES

CONDENSED, CONSOLIDATED BALANCE SHEETS
As of June 30, 2004 and December 31, 2003
(Unaudited)
(In thousands, except par value)


	June 30,			December 31,
	2004			2003
ASSETS
Current assets:
Cash and cash equivalents	$	32,836		$	17,237
Restricted cash		1,365			—
Trade accounts receivable, less allowance for uncollectible accounts of $7,187 and $6,681 at June 30, 2004 and December 31, 2003, respectively		26,753			22,335
Inventory, prepaid expenses and other		10,778			9,432
Deferred income taxes		12,672			11,040
Prepaid income taxes		5,866			7,266

Total current assets		90,270			67,310
Property and equipment, net		110,967			99,161
Other assets:
Goodwill		477,733			373,238
Other intangible assets, net		8,177			4,692
Deferred financing costs, net		4,222			4,601
Other		6,039			5,801

Total assets	$	697,408		$	554,803

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term obligations	$	4,578		$	2,403
Accounts payable		12,258			9,208
Accrued payroll and related liabilities		18,200			15,716
Accrued interest		1,665			1,538
Other accrued liabilities		17,971			15,006

Total current liabilities		54,672			43,871
Long-term obligations, less current portion		393,989			315,066
Deferred income taxes		28,914			24,532
Other liabilities		11,860			5,392
Minority interest		8,823			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 40,949 and 40,715 shares outstanding as of June 30, 2004 and December 31, 2003, respectively		41			41
Additional paid-in capital		248,378			244,311
Accumulated deficit		(49,420	)		(82,331	)
Accumulated other comprehensive income (loss) — unrealized gain (loss) on hedging instruments		161			(82	)
Notes receivable from stockholders		(10	)		(16	)

Total stockholders’ equity		199,150			161,923

Total liabilities and stockholders’ equity	$	697,408		$	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 and Six Months Ended June 30, 2004 and 2003
(Unaudited)
(In thousands, except per share amounts)


	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2004			2003		2004			2003
				(Restated)					(Restated)
Revenue	$	169,947		$	142,761	$	314,297		$	268,340
Direct costs		119,943			100,005		224,733			192,566

Gross profit		50,004			42,756		89,564			75,774
Selling, general and administrative		11,765			9,484		20,466			19,193
Loss (gain) on sale of assets		4			78		66			(160	)

Operating income		38,235			33,194		69,032			56,741
Interest expense, net		6,098			6,418		12,083			13,410
Debt retirement costs		810			—		810			7,417
Other (income) expense		(287	)		131		(176	)		258
Minority interest in income of subsidiaries		755			462		1,171			823

Income before provision for income taxes		30,859			26,183		55,144			34,833
Provision for income taxes		12,692			10,833		22,233			14,300

Net income	$	18,167		$	15,350	$	32,911		$	20,533

Basic earnings per common share	$	0.44		$	0.38	$	0.81		$	0.52

Diluted earnings per common share	$	0.44		$	0.37	$	0.79		$	0.51

Shares used for computing basic earnings per share		40,837			40,606		40,789			39,818

Shares used for computing diluted earnings per share		41,691			41,136		41,609			40,288

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 Six Months Ended June 30, 2004 and 2003
(Unaudited)
(In thousands)


	Six Months Ended
	June 30,
	2004			2003
Cash flows from operating activities:
Net income	$	32,911		$	20,533
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		7,435			7,074
Amortization of deferred financing costs and debt discount		367			456
Provision for uncollectible accounts		1,084			1,557
Debt retirement costs		810			7,417
Loss (gain) on sale of assets		66			(160	)
Other		(92	)		—
Minority interest in income of subsidiaries		1,171			823
Distributions to minority interest partners		(813	)		(797	)
Increase in accounts receivable		(4,962	)		(5,351	)
Decrease (increase) in inventory, prepaid expenses and other assets		(522	)		168
Increase in accounts payable and other accrued liabilities		598			1,343
Decrease in accrued payroll and related liabilities		(2,596	)		(2,196	)
Increase (decrease) in accrued interest		10			(32	)
Decrease in prepaid income taxes		3,435			4,910
Increase in deferred income tax assets		(574	)		(877	)
Increase in deferred income tax liabilities		3,987			3,652

Net cash provided by operating activities		42,315			38,520

Cash flows used in investing activities:
Business acquisitions, net of cash acquired		(92,931	)		(19,926	)
Real estate acquired in connection with business acquisitions		(4,385	)		(589	)
Property and equipment additions, net		(9,027	)		(6,168	)
Proceeds from sale of assets		179			355
Other		123			361

Net cash used in investing activities		(106,041	)		(25,967	)

Cash flows from financing activities:
Repayment of long-term obligations, including redemption fees		(146,842	)		(43,011	)
Proceeds from the issuance of long-term debt		225,000			—
Repayment of revolving credit facility		—			(7,500	)
Payment of financing costs		(794	)		(382	)
Proceeds from issuance of common stock under stock option plans		1,961			67
Proceeds from issuance of common stock		—			54,323

Net cash provided by financing activities		79,325			3,497

Increase in cash and cash equivalents		15,599			16,050
Cash and cash equivalents at beginning of period		17,237			6,462

Cash and cash equivalents at end of period	$	32,836		$	22,512

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

VCA ANTECH, INC. AND SUBSIDIARIES

NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
June 30, 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 (“GAAP”) 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 and six months ended June 30, 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

National PetCare Centers, Inc.

On June 1, 2004, the Company consummated a merger agreement with National PetCare Centers, Inc. (“NPC”), which operated 67 animal hospitals located in 11 states as of the merger date. As of June 30, 2004, the Company had not finalized the purchase price accounting for the transaction, however, as of that date, the total consideration was $89.3 million consisting of $66.1 million in cash (net of cash acquired) paid to holders of NPC stock and debt, $2.6 million in assumed debt, $12.8 million in assumed liabilities, $6.3 million of assumed operating leases whose terms were in excess of market and $1.5 million paid for professional services. The preliminary allocation for the $89.3 million is as follows: $11.6 million to tangible assets, $76.3 million to goodwill and $1.4 million to other intangible assets. The Company expects that approximately $18.6 million of the goodwill for NPC will be fully deductible for income tax purposes.

The Company intends to close underperforming NPC animal hospitals and NPC’s corporate office and to terminate NPC employees whose functions are duplicative of those of VCA employees. The Company intends to incur costs associated with these activities, consisting primarily of lease termination costs and employee severance costs. These costs will result in an increase in the total purchase price of the transaction. As of June 30, 2004, the Company has not finalized its formal plan for these activities.

Total Acquisition Activity

The following table summarizes the number of acquired animal hospitals and veterinary diagnostic laboratories (including the NPC acquisition on June 1, 2004):


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2004			2003			2004			2003
Laboratories:
Acquisitions		—			5			—			6
Acquisitions relocated into the Company’s laboratories		—			(2	)		—			(2	)

		—			3			—			4

Animal hospitals:
Acquisitions		73			11			82			16
Acquisitions relocated into the Company’s animal hospitals		(1	)		(5	)		(3	)		(5	)

		72			6			79			11

The following table summarizes the aggregate consideration, including acquisition costs, paid by the Company for its acquisitions (including the NPC acquisition on June 1, 2004) and the preliminary allocation of the purchase price (in thousands):


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2004		2003		2004		2003
Consideration:
Cash	$	80,410	$	13,813	$	94,185	$	19,374
Obligation to be settled in cash or common stock		—		2,250		—		2,250
Obligations to sellers (1)		410		220		1,135		682
Notes payable and other liabilities assumed		21,771		1,180		21,910		1,230

Total	$	102,591	$	17,463	$	117,230	$	23,536

Purchase Price Allocation (2):
Tangible assets	$	12,667	$	2,042	$	13,229	$	2,248
Identifiable intangible assets		3,768		791		4,478		1,205
Goodwill (3)		86,156		14,630		99,523		20,083

Total	$	102,591	$	17,463	$	117,230	$	23,536

(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)		Represents purchase price allocations subject to change in accordance with GAAP. In addition, all purchase price adjustments related to prior period acquisitions are reflected within the balances above.

