10-Q/A
Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q/A
Amendment No. 1

     
x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2003
     
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   95-4097995
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   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)

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common stock, $0.001 par value

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 class of common stock as of the latest practicable date: Common stock, $0.001 par value 40,640,159 shares as of August 11, 2003.


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EXPLANATORY NOTE

This Amendment No. 1 to Form 10-Q for the period ended June 30, 2003, is being made in order to revise Item 4 of Part I, the certifications required by Section 302 of the Sarbanes-Oxley Act of 2002 (Exhibits 31.1 and 31.2) and the certifications required by Section 906 of the Sarbanes-Oxley Act of 2002 (Exhibit 32.1) to incorporate those amendments set forth in the Securities and Exchange Commission’s Release No. 33-8283 which were inadvertently omitted from our original filing on August 13, 2003.

Except for the items described above, none of the information contained in our original filing on Form 10-Q has been updated, modified or revised. The remainder of our original report on Form 10-Q is included herein for the convenience of the reader.

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


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VCA ANTECH, INC.
FORM 10-Q
JUNE 30, 2003

TABLE OF CONTENTS

                 
            Page Number
           
Part I.  
Financial Information
       
Item 1.  
Financial Statements
       
   
Condensed, Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002 (Unaudited)
    1  
       
Condensed, Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2003 and 2002 (Unaudited)
    2  
       
Condensed, Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2003 and 2002 (Unaudited)
    3  
       
Notes to Condensed, Consolidated Financial Statements
    4  
Item 2.  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
    24  
Item 3.  
Quantitative and Qualitative Disclosures About Market Risk
    49  
Item 4.  
Controls and Procedures
    50  
Part II.  
Other Information
       
Item 1.  
Legal Proceedings
    50  
Item 2.  
Changes in Securities
    51  
Item 3.  
Defaults Upon Senior Securities
    51  
Item 4.  
Submission of Matters to a Vote of Security Holders
    51  
Item 5.  
Other Information
    51  
Item 6.  
Exhibits and Reports on Form 8-K
    52  
       
Signature
    53  
       
Exhibit Index
    54  

 


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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VCA ANTECH, INC. AND SUBSIDIARIES
CONDENSED, CONSOLIDATED BALANCE SHEETS
As of June 30, 2003 and December 31, 2002
(Unaudited)
(In thousands, except par value)

                     
        June 30,   December 31,
        2003   2002
       
 
ASSETS
               
Current assets:
               
 
Cash and cash equivalents
  $ 22,512     $ 6,462  
 
Trade accounts receivable, less allowance for uncollectible accounts of $6,550 and $6,408 at June 30, 2003 and December 31, 2002, respectively
    25,537       20,727  
 
Inventory, prepaid expenses and other
    8,593       8,643  
 
Deferred income taxes
    10,405       9,528  
 
Prepaid income taxes
    2,704       7,614  
 
 
   
     
 
   
Total current assets
    69,751       52,974  
Property and equipment, net
    96,845       95,303  
Other assets:
               
 
Goodwill, net
    363,229       342,614  
 
Covenants not to compete, net
    5,041       4,735  
 
Deferred financing costs, net
    5,952       6,778  
 
Other
    4,435       5,024  
 
 
   
     
 
   
Total assets
  $ 545,253     $ 507,428  
 
 
   
     
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
 
Current portion of long-term obligations
  $ 2,698     $ 9,622  
 
Accounts payable
    10,130       10,223  
 
Accrued payroll and related liabilities
    12,538       14,734  
 
Accrued interest
    1,533       1,565  
 
Other accrued liabilities
    18,440       13,464  
 
 
   
     
 
   
Total current liabilities
    45,339       49,608  
Long-term obligations, less current portion
    335,792       371,935  
Deferred income taxes
    19,028       15,376  
Other liabilities
    2,007       2,007  
Minority interest
    5,138       5,416  
Stockholders’ equity:
               
 
Common stock, par value $0.001, 75,000 shares authorized, and 40,633 and 36,765 shares outstanding as of June 30, 2003 and December 31, 2002, respectively
    41       37  
 
Additional paid-in capital
    243,327       188,941  
 
Accumulated deficit
    (105,221 )     (125,754 )
 
Accumulated comprehensive loss - unrealized loss on hedging instruments
    (103 )      
 
Notes receivable from stockholders
    (95 )     (138 )
 
 
   
     
 
   
Total stockholders’ equity
    137,949       63,086  
 
 
   
     
 
   
Total liabilities and stockholders’ equity
  $ 545,253     $ 507,428  
 
 
   
     
 

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

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VCA ANTECH, INC. AND SUBSIDIARIES
CONDENSED, CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three and Six Months Ended June 30, 2003 and 2002
(Unaudited)
(In thousands, except per share amounts)

                                   
      Three Months Ended   Six Months Ended
      June 30,   June 30,
     
 
      2003   2002   2003   2002
     
 
 
 
Revenue
  $ 132,363     $ 117,225     $ 248,363     $ 221,920  
Direct costs (excludes operating depreciation of $2,665 and $2,360 for the three months ended June 30, 2003 and 2002, respectively, and $5,419 and $4,608 for the six months ended June 30, 2003 and 2002, respectively)
    86,504       77,004       166,255       149,592  
 
   
     
     
     
 
 
    45,859       40,221       82,108       72,328  
Selling, general and administrative expense
    9,090       8,539       18,453       17,161  
Depreciation and amortization
    3,497       3,139       7,074       6,302  
Loss (gain) on sale of assets
    78             (160 )      
 
   
     
     
     
 
 
Operating income
    33,194       28,543       56,741       48,865  
Interest expense, net
    6,418       10,344       13,410       20,333  
Debt retirement costs
                7,417        
Other (income) expense
    131       (61 )     258       (154 )
Minority interest in income of subsidiaries
    462       528       823       930  
 
   
     
     
     
 
 
Income before provision for income taxes
    26,183       17,732       34,833       27,756  
Provision for income taxes
    10,833       7,237       14,300       11,626  
 
   
     
     
     
 
 
Net income
  $ 15,350     $ 10,495     $ 20,533     $ 16,130  
 
   
     
     
     
 
Basic earnings per common share
  $ 0.38     $ 0.29     $ 0.52     $ 0.44  
 
   
     
     
     
 
Diluted earnings per common share
  $ 0.37     $ 0.28     $ 0.51     $ 0.43  
 
   
     
     
     
 
Shares used for computing basic earnings per share
    40,606       36,739       39,818       36,738  
 
   
     
     
     
 
Shares used for computing diluted earnings per share
    41,136       37,087       40,288       37,084  
 
   
     
     
     
 

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

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VCA ANTECH, INC. AND SUBSIDIARIES
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, 2003 and 2002
(Unaudited)
(In thousands)

                         
            Six Months Ended
            June 30,
           
            2003   2002
           
 
Cash flows from operating activities:
               
   
Net income
  $ 20,533     $ 16,130  
   
Adjustments to reconcile net income to net cash provided by operating activities:
               
     
Depreciation and amortization
    7,074       6,302  
     
Amortization of deferred financing costs and debt discount
    456       847  
     
Provision for uncollectible accounts
    1,557       1,420  
     
Debt retirement costs
    7,417        
     
Interest paid in kind on 15.5% senior notes
          4,645  
     
Gain on sale of assets
    (160 )      
     
Minority interest in income of subsidiaries
    823       930  
     
Distributions to minority interest partners
    (797 )     (805 )
     
Increase in trade accounts receivable
    (5,351 )     (5,845 )
     
Decrease (increase) in inventory, prepaid expenses and other assets
    168       (362 )
     
Increase in accounts payable and other accrued liabilities
    1,343       825  
     
Decrease in accrued payroll and related liabilities
    (2,196 )     (238 )
     
Decrease in accrued interest
    (32 )     (270 )
     
Decrease in prepaid income taxes
    4,910       2,782  
     
Increase in income taxes payable
          1,901  
     
Increase in deferred income taxes asset
    (877 )     (946 )
     
Increase in deferred income taxes liability
    3,652       4,498  
   
 
   
     
 
       
Net cash provided by operating activities
    38,520       31,814  
   
 
   
     
 
Cash flows from investing activities:
               
 
Business acquisitions, net of cash acquired
    (19,926 )     (9,997 )
 
Real estate acquired in connection with business acquisitions
    (589 )      
 
Property and equipment additions, net
    (6,168 )     (6,204 )
 
Proceeds from sale of assets
    355        
 
Other
    361       129  
   
 
   
     
 
       
Net cash used in investing activities
    (25,967 )     (16,072 )
   
 
   
     
 
Cash flows from financing activities:
               
   
Repayment of long-term obligations, including redemption fees
    (50,511 )     (2,485 )
   
Payment of deferred financing and recapitalization costs
    (382 )     (2,673 )
   
Proceeds from issuance of common stock under stock option plans
    67       17  
   
Proceeds from issuance of common stock
    54,323        
   
 
   
     
 
       
Net cash provided by (used in) financing activities
    3,497       (5,141 )
   
 
   
     
 
Increase in cash and cash equivalents
    16,050       10,601  
Cash and cash equivalents at beginning of period
    6,462       7,103  
   
 
   
     
 
Cash and cash equivalents at end of period
  $ 22,512     $ 17,704  
   
 
   
     
 

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

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VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003
(Unaudited)

(1)   General

     The accompanying unaudited condensed, consolidated financial statements of VCA Antech, Inc. and subsidiaries (the “Company” or “VCA”) have been prepared in accordance with generally accepted accounting principles in the United States for interim financial information and in accordance with the rules and regulations of the United States Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States for complete financial statements as permitted under applicable rules and regulations. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. The results of operations for the three and six months ended June 30, 2003 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 2002 Annual Report on Form 10-K.

(2)   Acquisitions

     During the three months ended June 30, 2003, the Company purchased 11 animal hospitals and five veterinary diagnostic laboratories. Five of the acquired animal hospitals and two of the acquired laboratories were merged into existing VCA facilities upon acquisition. Including acquisition costs, the Company paid an aggregate consideration of $16.4 million, consisting of $13.8 million in cash, $2.3 million in an obligation to be settled in either cash or shares of the Company’s common stock, and $385,000 in certain obligations to sellers and other liabilities assumed. The $16.4 million aggregate purchase price was allocated as follows: $1.1 million to tangible assets, $14.6 million to goodwill and $791,000 to other intangible assets. Goodwill was assigned to the animal hospital and laboratory reporting units in the amounts of $8.6 million and $6.0 million, respectively. The Company expects that $6.5 million of the goodwill recorded will be fully deductible for income tax purposes.

     During the six months ended June 30, 2003, the Company purchased 16 animal hospitals and six veterinary diagnostic laboratories. Five of the acquired animal hospitals and two of the acquired laboratories were merged into existing VCA facilities upon acquisition. Including acquisition costs, the Company paid an aggregate consideration of $22.5 million, consisting of $19.4 million in cash, $2.3 million in an obligation to be settled in either cash or shares of the Company’s common stock, and $907,000 in certain obligations to sellers and other liabilities assumed. The $22.5 million aggregate purchase price was allocated as follows: $1.2 million to tangible assets, $20.1 million to goodwill and $1.2 million to other intangible assets. Goodwill was assigned to the animal hospital and laboratory reporting units in the amounts of $13.8 million and $6.3 million, respectively. The Company expects that $11.0 million of the goodwill recorded will be fully deductible for income tax purposes.

     During the six months ended June 30, 2003, the Company purchased the total ownership interest of partners in two non-wholly owned subsidiaries of the Company for approximately $910,000, consisting of $106,000 in cash, $763,000 in a note payable, and $41,000 in the forgiveness of certain notes owed to the Company by the partner. The Company recorded goodwill of $362,000 related to the purchase and expects that it will be fully deductible for income tax purposes.

     The Company also made payments of $465,000 during the six months ended June 30, 2003 related to certain other obligations incurred at the time of acquisition.

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(3)   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,
       
 
        2003   2002   2003   2002
       
 
 
 
Net income
  $ 15,350     $ 10,495     $ 20,533     $ 16,130  
 
   
     
     
     
 
Weighted average common shares outstanding:
                               
 
Basic
    40,606       36,739       39,818       36,738  
 
Effect of dilutive common shares:
                               
   
Stock options
    494       348       452       346  
   
Contracts that may be settled in stock or cash
    36             18        
 
   
     
     
     
 
 
Diluted
    41,136       37,087       40,288       37,084  
 
   
     
     
     
 
Earnings per common share:
                               
 
Basic
  $ 0.38     $ 0.29     $ 0.52     $ 0.44  
 
   
     
     
     
 
 
Diluted
  $ 0.37     $ 0.28     $ 0.51     $ 0.43  
 
   
     
     
     
 

(4)   Comprehensive Income

     Below is a calculation of comprehensive income (in thousands):

                                   
      Three Months Ended   Six Months Ended
      June 30,   June 30,
     
 
      2003   2002   2003   2002
     
 
 
 
Net income
  $ 15,350     $ 10,495     $ 20,533     $ 16,130  
 
Unrealized gain (loss) on hedging instruments
    (114 )     590       (114 )     1,050  
 
Less portion of unrealized loss (gain) recognized
    11       (61 )     11       (154 )
 
   
     
     
     
 
Net comprehensive income
  $ 15,247     $ 11,024     $ 20,430     $ 17,026  
 
   
     
     
     
 

     All unrealized gains and losses presented are the result of changes in the fair market value of interest rate hedging agreements (see footnote 5, Interest Rate Hedging Agreements). The agreements are two-year agreements that will have zero market value at the end of their terms. Accordingly, all unrealized gains and losses will net to zero over the life of the contract. As a result, the Company has not recognized an income tax expense or benefit relating to these gains and losses.