(3)		The Company expects that $26.4 million and $6.5 million of the goodwill recorded for the three months ended June 30, 2004 and 2003, respectively, and $38.3 million and $11.0 million of the goodwill recorded for the six months ended June 30, 2004 and 2003, respectively, will be fully deductible for income tax purposes.

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


	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2004			2003		2004			2003
Laboratory (1)	$	(1,530	)	$	6,047	$	(1,482	)	$	6,321
Animal hospital		87,686			8,583		101,005			13,762

Total	$	86,156		$	14,630	$	99,523		$	20,083

(1)

In 2004, the Company reallocated $1.5 million to non-contractual customer relationships related to an acquisition that occurred in 2003.

Partnership Interests

During the six months ended June 30, 2004, the Company purchased the ownership interests of partners in four partially-owned subsidiaries of the Company; three of those interests were purchased during the second quarter of 2004. During the six months ended June 30, 2003, the Company purchased the total ownership interest of partners in two partially-owned subsidiaries of the Company; one of those interests was purchased during the second quarter of 2003. The following table summarizes the consideration paid by the Company and the amount of goodwill recorded (in thousands):


	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2004		2003			2004		2003
Consideration:
Cash	$	250	$	106		$	306	$	106
Notes receivable (1)		184		41			184		41
Notes payable		—		—			131		763

Total	$	434	$	147		$	621	$	910

Goodwill recorded (2)	$	447	$	(1	)	$	610	$	362

(1)		The Company forgave certain notes owed to the Company by the partner.

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

Other Acquisition Payments

During the six months ended June 30, 2004 and 2003, the Company paid $500,000 and $438,000 respectively, of unused holdbacks to the respective sellers.

During the three months ended June 30, 2004, the Company paid $75,000 pursuant to the earn-out provisions of a purchase agreement related to a prior acquisition.

In June 2004, the Company paid $2.3 million in cash to settle an obligation incurred in connection with a prior year acquisition.

3. Goodwill and Other Intangible Assets

Goodwill represents the excess of the cost of an acquired entity over the net of the amounts assigned to identifiable assets acquired and liabilities assumed. Other intangible assets represent non-contractual customer relationships for veterinary diagnostic laboratories, covenants-not-to-compete and client lists, all of which are associated with acquisitions.

The following table presents the changes in the carrying amount of goodwill for the six months ended June 30, 2004 (in thousands):


				Animal
	Laboratory			Hospital			Total
Balance as of January 1, 2004	$	94,770		$	278,468		$	373,238
Goodwill acquired		(1,407	)		101,615			100,208
Goodwill related to partnerships		—			4,307			4,307
Goodwill written-off related to sale of animal hospital		—			(20	)		(20	)

Balance as of June 30, 2004	$	93,363		$	384,370		$	477,733

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


	As of June 30, 2004							As of December 31, 2003
	Gross					Net		Gross					Net
	Carrying		Accumulated			Carrying		Carrying		Accumulated			Carrying
	Amount		Amortization			Amount		Amount		Amortization			Amount
Non-contractual customer relationships	$	1,530	$	(64	)	$	1,466	$	—	$	—		$	—
Covenants-not-to-compete		12,920		(6,410	)		6,510		10,141		(5,515	)		4,626
Client lists		667		(466	)		201		498		(432	)		66

Total	$	15,117	$	(6,940	)	$	8,177	$	10,639	$	(5,947	)	$	4,692

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


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2004		2003		2004		2003
Aggregate amortization expense	$	553	$	438	$	993	$	915

Based on balances at June 30, 2004, estimated amortization expense for other intangible assets for the current year and the next four fiscal years is as follows (in thousands):


2004	$	2,130
2005	$	1,901
2006	$	1,546
2007	$	1,307
2008	$	894

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				Six Months Ended
	June 30,				June 30,
	2004		2003		2004		2003
Net income	$	18,167	$	15,350	$	32,911		$	20,533

Weighted average common shares outstanding:
Basic		40,837		40,606		40,789			39,818
Effect of dilutive common shares:
Stock options		814		494		765			452
Contracts that may be settled in stock or cash		40		36		55			18

Diluted		41,691		41,136		41,609			40,288

Basic earnings per common share	$	0.44	$	0.38	$	0.81		$	0.52

Diluted earnings per common share	$	0.44	$	0.37	$	0.79		$	0.51

5. Interest-Rate Hedging Agreements

The Company has entered into no-fee swap agreements (“Swap Agreements”), whereby the Company pays to counterparties amounts based on fixed interest rates and set notional amounts in exchange for the receipt of payments from counterparties 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 are 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 with the fair market value reflected as an asset or liability on the balance sheet.

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


	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2004			2003		2004			2003
Cash paid (1)	$	166		$	102	$	329		$	187
Unrealized loss (gain) (2)	$	(287	)	$	131	$	(176	)	$	258

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

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

The valuations of the Swap Agreements are determined by the counterparties based on fair market valuations for similar agreements. At June 30, 2004, the fair market value of the Swap Agreements resulted in an asset from interest-rate hedging activities of $142,000 and at December 31, 2003, resulted in a liability of $277,000.

6. Consolidation of Variable Interest Entities

Under the provisions of Financial Accounting Standards Board 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 periods presented have 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 $10.4 million and $20.0 million for the three and six months ended June 30, 2003, thus there was no impact on gross profit, operating income, net income, earnings per share or cash flows.

7. Lines of Business

During the three and six months ended June 30, 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 June 30, 2004
Revenue	$	51,951	$	121,384		$	—		$	(3,388	)	$	169,947
Direct costs		27,983		95,348			—			(3,388	)		119,943

Gross profit		23,968		26,036			—			—			50,004
Selling, general and administrative		3,190		3,056			5,519			—			11,765
Loss on sale of assets		2		2			—			—			4

Operating income (loss)	$	20,776	$	22,978		$	(5,519	)	$	—		$	38,235

Depreciation and amortization	$	897	$	2,536		$	386		$	—		$	3,819

Capital expenditures	$	1,057	$	4,078		$	427		$	—		$	5,562

Three Months Ended June 30, 2003
Revenue	$	46,691	$	98,822		$	—		$	(2,752	)	$	142,761
Direct costs		25,615		77,142			—			(2,752	)		100,005

Gross profit		21,076		21,680			—			—			42,756
Selling, general and administrative		2,797		2,519			4,168			—			9,484
Loss (gain) on sale of assets		21		58			(1	)		—			78

Operating income (loss)	$	18,258	$	19,103		$	(4,167	)	$	—		$	33,194

Depreciation and amortization	$	799	$	2,304		$	394		$	—		$	3,497

Capital expenditures	$	590	$	2,165		$	588		$	—		$	3,343

Six Months Ended June 30, 2004
Revenue	$	101,133	$	219,340		$	—		$	(6,176	)	$	314,297
Direct costs		55,698		175,211			—			(6,176	)		224,733

Gross profit		45,435		44,129			—			—			89,564
Selling, general and administrative		6,363		5,804			8,299			—			20,466
Loss on sale of assets		1		65			—			—			66

Operating income (loss)	$	39,071	$	38,260		$	(8,299	)	$	—		$	69,032

Depreciation and amortization	$	1,718	$	4,937		$	780		$	—			7,435

Capital expenditures	$	1,803	$	6,531		$	693		$	—		$	9,027

Six Months Ended June 30, 2003
Revenue	$	88,389	$	185,129		$	—		$	(5,178	)	$	268,340
Direct costs		49,825		147,919			—			(5,178	)		192,566

Gross profit		38,564		37,210			—			—			75,774
Selling, general and administrative		5,504		5,022			8,667			—			19,193
Loss (gain) on sale of assets		19		(178	)		(1	)		—			(160	)

Operating income (loss)	$	33,041	$	32,366		$	(8,666	)	$	—		$	56,741

Depreciation and amortization	$	1,553	$	4,781		$	740		$	—		$	7,074

Capital expenditures	$	1,764	$	3,358		$	1,046		$	—		$	6,168


			Animal				Intercompany
	Laboratory		Hospital		Corporate		Eliminations		Total
At June 30, 2004
Total assets	$	134,308	$	496,864	$	66,236	$	—	$	697,408

At December 31, 2003
Total 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 June 30,					Six Months Ended June 30,
	2004			2003		2004			2003
Total segment operating income after eliminations	$	38,235		$	33,194	$	69,032		$	56,741
Interest expense, net		6,098			6,418		12,083			13,410
Debt retirement costs		810			—		810			7,417
Other (income) expense		(287	)		131		(176	)		258
Minority interest in income of subsidiaries		755			462		1,171			823

Income before provision for income taxes	$	30,859		$	26,183	$	55,144		$	34,833

8. Financing Transactions

On June 1, 2004, the Company amended and restated its Credit and Guaranty Agreement to replace its existing senior term D notes in the principal amount of $145.3 million with an interest rate margin of 2.50% with new senior term E notes in the principal amount of $225.0 million with an interest rate margin of 2.25%. The Company used the additional borrowings to fund the NPC merger as detailed above in “Footnote 2. Acquisitions” and plans to use the remaining borrowings for related merger costs and general corporate purposes. The Company incurred debt retirement costs of $810,000 as a result of amending and restating its Credit and Guaranty Agreement.