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(5)   Interest Rate Hedging Agreements

     The Company entered into the following no-fee swap agreements (“Swap Agreements”), which swap monthly variable London interbank offer rates (“LIBOR”) for the fixed rates indicated below:

                         
    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

     Swap #2 and Swap #3 qualify for hedge accounting and the Company considers these to be cash flow hedging instruments. However, in May 2003 management determined that Swap #1 was no longer an effective tool to hedge against interest rate risk because LIBOR projections were considerably below the initial LIBOR forecasts used to price the swap at inception of the contract. As a result of this determination, Swap #1 no longer qualifies for hedge accounting and all changes in its market value are recognized as income or expense in the period of change.

     On November 13, 2000, the Company entered into a no-fee interest rate collar agreement with Wells Fargo Bank, which expired on November 15, 2002, (“Collar Agreement”). The Collar Agreement reset monthly and had a cap and floor notional amount of $62.5 million with a cap and floor interest rate of 7.5% and 5.9%, respectively. The Collar Agreement qualified for hedge accounting and the Company considered it a cash flow hedging instrument.

     The valuations of the Swap Agreements and the Collar Agreement were determined by the counter parties. At June 30, 2003 and December 31, 2002, the fair market values of the Swap Agreements resulted in a liability from interest rate hedging activities of $674,000 and $313,000, respectively. As a result of the Company’s interest rate hedging activities, it recognized an unrealized loss of $131,000 and an unrealized gain of $61,000 during the three months ended June 30, 2003 and 2002, respectively, and it recognized an unrealized loss of $258,000 and an unrealized gain of $154,000 during the six months ended June 30, 2003 and 2002, respectively. These charges have been reported as part of other (income) expense.

     The Company made payments under the Swap Agreements amounting to $102,000 for the three months ended June 30, 2003 and $187,000 for the six months ended June 30, 2003, resulting from LIBOR being below the fixed interest rate. The Company made payments under the Collar Agreement amounting to $639,000 for the three months ended June 30, 2002 and $1.3 million for the six months ended June 30, 2002 resulting from LIBOR being below the floor interest rate of 5.9%. These payments have been reported as part of interest expense.

(6)   Lines of Business

     During the three and six months ended June 30, 2003 and 2002, 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 2002 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.

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     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, 2003
                                       
 
Revenue
  $ 46,691     $ 88,424     $     $ (2,752 )   $ 132,363  
 
Direct costs (excluding operating depreciation)
    24,816       64,440             (2,752 )     86,504  
 
Selling, general and administrative
    2,797       2,519       3,774             9,090  
 
Loss (gain) on sale of assets
    21       58       (1 )           78  
 
Depreciation and amortization
    799       2,304       394             3,497  
 
 
   
     
     
     
     
 
     
Operating income (loss)
  $ 18,258     $ 19,103     $ (4,167 )   $     $ 33,194  
 
 
   
     
     
     
     
 
 
Capital expenditures
  $ 590     $ 2,165     $ 588     $     $ 3,343  
 
Three Months Ended June 30, 2002
                                       
 
Revenue
  $ 40,604     $ 78,621     $ 500     $ (2,500 )   $ 117,225  
 
Direct costs (excluding operating depreciation)
    22,134       57,370             (2,500 )     77,004  
 
Selling, general and administrative
    2,396       2,478       3,665             8,539  
 
Depreciation and amortization
    726       2,069       344             3,139  
 
 
   
     
     
     
     
 
     
Operating income (loss)
  $ 15,348     $ 16,704     $ (3,509 )   $     $ 28,543  
 
 
   
     
     
     
     
 
 
Capital expenditures
  $ 825     $ 1,818     $ 393     $     $ 3,036  
 
Six Months Ended June 30, 2003
                                       
 
Revenue
  $ 88,389     $ 165,152     $     $ (5,178 )   $ 248,363  
 
Direct costs (excluding operating depreciation)
    48,272       123,161             (5,178 )     166,255  
 
Selling, general and administrative
    5,504       5,022       7,927             18,453  
 
Loss (gain) on sale of assets
    19       (178 )     (1 )           (160 )
 
Depreciation and amortization
    1,553       4,781       740             7,074  
 
 
   
     
     
     
     
 
     
Operating income (loss)
  $ 33,041     $ 32,366     $ (8,666 )   $     $ 56,741  
 
 
   
     
     
     
     
 
 
Capital expenditures
  $ 1,764     $ 3,358     $ 1,046     $     $ 6,168  
 
Six Months Ended June 30, 2002
                                       
 
Revenue
  $ 78,261     $ 147,265     $ 1,000     $ (4,606 )   $ 221,920  
 
Direct costs (excluding operating depreciation)
    43,696       110,502             (4,606 )     149,592  
 
Selling, general and administrative
    5,069       4,992       7,100             17,161  
 
Depreciation and amortization
    1,423       4,205       674             6,302  
 
 
   
     
     
     
     
 
     
Operating income (loss)
  $ 28,073     $ 27,566     $ (6,774 )   $     $ 48,865  
 
 
   
     
     
     
     
 
 
Capital expenditures
  $ 1,430     $ 3,955     $ 819     $     $ 6,204  
 
At June 30, 2003
                                       
 
Identifiable assets
  $ 130,146     $ 365,880     $ 49,227     $     $ 545,253  
At December 31, 2002
                                       
 
Identifiable assets
  $ 117,443     $ 350,980     $ 39,005     $     $ 507,428  

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     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 statements of operations (in thousands):

                                 
    Three Months Ended   Six Months Ended
    June 30,   June 30,
   
 
    2003   2002   2003   2002
   
 
 
 
Total segment operating income after eliminations
  $ 33,194     $ 28,543     $ 56,741     $ 48,865  
Interest expense, net
    6,418       10,344       13,410       20,333  
Debt retirement costs
                7,417        
Other (income) expense
    131       (61 )     258       (154 )
Minority interest in income of subsidiaries
    462       528       823       930  
 
   
     
     
     
 
Income before provision for income taxes
  $ 26,183     $ 17,732     $ 34,833     $ 27,756  
 
   
     
     
     
 

(7)   Secondary Offering and Debt Retirement

     In February 2003, the Company completed a secondary offering of 10.1 million shares of its common stock. As part of this offering, the Company granted its underwriters an over-allotment option to purchase an additional 1.5 million shares of its common stock that was exercised in full in February 2003. In conjunction with these transactions, the Company sold 3.8 million primary shares of its common stock in exchange for net proceeds of approximately $54.3 million. The Company used approximately $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 resulting in debt retirement costs of approximately $7.4 million. The Company is using the remaining $11.6 million of net proceeds for general corporate purposes.

(8)   Goodwill and Other Intangible Assets

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

     The following table presents the changes in the carrying amount of goodwill for the six months ended June 30, 2003 (in thousands):

                         
            Animal        
    Laboratory   Hospital   Total
   
 
 
Balance as of January 1, 2003
  $ 87,313     $ 255,301     $ 342,614  
Goodwill acquired and purchase price adjustments
    6,321       14,294       20,615  
 
   
     
     
 
Balance as of June 30, 2003
  $ 93,634     $ 269,595     $ 363,229  
 
   
     
     
 

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

                         
    As of June 30, 2003
   
    Gross Carrying   Accumulated   Net Carrying
    Amount   Amortization   Amount
   
 
 
Covenants not to compete
  $ 12,924     $ (7,883 )   $ 5,041  
Client lists
    592       (499 )     93  
 
   
     
     
 
Total
  $ 13,516     $ (8,382 )   $ 5,134  
 
   
     
     
 

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

                                 
    Three Months Ended   Six Months Ended
    June 30,   June 30,
   
 
    2003   2002   2003   2002
   
 
 
 
Aggregate amortization expense
  $ 438     $ 435     $ 915     $ 1,020  
 
   
     
     
     
 

     Based on balances at June 30, 2003, estimated amortization expense for other intangible assets for the current year and the next four fiscal years is as follows (in thousands):

         
2003
  $ 1,815  
2004
  $ 1,478  
2005
  $ 1,087  
2006
  $ 712  
2007
  $ 501  

(9)   Accounting Pronouncements

  a.   Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity

     In May 2003, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 clarifies the accounting for certain financial instruments with characteristics of both liabilities and equity and requires that those instruments be classified as liabilities. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company currently has a $2.3 million obligation to be settled in either cash or common stock that is classified as a liability. It does not have any immediate plans to enter into other financial instruments subject to the accounting requirements of SFAS No. 150. The adoption of SFAS No. 150 will not have a material impact on the Company’s financial statements.

  b.   Accounting for Derivative Instruments and Hedging Activities

     In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 clarifies financial accounting and reporting requirements for derivative instruments and hedging activities as set forth under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships entered into after June 30, 2003. The adoption of SFAS No. 149 will not have a material impact on the Company’s financial statements.

  c.   Consolidations of Variable Interest Entities

     In January 2003, the FASB issued FASB Interpretation (“FIN”) No. 46, Consolidation of Variable Interest Entities, requiring that companies consolidate variable interest entities if they are the primary beneficiaries, as defined under FIN No. 46, of the activities of the variable interest entities. Companies are required to apply FIN No. 46 immediately for all variable interest entities created after January 31, 2003 and as of the beginning of the first interim period beginning after June 15, 2003 for all other variable interest entities.

     The Company provides management services to certain veterinary medical groups in states with laws that prohibit business corporations from providing, or holding themselves out as providers of, veterinary medical care. As of June 30, 2003, the Company operated in 11 of these states. In these states, the Company provides management services to veterinary medical groups pursuant to long-term management agreements (the “Management Agreements”), ranging from 10 to 40 years with non-binding renewal options, where allowable. Pursuant to these Management Agreements, the veterinary medical groups are each solely responsible for all aspects of veterinary medicine, as defined by their respective state. The Company provides administrative and other support services.

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     Currently, the Company does not consolidate the operations of the veterinary medical groups since it has no ownership interests in them. However, the Company is finalizing its analysis of FIN No. 46, and it is reasonably possible that the operations of the veterinary medical groups will be consolidated. If the veterinary medical groups were to be consolidated into the Company’s operating results, there would be no effect on operating income and the Company would not be exposed to additional losses. A comparative analysis of the Company’s animal hospital operations both as currently reported and as would be reported if we consolidated the veterinary medical groups is as follows (in thousands):

                         
    For the Six Months Ended June 30, 2003
   
    As Reported   As Consolidated   Difference
   
 
 
Revenue
  $ 165,152     $ 185,129     $ 19,977  
Direct costs (excluding operating depreciation)
  $ 123,161     $ 143,138     $ 19,977  
Operating income
  $ 32,366     $ 32,366     $  

  d.   Guarantor’s Accounting and Disclosure Requirements for Guarantees

     In January 2003, the FASB issued FIN No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 requires a company to recognize a liability for the obligations it has undertaken in issuing a guarantee. This liability would be recorded at the inception of a guarantee and would be measured at fair value. The measurement provisions of this statement apply prospectively to guarantees issued or modified after December 31, 2002 for periods ending after December 15, 2002. The Company does not have any obligations subject to the provisions of FIN No. 45.

  e.   Consideration Received from a Vendor

     In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus regarding two issues raised by EITF Issue No. 02-16, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor. The EITF concluded that:

    cash received by a vendor is presumed to be a reduction of the cost of the vendor’s products or services, however that presumption is overcome when the consideration is either a) payment for assets or services, in which case the consideration is characterized as revenue, or b) a reimbursement of specific and identifiable costs incurred on behalf of the vendor in selling the vendor’s products or services, in which case the consideration is a reduction of that cost; and
 
    rebates offered to a customer or reseller should be recognized as a reduction of the cost of sales based on a systematic and rational allocation provided that the amounts recognized are probable and reasonably estimable.

     EITF Issue No. 02-16 is effective for changes made to existing agreements or new agreements entered into on or after January 1, 2003. The Company adopted EITF Issue No. 02-16 on January 1, 2003 without a material impact on its financial statements and does not expect it to have a material impact on its financial statements in the future.

  f.   Costs Associated with Exit or Disposal Activities

     In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 requires that liabilities associated with exit or disposal activities be recognized when a company is committed to future payment of those liabilities under a binding, legal obligation. SFAS No. 146 nullifies EITF No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring), which required that exit and disposal costs be recognized as liabilities when a company formalized its plan for exiting or disposing of an activity even if no legal obligation had been established.