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 the Company incurred debt retirement costs of $7.4 million.

9. Letters of Credit and Restricted Cash

In connection with the acquisition of NPC, the Company assumed letter of credit agreements, which serve as security for potential claims due under NPC’s existing workers’ compensation insurance policies. These letter of credit agreements aggregated approximately $1.5 million at June 30, 2004, are collateralized by $1.4 million of restricted cash and their terms are less than one year.

10. 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 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 and six months ended June 30, 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						Six Months Ended
	June 30,						June 30,
	2004			2003			2004			2003
As reported	$	18,167		$	15,350		$	32,911		$	20,533
Deduct: Total stock-based employee compensation expense determined under fair-value-based method for all awards, net of related tax effects		(485	)		(215	)		(762	)		(428	)

Pro forma net income available to common stockholders	$	17,682		$	15,135		$	32,149		$	20,105

Earnings per common share:
Basic - as reported	$	0.44		$	0.38		$	0.81		$	0.52
Basic - pro forma	$	0.43		$	0.37		$	0.79		$	0.50
Diluted - as reported	$	0.44		$	0.37		$	0.79		$	0.51
Diluted - pro forma	$	0.42		$	0.37		$	0.77		$	0.50

11. 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.

12. Reclassifications

Certain 2003 balances have been reclassified to conform to the 2004 financial statement presentation. The most significant of these changes was the reclassification of depreciation and amortization into direct costs and selling, general and administrative expense.

13. 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 June 30, 2004
(Unaudited)
(In thousands)


									Non-
							Guarantor		Guarantor
	VCA			Vicar			Subsidiaries		Subsidiaries			Elimination			Consolidated
Current assets:
Cash and cash equivalents	$	—		$	30,451		$	2,288	$	97		$	—		$	32,836
Restricted cash		—			1,365			—		—			—			1,365
Trade accounts receivable, net		—			6			26,075		672			—			26,753
Inventory, prepaid expenses and other		—			3,105			7,083		590			—			10,778
Deferred income taxes		—			12,672			—		—			—			12,672
Prepaid income taxes		—			5,866			—		—			—			5,866

Total current assets		—			53,465			35,446		1,359			—			90,270
Property and equipment, net		—			6,558			101,971		2,438			—			110,967
Other assets:
Goodwill		—			—			446,408		31,325			—			477,733
Other intangible assets, net		—			—			7,353		824			—			8,177
Deferred financing costs, net		—			4,222			—		—			—			4,222
Other		29			1,962			3,287		2,476			(1,715	)		6,039
Investment in subsidiaries		236,294			358,379			32,260		—			(626,933	)		—

Total assets	$	236,323		$	424,586		$	626,725	$	38,422		$	(628,648	)	$	697,408

Current liabilities:
Current portion of long-term obligations	$	—		$	2,618		$	1,960	$	300		$	(300	)	$	4,578
Accounts payable		—			10,256			2,002		—			—			12,258
Accrued payroll and related liabilities		—			9,671			8,177		352			—			18,200
Accrued interest		—			1,516			149		—			—			1,665
Other accrued liabilities		—			13,466			4,505		—			—			17,971

Total current liabilities		—			37,527			16,793		652			(300	)		54,672
Long-term obligations, less current portion		—			393,795			1,609		—			(1,415	)		393,989
Deferred income taxes		—			28,914			—		—			—			28,914
Other liabilities		—			9,705			2,155		—			—			11,860
Intercompany payable/(receivable)		37,173			(281,649	)		247,789		(3,313	)		—			—
Minority interest		—			—			—		—			8,823			8,823
Preferred stock		—			—			—		—			—			—
Stockholders’ equity:
Common stock		41			—			—		—			—			41
Additional paid-in capital		248,378			—			—		—			—			248,378
Accumulated equity (deficit)		(49,420	)		236,133			358,379		41,083			(635,595	)		(49,420	)
Accumulated other comprehensive income - unrealized gain on hedging instruments		161			161			—		—			(161	)		161
Notes receivable from stockholders		(10	)		—			—		—			—			(10	)

Total stockholders’ equity		199,150			236,294			358,379		41,083			(635,756	)		199,150

Total liabilities and stockholders’ equity	$	236,323		$	424,586		$	626,725	$	38,422		$	(628,648	)	$	697,408

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		—			—			351,130		22,108			—			373,238
Other intangible assets, net		—			—			4,116		576			—			4,692
Deferred financing costs, net		—			4,601			—		—			—			4,601
Other		30			1,939			2,451		2,296			(915	)		5,801
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			2,176		—			—			5,392
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 June 30, 2004
(Unaudited)
(In thousands)


									Non-
							Guarantor		Guarantor
	VCA			Vicar			Subsidiaries		Subsidiaries			Elimination			Consolidated
Revenue	$	—		$	—		$	155,716	$	14,649		$	(418	)	$	169,947
Direct costs		—			—			109,006		11,355			(418	)		119,943

Gross profit		—			—			46,710		3,294			—			50,004
Selling, general and administrative		—			5,519			5,707		539			—			11,765
Loss on sale of assets		—			—			4		—			—			4

Operating income (loss)		—			(5,519	)		40,999		2,755			—			38,235
Interest expense, net		(1	)		6,101			69		(71	)		—			6,098
Debt retirement costs		—			810			—		—			—			810
Other income		—			(287	)		—		—			—			(287	)
Equity interest in income of subsidiaries		18,167			25,315			2,071		—			(45,553	)		—
Minority interest in income of subsidiaries		—			—			—		—			755			755

Income before provision (benefit) for income taxes		18,168			13,172			43,001		2,826			(46,308	)		30,859
Provision (benefit) for income taxes		1			(4,995	)		17,686		—			—			12,692

Net income	$	18,167		$	18,167		$	25,315	$	2,826		$	(46,308	)	$	18,167

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

CONDENSED, CONSOLIDATING INCOME STATEMENTS
For the Three Months Ended June 30, 2003
(Unaudited)
(In thousands)


									Non-
							Guarantor		Guarantor
	VCA			Vicar			Subsidiaries		Subsidiaries			Elimination			Consolidated
Revenue	$	—		$	—		$	132,132	$	10,878		$	(249	)	$	142,761
Direct costs		—			—			91,790		8,464			(249	)		100,005

Gross profit		—			—			40,342		2,414			—			42,756
Selling, general and administrative		—			4,168			4,930		386			—			9,484
Loss (gain) on sale of assets		—			(1	)		79		—			—			78

Operating income (loss)		—			(4,167	)		35,333		2,028			—			33,194
Interest expense, net		(5	)		6,429			37		(43	)		—			6,418
Other expense		—			131			—		—			—			131
Equity interest in income of subsidiaries		15,347			21,491			1,609		—			(38,447	)		—
Minority interest in income of subsidiaries		—			—			—		—			462			462

Income before provision (benefit) for income taxes		15,352			10,764			36,905		2,071			(38,909	)		26,183
Provision (benefit) for income taxes		2			(4,583	)		15,414		—			—			10,833

Net income	$	15,350		$	15,347		$	21,491	$	2,071		$	(38,909	)	$	15,350

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

CONDENSED, CONSOLIDATING INCOME STATEMENTS
For the Six Months Ended June 30, 2004
(Unaudited)
(In thousands)


									Non-
							Guarantor		Guarantor
	VCA			Vicar			Subsidiaries		Subsidiaries			Elimination			Consolidated
Revenue	$	—		$	—		$	289,578	$	25,394		$	(675	)	$	314,297
Direct costs		—			—			205,478		19,930			(675	)		224,733

Gross profit		—			—			84,100		5,464			—			89,564
Selling, general and administrative		—			8,299			11,263		904			—			20,466
Loss on sale of assets		—			—			66		—			—			66

Operating income (loss)		—			(8,299	)		72,771		4,560			—			69,032
Interest expense, net		(2	)		12,084			109		(108	)		—			12,083
Debt retirement costs		—			810			—		—			—			810
Other income		—			(176	)		—		—			—			(176	)
Equity interest in income of subsidiaries		32,910			44,814			3,497		—			(81,221	)		—
Minority interest in income of subsidiaries		—			—			—		—			1,171			1,171

Income before provision (benefit) for income taxes		32,912			23,797			76,159		4,668			(82,392	)		55,144
Provision (benefit) for income taxes		1			(9,113	)		31,345		—			—			22,233

Net income	$	32,911		$	32,910		$	44,814	$	4,668		$	(82,392	)	$	32,911

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

CONDENSED, CONSOLIDATING INCOME STATEMENTS
For the Six Months Ended June 30, 2003
(Unaudited)
(In thousands)


										Non-
							Guarantor			Guarantor
	VCA			Vicar			Subsidiaries			Subsidiaries			Elimination			Consolidated
Revenue	$	—		$	—		$	248,299		$	20,516		$	(475	)	$	268,340
Direct costs		—			—			176,884			16,157			(475	)		192,566

Gross profit		—			—			71,415			4,359			—			75,774
Selling, general and administrative		—			8,667			9,797			729			—			19,193
Gain on sale of assets		—			(1	)		(159	)		—			—			(160	)

Operating income (loss)		—			(8,666	)		61,777			3,630			—			56,741
Interest expense, net		526			12,893			66			(75	)		—			13,410
Debt retirement costs		7,417			—			—			—			—			7,417
Other expense		—			258			—			—			—			258
Equity interest in income of subsidiaries		25,219			38,076			2,882			—			(66,177	)		—
Minority interest in income of subsidiaries		—			—			—			—			823			823

Income before provision (benefit) for income taxes		17,276			16,259			64,593			3,705			(67,000	)		34,833
Provision (benefit) for income taxes		(3,257	)		(8,960	)		26,517			—			—			14,300

Net income	$	20,533		$	25,219		$	38,076		$	3,705		$	(67,000	)	$	20,533

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

CONDENSED, CONSOLIDATING STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, 2004
(Unaudited)
(In thousands)


										Non-
							Guarantor			Guarantor
	VCA			Vicar			Subsidiaries			Subsidiaries			Elimination			Consolidated
Cash flows from operating activities:
Net income	$	32,911		$	32,910		$	44,814		$	4,668		$	(82,392	)	$	32,911
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Equity interest in earnings of subsidiaries		(32,910	)		(44,814	)		(3,497	)		—			81,221			—
Depreciation and amortization		—			780			6,296			359			—			7,435
Amortization of deferred financing costs and debt discount		—			363			4			—			—			367
Provision for uncollectible accounts		—			—			849			235			—			1,084
Debt retirement costs		—			810			—			—			—			810
Loss on sale of assets		—			—			66			—			—			66
Other		—			(92	)		—			—			—			(92	)
Minority interest in income of subsidiaries		—			—			—			—			1,171			1,171
Distributions to minority interest partners		—			(813	)		—			—			—			(813	)
Increase in accounts receivable		—			—			(4,594	)		(368	)		—			(4,962	)
Decrease (increase) in inventory, prepaid expenses and other assets		—			(255	)		(274	)		7			—			(522	)
Increase (decrease) in accounts payable and other accrued liabilities		—			5,837			(4,588	)		7			—			1,256
Increase (decrease) in accrued payroll and related liabilities		—			1,834			(5,102	)		14			—			(3,254	)
Increase (decrease) in accrued interest		—			(1	)		16			(5	)		—			10
Decrease in prepaid income taxes		—			3,435			—			—			—			3,435
Increase in deferred income tax assets		—			(574	)		—			—			—			(574	)
Increase in deferred income tax liabilities		—			3,987			—			—			—			3,987
Increase (decrease) in intercompany payable/(receivable)		(1,969	)		39,172			(32,273	)		(4,930	)		—			—

Net cash provided by (used in) operating activities		(1,968	)		42,579			1,717			(13	)		—			42,315

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

CONDENSED, CONSOLIDATING STATEMENTS OF CASH FLOWS — (Continued)
For the Six Months Ended June 30, 2004
(Unaudited)
(In thousands)


									Non-
						Guarantor			Guarantor
	VCA		Vicar			Subsidiaries			Subsidiaries			Elimination		Consolidated
Cash flows from investing activities:
Business acquisitions, net of cash acquired	$	—	$	(92,931	)	$	—		$	—		$	—	$	(92,931	)
Real estate acquired in connection with business acquisitions		—		(4,385	)		—			—			—		(4,385	)
Property and equipment additions, net		—		(7,224	)		(1,803	)		—			—		(9,027	)
Proceeds from sale of assets		—		178			1			—			—		179
Other		7		(13	)		129			—			—		123

Net cash provided by (used in) investing activities		7		(104,375	)		(1,673	)		—			—		(106,041	)

Cash flows from financing activities:
Repayment of long-term obligations		—		(146,842	)		—			—			—		(146,842	)
Proceeds from issuance of long-term debt		—		225,000			—			—			—		225,000
Payment of financing costs		—		(794	)		—			—			—		(794	)
Proceeds from issuance of common stock under stock option plans		1,961		—			—			—			—		1,961

Net cash provided by financing activities		1,961		77,364			—			—			—		79,325

Increase (decrease) in cash and cash equivalents		—		15,568			44			(13	)		—		15,599
Cash and cash equivalents at beginning of period		—		14,883			2,244			110			—		17,237

Cash and cash equivalents at end of period	$	—	$	30,451		$	2,288		$	97		$	—	$	32,836

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

CONDENSED, CONSOLIDATING STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, 2003
(Unaudited)
(In thousands)


										Non-
							Guarantor			Guarantor
	VCA			Vicar			Subsidiaries			Subsidiaries			Elimination			Consolidated
Cash flows from operating activities:
Net income	$	20,533		$	25,219		$	38,076		$	3,705		$	(67,000	)	$	20,533
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Equity interest in earnings of subsidiaries		(25,219	)		(38,076	)		(2,882	)		—			66,177			—
Depreciation and amortization		—			740			6,018			316			—			7,074
Amortization of deferred financing costs and debt discount		14			442			—			—			—			456
Provision for uncollectible accounts		—			—			1,408			149			—			1,557
Debt retirement costs		7,417			—			—			—			—			7,417
Gain on sale of assets		—			(1	)		(159	)		—			—			(160	)
Minority interest in income of subsidiaries		—			—			—			—			823			823
Distributions to minority interest partners		—			(797	)		—			—			—			(797	)
Increase in accounts receivable		—			(4	)		(5,196	)		(151	)		—			(5,351	)
Decrease (increase) in inventory, prepaid expenses and other assets		70			363			(322	)		57			—			168
Increase (decrease) in accounts payable and other accrued liabilities		—			2,395			(1,132	)		80			—			1,343
Decrease in accrued payroll and related liabilities		—			(1,652	)		(521	)		(23	)		—			(2,196	)
Increase (decrease) in accrued interest		—			(54	)		22			—			—			(32	)
Decrease in prepaid income taxes		—			4,910			—			—			—			4,910
Increase in deferred income tax assets		—			(877	)		—			—			—			(877	)
Increase in deferred income tax liabilities		—			3,652			—			—			—			3,652
Increase (decrease) in intercompany payable/(receivable)		(15,011	)		52,148			(33,038	)		(4,099	)		—			—

Net cash provided by (used in) operating activities		(12,196	)		48,408			2,274			34			—			38,520