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     SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. Currently, the Company has no plans to exit or dispose of any of its business activities that would require the use of SFAS No. 146 nor does it anticipate that SFAS No. 146 will change any of its business practices.

  g.   Gains and Losses from Extinguishment of Debt and Capital Leases

     In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, to be applied in fiscal years beginning after May 15, 2002.

     Under SFAS No. 145, gains and losses from extinguishment of debt should be classified as extraordinary items only if they meet the criteria of Accounting Principles Board Opinion (“APB”) No. 30. Under APB No. 30, events are considered extraordinary only if they possess a high degree of abnormality and are not likely to recur in the foreseeable future.

     In February 2003, the Company redeemed the remaining principal amount outstanding of its 15.5% senior notes. This voluntary repayment resulted in the recognition of a loss on the early extinguishment of debt of $7.4 million. The Company does not believe the loss meets the criteria of APB No. 30 as it has historically and may continue to change its capital structure to take advantage of current market conditions. As a result of adopting SFAS No. 145 on January 1, 2003, the Company recorded the debt retirement costs as a component of income from recurring operations.

     SFAS No. 145 also amends SFAS No. 13, Accounting for Leases. Under SFAS No. 145, if a capital lease is modified such that it becomes an operating lease, a gain or loss must be recognized similar to the accounting used for sale-leaseback transactions as provided in SFAS No. 28 and No. 98. At June 30, 2003, the Company had capital lease obligations of $454,000; however, the Company currently has no plans to modify these or any future capital leases.

  h.   Asset Retirement Obligations

     In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Company adopted SFAS No. 143 on January 1, 2003 without a material impact on its financial statements.

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(10)   Stock-Based Compensation

     The Company has granted stock options to various employees and accounts for these options under APB Opinion No. 25, Accounting for Stock Issued to Employees. Under this method, when options are issued with a strike price equal to or greater than the market price on the date of issuance, there is no impact on earnings either on the date of issuance or thereafter regardless of strike price. This method is not a fair-value-based method of accounting as defined by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, and Amendment of FASB Statement No. 123. Fair-value-based methods of accounting require compensation expense to be recognized annually equal to the fair value of the options granted divided by their vesting period. Had the Company accounted for their stock options under SFAS No. 148 and the fair-value-based method of accounting, the Company’s net income and earnings per share on a pro forma basis would be as indicated below (in thousands, except per share amounts):

                                   
      Three Months Ended   Six Months Ended
      June 30,   June 30,
     
 
      2003   2002   2003   2002
     
 
 
 
As reported
  $ 15,350     $ 10,495     $ 20,533     $ 16,130  
 
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects
  (215 )     (23 )     (428 )     (37 )
 
 
   
     
     
     
 
 
Pro forma net income available to common stockholders
  $ 15,135     $ 10,472     $ 20,105     $ 16,093  
 
 
   
     
     
     
 
Earnings per common share:
                               
 
Basic - as reported
  $ 0.38     $ 0.29     $ 0.52     $ 0.44  
 
Basic - pro forma
  $ 0.37     $ 0.29     $ 0.50     $ 0.44  
 
Diluted - as reported
  $ 0.37     $ 0.28     $ 0.51     $ 0.43  
 
Diluted - pro forma
  $ 0.37     $ 0.28     $ 0.50     $ 0.43  

(11)   Commitments and Contingencies

  a.   State Laws

     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. The Company operates 64 animal hospitals in 11 states with these laws. The Company may experience difficulty in expanding operations into other states with similar laws. Given varying and uncertain interpretations of the veterinary laws of each state, the Company may not be in compliance with restrictions on the corporate practice of veterinary medicine in all states. A determination that the Company is in violation of applicable restrictions on the practice of veterinary medicine in any state in which it operates could have a material adverse effect, particularly if the Company were unable to restructure its operations to comply with the requirements of that state.

     All of the states in which the Company operates impose various registration requirements. To fulfill these requirements, each facility has been registered with appropriate governmental agencies and, where required, has appointed a licensed veterinarian to act on behalf of each facility. All veterinarians practicing in the Company’s clinics are required to maintain valid state licenses to practice.

  b.   Other 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 significantly affect the Company’s financial position or results of operations.

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     On November 30, 2001, two majority stockholders of a company that merged with Zoasis Corporation (“Zoasis”) in June 2000 filed a civil complaint against VCA, Zoasis and Robert Antin. Robert Antin, VCA’s Chief Executive Officer, President and Chairman of the Board, is the majority stockholder of Zoasis and serves on its Board of Directors. The complaint alleges various tort claims under California law arising from the plaintiffs’ investment in Zoasis. Zoasis filed a counter claim alleging breach of contract and claim and delivery. On March 25, 2003, the parties settled all claims in the litigation and executed a Settlement Agreement, Mutual Release and Covenant Not to Sue. Under the terms of the settlement, the parties dismissed their claims in the litigation with prejudice on April 17, 2003, and VCA paid plaintiffs $2.0 million. Concurrent with the settlement, plaintiffs surrendered all of their Zoasis common stock. The $2.0 million settlement and other related legal fees were fully accrued at December 31, 2002.

(12)   Reclassifications

     Certain 2002 balances have been reclassified to conform to the 2003 financial statement presentation.

(13)   Subsequent Events

     From July 1, 2003 through August 11, 2003, the Company acquired one animal hospital and one veterinary diagnostic laboratory, which was merged into an existing laboratory upon acquisition. Including acquisition costs, the Company paid an aggregate consideration of $3.6 million, consisting of $2.9 million in cash and $770,000 in certain obligations to sellers and other liabilities assumed.

(14)   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.

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

CONDENSED, CONSOLIDATING BALANCE SHEETS
As of June 30, 2003
(Unaudited)
(In thousands)

                                                     
                                Non-                
                        Guarantor   Guarantor                
        VCA   Vicar   Subsidiaries   Subsidiaries   Elimination   Consolidated
       
 
 
 
 
 
Current assets:
                                               
 
Cash and cash equivalents
  $     $ 20,355     $ 1,977     $ 180     $     $ 22,512  
 
Trade accounts receivable, net
          9       24,889       639             25,537  
 
Inventory, prepaid expenses and other
          2,180       5,925       488             8,593  
 
Deferred income taxes
          10,405                         10,405  
 
Prepaid income taxes
          2,704                         2,704  
 
   
     
     
     
     
     
 
   
Total current assets
          35,653       32,791       1,307             69,751  
 
Property and equipment, net
          7,056       88,231       1,558             96,845  
 
Goodwill, net
                342,439       20,790             363,229  
 
Covenants not to compete, net
                4,438       603             5,041  
 
Deferred financing costs, net
          5,952                         5,952  
 
Other
    69       497       2,988       1,796       (915 )     4,435  
 
Investment in subsidiaries
    180,231       277,747       21,901             (479,879 )      
 
   
     
     
     
     
     
 
   
Total assets
  $ 180,300     $ 326,905     $ 492,788     $ 26,054     $ (480,794 )   $ 545,253  
 
   
     
     
     
     
     
 
Current liabilities:
                                               
 
Current portion of long-term obligations
  $     $ 1,743     $ 955     $     $     $ 2,698  
 
Accounts payable
          7,383       2,747                   10,130  
 
Accrued payroll and related liabilities
          5,416       6,818       304             12,538  
 
Accrued interest
          1,493       40                   1,533  
 
Other accrued liabilities
          12,146       6,199       95             18,440  
 
   
     
     
     
     
     
 
   
Total current liabilities
          28,181       16,759       399             45,339  
Long-term obligations, less current portion
          335,021       1,686             (915 )     335,792  
Deferred income taxes
          19,028                         19,028  
Other liabilities
          2,007                         2,007  
Intercompany payable/(receivable)
    42,351       (237,563 )     196,596       (1,384 )            
Minority interest
                            5,138       5,138  
Stockholders’ equity:
                                               
 
Common stock
    41                               41  
 
Additional paid-in capital
    243,327                               243,327  
 
Notes receivable from stockholders
    (95 )                             (95 )
 
Accumulated equity (deficit)
    (105,221 )     180,334       277,747       27,039       (485,120 )     (105,221 )
 
Accumulated comprehensive loss - unrealized loss on hedging instruments
    (103 )     (103 )                 103       (103 )
 
   
     
     
     
     
     
 
   
Total stockholders’ equity
    137,949       180,231       277,747       27,039       (485,017 )     137,949  
 
   
     
     
     
     
     
 
   
Total liabilities and stockholders’ equity
  $ 180,300     $ 326,905     $ 492,788     $ 26,054     $ (480,794 )   $ 545,253  
 
   
     
     
     
     
     
 

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

CONDENSED, CONSOLIDATING BALANCE SHEETS
As of December 31, 2002
(In thousands)

                                                     
                                Non-                
                        Guarantor   Guarantor                
        VCA   Vicar   Subsidiaries   Subsidiaries   Elimination   Consolidated
       
 
 
 
 
 
Current assets:
                                               
 
Cash and cash equivalents
  $     $ 5,083     $ 1,233     $ 146     $     $ 6,462  
 
Trade accounts receivable, net
          5       20,085       637             20,727  
 
Inventory, prepaid expenses and other
          2,684       5,414       545             8,643  
 
Deferred income taxes
          9,528                         9,528  
 
Prepaid income taxes
          7,614                         7,614  
 
   
     
     
     
     
     
 
   
Total current assets
          24,914       26,732       1,328             52,974  
 
Property and equipment, net
          6,727       86,077       2,499             95,303  
 
Goodwill, net
                321,887       20,727             342,614  
 
Covenants not to compete, net
                4,098       637             4,735  
 
Deferred financing costs, net
    386       6,392                         6,778  
 
Other
    139       447       2,679       1,759             5,024  
 
Investment in subsidiaries
    155,115       239,671       23,403             (418,189 )      
 
   
     
     
     
     
     
 
   
Total assets
  $ 155,640     $ 278,151     $ 464,876     $ 26,950     $ (418,189 )   $ 507,428  
 
   
     
     
     
     
     
 
Current liabilities:
                                               
 
Current portion of long-term obligations
  $     $ 9,240     $ 382     $     $     $ 9,622  
 
Accounts payable
          6,706       3,517                   10,223  
 
Accrued payroll and related liabilities
          7,068       7,339       327             14,734  
 
Accrued interest
          1,547       18                   1,565  
 
Other accrued liabilities
          10,325       3,124       15             13,464  
 
   
     
     
     
     
     
 
   
Total current liabilities
          34,886       14,380       342             49,608  
Long-term obligations, less current portion
    35,145       335,895       895                   371,935  
Deferred income taxes
          15,376                         15,376  
Other liabilities
          2,007                         2,007  
Intercompany payable/(receivable)
    57,409       (265,128 )     209,930       (2,211 )            
Minority interest
                            5,416       5,416  
Stockholders’ equity:
                                               
 
Common stock
    37                               37  
 
Additional paid-in capital
    188,941                               188,941  
 
Accumulated equity (deficit)
    (125,754 )     155,115       239,671       28,819       (423,605 )     (125,754 )
 
Notes receivable from stockholders
    (138 )                             (138 )
 
   
     
     
     
     
     
 
   
Total stockholders’ equity
    63,086       155,115       239,671       28,819       (423,605 )     63,086  
 
   
     
     
     
     
     
 
   
Total liabilities and stockholders’ equity
  $ 155,640     $ 278,151     $ 464,876     $ 26,950     $ (418,189 )   $ 507,428  
 
   
     
     
     
     
     
 

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

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

                                                     
                                Non-                
                        Guarantor   Guarantor                
        VCA   Vicar   Subsidiaries   Subsidiaries   Elimination   Consolidated
       
 
 
 
 
 
Revenue
  $     $     $ 123,295     $ 9,317     $ (249 )   $ 132,363  
Direct costs
                80,012       6,741       (249 )     86,504  
 
   
     
     
     
     
     
 
 
                43,283       2,576             45,859  
Selling, general and administrative
          3,774       4,930       386             9,090  
Depreciation and amortization
          394       2,941       162             3,497  
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 )      
 
   
     
     
     
     
     
 
   
Income before minority interest and provision for income taxes
    15,352       10,764       36,905       2,071       (38,447 )     26,645  
Minority interest in income of subsidiaries
                            462       462  
 
   
     
     
     
     
     
 
 
Income before provision 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  
 
   
     
     
     
     
     
 

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

CONDENSED, CONSOLIDATING STATEMENTS OF OPERATIONS
For the Three Months Ended June 30, 2002
(Unaudited)
(In thousands)

                                                   
                              Non-                
                      Guarantor   Guarantor                
      VCA   Vicar   Subsidiaries   Subsidiaries   Elimination   Consolidated
     
 
 
 
 
 
Revenue
  $     $ 500     $ 107,515     $ 9,453     $ (243 )   $ 117,225  
Direct costs
                70,507       6,740       (243 )     77,004  
 