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

CONDENSED, CONSOLIDATING STATEMENTS OF CASH FLOWS — (Continued)
For the Six Months Ended June 30, 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	$	—		$	(19,926	)	$	—		$	—	$	—	$	(19,926	)
Real estate acquired in connection with business acquisitions		—			(589	)		—			—		—		(589	)
Property and equipment additions, net		—			(4,404	)		(1,764	)		—		—		(6,168	)
Proceeds from sale of assets		—			348			7			—		—		355
Other		(4	)		138			227			—		—		361

Net cash used in investing activities		(4	)		(24,433	)		(1,530	)		—		—		(25,967	)

Cash flows from financing activities:
Repayment of long-term obligations, including redemption fees		(41,808	)		(1,203	)		—			—		—		(43,011	)
Repayment of revolving credit facility		—			(7,500	)		—			—		—		(7,500	)
Payment of financing costs		(382	)		—			—			—		—		(382	)
Proceeds from issuance of common stock under stock option plans		67			—			—			—		—		67
Proceeds from issuance of common stock		54,323			—			—			—		—		54,323

Net cash provided by (used in) financing activities		12,200			(8,703	)		—			—		—		3,497

Increase in cash and cash equivalents		—			15,272			744			34		—		16,050
Cash and cash equivalents at beginning of period		—			5,083			1,233			146		—		6,462

Cash and cash equivalents at end of period	$	—		$	20,355		$	1,977		$	180	$	—	$	22,512

14. Subsequent Events

Acquisitions

From July 1, 2004 through August 3, 2004, the Company acquired one animal hospital, which was merged into an existing VCA animal hospital, for an aggregate consideration of $190,000 in cash.

Common Stock

On July 13, 2004, the Company amended its Amended and Restated Certificate of Incorporation to increase the number of shares of common stock the Company is authorized to issue from 75.0 million to 175.0 million.

Stock Split

On July 27, 2004, the Company announced a two-for-one stock split to be effected in the form of a 100% stock dividend. To effect the stock split, stock will be distributed on August 25, 2004 to stockholders of record as of August 11, 2004. Pro forma earnings per common share, giving retroactive effect to the stock split, are as follows (in thousands, except per share amounts):


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2004		2003		2004		2003
Basic earnings per common share	$	0.22	$	0.19	$	0.40	$	0.26
Diluted earnings per common share	$	0.22	$	0.19	$	0.40	$	0.25
Shares used for computing basic earnings per share		81,674		81,212		81,578		79,636
Shares used for computing diluted earnings per share		83,382		82,272		83,218		80,576

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 August 3, 2004, and we undertake no duty to update this information. Shareholders and prospective investors can find information filed with the SEC after August 3, 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 June 30, 2004, our laboratory network consisted of 25 laboratories serving all 50 states and our animal hospital network consisted of 317 animal hospitals in 36 states. We primarily focus on generating internal growth to increase revenue and profitability. In addition, as part of our operating plan, we plan to augment internal growth by acquiring animal hospitals, however, we may pursue acquisitions of animal hospital chains or laboratories if favorable opportunities are presented. In accord with that strategy, we acquired National PetCare Centers, Inc., or NPC, on June 1, 2004 (discussed below), which at the date of acquisition, operated 67 animal hospitals and recorded annual revenues of $81.7 million for the year ended December 31, 2003.

Significant Acquisition

On June 1, 2004, the Company consummated a merger agreement with NPC, which operated 67 animal hospitals located in 11 states as of the merger date. This merger allowed us to expand our animal hospital operations in nine states, particularly California and Texas, and to expand into two new states, Oregon and Oklahoma.

As of June 30, 2004, we had not finalized the purchase price accounting for the transaction, however, as of June 30, 2004 the total consideration was $89.3 million consisting of $66.1 million in cash paid to holders of NPC stock and debt, $2.6 million in assumed debt, $12.8 million in assumed working capital liabilities, $6.3 million of operating leases whose terms were in excess of market and $1.5 million paid for professional services.

We intend to close underperforming NPC animal hospitals and NPC’s corporate office and to terminate NPC employees whose functions are duplicative of those of our employees. We intend to incur costs associated with these activities, consisting primarily of lease termination costs and employee severance costs. These costs will result in an increase in the total purchase price of the transaction. As of June 30, 2004, we have not finalized our formal plan for these activities. During the quarter ended June 30, 2004 we incurred integration costs of $570,000 with respect to our acquisition of NPC. We expect to incur additional integration costs during the remainder of 2004 as we continue to integrate NPC’s animal hospital operations into our own. These integration costs will be expensed as incurred.

The gross profit margins for NPC’s animal hospitals have been historically lower than the gross profit margins for our own animal hospitals. As a result, we expect the integration of NPC to temporarily lower our animal hospital margins until certain efficiencies and leverage are realized.

The total consideration, including merger costs and integration costs, was funded with cash on-hand and the additional funds borrowed under our senior credit facility on June 1, 2004.

Growth in Facilities

The following table summarizes our growth in facilities:


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2004			2003			2004			2003
Laboratories:
Beginning of period		23			20			23			19
Acquisitions and new facilities		2			5			2			6
Relocated into other labs operated by us		—			(2	)		—			(2	)

End of period		25			23			25			23

Animal hospitals:
Beginning of period		247			233			241			229
Acquisitions		73			11			82			16
Relocated into hospitals operated by us		(1	)		(5	)		(3	)		(5	)
Sold or closed		(2	)		(1	)		(3	)		(2	)

End of period		317			238			317			238

Stock Split

On July 27, 2004, we announced a two-for-one stock split to be effected in the form of a 100% stock dividend. To effect the stock split, stock will be distributed on August 25, 2004 to stockholders of record as of August 11, 2004. Earnings per share presented in future filings for periods prior to July 1, 2004 will be adjusted to reflect the stock split.

Reclassifications

During 2004, we began including depreciation and amortization in direct costs and selling, general and administrative expense. Prior periods presented have been reclassified to reflect this change.

Adoption of FIN No. 46R

We adopted Financial Accounting Standards Board, FASB, Interpretation No. 46R, or FIN No. 46R, Consolidation of Variable Interest Entities, in the fourth quarter of 2003 and accordingly, restated the prior periods to conform to the current period presentation. Pursuant to 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 or net income.

Basis of Reporting

General

Our discussion and analysis of our financial condition and results of operations are based upon our unaudited 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. Revisions to these estimates, if any, are not expected to 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-store 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, depreciation and amortization, 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, depreciation and amortization, 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 as well as corporate depreciation.

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 (9 months of policy elapsed as of 6/30/04)	$	155,056		2.10	%	$	3,256		1.53	%	$	2,372		2.82	%	$	4,368
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	$	509,985		2.08	%	$	10,601		1.55	%	$	7,906		2.61	%	$	13,317

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 accrued liabilities. If our estimates prove to be incorrect as the losses develop over several years, we may have to adjust the accrual accordingly, and also may have to either pay additional claims losses or receive refunds from our insurance carriers. 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.

In connection with the NPC acquisition, we assumed additional workers’ compensation claim liabilities in the amount of $1.1 million, related to self-insurance retention policies for four policy years. We reviewed policy terms, claims history and current claims status for each policy to determine that the assumed liability is adequate.

Valuation of Goodwill

Our goodwill represents the excess of the cost of an acquired entity over the net of the amounts assigned to identifiable assets acquired and liabilities assumed. The total amount of our net goodwill at June 30, 2004 was $477.7 million, consisting of $93.3 million for our laboratory operating segment and $384.4 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.

We will review our goodwill for impairment again at December 31, 2004 or upon additional material changes in our operating environment, however, we do not anticipate that there will be additional significant changes in our operations or operating environments in the near future.

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 that 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.