   
     
     
     
     
     
 
 
          500       37,008       2,713             40,221  
Selling, general and administrative
          3,665       4,503       371             8,539  
Depreciation and amortization
          344       2,614       181             3,139  
 
   
     
     
     
     
     
 
 
Operating income (loss)
          (3,509 )     29,891       2,161             28,543  
Interest expense, net
    2,386       7,956       32       (30 )           10,344  
Other income
          (61 )                       (61 )
Equity interest in income of subsidiaries
    11,995       19,204       1,663             (32,862 )      
 
   
     
     
     
     
     
 
 
Income before minority interest and provision for income taxes
    9,609       7,800       31,522       2,191       (32,862 )     18,260  
Minority interest in income of subsidiaries
                            528       528  
 
   
     
     
     
     
     
 
 
Income before provision for income taxes
    9,609       7,800       31,522       2,191       (33,390 )     17,732  
Provision (benefit) for income taxes
    (886 )     (4,195 )     12,318                   7,237  
 
   
     
     
     
     
     
 
 
Net income
  $ 10,495     $ 11,995     $ 19,204     $ 2,191     $ (33,390 )   $ 10,495  
 
   
     
     
     
     
     
 

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

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

                                                     
                                Non-                
                        Guarantor   Guarantor                
        VCA   Vicar   Subsidiaries   Subsidiaries   Elimination   Consolidated
       
 
 
 
 
 
Revenue
  $     $     $ 231,303     $ 17,535     $ (475 )   $ 248,363  
Direct costs
                153,870       12,860       (475 )     166,255  
 
   
     
     
     
     
     
 
 
                77,433       4,675             82,108  
Selling, general and administrative
          7,927       9,797       729             18,453  
Depreciation and amortization
          740       6,018       316             7,074  
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 )      
 
   
     
     
     
     
     
 
   
Income before minority interest and provision for income taxes
    17,276       16,259       64,593       3,705       (66,177 )     35,656  
Minority interest in income of subsidiaries
                            823       823  
 
   
     
     
     
     
     
 
 
Income before provision 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  
 
   
     
     
     
     
     
 

18


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

CONDENSED, CONSOLIDATING STATEMENTS OF OPERATIONS
For the Six Months Ended June 30, 2002
(Unaudited)
(In thousands)

                                                     
                                Non-                
                        Guarantor   Guarantor                
        VCA   Vicar   Subsidiaries   Subsidiaries   Elimination   Consolidated
       
 
 
 
 
 
Revenue
  $     $ 1,000     $ 203,941     $ 17,414     $ (435 )   $ 221,920  
Direct costs
                137,484       12,543       (435 )     149,592  
 
   
     
     
     
     
     
 
 
          1,000       66,457       4,871             72,328  
Selling, general and administrative
          7,100       9,384       677             17,161  
Depreciation and amortization
          674       5,279       349             6,302  
 
   
     
     
     
     
     
 
   
Operating income (loss)
          (6,774 )     51,794       3,845             48,865  
Interest expense, net
    4,527       15,801       62       (57 )           20,333  
Other income
          (154 )                       (154 )
Equity interest in income of subsidiaries
    18,750       31,731       2,972             (53,453 )      
 
   
     
     
     
     
     
 
   
Income before minority interest and provision for income taxes
    14,223       9,310       54,704       3,902       (53,453 )     28,686  
Minority interest in income of subsidiaries
                            930       930  
 
   
     
     
     
     
     
 
 
Income before provision for income taxes
    14,223       9,310       54,704       3,902       (54,383 )     27,756  
Provision (benefit) for income taxes
    (1,907 )     (9,440 )     22,973                   11,626  
 
   
     
     
     
     
     
 
 
Net income
  $ 16,130     $ 18,750     $ 31,731     $ 3,902     $ (54,383 )   $ 16,130  
 
   
     
     
     
     
     
 

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Table of Contents

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 of sale of assets
          (1 )     (159 )                 (160 )
 
Minority interest in income of subsidiaries
                            823       823  
 
Distributions to minority interest partners
          (797 )                       (797 )
 
Increase in trade 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 taxes asset
          (877 )                       (877 )
 
Increase in deferred income taxes liability
          3,652                         3,652  
 
Increase 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  
 
   
     
     
     
     
     
 

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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 from investing activities:
                                               
 
Business acquisitions, net of cash acquired
  $     $ (19,926 )   $     $     $     $ (19,926 )
 
Real estate acquired in connection with 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 )     (8,703 )                       (50,511 )
 
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  
 
   
     
     
     
     
     
 

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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, 2002
(Unaudited)
(In thousands)

                                                     
                                Non-                
                        Guarantor   Guarantor                
        VCA   Vicar   Subsidiaries   Subsidiaries   Elimination   Consolidated
       
 
 
 
 
 
Cash flows from operating activities:
                                               
 
Net income
  $ 16,130     $ 18,750     $ 31,731     $ 3,902     $ (54,383 )   $ 16,130  
 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
                                               
 
Equity interest in earnings of subsidiaries
    (18,750 )     (31,731 )     (2,972 )           53,453        
 
Depreciation and amortization
          674       5,279       349             6,302  
 
Amortization of deferred financing costs and debt discount
    313       534                         847  
 
Provision for uncollectible accounts
                1,243       177             1,420  
 
Interest paid in kind on 15.5% senior notes
    4,645                               4,645  
 
Minority interest in income of subsidiaries
                            930       930  
 
Distributions to minority interest partners
          (805 )                       (805 )
 
Increase in trade accounts receivable
                (5,278 )     (567 )           (5,845 )
 
Decrease (increase) in inventory, prepaid expenses and other assets
          458       (829 )     9             (362 )
 
Increase (decrease) in accounts payable and other accrued liabilities
          (703 )     1,462       66             825  
 
Increase (decrease) in accrued payroll and related liabilities
          (518 )     280                   (238 )
 
Increase (decrease) in accrued interest
          (295 )     25                   (270 )
 
Decrease in prepaid income taxes
          2,782                         2,782  
 
Increase in income taxes payable
          1,901                         1,901  
 
Increase in deferred income taxes asset
          (946 )                       (946 )
 
Increase in deferred income taxes liability
          4,498                         4,498  
 
Increase in intercompany payable/(receivable)
    (2,423 )     38,035       (31,373 )     (4,239 )            
 
   
     
     
     
     
     
 
   
Net cash provided by (used in) operating activities
    (85 )     32,634       (432 )     (303 )           31,814  
 
   
     
     
     
     
     
 

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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, 2002
(Unaudited)
(In thousands)

                                                       
                                  Non-                
                          Guarantor   Guarantor                
          VCA   Vicar   Subsidiaries   Subsidiaries   Elimination   Consolidated
         
 
 
 
 
 
Cash flows from investing activities:
                                               
   
Business acquisitions, net of cash acquired
  $     $ (9,997 )   $     $     $     $ (9,997 )
   
Property and equipment additions, net
          (4,774 )     (1,430 )                 (6,204 )
   
Other
    68             61                   129  
 
   
     
     
     
     
     
 
     
Net cash provided by (used in) investing activities
    68       (14,771 )     (1,369 )                 (16,072 )
 
   
     
     
     
     
     
 
Cash flows from financing activities:
                                               
   
Repayment of long-term obligations
          (2,485 )                       (2,485 )
 
Payment of deferred financing and recapitalization costs
          (2,673 )                       (2,673 )
   
Proceeds from issuance of common stock under stock option plans
    17                               17  
 
   
     
     
     
     
     
 
     
Net cash provided by (used in) financing activities
    17       (5,158 )                       (5,141 )
 
   
     
     
     
     
     
 
Increase (decrease) in cash and cash equivalents
          12,705       (1,801 )     (303 )           10,601  
Cash and cash equivalents at beginning of period
          3,467       3,260       376             7,103  
 
   
     
     
     
     
     
 
Cash and cash equivalents at end of period
  $     $ 16,172     $ 1,459     $ 73     $     $ 17,704  
 
   
     
     
     
     
     
 

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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 1 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 of 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 11, 2003, and we undertake no duty to update this information. Shareholders and prospective investors can find information filed with the Securities and Exchange Commission after August 11, 2003 at our website at www.vcaantech.com or at the Securities and Exchange Commission’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 free-standing, 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 routine vaccinations, health examinations, diagnostic testing, spaying, neutering and dental care.

          Our company was formed in 1986 by Robert Antin, Arthur Antin and Neil Tauber, who have served since our inception as our Chief Executive Officer, Chief Operating Officer and Senior Vice President of Development, respectively. During the 1990s, we established a premier position in the veterinary diagnostic laboratory and animal hospital markets through both internal growth and acquisitions. By 1997, we achieved a critical mass, building a laboratory network of 12 laboratories servicing animal hospitals in most states and completing acquisitions for a total of 160 animal hospitals. At June 30, 2003, our laboratory network consisted of 23 laboratories serving all 50 states and our animal hospital network consisted of 238 animal hospitals in 34 states. We primarily focus on generating internal growth to increase revenue and profitability. In order to augment internal growth, we may selectively acquire laboratories and intend to acquire approximately 15 to 25 animal hospitals per year, depending upon the attractiveness of candidates and the strategic fit with our existing operations.

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          The following table summarizes our growth in facilities for the periods presented:

                                   
      Three Months               Six Months
      Ended June 30,               Ended June 30,
     
             
      2003   2002   2003   2002
     
 
 
 
Laboratories:
                               
 
Beginning of period
    20       16       19       16  
 
Acquisitions and new facilities
    5       2       6       2  
 
Relocated into other labs operated by us
    (2 )           (2 )      
 
   
     
     
     
 
 
End of period
    23       18       23       18  
 
   
     
     
     
 
Animal hospitals:
                               
 
Beginning of period
    233       216       229       214  
 
Acquisitions
    11       8       16       11  
 
Relocated into other hospitals operated by us
    (5 )     (4 )     (5 )     (5 )
 
Sold or closed
    (1 )           (2 )      
 
   
     
     
     
 
 
End of period
    238       220       238       220  
 
   
     
     
     
 
Owned at end of period
    174       163       174       163  
Managed at end of period
    64       57       64       57  

Basis of Reporting

     General

          Our discussion and analysis of our financial condition and results of operations are based upon our condensed, consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States, 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. On an on-going basis, we evaluate our estimates. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or 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 discounts.

     Laboratory Revenue

          A portion of laboratory revenue is intercompany revenue that was generated by providing laboratory services to our animal hospitals. Laboratory internal revenue growth for the three and six months ended June 30, 2003 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 to exclude the impact resulting from differences in the number of billing days in comparable periods.

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          Laboratory revenue is presented net of discounts. Some discounts, such as those given to clients for prompt payment, are applied to clients’ accounts in periods subsequent to the period the revenue was recognized. These discounts are estimated and deducted from revenue in the period the related revenue was recognized. These estimates are based upon historical experience. Errors in estimates would not have a material effect on our financial statements.

     Animal Hospital Revenue

          Animal hospital revenue is comprised of revenue of the animal hospitals that we own and the management fees for animal hospitals that we manage. 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 group pays us a management fee. We do not consolidate the operations of animal hospitals that we manage.

          However, we believe that investors’ understanding of the performance of our animal hospitals is enhanced by disclosing combined animal hospital revenue and animal hospital adjusted same-facility revenue, both of which include the revenue of the animal hospitals that we manage and exclude the management fees charged to those same animal hospitals. Management uses these non-GAAP financial measures to aid in its understanding of how all animal hospitals owned and managed are performing as a group.

          There are material limitations associated with the use of these non-GAAP financial measures, as they are not reflective of the consolidated results for animal hospitals owned and managed as reported in our consolidated financials statements. To compensate for these limitations, we ensure that our disclosures provide a complete understanding of all adjustments found in non-GAAP financial measures, and we provide a reconciliation between the GAAP financial measures and the non-GAAP financial measures in “Results of Operations.”

          Same-facility revenue growth based on GAAP and adjusted same-facility revenue growth include revenue generated by customers referred from our relocated or combined animal hospitals, including those combined upon acquisition.

     Other Revenue

          We recorded consulting fees from Heinz Pet Products relating to the marketing of its proprietary pet food. As of September 2002, the consulting agreement with Heinz Pet Products had expired.

     Direct Costs

          Laboratory direct costs are comprised of all costs of laboratory services, including salaries of veterinarians, specialists, technicians and other non-administrative, laboratory-based personnel, facilities rent, occupancy costs and supply costs. Animal hospital direct costs are comprised of all costs of services and products at the hospitals, including salaries of veterinarians, technicians and all other hospital-based personnel employed by the hospitals we own, facilities rent, occupancy costs, supply costs, certain marketing and promotional expense and costs of goods sold associated with the retail sales of pet food and pet supplies. Direct costs do not include salaries of veterinarians, technicians and certain other hospital-based personnel employed by the hospitals we manage. As a result, our direct costs are lower as a percentage of revenue than if we had consolidated the operating results of the animal hospitals we manage into our operating results.

          However, we believe that the investors’ understanding of our performance is enhanced by disclosing the combined direct costs of animal hospitals owned and manged for the entire periods presented. Management uses this non-GAAP financial measure to aid in its understanding of how all animal hospitals owned and managed are performing as a group.

          There are material limitations associated with the use of this non-GAAP financial measure, as it is not reflective of the consolidated results for animal hospitals owned and managed as reported in our consolidated financial statements. To compensate for this limitation, we ensure that our disclosures provide a complete

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understanding of all adjustments found in non-GAAP financial measures, and we provide a reconciliation between the GAAP financial measures and the non-GAAP financial measures in “Results of Operations.”

     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 sales and administrative and accounting personnel and selling, marketing and promotional expense. Animal hospital selling, general and administrative expense consists primarily of field management, certain administrative and accounting personnel, recruiting and certain marketing expense. Corporate selling, general and administrative expense consists of administrative expense at our headquarters, including the salaries of corporate officers, rent, accounting, finance, legal and other professional expense and occupancy costs.

     Software Development Costs

          We frequently research, 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, particularly in the preliminary planning stages and the post-implementation and training stages. Costs related directly to the software design, coding, testing and installation are capitalized and amortized over the expected life of the software, generally three to five 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

          Management is required to make critical accounting estimates that directly impact our consolidated financial statements and related disclosures. Critical accounting 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 our results of our operations. Management bases its assumptions and estimates on historical experience and on various other factors believed to be reasonable under the circumstances. The following represent what management believes are the critical accounting policies most affected by significant management estimates and judgments. Management has discussed these critical accounting policies, the basis for their underlying assumptions and estimates and the nature of our related disclosures herein with our audit committee.

     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. Our workers’ compensation insurance policies are self-insurance retention programs, which mean that we bear the significant portion of the financial risk associated with claims losses, while the insurance company bears only the financial risk of large individual losses and large aggregate losses.

          As a result of utilizing self-insurance retention policies, we must 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 must be 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. The risk control environment includes proper safety training, safe working environment, availability of safety equipment for specific tasks, and management

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emphasis and monitoring of safe practices. Claims handling includes proper reporting of claims, proper care given to injured employees, availability of return-to-work programs, and oversight of the claims process by both the insurance claims handler and our own management. 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 carrier required us to pre-fund claims losses at a loss pick of 1.54% for the policy year ending September 30, 2002 and gave us a maximum loss pick of 2.49%, above which the carrier is responsible for paying all claims. For the policy year ending September 30, 2003, we are required to pre-fund claims losses at a loss pick of 1.59% and have a maximum loss pick of 2.55%. The ranges set forth by the insurance carrier reflect the most probable potentials 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 chose a loss pick of 2.04% for the policy year ended September 30, 2002 and 2.00% for the policy year ending September 30, 2003. The decrease in our loss pick reflects the implementation of programs to reduce the risks in our operating environment and the improving trends in our historical claims losses.

          The following table reflects the ranges for the loss picks and the loss picks used by us in the estimate of our workers’ compensation costs (in thousands):

                                   
                      Probable Expense Range
      Estimated   Expense  
      Payroll   Recorded   Low-end   High-end
     
 
 
 
Policy year ended September 30, 2002:
                               
Loss pick percentage
            2.04 %     1.54 %     2.49 %
 
           
     
     
 
Calculated loss pick in dollars
  $ 169,022     $ 3,441     $ 2,603     $ 4,208  
Premiums and other fees
            1,387       1,353       1,419  
 
           
     
     
 
 
Total workers’ compensation expense
          $ 4,828     $ 3,956     $ 5,627  
 
           
     
     
 
Policy year ending September 30, 2003 (9 months of a 12-month policy):
                               
Loss pick percentage
            2.00 %     1.59 %     2.55 %
 
           
     
     
 
Calculated loss pick in dollars
  $ 135,972     $ 2,719     $ 2,162     $ 3,467  
Premiums and other fees
            1,190       1,166       1,220  
 
           
     
     
 
 
Total workers’ compensation expense
          $ 3,909     $ 3,328     $ 4,687  
 
           
     
     
 

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

          The insurance policies in place for 2000 and prior years did not have large deductibles and we have accrued for the maximum possible expense under these policies.

     Impairment of Goodwill

          Our goodwill represents the purchase price paid and liabilities assumed for animal hospital and laboratory acquisitions in excess of the fair market value of the net tangible assets acquired. The total amount of our net goodwill at June 30, 2003 was $363.2 million, consisting of $93.6 million for our laboratory operating segment and $269.6 million for our animal hospital operating segment.

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          We estimate annually the fair market value of our laboratory and animal hospital operating segments and compare that estimated fair market value against the net book value of those operating segments, as reflected in our financial statements, to determine if our goodwill is fairly stated or if its value is impaired. At December 31, 2002, we estimated the fair value of each of our operating segments and determined that the estimated fair value of each exceeded their respective net book value, resulting in a conclusion that our goodwill was fairly stated. For the period from December 31, 2002 through the date of this filing, there have been no significant changes in the operating environment of our operating segments or in the other variables used in our estimate of fair value that would cause us to believe that the fair value of our operating segments might have materially changed since our evaluation at December 31, 2002. We will review our goodwill for impairment again at December 31, 2003 or upon material changes in our operating environment. We do not anticipate that there will be significant changes in our operations or operating environments in the near future other than those related to possible acquisitions.

     Legal Settlements

          We are a party to various legal proceedings. Although we cannot determine the ultimate disposition of these proceedings, we can use judgment to reasonably estimate our liability for legal settlement costs that may arise as a result of these proceedings. Based on our prior experience, the nature of the current proceedings and our insurance policy coverage for such matters, we have accrued $1.9 million as of June 30, 2003 for legal settlements as part of other accrued liabilities. We believe that our present insurance coverage and reserves are sufficient to cover currently known claims, but we cannot assure you that we will not incur liabilities in excess of recorded reserves.

     Allowance for Uncollectible Accounts

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

     Income Taxes

          We make estimates in recording our provision for income taxes, including our determination of deferred income taxes assets, deferred income taxes liabilities and any valuation allowance against a deferred income taxes asset.

          We operate in multiple states with varying tax laws. Our Federal income tax returns have been examined by the Internal Revenue Service through our fiscal year 1998, which resulted in no adjustment to our financial statements.

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Results of Operations

          The following table sets forth components of our statements of operations data expressed as a percentage of revenue for the indicated periods:

                                     
        Three Months Ended   Six Months Ended
        June 30,   June 30,
       
 
        2003   2002   2003   2002
       
 
 
 
Revenue:
                               
 
Laboratory
    35.3 %     34.6 %     35.6 %     35.3 %
 
Animal hospital
    66.8       67.1       66.5       66.4  
 
Other
          0.4             0.4  
 
Intercompany
    (2.1 )     (2.1 )     (2.1 )     (2.1 )
 
 
   
     
     
     
 
   
Total revenue
    100.0       100.0       100.0       100.0  
Direct costs (excluding operating depreciation)
    65.4       65.7       66.9       67.4  
Selling, general and administrative
    6.9       7.3       7.4       7.7  
Depreciation and amortization
    2.6       2.7       2.9       2.9  
 
 
   
     
     
     
 
   
Operating income
    25.1       24.3       22.8       22.0  
Interest expense, net
    4.9       8.8       5.4       9.2  
Debt retirement costs
                3.0        
Other (income) expense
    0.1       (0.1 )     0.1       (0.1 )
Minority interest in income of subsidiaries
    0.3       0.4       0.3       0.4  
Provision for income taxes
    8.2       6.2       5.7       5.2  
 
 
   
     
     
     
 
   
Net income
    11.6 %     9.0 %     8.3 %     7.3 %
 
 
   
     
     
     
 

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

                                             
                                Inter-        
                Animal           company        
        Laboratory   Hospital   Corporate   Eliminations   Total
       
 
 
 
 
Three Months Ended June 30, 2003
                                       
 
Revenue
  $ 46,691     $ 88,424     $     $ (2,752 )   $ 132,363  
 
Direct costs (excluding operating depreciation)
    24,816       64,440             (2,752 )     86,504  
 
Selling, general and administrative
    2,797       2,519       3,774             9,090  
 
Loss (gain) on sale of assets
    21       58       (1 )           78  
 
Depreciation and amortization
    799       2,304       394             3,497  
 
   
     
     
     
     
 
   
Operating income (loss)
  $ 18,258     $ 19,103     $ (4,167 )   $     $ 33,194  
 
   
     
     
     
     
 
   
Operating margin
    39.1 %     21.6 %     (3.1 )%           25.1 %
 
   
     
     
     
     
 
Three Months Ended June 30, 2002
                                       
 
Revenue
  $ 40,604     $ 78,621     $ 500     $ (2,500 )   $ 117,225  
 
Direct costs (excluding operating depreciation)
    22,134       57,370             (2,500 )     77,004  
 
Selling, general and administrative
    2,396       2,478       3,665             8,539  
 
Depreciation and amortization
    726       2,069       344             3,139  
 
   
     
     
     
     
 
   
Operating income (loss)
  $ 15,348     $ 16,704     $ (3,509 )   $     $ 28,543  
 
   
     
     
     
     
 
   
Operating margin
    37.8 %     21.2 %     (3.0 )%           24.3 %
 
   
     
     
     
     
 
Six Months Ended June 30, 2003
                                       
 
Revenue
  $ 88,389     $ 165,152     $     $ (5,178 )   $ 248,363  
 
Direct costs (excluding operating depreciation)
    48,272       123,161             (5,178 )     166,255  
 
Selling, general and administrative
    5,504       5,022       7,927             18,453  
 
Loss (gain) on sale of assets
    19       (178 )     (1 )           (160 )
 
Depreciation and amortization
    1,553       4,781       740             7,074  
 
   
     
     
     
     
 
   
Operating income (loss)
  $ 33,041     $ 32,366     $ (8,666 )   $     $ 56,741  
 
   
     
     
     
     
 
   
Operating margin
    37.4 %     19.6 %     (3.5 )%           22.8 %
 
   
     
     
     
     
 
Six Months Ended June 30, 2002
                                       
 
Revenue
  $ 78,261     $ 147,265     $ 1,000     $ (4,606 )   $ 221,920  
 
Direct costs (excluding operating depreciation)
    43,696       110,502             (4,606 )     149,592  
 
Selling, general and administrative
    5,069       4,992       7,100             17,161  
 
Depreciation and amortization
    1,423       4,205       674             6,302  
 
   
     
     
     
     
 
   
Operating income (loss)
  $ 28,073     $ 27,566     $ (6,774 )   $     $ 48,865  
 
   
     
     
     
     
 
   
Operating margin
    35.9 %     18.7 %     (3.1 )%           22.0 %
 
   
     
     
     
     
 

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     Revenue

          The following table summarizes our revenue (in thousands):

                                                   
      Three Months Ended June 30,   Six Months Ended June 30,
     
 
      2003   2002   % Change   2003   2002   % Change
     
 
 
 
 
 
Laboratory
  $ 46,691     $ 40,604       15.0 %   $ 88,389     $ 78,261       12.9 %
Animal hospital
    88,424       78,621       12.5 %     165,152       147,265       12.1 %
Other
          500                     1,000          
Intercompany
    (2,752 )     (2,500 )             (5,178 )     (4,606 )        
 
   
     
             
     
         
 
Total revenue
  $ 132,363     $ 117,225       12.9 %   $ 248,363     $ 221,920       11.9 %
 
   
     
             
     
         

     Laboratory Revenue

          Laboratory revenue increased $6.1 million for the three months ended June 30, 2003 and increased $10.1 million for the six months ended June 30, 2003 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:
  2003   2002   % Change   2003   2002   % Change
     
 
 
 
 
 
Internal growth:
                                               
 
Number of requisitions
    2,169       2,064       5.1 %     4,005       3,840       4.3 %
 
Average revenue per requisition (1)
  $ 21.02     $ 19.67       6.9 %   $ 21.73     $ 20.25       7.3 %
 
   
     
             
     
         
Total internal revenue (2)
  $ 45,583     $ 40,604       12.3 %   $ 87,031     $ 77,753       11.9 %
Billing day adjustment
                              508          
Acquired revenue
    1,108                     1,358                
 
   
     
             
     
         
 
Total
  $ 46,691     $ 40,604       15.0 %   $ 88,389     $ 78,261       12.9 %
 
   
     
             
     
         

     (1)  Computed by dividing total internal revenue by the number of requisitions.
     (2)  Numbers may not calculate exactly due to rounding.

          Laboratory revenue and requisitions generated from internal growth, as referred to in the above table, have been adjusted to exclude revenue and requisitions for newly acquired laboratories (those laboratories that we did not own for the entire periods presented) and have been adjusted for differences in the number of billing days in comparable periods.