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 June 30, 2004
Revenue	$	51,951		$	121,384		$	—		$	(3,388	)	$	169,947
Direct costs		27,983			95,348			—			(3,388	)		119,943

Gross profit		23,968			26,036			—			—			50,004
Selling, general and administrative		3,190			3,056			5,519			—			11,765
Loss on sale of assets		2			2			—			—			4

Operating income (loss)	$	20,776		$	22,978		$	(5,519	)	$	—		$	38,235

Operating margin		40.0	%		18.9	%		(3.2	)%					22.5	%

Depreciation and amortization	$	897		$	2,536		$	386		$	—		$	3,819

Three Months Ended June 30, 2003
Revenue	$	46,691		$	98,822		$	—		$	(2,752	)	$	142,761
Direct costs		25,615			77,142			—			(2,752	)		100,005

Gross profit		21,076			21,680			—			—			42,756
Selling, general and administrative		2,797			2,519			4,168			—			9,484
Loss (gain) on sale of assets		21			58			(1	)		—			78

Operating income (loss)	$	18,258		$	19,103		$	(4,167	)	$	—		$	33,194

Operating margin		39.1	%		19.3	%		(2.9	)%					23.3	%

Depreciation and amortization	$	799		$	2,304		$	394		$	—		$	3,497

Six Months Ended June 30, 2004
Revenue	$	101,133		$	219,340		$	—		$	(6,176	)	$	314,297
Direct costs		55,698			175,211			—			(6,176	)		224,733

Gross profit		45,435			44,129			—			—			89,564
Selling, general and administrative		6,363			5,804			8,299			—			20,466
Loss on sale of assets		1			65			—			—			66

Operating income (loss)	$	39,071		$	38,260		$	(8,299	)	$	—		$	69,032

Operating margin		38.6	%		17.4	%		(2.6	)%					22.0	%

Depreciation and amortization	$	1,718		$	4,937		$	780		$	—		$	7,435

Six Months Ended June 30, 2003
Revenue	$	88,389		$	185,129		$	—		$	(5,178	)	$	268,340
Direct costs		49,825			147,919			—			(5,178	)		192,566

Gross profit		38,564			37,210			—			—			75,774
Selling, general and administrative		5,504			5,022			8,667			—			19,193
Loss (gain) on sale of assets		19			(178	)		(1	)		—			(160	)

Operating income (loss)	$	33,041		$	32,366		$	(8,666	)	$	—		$	56,741

Operating margin		37.4	%		17.5	%		(3.2	)%					21.1	%

Depreciation and amortization	$	1,553		$	4,781		$	740		$	—		$	7,074

Revenue

The following table summarizes our revenue (in thousands):


	Three Months Ended June 30,									Six Months Ended June 30,
	2004			2003			% Change			2004			2003			% Change
Laboratory	$	51,951		$	46,691			11.3	%	$	101,133		$	88,389			14.4	%
Animal hospital		121,384			98,822			22.8	%		219,340			185,129			18.5	%
Intercompany		(3,388	)		(2,752	)					(6,176	)		(5,178	)

Total revenue	$	169,947		$	142,761			19.0	%	$	314,297		$	268,340			17.1	%

Laboratory Revenue

Laboratory revenue increased $5.3 million for the three months ended June 30, 2004 and increased $12.7 million for the six months ended June 30, 2004 compared to the same periods 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 June 30,							Six Months Ended June 30,
Laboratory Revenue:	2004		2003		% Change			2004		2003		% Change
Internal growth:
Number of requisitions		2,295		2,222		3.3	%		4,291		4,068		5.5	%
Average revenue per requisition (1)	$	22.01	$	21.01		4.8	%	$	22.59	$	21.73		4.0	%

Total internal revenue (2)	$	50,524	$	46,691		8.2	%	$	96,940	$	88,389		9.7	%
Billing day adjustment (3)		—		—					606		—
Acquired revenue		1,427		—					3,587		—

Total	$	51,951	$	46,691		11.3	%	$	101,133	$	88,389		14.4	%

(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 six months ended June 30, 2004 as compared to the same period in the prior year.

The increases in requisitions from internal growth for the three and six months ended June 30, 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 and six months ended June 30, 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 April 1, 2003, we generated an additional $1.4 million of revenue (referred to in the above table as “acquired revenue”) during the three months ended June 30, 2004 in comparison to the same period in the prior year. As the result of our laboratory acquisitions subsequent to January 1, 2003, we generated an additional $3.6 million of revenue (referred to in the above table as “acquired revenue”) during the six months ended June 30, 2004 in comparison to the same period in the prior year.

Animal Hospital Revenue

Animal hospital revenue increased $22.6 million for the three months ended June 30, 2004 and increased $34.2 million for the six months ended June 30, 2004 compared to the same periods in the prior year. The components of the increases are summarized in the following table (in thousands, except average price per order):


	Three Months Ended June 30,							Six Months Ended June 30,
Animal Hospital Revenue:	2004		2003		% Change			2004		2003		% Change
Same-store:
Orders		886		894		(0.9	)%		1,695		1,706		(0.6	)%
Average revenue per order (1)	$	114.69	$	108.79		5.4	%	$	110.99	$	105.06		5.6	%

Same-store revenue (2)	$	101,613	$	97,316		4.4	%	$	188,143	$	179,248		5.0	%
Business day adjustment (3)		—		—					1,092		—
Net acquired revenue		19,771		1,506					30,105		5,881

Total	$	121,384	$	98,822		22.8	%	$	219,340	$	185,129		18.5	%

(1)		Computed by dividing same-store revenue by same-store 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 six months ended June 30, 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, our 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 after the beginning of the comparative period, which was April 1, 2003 for the three months ended June 30, 2004 and January 1, 2003 for the six months ended June 30, 2004. Fluctuations in net acquired revenue occur due to the volume, size, and timing of acquisitions and disposals during the periods compared.

Gross Profit

The following table summarizes our gross profit and our gross profit as a percentage of applicable revenue, or gross profit margin (in thousands):


	Three Months Ended June 30,													Six Months Ended June 30,
	2004					2003								2004					2003
			Gross					Gross								Gross					Gross
			Profit					Profit			%					Profit					Profit			%
	$		Margin			$		Margin			Change			$		Margin			$		Margin			Change
Laboratory	$	23,968		46.1	%	$	21,076		45.1	%		13.7	%	$	45,435		44.9	%	$	38,564		43.6	%		17.8	%
Animal hospital		26,036		21.4	%		21,680		21.9	%		20.1	%		44,129		20.1	%		37,210		20.1	%		18.6	%

Total gross profit	$	50,004		29.4	%	$	42,756		29.9	%		17.0	%	$	89,564		28.5	%	$	75,774		28.2	%		18.2	%

Laboratory Gross Profit

The increase in laboratory gross profit margins during the three and six months ended June 30, 2004 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 Gross Profit

Since January 1, 2004, we have had significant growth in our animal hospital division as a result of the acquisition of 82 hospitals. Sixty-seven of these were acquired in the NPC merger on June 1, 2004. Our animal hospital gross profit margin decreased for the three months ended June 30, 2004 compared to the same period in the prior year, primarily as a result of the impact of the relatively large number of hospitals we recently acquired. As expected, the hospitals we recently acquired, as a group, had a gross profit margin lower than those animal hospitals that we have operated for a period of time sufficient to allow us to achieve operating efficiencies.

Animal hospital gross profit margin during the six months ended June 30, 2004 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 June 30,													Six Months Ended June 30,
	2004					2003								2004					2003
			% of					% of			%					% of					% of			%
	$		Revenue			$		Revenue			Change			$		Revenue			$		Revenue			Change
Laboratory	$	3,190		6.1	%	$	2,797		6.0	%		14.1	%	$	6,363		6.3	%	$	5,504		6.2	%		15.6	%
Animal hospital		3,056		2.5	%		2,519		2.5	%		21.3	%		5,804		2.6	%		5,022		2.7	%		15.6	%
Corporate		5,519		3.2	%		4,168		2.9	%		32.4	%		8,299		2.6	%		8,667		3.2	%		(4.2	)%

Total SG&A	$	11,765		6.9	%	$	9,484		6.6	%		24.1	%	$	20,466		6.5	%	$	19,193		7.2	%		6.6	%

Laboratory SG&A

The increase in laboratory SG&A as a percentage of laboratory revenue during the three and six months ended June 30, 2004 as compared to the same periods in the prior year was the result of hiring additional sales personnel.

Animal Hospital SG&A

Animal hospital SG&A as a percentage of animal hospital revenue during the three months ended June 30, 2004 was consistent with the same period in the prior year. The decrease in animal hospital SG&A as a percentage of animal hospital revenue during the six months ended June 30, 2004 was primarily attributable to increases in animal hospital revenue combined with operating leverage associated with our animal hospital business.

Corporate SG&A

In March 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. In addition, during the three and six months ended June 30, 2004, we incurred integration costs of $570,000 in connection with the NPC acquisition. The following table reconciles corporate SG&A as reported to corporate SG&A excluding the insurance claim settlement and integration costs (in thousands):


	Three Months Ended June 30,														Six Months Ended June 30,
	2004						2003								2004						2003
				% of					% of			%						% of					% of			%
	$			Revenue			$		Revenue			Change			$			Revenue			$		Revenue			Change
Corporate SG&A as reported	$	5,519			3.2	%	$	4,168		2.9	%		32.4	%	$	8,299			2.6	%	$	8,667		3.2	%		(4.2	)%
Impact of insurance claim settlement:
Litigation settlement reimbursement		—						—								1,124						—
Legal fees reimbursement		—						—								801						—
Integration costs		(570	)					—								(570	)					—

Corporate SG&A excluding the insurance claim settlement and integration costs	$	4,949			2.9	%	$	4,168		2.9	%		18.7	%	$	9,654			3.1	%	$	8,667		3.2	%		11.4	%

Excluding the impact of the insurance claim settlement and integration costs, Corporate SG&A as a percentage of total revenue during the three months ended June 30, 2004 was consistent with the same period in the prior year. Excluding the impact of the insurance claim settlement and integration costs, corporate SG&A decreased as a percentage of total revenue during the six months ended June 30, 2004 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				Six Months Ended
	June 30,				June 30,
	2004		2003		2004		2003
Interest expense:
Revolving credit facility	$	—	$	—	$	—	$	27
Senior term C notes		—		1,837		—		3,675
Senior term D notes		893		—		2,235		—
Senior term E notes		634		—		634		—
9.875% senior subordinated notes		4,197		4,197		8,394		8,394
15.5% senior notes		—		—		—		522
Interest-rate hedging agreements		166		102		329		187
Amortization of deferred financing costs and debt discount		183		223		367		456
Secured seller notes & other		192		185		381		368

		6,265		6,544		12,340		13,629
Interest income		167		126		257		219

Total interest expense, net of interest income	$	6,098	$	6,418	$	12,083	$	13,410

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 June 1, 2004, we amended and restated our senior credit facility to replace the existing senior term D notes in the principal amount of $145.3 million with an interest rate margin of 2.50% with new senior term E notes in the principal amount of $225.0 million with an interest rate margin of 2.25%. The additional borrowings were used to fund the acquisition of NPC, which we discuss above in “Significant Acquisition.” In conjunction with amending and restating our senior credit facility, we recorded debt retirement costs of $810,000.

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 first quarter of 2004, which we discuss above in “Corporate SG&A.” This reimbursement had no related tax expense and reduced our effective tax rate to 40.3% for the six months ended June 30, 2004. This reimbursement will not impact our effective tax rate for individual quarters ending subsequent to March 31, 2004. Our effective tax rate for the three months ended June 30, 2004 was 41.1%.

Liquidity and Capital Resources

Cash and Cash Equivalents

Cash and cash equivalents at June 30, 2004 totaled $32.8 million, up from $17.2 million at December 31, 2003. The increase is a result of net cash provided by operations and financing exceeding net cash used in investing activities.

Cash Flows from Operating Activities

Net cash provided by operating activities increased $3.8 million for the six months ended June 30, 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 $1.2 million 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) an $8.8 million increase in taxes paid; and (b) a use of $1.9 million from changes in working capital.

Cash Flows used in Investing Activities

In each of the six months ended June 30, 2004 and 2003, net cash used in investing activities was primarily comprised of cash used for the acquisition of animal hospitals and laboratories, including the acquisition of NPC, and expenditures for property and equipment.

We anticipate spending an additional $3.0 million to $5.0 million for acquisitions and $8.0 million to $10.0 million for property and equipment during the remainder of 2004. However, we may spend more for acquisitions than we are currently 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, as amended and restated on June 1, 2004, permitted the acquisition of NPC and allow us to spend $50.0 million per year on other acquisitions, and we would require a waiver or amendment to the covenant to exceed this amount.

Cash Flows from Financing Activities

In February 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 June 30, 2004, we had no borrowings under our revolving credit facility.

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	$	397,917		$	2,631		$	3,022		$	29,477	$	110,217	$	82,562	$	170,008
Capital lease obligations		650			144			233			146		102		25		—
Operating leases		374,893			11,232			22,340			22,227		22,168		21,945		274,981
Fixed cash interest expense		93,954			8,798			17,351			17,184		16,849		16,985		16,787
Variable cash interest expense (2)		44,609			5,043			11,680			13,764		10,934		3,188		—
Deferred income tax liabilities		28,914			—			—			—		—		—		28,914
Mandatorily redeemable partnership interests		2,155			—			—			—		—		—		2,155
Swap agreements (2)		(364	)		(133	)		(231	)		—		—		—		—

	$	942,728		$	27,715		$	54,395		$	82,798	$	160,270	$	124,705	$	492,845

(1)		Consists of the period July 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 2.25%. Including the fixed 2.25%, we estimate that the interest rate on our variable-rate debt will be 4.5%, 5.25%, 6.25%, 7.25%, and 7.75% 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.

Debt 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 cash 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 June 30, 2004, we had a fixed charge coverage ratio of 1.63 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 counterparties amounts based on fixed interest rates and set notional principal amounts in exchange for the receipt of payments from counterparties 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	$20.0 million
Effective date	11/29/2002	5/30/2003		5/30/2003
Expiration date	11/29/2004	5/31/2005		5/31/2005
Counter party	Wells Fargo Bank	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 June 30, 2004, we had $224.4 million principal amount outstanding under our senior term E 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 E notes is 1.25% 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 E notes is 2.25% per annum.

The senior term E 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 June 30, 2004, the outstanding principal balance of these senior subordinated notes was $170.0 million. We and each existing domestic wholly-owned subsidiary of Vicar have jointly and severally, fully and unconditionally guaranteed these notes. Future domestic wholly-owned subsidiaries of Vicar will also be required to guarantee 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 June 30, 2004, we had seller notes secured by assets of animal hospitals, unsecured debt and capital leases that totaled $4.2 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.

If we are unable to successfully integrate NPC animal hospital operations into our animal hospital operations in a timely and efficient manner, we may incur substantial costs, and our revenue, margins and net income may be adversely affected.

On June 1, 2004, we acquired NPC. Prior to our acquisition, the NPC animal hospitals, as a group, operated at gross profit margins lower than our animal hospitals, and, as a result, we expect our animal hospital margins to be lower than historical amounts for the next several quarters. We entered into the merger agreement with NPC with the expectation that the merger will result in improved operating results and beneficial synergies, such as the realization of improved operating margins at animal hospitals through a strategy of centralizing various corporate and administrative functions and leveraging fixed costs. Our ability to realize on the benefits of this acquisition is dependent, in part, on achieving these efficiencies and increasing the gross profit margins of the acquired NPC hospitals.

Achieving these anticipated business benefits will depend on whether our operations and NPC’s operations are successfully integrated in an efficient, effective and timely manner. Any unanticipated costs or results, or delays or failures in the integration process may negatively impact our combined revenue, margins and net income. The combination of our company and NPC will require, among other things, the retention of key management and professional personnel, including specialists; the integration and expansion of the companies’ management staff, veterinarians and other professional staff; and the identification and elimination of unnecessary overhead and non-performing hospitals.

The integration of the operations of the combined companies requires the dedication of management resources, which may temporarily detract attention from the day-to-day business of the combined companies. Our field management may spend a predominant amount of time integrating these new hospitals and less time managing our existing hospitals in those regions. In addition, the employees of the combined companies may be less productive as a result of uncertainty during the integration process, which also may disrupt our business. Even if we successfully integrate NPC into our operations, the integration process itself will be accomplished over time and any attention paid to the integration process at the expense of the day-to-day operations and any uncertainty which results from the integration process itself may have an adverse effect on the business and results of operations of the combined companies. We also may experience unanticipated delays in converting the systems of NPC animal hospitals into our systems, which may result in unanticipated increases to payroll expense to collect our results and delays in reporting our results.

In addition, the present and potential customers of the animal hospitals acquired in the NPC merger may not continue their current utilization patterns or, alternatively, the merger and integration process may have an adverse impact on the relationships between those customers and the veterinarians and other animal health care professionals currently employed at the animal hospitals acquired in the NPC merger. Any significant reduction in utilization

patterns or any significant adverse impact on relationships between the customers and the veterinarians or other animal health care professionals currently employed at the animal hospitals acquired in the NPC merger may 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. For the three and six months ended June 30, 2004, our laboratory internal revenue growth was 8.2% and 9.7%, respectively, which are both below our historical rates for the prior three years. Our animal hospital same-store revenue growth rate has fluctuated between 3.6% and 5.0% for each fiscal year from 2001 through 2003. For the three and six months ended June 30, 2004, our animal hospital internal revenue growth was 4.4% and 4.9%, respectively. 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 June 30, 2004, our balance sheet reflected $477.7 million of goodwill, which is a substantial portion of our total assets of $697.4 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 June 30, 2004, our debt consisted of:

• $224.4 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

• $4.2 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., or Idexx. Idexx currently competes or intends to compete in most of the same markets in which we operate. In this regard, Idexx has recently acquired additional laboratories in the markets in which we operate and has announced plans to continue this expansion and aggressively “bundles” all of their products and services to compete with us. Increased competition may lead to pressures on the revenues and margins of our laboratory operations. 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 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 June 30, 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 June 30, 2004, we operated 99 animal hospitals in 12 states with these laws, including 22 in New York and 26 in Texas. 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.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As of June 30, 2004, we had borrowings of $224.4 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 $224.4 million to $144.4 million. Accordingly, for the twelve-month period ending June 30, 2005, for every 1.0% increase in LIBOR we will pay an additional $1.7 million in interest expense and for every 1.0% decrease in LIBOR we will save $1.7 million 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 AND USE OF PROCEEDS

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:

3.1 Amended and Restated Certificate of Incorporation of Registrant. Incorporated by reference to Exhibit 3.1 to the Registrant’s annual report on Form 10-K filed March 29, 2002.

3.2 Certificate of Amendment to the Certificate of Incorporation of Registrant. Incorporated by reference to Exhibit 3.1 to the Registrant’s current report on Form 8-K filed July 16, 2004.

3.3 Certificate of Correction to the Certificate of Amendment to the Amended and Restated Certificate of Incorporation of Registrant. Incorporated by reference to Exhibit 3.2 to the Registrant’s current report on Form 8-K filed July 16, 2004.

3.4 Amended and Restated Bylaws of Registrant.

10.1 Amended and Restated Credit and Guaranty Agreement, dated as of June 1, 2004, by and among Vicar Operating, Inc., VCA Antech, Inc., certain subsidiaries of Vicar Operating, Inc. as guarantors, various lenders from time to time party thereto, Goldman Sachs Credit Partners L.P., as joint lead arranger and sole syndication agent, and Wells Fargo Bank, N.A., as joint lead arranger and administrative agent. Incorporated by reference to Exhibit 10.1 to the Registrant’s current report on Form 8-K filed June 1, 2004.

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) On April 14, 2004, VCA filed a report on Form 8-K under Items 5 and 7 relating to the filing of a shelf registration statement allowing VCA to sell, from time to time, $250,000,000 of its common stock or other equity or debt securities and the future re-sale by Green Equity Investors III, L.P. of 6,846,937 million outstanding shares of VCA common stock.

(2) On April 27, 2004, VCA filed a report on Form 8-K under Items 5 and 7 relating to revised financial guidance for fiscal year 2004, and furnished under Items 7 and 12 financial information for the first quarter 2004.

(3) On May 10, 2004, VCA filed a report on Form 8-K under Items 5 and 7 relating to the signing of the definitive merger agreement between VCA and National PetCare Centers, Inc.

(4) On May 27, 2004, VCA filed a report on Form 8-K under Items 5 and 7 relating to the signing of an Underwriting Agreement by VCA and Green Equity Investors III, L.P. in connection with the sale of 3,000,000 shares of VCA common stock by Green Equity Investors III, L.P to Banc of America.

(5) On June 1, 2004, VCA filed a report on Form 8-K under Items 5 and 7 relating to the completion of the merger with National PetCare Centers, Inc., the refinancing of its senior credit facility and revised financial guidance for the second quarter and fiscal year 2004.

(6) On June 29, 2004, VCA filed a report on Form 8-K under Item 5 relating to management’s recommendation to the Board of Directors to form an independent nominating committee.

EXHIBIT INDEX


Exhibit No.		Description
3.1		Amended and Restated Certificate of Incorporation of Registrant. Incorporated by reference to Exhibit 3.1 to the Registrant’s annual report on Form 10-K filed March 29, 2002.

3.2		Certificate of Amendment to the Certificate of Incorporation of Registrant. Incorporated by reference to Exhibit 3.1 to the Registrant’s current report on Form 8-K filed July 16, 2004.

3.3		Certificate of Correction to the Certificate of Amendment to the Amended and Restated Certificate of Incorporation of Registrant. Incorporated by reference to Exhibit 3.2 to the Registrant’s current report on Form 8-K filed July 16, 2004.

3.4		Amended and Restated Bylaws of Registrant.

10.1		Amended and Restated Credit and Guaranty Agreement, dated as of June 1, 2004, by and among Vicar Operating, Inc., VCA Antech, Inc., certain subsidiaries of Vicar Operating, Inc. as guarantors, various lenders from time to time party thereto, Goldman Sachs Credit Partners L.P., as joint lead arranger and sole syndication agent, and Wells Fargo Bank, N.A., as joint lead arranger and administrative agent. Incorporated by reference to Exhibit 10.1 to the Registrant’s current report on Form 8-K filed June 1, 2004.

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.


		Page
		Number
Part I. Financial Information
Item 1. Financial Statements
Condensed, Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003 (Unaudited)		1
Condensed, Consolidated Income Statements for the Three and Six Months Ended June 30, 2004 and 2003 (Unaudited)		2
Condensed, Consolidated Statements of Cash Flows for the Six Months Ended June 30, 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		25
Item 3. Quantitative and Qualitative Disclosures About Market Risk		45
Item 4. Controls and Procedures		45
Part II. Other Information		46
Item 1. Legal Proceedings		46
Item 2. Changes in Securities and Use of Proceeds		46
Item 3. Defaults Upon Senior Securities		46
Item 4. Submission of Matters to a Vote of Security Holders		46
Item 5. Other Information		46
Item 6. Exhibits and Reports on Form 8-K		46
Signature		48
Exhibit Index		49
Exhibit 3.4
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1

	•		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.

	•		$224.4 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

	•		$4.2 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.

(1)		On April 14, 2004, VCA filed a report on Form 8-K under Items 5 and 7 relating to the filing of a shelf registration statement allowing VCA to sell, from time to time, $250,000,000 of its common stock or other equity or debt securities and the future re-sale by Green Equity Investors III, L.P. of 6,846,937 million outstanding shares of VCA common stock.

(2)		On April 27, 2004, VCA filed a report on Form 8-K under Items 5 and 7 relating to revised financial guidance for fiscal year 2004, and furnished under Items 7 and 12 financial information for the first quarter 2004.

(3)		On May 10, 2004, VCA filed a report on Form 8-K under Items 5 and 7 relating to the signing of the definitive merger agreement between VCA and National PetCare Centers, Inc.

(4)		On May 27, 2004, VCA filed a report on Form 8-K under Items 5 and 7 relating to the signing of an Underwriting Agreement by VCA and Green Equity Investors III, L.P. in connection with the sale of 3,000,000 shares of VCA common stock by Green Equity Investors III, L.P to Banc of America.

(5)		On June 1, 2004, VCA filed a report on Form 8-K under Items 5 and 7 relating to the completion of the merger with National PetCare Centers, Inc., the refinancing of its senior credit facility and revised financial guidance for the second quarter and fiscal year 2004.

(6)		On June 29, 2004, VCA filed a report on Form 8-K under Item 5 relating to management’s recommendation to the Board of Directors to form an independent nominating committee.



Date: August 6, 2004	By:	/s/ Tomas W. Fuller
		Tomas W. Fuller
		Chief Financial Officer