          The increase in requisitions from internal growth during the three and six months ended June 30, 2003 is the result of a trend in veterinary medicine to focus on the importance of laboratory diagnostic testing in the diagnosis and treatment of diseases. In addition, our marketing programs include comprehensive education to our veterinarian clients, which have contributed to the growth in our revenue in both volume and breadth of tests performed.

          The increase in the average revenue per requisition during the three and six months ended June 30, 2003 is attributable to our sales and marketing efforts of our pet health and wellness programs, which have contributed to an increase in the number of tests performed per requisition, as well as a change in the mix of tests to more comprehensive and expensive tests. Also contributing to our increase in average revenue per requisition are price increases. The prices of most tests were increased 4% to 5% in February 2003.

          As the result of acquiring seven laboratories between November 2002 and June 2003, we generated an additional $1.1 million of revenue (referred to in the above table as “acquired revenue”) during the three months ended June 30, 2003 and $1.4 million of revenue during the six months ended June 30, 2003 compared to the same periods in the prior year.

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          The billing day adjustment, referred to in the above table, reflects the impact of one more billing day for the six months ended June 30, 2002 compared to the current period.

     Animal Hospital Revenue

          The following table reconciles our animal hospital revenue, as reported under GAAP, to the combined revenue of animal hospitals that we owned and managed, referred to as combined animal hospital revenue, as if we had consolidated the operating results of the animal hospitals we managed into our operating results (in thousands):

                                                   
      Three Months Ended June 30,   Six Months Ended June 30,
     
 
Animal Hospital Revenue:
  2003   2002   % Change   2003   2002   % Change
     
 
 
 
 
 
As reported
  $ 88,424     $ 78,621       12.5 %   $ 165,152     $ 147,265       12.1 %
Less: Management fees (1)
    (13,656 )     (12,488 )             (24,600 )     (22,193 )        
Add: Revenue of animal hospitals managed
    24,054       21,940               44,577       40,255          
 
   
     
             
     
         
 
Combined animal hospital (2)
  $ 98,822     $ 88,073       12.2 %   $ 185,129     $ 165,327       12.0 %
 
   
     
             
     
         

     (1)  Paid to us by veterinary medical groups.
     (2)  Represents the combined animal hospital revenue of hospitals owned and managed.

          The combined animal hospital revenue increased $10.7 million for the three months ended June 30, 2003 and increased $19.8 million for the six months ended June 30, 2003 compared to the same periods in the prior year. The components of the increase are summarized in the following table (in thousands, except average price per order):

                                                   
      Three Months Ended June 30,   Six Months Ended June 30,
     
 
Animal Hospital Revenue:
  2003   2002   % Change   2003   2002   % Change
     
 
 
 
 
 
Adjusted same-facility:
                                               
 
Orders (1)
    842       854       (1.4 )%     1,584       1,613       (1.8 )%
 
Average price per order (2)
  $ 106.26     $ 101.78       4.4 %   $ 106.10     $ 101.10       4.9 %
 
   
     
             
     
         
Adjusted same-facility revenue (1) (3)
  $ 89,467     $ 86,924       2.9 %   $ 168,055     $ 163,072       3.1 %
Net acquired revenue (1)
    9,355       1,149               17,074       2,255          
 
   
     
             
     
         
 
Combined animal hospital (4)
  $ 98,822     $ 88,073             $ 185,129     $ 165,327          
 
   
     
             
     
         

  (1)   Adjusted same-facility revenue, orders and net acquired revenue are non-GAAP measures of combined animal hospitals owned and managed. These non-GAAP measures are reconciled to the GAAP measures in tables below.
  (2)   Computed by dividing adjusted same-facility revenue by adjusted same-facility orders.
  (3)   Numbers may not calculate exactly due to rounding.
  (4)   Represents the combined animal hospital revenue of hospitals owned and managed.

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          Our animal hospital segment has placed a greater emphasis on providing high-quality veterinary care and comprehensive wellness programs, which has contributed to the increase in the average price per order and the increase in adjusted same-facility revenue for the three and six months ended June 30, 2003. The decrease in the number of orders for the current quarter is partly related to a decrease in the number of orders for sales of vaccines. Additionally, sales of flea and other over-the-counter products have decreased as a result of changes in the channels of distribution for these products.

          Net acquired revenue for the three months ended June 30, 2003 and 2002 represents revenue from hospitals acquired, sold or closed on or subsequent to April 1, 2002. Net acquired revenue for the six months ended June 30, 2003 and 2002 represents revenue from hospitals acquired, sold or closed on or subsequent to January 1, 2002.

     Reconciliation Between Non-GAAP and GAAP Measures

          In the above tables, we use non-GAAP measures to reflect the combined performance of animal hospitals owned and managed. The tables below reconcile those non-GAAP measures to their comparable GAAP measures (in thousands):

                                                   
      Three Months Ended June 30,   Six Months Ended June 30,
     
 
                      %                   %
Animal Hospital Revenue:   2003   2002   Change   2003   2002   Change
     
 
 
 
 
 
Adjusted same-facility revenue (1)
  $ 89,467     $ 86,924       2.9 %   $ 168,055     $ 163,072       3.1 %
Same-facility revenue of animal hospitals managed
    (21,482 )     (21,592 )             (39,743 )     (39,610 )        
 
   
     
             
     
         
Same-facility revenue of animal hospitals owned
    67,985       65,332               128,312       123,462          
Same-facility management fees (2)
    12,210       12,292               21,898       21,821          
 
   
     
             
     
         
 
Same-facility revenue
  $ 80,195     $ 77,624       3.3 %   $ 150,210     $ 145,283       3.4 %
 
   
     
             
     
         

     (1)  Adjusted same-facility revenue is a non-GAAP measure of combined animal hospitals owned and managed.

     (2)  Paid to us by veterinary medical groups.

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          The following table reconciles the non-GAAP measure of orders for combined animal hospitals owned and managed to the GAAP measure of orders for animal hospitals owned (in thousands, except average price per order):

                           
      Three Months Ended June 30,
     
      2003   2002   % Change
     
 
 
Same-facility:
                       
 
Orders for combined animal hospitals owned and managed
    842       854          
 
Orders for animal hospitals managed
    (207 )     (217 )        
 
   
     
         
 
Orders for animal hospitals owned
    635       637       (0.3 )%
 
Average price per order for animal hospitals owned (1)
  $ 107.06     $ 102.56       4.4 %
 
   
     
         
Same-facility revenue for animal hospitals owned (2)
  $ 67,985     $ 65,332       4.1 %
Same-facility management fees
    12,210       12,292          
Acquired revenue and management fees from acquired managed practices
    8,229       997          
 
   
     
         
 
Animal hospital revenue as reported
  $ 88,424     $ 78,621          
 
   
     
         
                           
      Six Months Ended June 30,
     
      2003   2002   % Change
     
 
 
Same-facility:
                       
 
Orders for combined animal hospitals owned and managed
    1,584       1,613          
 
Orders for animal hospitals managed
    (386 )     (404 )        
 
   
     
         
 
Orders for animal hospitals owned
    1,198       1,209       (0.9 )%
 
Average price per order for animal hospitals owned (1)
  $ 107.11     $ 102.12       4.9 %
 
   
     
         
Same-facility revenue for animal hospitals owned (2)
  $ 128,312     $ 123,462       3.9 %
Same-facility management fees
    21,898       21,821          
Acquired revenue and management fees from acquired managed practices
    14,942       1,982          
 
   
     
         
 
Animal hospital revenue as reported
  $ 165,152     $ 147,265          
 
   
     
         

  (1)   Computed by dividing same-facility revenue for animal hospitals owned by same-facility orders for animal hospitals owned.
  (2)   Numbers may not calculate exactly due to rounding.

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     The following table reconciles the non-GAAP measure of acquired revenue for combined animal hospitals owned and managed to the GAAP measure of acquired revenue (in thousands):

                                   
      Three Months Ended   Six Months Ended
      June 30,   June 30,
     
 
      2003   2002   2003   2002
     
 
 
 
Acquired revenue for combined animal hospitals owned and managed
  $ 9,355     $ 1,149     $ 17,074     $ 2,255  
Less: acquired revenue for animal hospitals managed
    (2,571 )     (349 )     (4,833 )     (646 )
 
   
     
     
     
 
 
Acquired revenue for animal hospitals owned
  $ 6,784     $ 800     $ 12,241     $ 1,609  
 
   
     
     
     
 

     Other Revenue

          Other revenue consists of fees earned from a marketing consulting agreement with Heinz Pet Products, which paid a monthly fee of approximately $167,000 commencing October 1, 2000 through September 30, 2002. For the three and six months ended June 30, 2002, we recognized revenue of $500,000 and $1.0 million, respectively, related to this agreement. There were no consulting agreements effective in 2003.

     Direct Costs

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

                                                                                   
      Three Months Ended June 30,   Six Months Ended June 30,
     
 
      2003   2002           2003   2002        
     
 
         
 
       
              % of           % of   %           % of           % of   %
      $   Revenue   $   Revenue   Change   $   Revenue   $   Revenue   Change
     
 
 
 
 
 
 
 
 
 
Laboratory
  $ 24,816       53.1 %   $ 22,134       54.5 %     12.1 %   $ 48,272       54.6 %   $ 43,696       55.8 %     10.5 %
Animal hospital
    64,440       72.9 %     57,370       73.0 %     12.3 %     123,161       74.6 %     110,502       75.0 %     11.5 %
Intercompany
    (2,752 )             (2,500 )                     (5,178 )             (4,606 )                
 
   
             
                     
             
                 
 
Total direct costs
  $ 86,504       65.4 %   $ 77,004       65.7 %     12.3 %   $ 166,255       66.9 %   $ 149,592       67.4 %     11.1 %
 
   
             
                     
             
                 

     Laboratory Direct Costs

          The decrease in laboratory direct costs as a percentage of laboratory revenue was primarily attributable to an increase 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.

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     Animal Hospital Direct Costs

          The following table summarizes our animal hospital direct costs as reported and the combined direct costs of animal hospitals that we owned and managed, referred to as combined animal hospital direct costs, had we consolidated the operating results of the animal hospitals we manage into our operating results (in thousands):

                                           
      Three Months Ended June 30,
     
      2003   2002        
     
 
       
              % of           % of        
Animal Hospital Direct Costs:   $   Revenue   $   Revenue   % Change
     
 
 
 
 
As reported
  $ 64,440       72.9 %   $ 57,370       73.0 %     12.3 %
Add: Direct costs of animal hospitals managed
    24,054               21,940                  
Less: Management fees (1)
    (13,656 )             (12,488 )                
 
   
             
                 
 
Combined animal hospital (2)
  $ 74,838       75.7 %   $ 66,822       75.9 %     12.0 %
 
   
             
                 
                                           
      Six Months Ended June 30,
     
      2003   2002        
     
 
       
              % of           % of        
Animal Hospital Direct Costs:   $   Revenue   $   Revenue   % Change
     
 
 
 
 
As reported
  $ 123,161       74.6 %   $ 110,502       75.0 %     11.5 %
Add: Direct costs of animal hospitals managed
    44,577               40,255                  
Less: Management fees (1)
    (24,600 )             (22,193 )                
 
   
             
                 
 
Combined animal hospital (2)
  $ 143,138       77.3 %   $ 128,564       77.8 %     11.3 %
 
   
             
                 

  (1)   Charged by us to veterinary medical groups.
  (2)   Represents the combined animal hospital direct costs of hospitals owned and managed.

          The decrease in combined animal hospital direct costs as a percentage of applicable revenue was attributable to the increase in the combined animal hospital revenue combined with the operating leverage associated with the animal hospital business, as most of the costs associated with this business do not increase proportionately with increases in the volume of services rendered.

     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,
     
 
      2003   2002           2003   2002        
     
 
         
 
       
              % of           % of   %           % of           % of   %
      $   Revenue   $   Revenue   Change   $   Revenue   $   Revenue   Change
     
 
 
 
 
 
 
 
 
 
Laboratory
  $ 2,797       6.0 %   $ 2,396       5.9 %     16.7 %   $ 5,504       6.2 %   $ 5,069       6.5 %     8.6 %
Animal hospital
    2,519       2.8 %     2,478       3.2 %     1.7 %     5,022       3.0 %     4,992       3.4 %     0.6 %
Corporate
    3,774       2.9 %     3,665       3.1 %     3.0 %     7,927       3.2 %     7,100       3.2 %     11.6 %
 
   
             
                     
             
                 
 
Total SG&A
  $ 9,090       6.9 %   $ 8,539       7.3 %     6.5 %   $ 18,453       7.4 %   $ 17,161       7.7 %     7.5 %
 
   
             
                     
             
                 

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     Laboratory SG&A

          The increase in laboratory SG&A as a percentage of laboratory revenue during the three months ended June 30, 2003 as compared to the same period in the prior year was primarily attributable to additional information technology personnel and commission payments to sales representatives. The decrease in laboratory SG&A as a percentage of laboratory revenue during the six months ended June 30, 2003 as compared to the same periods in the prior year was primarily attributable to a decrease in legal costs offset by the same factors attributable to the increase during the three months ended June 30, 2003.

     Animal Hospital SG&A

          The decrease in animal hospital SG&A as a percentage of animal hospital revenue during the three and six months ended June 30, 2003 as compared to the same periods in the prior year was primarily attributable to an increase in animal hospital revenue combined with operating leverage associated with our animal hospital business.

     Corporate SG&A

          The decrease in corporate SG&A as a percentage of total revenue for the three months ended June 30, 2003 as compared to the same period in the prior year was primarily due to a decrease in accounting fees. Corporate SG&A for the three months ended June 30, 2002 included additional accounting fees incurred in connection with changing our external auditors from Arthur Andersen LLP to KPMG LLP. For the six months ended June 30, 2003 and 2002, corporate SG&A remained constant as a percentage of revenue but increased 11.6% for the six months ended June 30, 2003 compared to the same period in the prior year. This increase was primarily attributable to increased legal and insurance fees as well as increases in salaries and bonuses.

     Depreciation and Amortization

          Depreciation and amortization expense increased $358,000, or 11.4%, for the three months ended June 30, 2003 and increased $772,000, or 12.3%, for the six months ended June 30, 2003 compared to the same periods in the prior year. The increase in depreciation and amortization was due to the purchase of property and equipment and the addition of non-competition agreements executed in connection with the acquisition of animal hospitals and laboratories.

     Loss (Gain) on Sale of Assets

          During the three and six months ended June 30, 2003, we sold certain assets for a loss of $78,000 and a gain of $160,000, respectively. The sales transactions consisted of real estate, one animal hospital practice and other fixed assets.

     Interest Expense, Net

          Interest expense, net of interest income decreased $3.9 million, or 38.0%, for the three months ended June 30, 2003 and decreased $6.9 million, or 34.0%, for the six months ended June 30, 2003 compared to the same periods in the prior year. The change in net interest expense was attributable to a decrease in the average debt balances outstanding and a decrease in the weighted average interest rate.

     Debt Retirement Costs

          On February 4, 2003, we voluntarily retired the entire principal amount of our 15.5% senior notes with net proceeds from the sale of our common stock during our secondary offering. In conjunction with that transaction, we recorded debt retirement costs of $7.4 million. The debt retirement costs consisted of the write-off of deferred financing costs and debt discounts and the payment of related transaction and retirement fees.

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     Other (Income) Expense

          Other expense was $131,000 for the three months ended June 30, 2003 and $258,000 for the six months ended June 30, 2003, consisting of a non-cash loss on the interest rate swap agreements. Other income was $61,000 for the three months ended June 30, 2002 and $154,000 for the six months ended June 30, 2002, consisting of a non-cash gain on the interest rate collar agreement.

     Minority Interest in Income of Subsidiaries

          Minority interest in income of the consolidated subsidiaries was $462,000 and $528,000 for the three months ended June 30, 2003 and 2002, respectively, and $823,000 and $930,000 for the six months ended June 30, 2003 and 2002, respectively. Minority interest in income of subsidiaries represents our partners’ proportionate share of net income generated by those subsidiaries that we do not wholly own.

     Provision for Income Taxes

          Our effective income tax rate for each period can vary from the statutory rate primarily due to the non-deductibility for income tax purposes of certain items. During the three and six months ended June 30, 2003, our effective income tax rate varied from the statutory rate primarily due to the non-deductibility of the amortization of a portion of intangible assets.

Liquidity and Capital Resources

     Discussion of the Six Months Ended June 30, 2003

          Our cash and cash equivalents increased to $22.5 million at June 30, 2003 compared to $6.5 million at December 31, 2002. The increase resulted from $38.5 million provided by operating activities and $3.5 million provided by financing activities offset by $26.0 million used in investing activities.

          Net cash provided by operating activities increased to $38.5 million during the six months ended June 30, 2003 compared to $31.8 million during the six months ended June 30, 2002. This increase was primarily attributable to an increase in operating income and a $2.2 million decrease in interest paid, offset by a $3.2 million increase in income taxes paid.

          We used net cash of $26.0 million for investing activities during the six months ended June 30, 2003 in which we:

    paid $19.9 million related to the acquisition of 16 animal hospitals and six laboratories and the settlement of certain obligations incurred or agreed to on the date of acquisition;
 
    paid $589,000 for real estate acquired in connection with acquisitions;
 
    paid $6.2 million in property and equipment additions; and
 
    received $716,000 from the sale of assets and other activities.

          We received net cash of $3.5 million from financing activities during the six months ended June 30, 2003 in which we:

    received $54.3 million in net proceeds from the issuance of 3.8 million shares of our common stock;
 
    paid $41.8 million to voluntarily redeem the entire principal amount of our 15.5% senior notes at a redemption price of 110% of the principal amount;
 
    paid $1.2 million for scheduled maturities of debt obligations;

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    repaid $7.5 million, the entire outstanding balance, of our revolving credit facility; and
 
    paid $382,000 of financing costs.

     Future Cash Requirements

          We expect to fund our liquidity needs primarily from operating cash flows, cash on hand and, if needed, borrowings under our $50.0 million revolving credit facility. At June 30, 2003, we had no borrowings outstanding under our revolving credit facility. We believe these sources of funds will be sufficient to continue our operations and planned capital expenditures and to satisfy our scheduled principal and interest payments under debt obligations for at least the next 12 months. However, a significant portion of our cash requirements will be determined by the pace and size of our acquisitions.

          Estimated future uses of cash for the remainder of 2003 include capital expenditures for land, buildings and equipment of approximately $11.8 million. In addition, we intend to use available liquidity to continue our growth through the selective acquisition of animal hospitals, primarily for cash. Our acquisition program contemplates the acquisition of 15 to 25 animal hospitals per year and a planned cash commitment of up to $30.0 million. However, we may purchase either a fewer or greater number of animal hospital facilities and we may purchase laboratory facilities during any year depending upon opportunities that present themselves and our cash requirements may change accordingly. We anticipate purchasing up to 20 animal hospitals and seven laboratories with a planned cash commitment of $31.9 million during 2003. Although we intend to primarily use cash in our acquisitions, we may use debt or stock to the extent we deem it appropriate.

          In addition to the foregoing, we will use approximately $1.3 million of cash for the remainder of 2003 to pay the mandatory principal payments due on our outstanding indebtedness. Also, we plan to pre-pay approximately $20.0 million of our senior term C notes in the near future and we may elect to pre-pay additional debt obligations.

Description of Indebtedness

          Credit and Guaranty Agreement. On September 20, 2000, we entered into a credit and guaranty agreement, which included senior term notes and a $50.0 million revolving credit facility. At June 30, 2003, we had $166.4 million principal amount outstanding under our senior term C notes and no borrowings outstanding under our revolving credit facility.

          Borrowings under the credit and guaranty agreement 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%, 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.” 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 C notes is 2.00%. 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 C notes is 3.00%.

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

          The credit and guaranty agreement contains certain financial covenants pertaining to interest coverage, fixed charge coverage and leverage ratios. In addition, the credit and guaranty agreement has restrictions pertaining to capital expenditures, acquisitions and the payment of dividends on all classes of stock. We currently believe the most restrictive covenant is the fixed-charge coverage ratio. Our credit agreement defines the fixed charge coverage ratio as that ratio which is calculated on a last twelve-month basis by dividing pro forma EBITDA, 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, 2003, we had a fixed charge coverage ratio of 1.44 to 1.00. The credit and guaranty agreement requires a fixed-charge coverage ratio of no less than 1.10 to 1.00.

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          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, 2003, the outstanding principal balance of these senior subordinated notes was $170.0 million. We and each existing and future domestic wholly-owned subsidiary of Vicar have jointly and severally, fully and unconditionally guaranteed these notes. These guarantees are unsecured and subordinated in right of payment to all existing and future indebtedness outstanding under the credit and guaranty agreement and any other indebtedness permitted to be incurred by Vicar under the terms of the indenture agreement governing these notes.

          15.5% Senior Notes. On February 4, 2003, we used approximately $42.7 million of the net proceeds received from the sale of our common stock during our secondary offering to redeem the remaining principal amount outstanding of our 15.5% senior notes due 2010 at a redemption price of 110% of the principal amount, plus accrued and unpaid interest.

          Other Debt. We had seller notes secured by assets of animal hospitals, unsecured debt and capital leases that totaled $2.1 million at June 30, 2003.

          Contractual Obligations. There have been no significant changes to our contractual obligations or commitments from those disclosed in our most recently filed Form 10-K.

     Interest Rate Hedging Agreements

          We entered into the following no-fee swap agreements, which swap monthly variable LIBOR for the fixed rates indicated below:

                         
    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

          Swap # 2 and Swap #3 qualify for hedge accounting and we consider them to be cash flow hedging instruments. However, in May 2003 management determined that Swap #1 was no longer an effective tool to hedge against interest rate risk because LIBOR projections were considerably below the initial LIBOR forecasts used to price the swap at inception of the contract. As a result of this determination, Swap #1 no longer qualifies for hedge accounting and all changes in its market value are recognized as income or expense in the period of change.

          At June 30, 2003, the fair market values of our swap agreements resulted in a net liability to us of $674,000, which is included in other accrued liabilities. For the three and six months ended June 30, 2003, we made payments of $102,000 and $187,000, respectively, as a result of LIBOR being below the fixed interest rates. These payments are included 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 will be or their possible impact.

New Accounting Pronouncements

     Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity

          In May 2003, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 clarifies the accounting for certain financial instruments with characteristics of both liabilities and equity and requires that those instruments be classified as liabilities. SFAS No.

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150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We currently have a $2.3 million obligation to be settled in either cash or common stock that is classified as a liability; we do not have any immediate plans to enter into other financial instruments subject to the accounting requirements of SFAS No. 150. The adoption of SFAS No. 150 will not have a material impact on our financial statements.

     Accounting for Derivative Instruments and Hedging Activities

          In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 clarifies financial accounting and reporting requirements for derivative instruments and hedging activities as set forth under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships entered into after June 30, 2003. The adoption of SFAS No. 149 will not have a material impact on our financial statements.

     Consolidations of Variable Interest Entities

          In January 2003, the FASB issued FASB Interpretation, or FIN, No. 46, Consolidation of Variable Interest Entities, requiring that companies consolidate variable interest entities if they are the primary beneficiaries, as defined under FIN No. 46, of the activities of the variable interest entities. Companies are required to apply FIN No. 46 immediately for all variable interest entities created after January 31, 2003 and as of the beginning of the first interim period beginning after June 15, 2003 for all other variable interest entities.

          We provide management services to certain veterinary medical groups in states with laws that prohibit business corporations from providing, or holding themselves out as providers of, veterinary medical care. As of June 30, 2003, we operated in 11 of these states. In these states, we provide management services to veterinary medical groups pursuant to long-term management agreements ranging from 10 to 40 years with non-binding renewal options, where allowable. Pursuant to the management agreements, the veterinary medical groups are each solely responsible for all aspects of the practice of veterinary medicine, as defined by their respective state. We provide administrative and other support services.

          Currently, we do not consolidate the operations of the veterinary medical groups since we have no ownership interests in them. However, we are finalizing our analysis of FIN No. 46 and it is reasonably possible that the operations of the veterinary medical groups will be consolidated. If the veterinary medical groups were to be consolidated into our operating results, there would be no effect on operating income and we would not be exposed to additional losses. We would consolidate the revenue and direct costs of the veterinary medical groups but would not recognize the management fees charged to them. See our discussions regarding animal hospital revenue included herein in the Revenue section for full details regarding the veterinary medical groups.

     Guarantor’s Accounting and Disclosure Requirements for Guarantees

          In January 2003, the FASB issued FIN No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 requires a company to recognize a liability for the obligations it has undertaken in issuing a guarantee. This liability would be recorded at the inception of a guarantee and would be measured at fair value. The measurement provisions of this statement apply prospectively to guarantees issued or modified after December 31, 2002 for periods ending after December 15, 2002. We do not have any obligations subject to the provisions of FIN No. 45.

     Consideration Received from a Vendor

          In November 2002, FASB’s Emerging Issues Task Force, or EITF, reached a consensus regarding two issues raised by EITF Issue No. 02-16, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor. The EITF concluded that:

    cash received by a vendor is presumed to be a reduction of the cost of the vendor’s products or services, however that presumption is overcome when the consideration is either (a) a payment for

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      assets or services, or b) a reimbursement of specific and identifiable costs incurred on behalf of the vendor in selling the vendor’s products or services, in which case the consideration is a reduction of that cost; and
 
    rebates offered to a customer or reseller should be recognized or new agreements entered into on or after January 1, 2003. We have adopted EITF Issue No. 02-16 and we do not expect it to have a material impact on our financial statements in the future.

     Costs Associated with Exit or Disposal Activities

          In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 requires that liabilities associated with exit or disposal activities be recognized when a company is committed to future payment of those liabilities under a binding, legal obligation. SFAS No. 146 nullifies EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring), which required that exit and disposal costs be recognized as liabilities when a company formalized its plan for exiting or disposing of an activity even if no legal obligation had been established.

          SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. Currently, we have no plans to exit or dispose of any of our business activities that would require the use of SFAS No. 146 nor do we anticipate that SFAS No. 146 will change any of our business practices.

     Gains and Losses from Extinguishment of Debt and Capital Leases

          In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, to be applied in fiscal years beginning after May 15, 2002.

          Under SFAS No. 145, gains and losses from extinguishment of debt should be classified as extraordinary items only if they meet the criteria of APB No. 30. Under APB No. 30, events are considered extraordinary only if they possess a high degree of abnormality and are not likely to recur in the foreseeable future. Any gains or losses on extinguishment of debt that do not meet the criteria of APB No. 30 shall be classified as a component of income from recurring operations. In addition, any gains or losses on extinguishment of debt that were classified as an extraordinary item in prior periods presented that do not meet the criteria of APB No. 30 shall be reclassified as a component of income from recurring operations. We adopted SFAS No. 145 on January 1, 2003.

          In February 2003, we redeemed the entire principal amount of our 15.5% senior notes. This voluntary repayment resulted in the recognition of a loss on the early extinguishment of debt of $7.4 million. We do not believe the loss meets the criteria of APB No. 30 as we have historically and may continue to change our capital structure to take advantage of current market conditions. As a result of adopting SFAS No. 145, we recorded the debt retirement costs as a component of income from recurring operations.

          SFAS No. 145 also amends SFAS No. 13, Accounting for Leases. Under SFAS No. 145, if a capital lease is modified such that it becomes an operating lease, a gain or loss must be recognized similar to the accounting used for sale-leaseback transactions as provided in SFAS No. 28 and No. 98. At June 30, 2003, we had capital lease obligations of $454,000; however, we currently have no plans to modify these or any future capital leases, and we do not expect SFAS No. 145 to have a material impact on our financial statements.

     Asset Retirement Obligations

          In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. We adopted SFAS No. 143 on January 1, 2003 without material impact on our financial statements.

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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 Securities and Exchange Commission reports, including but not limited to the items discussed below.

    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 12.5% and 14.1% for each fiscal year from 2000 through 2002. Similarly, our animal hospital adjusted same-facility revenue growth rate has fluctuated between 3.6% and 7.0% over the same fiscal years. Our internal growth may continue to fluctuate and may be below our historical rates. Any reductions in the rate of our internal growth may cause our revenues and margins to decrease. Our historical growth rates and margins are not necessarily indicative of future results.

          Demand for certain over the counter products could decline as their product life cycle matures and the products become available in more retail-oriented locations. Certain of these products are replaced and are distributed through veterinary hospitals only. This cycle and the replacement of existing products could affect veterinary visits. 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 established by our veterinarians who use their independent professional judgment. Some of our veterinarians have changed their protocols and others may change their protocol in light of recent literature.

    Our business and results of operations may be adversely affected if we are unable to manage our growth effectively.

          Since January 1, 1996, we have experienced rapid growth and expansion. Our failure to manage our growth effectively may increase our costs of operations and hinder our ability to execute our business strategy. Our rapid growth has placed, and will continue to place, a significant strain on our management and operational systems and resources. At January 1, 1996, we operated 59 animal hospitals, operated laboratories servicing approximately 9,000 customers in 27 states and had approximately 1,150 full-time equivalent employees. At June 30, 2003, we operated 238 animal hospitals, operated laboratories servicing approximately 14,000 customers in all 50 states and had approximately 4,000 full-time equivalent employees. If our business continues to grow, we will need to improve and enhance our overall financial and managerial controls, reporting systems and procedures, and expand, train and manage our workforce in order to maintain control of expense and achieve desirable economies of scale. We also will need to increase the capacity of our current systems to meet additional demands.

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

          Approximately 57.2% of our expense, 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 15 to 25 animal hospitals per year, however, based on the opportunity, the number could be higher. Historically we have experienced delays and increased costs in integrating some hospitals primarily 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. These factors have resulted in decreased revenue, increased costs and 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, 2003, our balance sheet reflected $363.2 million of goodwill, which is a substantial portion of our total assets of $545.3 million at that date. We expect that the aggregate amount of goodwill on our balance sheet will increase as a result of future acquisitions. We continually evaluate whether events or circumstances have occurred that suggest that the fair market value of each of our reporting units is below their carrying values. If we determine that the fair market value of one of our reporting units is less than its carrying value, this may result in an impairment write-down of the goodwill for that reporting unit. The impairment write-down would be reflected as expense and could have a material adverse effect on our results of operations during the period in which we recognize the expense. In 2002, we concluded that the fair value of our reporting units exceeded their carrying value and accordingly, as of that date, our net goodwill was fairly stated in our financial statements and there are currently no impairment issues. However, in the future we may incur impairment charges related to the goodwill already recorded or arising out of future acquisitions.

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    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, 2003, our debt, excluding unamortized discount, consisted primarily of:

    $166.4 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
 
    $2.1 million in principal amount outstanding under our other debt.

          The following table sets forth the scheduled principal and interest payments that are due on our debt for each of the periods indicated (in thousands):

                                         
    Payments Due by Period
   
            Less than                   More than
    Total   1 year (1)   1 - 3 years   3 - 5 years   5 years
   
 
 
 
 
Long-term debt
  $ 338,042     $ 1,167     $ 4,235     $ 102,261     $ 230,379  
Fixed interest
    110,721       8,658       34,519       33,945       33,599  
Variable interest
    54,182       5,486       23,795       22,336       2,565  
Capital lease obligations
    454       172       281       1        
Swap agreements
    (2,763 )     (674 )     (2,089 )            
 
   
     
     
     
     
 
 
  $ 500,636     $ 14,809     $ 60,741     $ 158,543     $ 266,543  
 
   
     
     
     
     
 

     (1)  Consists of the period July 1 through December 31, 2003.

          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 3.0%. Including the fixed 3.0%, we estimate that the total interest rate on our variable-rate debt will be 6.6%, 7.0%, 7.5%, 8.0%, 8.5% and 8.5% for years 2003 through 2008, respectively. Our consolidated financial statements included in our 2002 Annual Report on Form 10-K discuss these variable-rate notes in more detail.

          We entered into the following no-fee swap agreements, which swap monthly variable LIBOR for the fixed rates indicated below:

                         
    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  

          Swap #2 and Swap #3 qualify for hedge accounting and we consider them to be cash flow hedging instruments. However, as of May 2003 we no longer considered Swap #1 to be a cash flow hedge because the current rate environment was significantly different than the rate environment in existence at the effective date.

          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

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sufficient cash flow from operations, our strategy to increase operating efficiencies may not be realized and future borrowings may not be available to us under our senior credit facility in an amount sufficient to enable us to service our debt or to fund our other liquidity needs. In order to meet our debt obligations, we may need to refinance all or a portion of our debt. We may not be able to refinance any of our debt on commercially reasonable terms or at all.

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

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

    limit our funds available to repay the 9.875% senior subordinated notes;
 
    limit our ability to borrow additional funds or to obtain other financing in the future for working capital, capital expenditures, acquisitions, investments and general corporate purposes;
 
    limit our ability to dispose of our assets, create liens on our assets or to extend credit;
 
    make us more vulnerable to economic downturns and reduce our flexibility in responding to changing business and economic conditions;
 
    limit our flexibility in planning for, or reacting to, changes in our business or industry;
 
    place us at a competitive disadvantage to our competitors with less debt; and
 
    restrict our ability to pay dividends, repurchase or redeem our capital stock or debt, or merge or consolidate with another entity.

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

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

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

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

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

          There are many clinical laboratory companies that provide a broad range of laboratory testing services in the same markets we service. Our largest competitor for outsourced laboratory testing services is Idexx Laboratories, Inc., which currently competes or intends to compete in most of the same markets in which we operate.

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Also, Idexx and several other national companies provide on-site diagnostic equipment that allows veterinarians to perform their own laboratory tests.

          Our primary competitors for our animal hospitals in most markets are individual practitioners or small, regional, multi-clinic practices. Also, regional pet care companies and some national companies, including operators of super-stores, are developing multi-regional networks of animal hospitals in markets in which we operate. Historically, when a competing animal hospital opens in close proximity to one of our hospitals, we have reduced prices, expanded our facility, retained additional qualified personnel, increased our marketing efforts or taken other actions designed to retain and expand our client base. As a result, our revenue may decline and our costs 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, 2003, 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 across the country, particularly in some regional markets in which we operate animal hospitals including Northern California. During these 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, 2003 we operated 64 animal hospitals in 11 states with these laws, including 21 in New York. We may experience difficulty in expanding our operations into other states with similar laws. Given varying and uncertain interpretations of the veterinary laws of each state, we may not be in compliance with restrictions on the corporate practice of veterinary medicine in all states. A determination that we are in violation of applicable restrictions on the practice of veterinary medicine in any state in which we operate could have a material adverse effect on us, particularly if we were unable to restructure our operations to comply with the requirements of that state.

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

    Any failure in our information technology systems or disruption in our transportation network 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

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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. In addition, our Test Express service, which services customers outside of major metropolitan areas, is dependent on flight services in and out of Memphis and the transportation network of Federal Express. Any sustained interruption in either flight services in Memphis or the transportation network of Federal Express would result in increased turn-around time for the reporting of test results to customers serviced by our Test Express service.

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

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

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

          Our executive officers, directors and principal stockholders beneficially own, in the aggregate, 25.4% of our outstanding common stock. As a result, these stockholders are able to significantly affect our management, our policies and all matters requiring stockholder approval. The directors supported by these stockholders will be able to significantly affect decisions relating to our capital structure, including decisions to issue additional capital stock, implement stock repurchase programs and incur indebtedness. This concentration of ownership may have the effect of deterring hostile takeovers, delaying or preventing changes in control or changes in management, or limiting the ability of our other stockholders to approve transactions that they may deem to be in their best interests.

    Political and military events and the uncertainty resulting from them may have a material adverse effect on our operating results.

          The United States military’s continuing involvement in Iraq, the terrorist attacks which took place in the United States on September 11, 2001, the United States military campaign against terrorism, ongoing violence in the Middle East and the increasing concern with respect to developments in North Korea have created many economic and political uncertainties, some of which may affect the markets in which we operate, our operations and profitability and your investment. The potential near-term and long-term effect that political uncertainty, armed conflict and possible terrorist and other attacks may have for our customers, the markets for our services and the U.S. economy are uncertain. The consequences of our involvement in Iraq and any terrorist attacks or other armed conflicts are unpredictable and we may not be able to foresee events that could have an adverse effect on our markets, our business or your investment.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

          As of June 30, 2003, we had borrowings of $166.4 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

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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 $166.4 million to $86.4 million. Accordingly, for the next 12-month period, for every 1.0% increase in the LIBOR rate we will pay an additional $864,000 in interest expense and for every 1.0% decrease in the LIBOR rate we will save $864,000 in interest expense.

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

ITEM 4. CONTROLS AND PROCEDURES

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

          In accordance with the requirements of the Securities and Exchange Commission, 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. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. 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

          As previously disclosed, the litigation between VCA, Zoasis Corporation and Robert Antin and two majority stockholders of a company that merged with Zoasis, was dismissed with prejudice on April 17, 2003 pursuant to the settlement agreement announced in our 2002 annual report on Form 10-K.

          We are a party to various legal proceedings that arise in the ordinary course of business. Although we cannot determine the ultimate disposition of these proceedings, we can use judgment to reasonably estimate our liability for legal settlement costs that may arise as a result of these proceedings. Based on our prior experience, the nature of the current proceedings and our insurance policy coverage for such matters, we have accrued $1.9 million as of June 30, 2003 for legal settlements as part of other accrued liabilities.

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ITEM 2. CHANGES IN SECURITIES

          None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

          None

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

          On May 28, 2003, we held our annual meeting of stockholders at which our stockholders:

    elected three Class I directors;
 
    approved an additional 1,500,000 shares of our common stock to be reserved for issuance under our 2001 Stock Incentive Plan; and
 
    ratified KPMG LLP as our independent auditor.

          The names of the three nominees elected to serve as our Class I directors and the results of the election are as follows:

                                 
Candidates   Yes Votes   No Votes   Abstain   Broker-Non-Vote

 
 
 
 
Arthur J. Antin
    27,077,087             5,549,014        
John M. Baumer
    31,859,432             766,669        
Frank Reddick
    26,872,732             5,753,369        

          The results of the other two matters upon which our stockholders voted are as follows:

                                 
Proposal   Yes Votes   No Votes   Abstain   Broker-Non-Vote

 
 
 
 
Reserve additional 1,500,000 shares of common stock for issuance under our 2001 Stock Incentive Plan
    19,761,751       12,845,080       19,270        
Ratify KPMG LLP as our independent auditor
    3,554,136       54,580       17,385        

ITEM 5. OTHER INFORMATION

          None

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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

          (a) Exhibits: