##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE
COMMISSION Washington, D.C. 20549
   FORM 10-Q þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended March 31, 2005o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 Commission File Number: 001-16783   VCA ANTECH, INC. (Exact name of registrant as specified in its charter)
 Delaware(State or other jurisdiction of
incorporation or organization)
    
    95-4097995(I.R.S. Employer
Identification No.)
 12401 West Olympic Boulevard
Los Angeles, California 90064-1022(Address of principal executive offices) (310) 571-6500(Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. þ o
 Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act). þ o
 Indicate the number of shares outstanding of each of the issuers classes of common stock as of
the latest practicable date: common stock, $0.001 par value
82,287,120 shares as of May 6,
2005.




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VCA ANTECH, INC.
FORM 10-Q
MARCH 31, 2005 TABLE OF CONTENTS PageNumberPart I. Financial InformationItem 1. Financial Statements (Unaudited)Condensed, Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004
    
    1Condensed, Consolidated Income Statements for the Three Months Ended March 31, 2005 and 2004
    
    2Condensed, Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2004
    
    3Notes to Condensed, Consolidated Financial Statements
    
    4Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    20Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    42Item 4. Controls and Procedures
    
    42Part II. Other InformationItem 1. Legal Proceedings
    
    43Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    43Item 3. Defaults Upon Senior Securities
    
    43Item 4. Submission of Matters to a Vote of Security Holders
    
    43Item 5. Other Information
    
    43Item 6. Exhibits
    
    43Signature
    
    44Exhibit Index
    
    45Exhibit 31.1Exhibit 31.2Exhibit 32.1




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PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS VCA ANTECH, INC. AND SUBSIDIARIES 
 CONDENSED,
CONSOLIDATED BALANCE SHEETS

As of March 31, 2005 and December 31, 2004
 (Unaudited)
 (In thousands, except par value)
 March 31,
    
    
    December 31,2005
    
    
    2004ASSETSCurrent assets:Cash and cash equivalents
    
    $
    41,526
    
    
    $
    30,964Restricted cash
    
    
    1,250
    
    
    
    1,250Trade accounts receivable, less allowance for uncollectible accounts of $8,095
and $7,668 at March 31, 2005 and December 31, 2004, respectively
    
    
    31,735
    
    
    
    28,936Inventory
    
    
    13,169
    
    
    
    10,448Prepaid expenses and other
    
    
    6,305
    
    
    
    6,275Deferred income taxes
    
    
    12,220
    
    
    
    11,472Prepaid income taxes
    
    
    1,219
    
    
    
    10,830Total current assets
    
    
    107,424
    
    
    
    100,175Property and equipment, net
    
    
    123,708
    
    
    
    119,903Other assets:Goodwill
    
    
    513,477
    
    
    
    499,144Other intangible assets, net
    
    
    11,629
    
    
    
    11,660Deferred financing costs, net
    
    
    3,843
    
    
    
    4,052Other
    
    
    6,494
    
    
    
    7,166Total assets
    
    $
    766,575
    
    
    $
    742,100LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Current portion of long-term obligations
    
    $
    3,323
    
    
    $
    6,043Accounts payable
    
    
    15,883
    
    
    
    15,566Accrued payroll and related liabilities
    
    
    21,742
    
    
    
    19,850Accrued interest
    
    
    5,769
    
    
    
    1,578Other accrued liabilities
    
    
    24,043
    
    
    
    21,874Total current liabilities
    
    
    70,760
    
    
    
    64,911Long-term obligations, less current portion
    
    
    390,152
    
    
    
    390,846Deferred income taxes
    
    
    32,951
    
    
    
    31,514Other liabilities
    
    
    12,699
    
    
    
    12,915Minority interest
    
    
    9,659
    
    
    
    9,155Commitments and contingenciesPreferred stock, par value $0.001, 11,000 shares authorized, none outstanding
    
    
    
    
    
    
    Stockholders equity:Common stock, par value $0.001, 175,000 shares authorized, 82,272 and 82,191
shares outstanding as of March 31, 2005 and December 31, 2004, respectively
    
    
    82
    
    
    
    82Additional paid-in capital
    
    
    251,782
    
    
    
    251,412Accumulated deficit
    
    
    (1,513
    )
    
    
    (18,759
    )Accumulated other comprehensive income
    
    
    12
    
    
    
    34Notes receivable from stockholders
    
    
    (9
    )
    
    
    (10
    )Total stockholders equity
    
    
    250,354
    
    
    
    232,759Total liabilities and stockholders equity
    
    $
    766,575
    
    
    $
    742,100
 The accompanying notes are an integral part of these condensed, consolidated financial statements. 1




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VCA ANTECH, INC. AND SUBSIDIARIES 
 CONDENSED,
CONSOLIDATED INCOME STATEMENTS

For the Three Months Ended March 31, 2005 and 2004
 (Unaudited)
 (In thousands, except per share amounts)
 Three Months EndedMarch 31,2005
    
    
    2004Revenue
    
    $
    186,863
    
    
    $
    144,350Direct costs
    
    
    136,336
    
    
    
    104,790Gross
profit
    
    
    50,527
    
    
    
    39,560Selling, general and administrative expense
    
    
    14,132
    
    
    
    8,701Loss (gain) on sale of assets
    
    
    (10
    )
    
    
    62Operating income
    
    
    36,405
    
    
    
    30,797Interest expense, net
    
    
    6,667
    
    
    
    5,985Other
expense
    
    
    64
    
    
    
    111Minority interest in income of subsidiaries
    
    
    685
    
    
    
    416Income before provision for income taxes
    
    
    28,989
    
    
    
    24,285Provision for income taxes
    
    
    11,743
    
    
    
    9,541Net income
    
    $
    17,246
    
    
    $
    14,744Basic earnings per common share
    
    $
    0.21
    
    
    $
    0.18Diluted earnings per common share
    
    $
    0.21
    
    
    $
    0.18Shares used for computing basic earnings per share
    
    
    82,220
    
    
    
    81,482Shares used for computing diluted earnings per share
    
    
    83,511
    
    
    
    83,020
 The accompanying notes are an integral part of these condensed, consolidated financial
statements. 2




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VCA ANTECH, INC. AND SUBSIDIARIES 
 CONDENSED,
CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Three Months Ended March 31, 2005 and 2004
 (Unaudited)
 (In thousands)
 Three Months EndedMarch 31,2005
    
    
    2004Cash flows from operating activities:Net income
    
    $
    17,246
    
    
    $
    14,744Adjustments to reconcile net income to net cash provided by operating
activities:Depreciation and amortization
    
    
    4,342
    
    
    
    3,616Amortization of debt costs
    
    
    209
    
    
    
    184Provision for uncollectible accounts
    
    
    1,033
    
    
    
    628Loss (gain) on sale of assets
    
    
    (10
    )
    
    
    62Other
    
    
    (248
    )
    
    
    Tax benefit from stock options exercised
    
    
    179
    
    
    
    323Minority interest in income of subsidiaries
    
    
    685
    
    
    
    416Distributions to minority interest partners
    
    
    (656
    )
    
    
    (374
    )Changes in operating assets and liabilities:Increase in accounts receivable
    
    
    (3,771
    )
    
    
    (4,485
    )Decrease (increase) in inventory, prepaid expenses and other assets
    
    
    (2,429
    )
    
    
    42Increase in accounts payable and other accrued liabilities
    
    
    2,059
    
    
    
    473Increase in accrued payroll and related liabilities
    
    
    1,892
    
    
    
    1,784Increase in accrued interest
    
    
    4,191
    
    
    
    4,092Decrease in prepaid income taxes
    
    
    9,642
    
    
    
    6,038Increase in deferred income tax assets
    
    
    (530
    )
    
    
    (393
    )Increase in deferred income tax liabilities
    
    
    1,534
    
    
    
    2,386Net cash provided by operating activities
    
    
    35,368
    
    
    
    29,536Cash flows used in investing activities:Business acquisitions, net of cash acquired
    
    
    (14,322
    )
    
    
    (14,113
    )Real estate acquired in connection with business acquisitions
    
    
    (221
    )
    
    
    Property and equipment additions, net
    
    
    (7,209
    )
    
    
    (3,465
    )Proceeds from sale of assets
    
    
    92
    
    
    
    178Other
    
    
    77
    
    
    
    95Net cash used in investing activities
    
    
    (21,583
    )
    
    
    (17,305
    )Cash flows used in financing activities:Repayment of long-term obligations
    
    
    (3,414
    )
    
    
    (529
    )Proceeds from issuance of common stock under stock option plans
    
    
    191
    
    
    
    422Net cash used in financing activities
    
    
    (3,223
    )
    
    
    (107
    )Increase in cash and cash equivalents
    
    
    10,562
    
    
    
    12,124Cash and cash equivalents at beginning of period
    
    
    30,964
    
    
    
    17,237Cash and cash equivalents at end of period
    
    $
    41,526
    
    
    $
    29,361
 The accompanying notes are an integral part of these condensed, consolidated financial statements. 3




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VCA ANTECH, INC. AND SUBSIDIARIES 
 NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
 March 31, 2005

(Unaudited)
 1. General The accompanying unaudited condensed, consolidated financial statements of our company, VCA
Antech, Inc. and subsidiaries, 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 annual financial statements as permitted under applicable rules and
regulations. In the opinion of our management, all adjustments considered necessary for a fair
presentation have been included. The results of operations for the three months ended March 31,
2005 are not necessarily indicative of the results to be expected for the full year. For further
information, refer to our consolidated financial statements and footnotes thereto included in our
2004 annual report on Form 10-K. 2. Acquisitions Our acquisition strategy includes the acquisition of animal hospitals. If favorable
opportunities are presented we may pursue the acquisition of animal hospital chains, laboratories
or related businesses. In accord with that strategy, we acquired the following: Three Months EndedMarch 31,2005
    
    
    2004Animal Hospitals:Acquisitions
    
    
    8
    
    
    
    9Acquisitions relocated into our existing animal hospitals
    
    
    (1
    )
    
    
    (2
    )Total
    
    
    7
    
    
    
    7
 The following table summarizes the preliminary aggregate consideration, including acquisition
costs, paid by us for our acquired animal hospitals and the allocation of the purchase price (in
thousands): Three Months EndedMarch 31,2005
    
    
    2004Consideration:Cash
    
    $
    13,620
    
    
    $
    13,776Obligations to sellers (1)
    
    
    900
    
    
    
    725Notes payable and other liabilities assumed
    
    
    21
    
    
    
    16Total
    
    $
    14,541
    
    
    $
    14,517Purchase Price Allocation:Goodwill (2)
    
    $
    13,209
    
    
    $
    13,358Identifiable intangible assets
    
    
    774
    
    
    
    710Tangible assets
    
    
    558
    
    
    
    449Total
    
    $
    14,541
    
    
    $
    14,517
   (1)
    
    Represents a portion of the purchase price withheld, or the holdback, as security for
indemnification obligations of the sellers under the acquisition agreement.(2)
    
    We expect that $8.5 million and
$11.9 million of the goodwill recorded for these acquisitions as of March 31, 2005
and 2004, respectively, will be fully deductible for income tax purposes. 4




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Partnership Interests We purchased the ownership interests of partners in certain partially-owned subsidiaries of
our company. The following table summarizes the consideration paid by us and the amount of
goodwill recorded for these acquisitions (in thousands): Three Months EndedMarch 31,2005
    
    
    2004Consideration:Cash
    
    $
    500
    
    
    $
    56Notes payable
    
    
    
    
    
    
    131Total
    
    $
    500
    
    
    $
    187Goodwill recorded (1)
    
    $
    25
    
    
    $
    163
   (1)
    
    We expect that the goodwill recorded in the three months ended March 31, 2004 will be fully
deductible for income tax purposes. Other Acquisition Payments We paid $575,000 and $280,000 during the three months ended March 31, 2005 and 2004,
respectively, of unused holdbacks to sellers in previously closed acquisitions. We paid $90,000 during the three months ended March 31, 2005 for earnout targets that were
met and recorded goodwill in the same amount. Significant Acquisitions STI On October 1, 2004, we acquired Sound Technologies Inc., STI, which is a supplier of
ultrasound and digital radiography equipment and related computer hardware, software and services
to the veterinary industry. As of March 31, 2005, we had not finalized the purchase price
accounting for this transaction as we are still in the process of integrating STI into our
operations. As part of integrating STI into our operations, we may incur additional legal and
accounting fees. In addition, pursuant to the terms of the purchase agreement, we are obligated to
pay an additional $3.5 million if certain performance targets are achieved. Costs incurred in
integrating STI and the payment of the $3.5 million obligation will result in additions to the
total purchase price of the transaction. The total consideration, excluding the potential integration costs and the $3.5 million
obligation described above, as of March 31, 2005, was $29.4 million, consisting of: $22.4 million
in cash paid to holders of STI stock; $1.1 million in assumed debt; $5.5 million in assumed
liabilities; and $350,000 paid for professional and other outside services. The preliminary
allocation of the $29.4 million purchase price was allocated as follows: $19.3 million to goodwill;
$4.7 million to identifiable intangible assets; and $5.4 million to tangible assets. We expect
that $389,000 of the goodwill recorded will be fully deductible for income tax purposes. National PetCare Centers, Inc. On June 1, 2004, we acquired NPC, which operated 67 animal hospitals located in 11 states as
of the merger date. This merger allowed us to expand our animal hospital operations in nine
states, particularly California and Texas, and to expand into two new states, Oregon and Oklahoma. The
purchase price accounting for this transaction has been finalized
except our plan to close or sell
certain NPC animal hospitals that do not meet our operating model. The costs to close or sell
these animal hospitals, which will consist primarily of lease termination costs and employee
severance, will result in additions to the purchase price. 5




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The total consideration, excluding the cost to close or sell certain NPC animal hospitals as
described above, as of March 31, 2005, was $90.1 million, consisting of: $66.2 million in cash paid
to holders of NPC stock and debt; $2.5 million in assumed debt; $12.4 million in assumed
liabilities; $4.5 million of operating leases whose terms were
in excess of market; $2.0 million
paid for professional and other outside services; and $2.5 million paid as part of our plan to
close certain facilities and terminate certain employees. The $90.1 million purchase price was allocated as follows: $76.4 million to goodwill; $1.4 million to
identifiable intangible assets; and $12.3 million to tangible assets, including real estate in the
amount of $5.0 million. We expect that $28.8 million of the goodwill recorded will be fully
deductible for income tax purposes. 3. Goodwill and Other Intangible Assets Goodwill represents the excess of the cost of an acquired entity over the net of the amounts
assigned to identifiable assets acquired and liabilities assumed. The following table presents the changes in the carrying amount of our goodwill by segment for
the three months ended March 31, 2005 (in thousands): Animal
    
    
    MedicalLaboratory
    
    
    Hospital
    
    
    Equipment
    
    
    TotalBalance as of January 1, 2005
    
    $
    93,671
    
    
    $
    386,255
    
    
    $
    19,218
    
    
    $
    499,144Goodwill acquired
    
    
    
    
    
    
    13,209
    
    
    
    
    
    
    
    13,209Other (1)
    
    
    
    
    
    
    546
    
    
    
    54
    
    
    
    600Goodwill related to partnership interests
    
    
    
    
    
    
    577
    
    
    
    
    
    
    
    577Goodwill related to sale of animal hospital
    
    
    
    
    
    
    (53
    )
    
    
    
    
    
    
    (53
    )Balance as of March 31, 2005
    
    $
    93,671
    
    
    $
    400,534
    
    
    $
    19,272
    
    
    $
    513,477
   (1)
    
    Other is the result of purchase price adjustments, purchasing the ownership interest of
partners and the payment of earnouts. In addition to goodwill, we have amortizable intangible assets at March 31, 2005 and
December 31, 2004 as follows (in thousands): As of March 31, 2005
    
    
    As of December 31, 2004Gross
    
    
    
    
    
    
    Net
    
    
    Gross
    
    
    
    
    
    
    NetCarrying
    
    
    Accumulated
    
    
    Carrying
    
    
    Carrying
    
    
    Accumulated
    
    
    CarryingAmount
    
    
    Amortization
    
    
    Amount
    
    
    Amount
    
    
    Amortization
    
    
    AmountCovenants-not-to-compete
    
    $
    12,370
    
    
    $
    (5,816
    )
    
    $
    6,554
    
    
    $
    11,604
    
    
    $
    (5,290
    )
    
    $
    6,314Noncontractual customer
relationships
    
    
    3,340
    
    
    
    (392
    )
    
    
    2,948
    
    
    
    3,340
    
    
    
    (246
    )
    
    
    3,094Technology
    
    
    1,250
    
    
    
    (125
    )
    
    
    1,125
    
    
    
    1,250
    
    
    
    (62
    )
    
    
    1,188Trademarks
    
    
    560
    
    
    
    (28
    )
    
    
    532
    
    
    
    560
    
    
    
    (14
    )
    
    
    546Contracts
    
    
    397
    
    
    
    (52
    )
    
    
    345
    
    
    
    397
    
    
    
    (26
    )
    
    
    371Client lists
    
    
    672
    
    
    
    (547
    )
    
    
    125
    
    
    
    665
    
    
    
    (518
    )
    
    
    147Total
    
    $
    18,589
    
    
    $
    (6,960
    )
    
    $
    11,629
    
    
    $
    17,816
    
    
    $
    (6,156
    )
    
    $
    11,660
 The following table summarizes our aggregate amortization expense related to other intangible
assets (in thousands): Three Months EndedMarch 31,2005
    
    
    2004Aggregate amortization expense
    
    $
    804
    
    
    $
    440
 6




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Based on balances at March 31, 2005, estimated annual amortization expense for other
intangible assets for the current year and the next four fiscal years is as follows (in thousands): 2005
    
    $
    3,0842006
    
    $
    2,7402007
    
    $
    2,4962008
    
    $
    1,9422009
    
    $
    905
 4. Calculation of Earnings per Common Share Basic and diluted earnings per common share were computed as follows (in thousands, except per
share amounts): Three Months EndedMarch 31,2005
    
    
    2004Net income
    
    $
    17,246
    
    
    $
    14,744Weighted average common shares outstanding:Basic
    
    
    82,220
    
    
    
    81,482Effect of dilutive potential common shares:Stock options
    
    
    1,291
    
    
    
    1,396Contracts that may be settled in stock or cash
    
    
    
    
    
    
    142Diluted
    
    
    83,511
    
    
    
    83,020Basic earnings per common share
    
    $
    0.21
    
    
    $
    0.18Diluted earnings per common share
    
    $
    0.21
    
    
    $
    0.18
 5. Lines of Business As of March 31, 2005, we had four reportable segments: Laboratory, Animal Hospital, Medical
Technology and Corporate. We acquired our Medical Technology segment on October 1, 2004 and
therefore do not have operating results for periods prior to that date. These segments
are strategic business units that have different products, services and/or 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
diagnostic laboratory testing services for veterinarians, both associated with our animal hospitals
and those independent of us. The Animal Hospital segment provides veterinary services for
companion animals and sells related retail and pharmaceutical products. The Medical Technology
segment sells ultrasound and digital radiography equipment, related computer hardware, software and
ancillary services to the veterinary market. The accounting policies of our segments are the same
as those described in the summary of significant accounting policies included in our consolidated
financial statements and footnotes thereto included in our 2004 annual report on Form 10-K. We
evaluate the performance of our segments based on gross profit. 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. 7




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Below is a summary of certain financial data for each of our segments (in thousands): Animal
    
    
    Medical
    
    
    
    
    
    
    IntercompanyLaboratory
    
    
    Hospital
    
    
    Technology
    
    
    Corporate
    
    
    Eliminations
    
    
    TotalThree Months Ended March 31, 2005Revenue
    
    $
    53,439
    
    
    $
    133,354
    
    
    $
    4,484
    
    
    $
    
    
    
    $
    (4,414
    )
    
    $
    186,863Direct costs
    
    
    29,570
    
    
    
    107,619
    
    
    
    3,445
    
    
    
    
    
    
    
    (4,298
    )
    
    
    136,336Gross profit
    
    
    23,869
    
    
    
    25,735
    
    
    
    1,039
    
    
    
    
    
    
    
    (116
    )
    
    
    50,527Selling, general and administrative
expense
    
    
    3,365
    
    
    
    3,703
    
    
    
    1,567
    
    
    
    5,497
    
    
    
    
    
    
    
    14,132Loss (gain) on sale of assets
    
    
    
    
    
    
    (10
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10
    )Operating income (loss)
    
    $
    20,504
    
    
    $
    22,042
    
    
    $
    (528
    )
    
    $
    (5,497
    )
    
    $
    (116
    )
    
    $
    36,405Depreciation and amortization
    
    $
    902
    
    
    $
    2,744
    
    
    $
    299
    
    
    $
    397
    
    
    $
    
    
    
    $
    4,342Capital expenditures
    
    $
    1,681
    
    
    $
    3,881
    
    
    $
    120
    
    
    $
    1,832
    
    
    $
    (305
    )
    
    $
    7,209Three Months Ended March 31, 2004Revenue
    
    $
    49,182
    
    
    $
    97,956
    
    
    $
    
    
    
    $
    
    
    
    $
    (2,788
    )
    
    $
    144,350Direct costs
    
    
    27,715
    
    
    
    79,863
    
    
    
    
    
    
    
    
    
    
    
    (2,788
    )
    
    
    104,790Gross profit
    
    
    21,467
    
    
    
    18,093
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    39,560Selling, general and administrative
expense
    
    
    3,173
    
    
    
    2,748
    
    
    
    
    
    
    
    2,780
    
    
    
    
    
    
    
    8,701Loss (gain) on sale of assets
    
    
    (1
    )
    
    
    63
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    62Operating income (loss)
    
    $
    18,295
    
    
    $
    15,282
    
    
    $
    
    
    
    $
    (2,780
    )
    
    $
    
    
    
    $
    30,797Depreciation and amortization
    
    $
    821
    
    
    $
    2,401
    
    
    $
    
    
    
    $
    394
    
    
    $
    
    
    
    $
    3,616Capital expenditures
    
    $
    746
    
    
    $
    2,453
    
    
    $
    
    
    
    $
    266
    
    
    $
    
    
    
    $
    3,465At March 31, 2005Total assets
    
    $
    143,948
    
    
    $
    520,955
    
    
    $
    35,811
    
    
    $
    65,861
    
    
    $
    
    
    
    $
    766,575At December 31, 2004Total assets
    
    $
    135,600
    
    
    $
    503,485
    
    
    $
    35,198
    
    
    $
    67,817
    
    
    $
    
    
    
    $
    742,100
 6. Stock-Based Compensation We have granted stock options to various employees under multiple stock option plans and are
accounting for those options under the intrinsic value method as prescribed in Accounting
Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees.Under that
method, when options are granted with a strike price equal to or greater than market price on date
of issuance, there is no impact on earnings either on the date of grant or thereafter, absent
modification to the options. This method is not a fair-value based method of accounting as defined
by Statement of Financial Accounting Standards, SFAS, No. 123, Accounting for Stock-Based
Compensation. Fair-value based methods of accounting require compensation expense to be recognized
based on the fair market value of the options granted over their vesting period. The following
table presents net income and earnings per common share as if we accounted for our stock options
under SFAS No. 123 and the fair-value based method of accounting (in thousands, except per share
amounts): 8




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##### Table of Contents



Three Months EndedMarch 31,2005
    
    
    2004As reported
    
    $
    17,246
    
    
    $
    14,744Deduct: Total stock-based employee compensation
expense determined under fair-value-based method
for all awards, net of related tax effects
    
    
    (2,303
    )
    
    
    (222
    )Pro forma net income available to common stockholders
    
    $
    14,943
    
    
    $
    14,522Earnings per common share:Basic  as reported
    
    $
    0.21
    
    
    $
    0.18Basic  pro forma
    
    $
    0.18
    
    
    $
    0.18Diluted  as reported
    
    $
    0.21
    
    
    $
    0.18Diluted  pro forma
    
    $
    0.18
    
    
    $
    0.17
 In December 2004, the Financial Accounting Standards Board, or FASB, issued SFAS No. 123R,
Share-Based Payment,which replaces SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123R
will require us to measure the cost of share-based payments to employees, including stock options,
based on the grant date fair value and to recognize the cost over the requisite service period. On April 19, 2005, the Securities and Exchange Commission amended the compliance date for SFAS
123R to fiscal years beginning after June 15, 2005. We plan to adopt SFAS 123R effective with the
compliance date applicable to us, which is currently scheduled for January 1, 2006. We are currently evaluating the method we will use to value
share-based payments and the impact of this standard on our consolidated financial statements. 7. Commitments and Contingencies We have certain commitments, including operating leases and supply purchase agreements,
incident to the ordinary course of our business. These items are discussed in detail in our
consolidated financial statements and footnotes thereto included in our 2004 annual report on Form
10-K. We also have contingencies, which are discussed below. a. Earn-out Payments In connection with certain acquisitions, we assumed certain contractual arrangements whereby
additional cash may be paid to former owners of acquired companies upon attainment of specified
financial criteria over periods of one to three years, as set forth in the respective agreements.
The amount to be paid cannot be determined until the earn-out periods expire and the attainment of
criteria is established. If the specified financial criteria are attained, we will be obligated to
make cash payments of $2.3 million for the remainder of 2005 and $2.2 million in 2006. b. Officers Compensation We
have entered into employment agreements with three of our officers whereby payments may be
required if our company terminates their employment in certain
circumstances. We have entered into an agreement with another officer
providing for similar benefits if we terminate his employment without
cause. The amounts payable
are based upon the executives salaries and/or bonus history at the time of termination and the cost
to our company of continuing to provide certain benefits. Had all of such officers been terminated
as of December 31, 2004, we would have had aggregate obligations
of approximately $9.4 million plus the cost of the continuing
benefits under such agreements. The employment agreements with our
three executives also obligate our company to make certain payments in the
event of a change in control of our company. The amounts payable by our company under these
agreements upon a change of control are based on the officers salary and bonus history at the time of termination and the
cost to our company of continuing to provide certain benefits. Had all of our officers been
terminated following
a change in control as of December 31, 2004, we would have aggregate obligations of
approximately $9.1 million under these agreements plus the cost
of the continuing benefits. These agreements also provide for the
acceleration of the vesting of certain of the stock options held by the officers in such
circumstances. 9




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##### Table of Contents



c. 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. At March 31, 2005, we operated
102 animal hospitals in 13 states with these laws, including 24 in New York and 26 in Texas. In
two of these states, we operated a mobile imaging service. We may experience difficulty in
expanding 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, particularly if we were unable to restructure its
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, 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
veterinary doctors practicing in our clinics are required to maintain valid state licenses to
practice. d. Other Contingencies We have certain contingent liabilities resulting from litigation and claims incident to the
ordinary course of our business. We believe that the probable resolution of such contingencies
will not have a material adverse effect on our consolidated financial position, results of
operations or cash flows. 8. Reclassifications Certain prior year balances have been reclassified to conform to the 2005 financial statement
presentation. 9. Condensed, Consolidating Information We have a legal structure comprised of a holding company and an operating company. VCA is our
holding company, or commonly referred to as our parent company. Vicar Operating, Inc., or Vicar,
is our operating company and is wholly owned by VCA. Vicar owns the capital stock of all of our
subsidiaries. The borrowings under our senior credit facility are secured obligations owed by Vicar. These
borrowings are guaranteed by VCA, and its wholly-owned subsidiaries. Vicar may borrow up to $50.0
million under a revolving line of credit under the senior credit facility. Vicars obligations
under the senior credit facility are secured by the assets of VCA and its wholly-owned subsidiaries
in addition to a pledge of capital stock or similar equity interests of VCAs wholly-owned
subsidiaries. The borrowings under our 9.875% senior subordinated notes are general unsecured obligations
owed by Vicar. These notes are unconditionally guaranteed on a senior subordinated basis by VCA
and its wholly-owned subsidiaries. Our partnerships may elect to serve as guarantors of our obligations; however, none of our
partnerships have elected to do so. The partnerships are referred to as Non-Guarantor Subsidiaries
in the following financial statements. 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 and other obligations depends on the financial results and condition of its
subsidiaries and its ability to receive funds from its subsidiaries. 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 we determined they would not be material to investors. 10




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##### Table of Contents



VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS  (Continued) CONDENSED, CONSOLIDATED BALANCE SHEETS
As of March 31, 2005
(In thousands) Non-Guarantor
    
    
    GuarantorVCA
    
    
    Vicar
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Elimination
    
    
    ConsolidatedCurrent assets:Cash and cash equivalents
    
    $
    
    
    
    $
    34,603
    
    
    $
    6,820
    
    
    $
    103
    
    
    $
    
    
    
    $
    41,526Restricted cash
    
    
    
    
    
    
    1,250
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,250Trade accounts receivable, net
    
    
    
    
    
    
    (197
    )
    
    
    31,270
    
    
    
    662
    
    
    
    
    
    
    
    31,735Inventory
    
    
    
    
    
    
    
    
    
    
    12,659
    
    
    
    510
    
    
    
    
    
    
    
    13,169Prepaid expenses and other
    
    
    
    
    
    
    3,439
    
    
    
    2,538
    
    
    
    328
    
    
    
    
    
    
    
    6,305Deferred income taxes
    
    
    
    
    
    
    12,220
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,220Prepaid income taxes
    
    
    
    
    
    
    1,219
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,219Total current assets
    
    
    
    
    
    
    52,534
    
    
    
    53,287
    
    
    
    1,603
    
    
    
    
    
    
    
    107,424Property and equipment, net
    
    
    
    
    
    
    7,499
    
    
    
    113,751
    
    
    
    2,458
    
    
    
    
    
    
    
    123,708Other assets:Goodwill, net
    
    
    
    
    
    
    
    
    
    
    481,783
    
    
    
    31,694
    
    
    
    
    
    
    
    513,477Covenants-not-to-compete, net
    
    
    
    
    
    
    
    
    
    
    10,949
    
    
    
    680
    
    
    
    
    
    
    
    11,629Deferred financing costs, net
    
    
    
    
    
    
    3,843
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,843Other
    
    
    27
    
    
    
    1,958
    
    
    
    3,662
    
    
    
    3,065
    
    
    
    (2,218
    )
    
    
    6,494Investment in subsidiaries
    
    
    284,050
    
    
    
    438,805
    
    
    
    32,261
    
    
    
    
    
    
    
    (755,116
    )
    
    
    Total assets
    
    $
    284,077
    
    
    $
    504,639
    
    
    $
    695,693
    
    
    $
    39,500
    
    
    $
    (757,334
    )
    
    $
    766,575Current liabilities:Current portion of long-term obligations
    
    $
    
    
    
    $
    2,297
    
    
    $
    1,026
    
    
    $
    
    
    
    $
    
    
    
    $
    3,323Accounts payable
    
    
    
    
    
    
    10,374
    
    
    
    5,509
    
    
    
    
    
    
    
    
    
    
    
    15,883Accrued payroll and related liabilities
    
    
    
    
    
    
    13,782
    
    
    
    7,525
    
    
    
    435
    
    
    
    
    
    
    
    21,742Accrued interest
    
    
    
    
    
    
    5,623
    
    
    
    146
    
    
    
    
    
    
    
    
    
    
    
    5,769Other accrued liabilities
    
    
    
    
    
    
    15,031
    
    
    
    9,001
    
    
    
    11
    
    
    
    
    
    
    
    24,043Total current liabilities
    
    
    
    
    
    
    47,107
    
    
    
    23,207
    
    
    
    446
    
    
    
    
    
    
    
    70,760Long-term obligations, less current portion
    
    
    
    
    
    
    390,388
    
    
    
    1,982
    
    
    
    
    
    
    
    (2,218
    )
    
    
    390,152Deferred income taxes
    
    
    
    
    
    
    30,880
    
    
    
    2,071
    
    
    
    
    
    
    
    
    
    
    
    32,951Other liabilities
    
    
    
    
    
    
    6,294
    
    
    
    6,405
    
    
    
    
    
    
    
    
    
    
    
    12,699Intercompany payable/(receivable)
    
    
    33,723
    
    
    
    (254,080
    )
    
    
    223,223
    
    
    
    (2,866
    )
    
    
    
    
    
    
    Minority interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,659
    
    
    
    9,659Preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stockholders equity:Common stock
    
    
    82
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    82Additional paid-in capital
    
    
    251,782
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    251,782Accumulated equity (deficit)
    
    
    (1,513
    )
    
    
    284,038
    
    
    
    438,805
    
    
    
    41,920
    
    
    
    (764,763
    )
    
    
    (1,513
    )Accumulated other comprehensive income
    
    
    12
    
    
    
    12
    
    
    
    
    
    
    
    
    
    
    
    (12
    )
    
    
    12Notes receivable from stockholders
    
    
    (9
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9
    )Total stockholders equity
    
    
    250,354
    
    
    
    284,050
    
    
    
    438,805
    
    
    
    41,920
    
    
    
    (764,775
    )
    
    
    250,354Total liabilities and stockholders equity
    
    $
    284,077
    
    
    $
    504,639
    
    
    $
    695,693
    
    
    $
    39,500
    
    
    $
    (757,334
    )
    
    $
    766,575
 11




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##### Table of Contents



VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS  (Continued) CONDENSED, CONSOLIDATED BALANCE SHEETS
As of December 31, 2004
(In thousands) Non-Guarantor
    
    
    GuarantorVCA
    
    
    Vicar
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Elimination
    
    
    ConsolidatedCurrent assets:Cash and cash equivalents
    
    $
    
    
    
    $
    27,947
    
    
    $
    2,944
    
    
    $
    73
    
    
    $
    
    
    
    $
    30,964Restricted cash
    
    
    
    
    
    
    1,250
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,250Trade accounts receivable, net
    
    
    
    
    
    
    11
    
    
    
    28,220
    
    
    
    705
    
    
    
    
    
    
    
    28,936Inventory
    
    
    
    
    
    
    
    
    
    
    9,955
    
    
    
    493
    
    
    
    
    
    
    
    10,448Prepaid expenses and other
    
    
    
    
    
    
    3,774
    
    
    
    2,205
    
    
    
    296
    
    
    
    
    
    
    
    6,275Deferred income taxes
    
    
    
    
    
    
    11,472
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,472Prepaid income taxes
    
    
    
    
    
    
    10,830
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,830Total current assets
    
    
    
    
    
    
    55,284
    
    
    
    43,324
    
    
    
    1,567
    
    
    
    
    
    
    
    100,175Property and equipment, net
    
    
    
    
    
    
    6,544
    
    
    
    110,843
    
    
    
    2,516
    
    
    
    
    
    
    
    119,903Other assets:Goodwill, net
    
    
    
    
    
    
    
    
    
    
    467,819
    
    
    
    31,325
    
    
    
    
    
    
    
    499,144Covenants-not-to-compete, net
    
    
    
    
    
    
    
    
    
    
    10,979
    
    
    
    681
    
    
    
    
    
    
    
    11,660Deferred financing costs, net
    
    
    
    
    
    
    4,052
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,052Other
    
    
    30
    
    
    
    1,907
    
    
    
    3,971
    
    
    
    2,774
    
    
    
    (1,516
    )
    
    
    7,166Investment in subsidiaries
    
    
    266,827
    
    
    
    404,414
    
    
    
    32,117
    
    
    
    
    
    
    
    (703,358
    )
    
    
    Total assets
    
    $
    266,857
    
    
    $
    472,201
    
    
    $
    669,053
    
    
    $
    38,863
    
    
    $
    (704,874
    )
    
    $
    742,100Current liabilities:Current portion of long-term obligations
    
    $
    
    
    
    $
    4,896
    
    
    $
    1,147
    
    
    $
    101
    
    
    $
    (101
    )
    
    $
    6,043Accounts payable
    
    
    
    
    
    
    9,644
    
    
    
    5,922
    
    
    
    
    
    
    
    
    
    
    
    15,566Accrued payroll and related liabilities
    
    
    
    
    
    
    12,283
    
    
    
    7,131
    
    
    
    436
    
    
    
    
    
    
    
    19,850Accrued interest
    
    
    
    
    
    
    1,425
    
    
    
    153
    
    
    
    
    
    
    
    
    
    
    
    1,578Other accrued liabilities
    
    
    
    
    
    
    12,651
    
    
    
    9,234
    
    
    
    (11
    )
    
    
    
    
    
    
    21,874Total current liabilities
    
    
    
    
    
    
    40,899
    
    
    
    23,587
    
    
    
    526
    
    
    
    (101
    )
    
    
    64,911Long-term obligations, less current portion
    
    
    
    
    
    
    390,160
    
    
    
    2,101
    
    
    
    
    
    
    
    (1,415
    )
    
    
    390,846Deferred income taxes
    
    
    
    
    
    
    29,443
    
    
    
    2,071
    
    
    
    
    
    
    
    
    
    
    
    31,514Other liabilities
    
    
    
    
    
    
    6,263
    
    
    
    6,652
    
    
    
    
    
    
    
    
    
    
    
    12,915Intercompany payable/(receivable)
    
    
    34,098
    
    
    
    (261,391
    )
    
    
    230,228
    
    
    
    (2,935
    )
    
    
    
    
    
    
    Minority interest
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,155
    
    
    
    9,155Preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stockholders equity:Common stock
    
    
    82
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    82Additional paid-in capital
    
    
    251,412
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    251,412Accumulated equity (deficit)
    
    
    (18,759
    )
    
    
    266,793
    
    
    
    404,414
    
    
    
    41,272
    
    
    
    (712,479
    )
    
    
    (18,759
    )Accumulated other comprehensive income
    
    
    34
    
    
    
    34
    
    
    
    
    
    
    
    
    
    
    
    (34
    )
    
    
    34Notes receivable from stockholders
    
    
    (10
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10
    )Total stockholders equity
    
    
    232,759
    
    
    
    266,827
    
    
    
    404,414
    
    
    
    41,272
    
    
    
    (712,513
    )
    
    
    232,759Total liabilities and stockholders equity
    
    $
    266,857
    
    
    $
    472,201
    
    
    $
    669,053
    
    
    $
    38,863
    
    
    $
    (704,874
    )
    
    $
    742,100
 12




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##### Table of Contents



VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS  (Continued) CONDENSED, CONSOLIDATED INCOME STATEMENTS
For the Three Months Ended March 31, 2005
(In thousands) Non-Guarantor
    
    
    GuarantorVCA
    
    
    Vicar
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Elimination
    
    
    ConsolidatedRevenue
    
    $
    
    
    
    $
    
    
    
    $
    172,796
    
    
    $
    14,504
    
    
    $
    (437
    )
    
    $
    186,863Direct costs
    
    
    
    
    
    
    
    
    
    
    125,428
    
    
    
    11,345
    
    
    
    (437
    )
    
    
    136,336Gross profit
    
    
    
    
    
    
    
    
    
    
    47,368
    
    
    
    3,159
    
    
    
    
    
    
    
    50,527Selling, general and administrative expense
    
    
    
    
    
    
    5,497
    
    
    
    8,136
    
    
    
    499
    
    
    
    
    
    
    
    14,132Gain on sale of assets
    
    
    
    
    
    
    
    
    
    
    (10
    )
    
    
    
    
    
    
    
    
    
    
    (10
    )Operating income (loss)
    
    
    
    
    
    
    (5,497
    )
    
    
    39,242
    
    
    
    2,660
    
    
    
    
    
    
    
    36,405Interest expense, net
    
    
    (1
    )
    
    
    6,642
    
    
    
    75
    
    
    
    (49
    )
    
    
    
    
    
    
    6,667Other expense
    
    
    
    
    
    
    64
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    64Minority interest in income of subsidiaries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    685
    
    
    
    685Equity interest in income of subsidiaries
    
    
    17,245
    
    
    
    34,391
    
    
    
    2,024
    
    
    
    
    
    
    
    (53,660
    )
    
    
    Income before provision for income
taxes
    
    
    17,246
    
    
    
    22,188
    
    
    
    41,191
    
    
    
    2,709
    
    
    
    (54,345
    )
    
    
    28,989Provision for income taxes
    
    
    
    
    
    
    4,943
    
    
    
    6,800
    
    
    
    
    
    
    
    
    
    
    
    11,743Net income
    
    $
    17,246
    
    
    $
    17,245
    
    
    $
    34,391
    
    
    $
    2,709
    
    
    $
    (54,345
    )
    
    $
    17,246
 13




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##### Table of Contents



VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS  (Continued) CONDENSED, CONSOLIDATED INCOME STATEMENTS
For the Three Months Ended March 31, 2004
(In thousands) Non-Guarantor
    
    
    GuarantorVCA
    
    
    Vicar
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Elimination
    
    
    ConsolidatedRevenue
    
    $
    
    
    
    $
    
    
    
    $
    133,862
    
    
    $
    10,745
    
    
    $
    (257
    )
    
    $
    144,350Direct costs
    
    
    
    
    
    
    
    
    
    
    96,472
    
    
    
    8,575
    
    
    
    (257
    )
    
    
    104,790Gross profit
    
    
    
    
    
    
    
    
    
    
    37,390
    
    
    
    2,170
    
    
    
    
    
    
    
    39,560Selling, general and administrative expense
    
    
    
    
    
    
    2,780
    
    
    
    5,556
    
    
    
    365
    
    
    
    
    
    
    
    8,701Loss on sale of assets
    
    
    
    
    
    
    
    
    
    
    62
    
    
    
    
    
    
    
    
    
    
    
    62Operating income (loss)
    
    
    
    
    
    
    (2,780
    )
    
    
    31,772
    
    
    
    1,805
    
    
    
    
    
    
    
    30,797Interest expense, net
    
    
    (1
    )
    
    
    5,983
    
    
    
    40
    
    
    
    (37
    )
    
    
    
    
    
    
    5,985Other expense
    
    
    
    
    
    
    111
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    111Minority interest in income of subsidiaries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    416
    
    
    
    416Equity interest in income of subsidiaries
    
    
    14,743
    
    
    
    19,499
    
    
    
    1,426
    
    
    
    
    
    
    
    (35,668
    )
    
    
    Income before provision (benefit)
for income taxes
    
    
    14,744
    
    
    
    10,625
    
    
    
    33,158
    
    
    
    1,842
    
    
    
    (36,084
    )
    
    
    24,285Provision (benefit) for income taxes
    
    
    
    
    
    
    (4,118
    )
    
    
    13,659
    
    
    
    
    
    
    
    
    
    
    
    9,541Net income
    
    $
    14,744
    
    
    $
    14,743
    
    
    $
    19,499
    
    
    $
    1,842
    
    
    $
    (36,084
    )
    
    $
    14,744
 14




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##### Table of Contents



VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS  (Continued) CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2005
(In thousands) Non-Guarantor
    
    
    GuarantorVCA
    
    
    Vicar
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Elimination
    
    
    ConsolidatedCash flows from operating activities:Net income
    
    $
    17,246
    
    
    $
    17,245
    
    
    $
    34,391
    
    
    $
    2,709
    
    
    $
    (54,345
    )
    
    $
    17,246Adjustments to reconcile net income to net
cash provided by (used in) operating activities:Equity interest in earnings of subsidiaries
    
    
    (17,245
    )
    
    
    (34,391
    )
    
    
    (2,024
    )
    
    
    
    
    
    
    53,660
    
    
    
    Depreciation and amortization
    
    
    
    
    
    
    397
    
    
    
    3,750
    
    
    
    195
    
    
    
    
    
    
    
    4,342Amortization of debt costs
    
    
    
    
    
    
    209
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    209Provision for uncollectible accounts
    
    
    
    
    
    
    
    
    
    
    967
    
    
    
    66
    
    
    
    
    
    
    
    1,033Loss on sale of assets
    
    
    
    
    
    
    
    
    
    
    (10
    )
    
    
    
    
    
    
    
    
    
    
    (10
    )Other
    
    
    
    
    
    
    
    
    
    
    (248
    )
    
    
    
    
    
    
    
    
    
    
    (248
    )Tax benefit from stock options exercised
    
    
    179
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    179Minority interest in income of subsidiaries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    685
    
    
    
    685Distributions to minority interest partners
    
    
    
    
    
    
    (656
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (656
    )Decrease (increase) in accounts receivable
    
    
    
    
    
    
    208
    
    
    
    (3,956
    )
    
    
    (23
    )
    
    
    
    
    
    
    (3,771
    )Decrease (increase) in inventory, prepaid
expenses and other assets
    
    
    
    
    
    
    271
    
    
    
    (2,651
    )
    
    
    (49
    )
    
    
    
    
    
    
    (2,429
    )Increase (decrease) in accounts payable
and other accrued liabilities
    
    
    
    
    
    
    3,110
    
    
    
    (1,073
    )
    
    
    22
    
    
    
    
    
    
    
    2,059Increase (decrease) in accrued payroll and
related liabilities
    
    
    
    
    
    
    1,499
    
    
    
    394
    
    
    
    (1
    )
    
    
    
    
    
    
    1,892Increase (decrease) in accrued interest
    
    
    
    
    
    
    4,198
    
    
    
    (7
    )
    
    
    
    
    
    
    
    
    
    
    4,191Decrease in prepaid income taxes
    
    
    
    
    
    
    9,611
    
    
    
    31
    
    
    
    
    
    
    
    
    
    
    
    9,642Increase in deferred income tax assets
    
    
    
    
    
    
    (748
    )
    
    
    218
    
    
    
    
    
    
    
    
    
    
    
    (530
    )Increase in deferred income tax liabilities
    
    
    
    
    
    
    1,783
    
    
    
    (249
    )
    
    
    
    
    
    
    
    
    
    
    1,534Increase in intercompany payable/(receivable)
    
    
    (375
    )
    
    
    27,599
    
    
    
    (24,335
    )
    
    
    (2,889
    )
    
    
    
    
    
    
    Net cash provided by (used in) operating
activities
    
    
    (195
    )
    
    
    30,335
    
    
    
    5,198
    
    
    
    30
    
    
    
    
    
    
    
    35,368
 15




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##### Table of Contents



VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS  (Continued) CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS  (Continued)
For the Three Months Ended March 31, 2005
(In thousands) Non-Guarantor
    
    
    GuarantorVCA
    
    
    Vicar
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Elimination
    
    
    ConsolidatedCash flows used in investing activities:Business acquisitions, net of cash acquired
    
    $
    
    
    
    $
    (14,322
    )
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (14,322
    )Real estate acquired in connection with
business acquisitions
    
    
    
    
    
    
    (221
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (221
    )Property and equipment additions, net
    
    
    
    
    
    
    (5,713
    )
    
    
    (1,496
    )
    
    
    
    
    
    
    
    
    
    
    (7,209
    )Proceeds from sale of assets
    
    
    
    
    
    
    
    
    
    
    92
    
    
    
    
    
    
    
    
    
    
    
    92Other
    
    
    4
    
    
    
    (9
    )
    
    
    82
    
    
    
    
    
    
    
    
    
    
    
    77Net cash used in investing activities
    
    
    4
    
    
    
    (20,265
    )
    
    
    (1,322
    )
    
    
    
    
    
    
    
    
    
    
    (21,583
    )Cash flows from financing activities:Repayment of long-term obligations
    
    
    
    
    
    
    (3,414
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,414
    )Proceeds from issuance of common
stock under stock option plans
    
    
    191
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    191Net cash provided by (used in) financing
activities
    
    
    191
    
    
    
    (3,414
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,223
    )Increase in cash and cash equivalents
    
    
    
    
    
    
    6,656
    
    
    
    3,876
    
    
    
    30
    
    
    
    
    
    
    
    10,562Cash and cash equivalents at beginning
of period
    
    
    
    
    
    
    27,947
    
    
    
    2,944
    
    
    
    73
    
    
    
    
    
    
    
    30,964Cash and cash equivalents at end of period
    
    $
    
    
    
    $
    34,603
    
    
    $
    6,820
    
    
    $
    103
    
    
    $
    
    
    
    $
    41,526
 16




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##### Table of Contents



VCA ANTECH, INC. AND SUBSIDIARIES NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS  (Continued)
 CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2004
(In thousands) Non-Guarantor
    
    
    GuarantorVCA
    
    
    Vicar
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Elimination
    
    
    ConsolidatedCash flows from operating activities:Net income
    
    $
    14,744
    
    
    $
    14,743
    
    
    $
    19,499
    
    
    $
    1,842
    
    
    $
    (36,084
    )
    
    $
    14,744Adjustments to reconcile net income to net
cash provided by (used in) operating activities:Equity interest in earnings of subsidiaries
    
    
    (14,743
    )
    
    
    (19,499
    )
    
    
    (1,426
    )
    
    
    
    
    
    
    35,668
    
    
    
    Depreciation and amortization
    
    
    
    
    
    
    394
    
    
    
    3,061
    
    
    
    161
    
    
    
    
    
    
    
    3,616Amortization of debt costs
    
    
    
    
    
    
    180
    
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    184Provision for uncollectible accounts
    
    
    
    
    
    
    
    
    
    
    569
    
    
    
    59
    
    
    
    
    
    
    
    628Loss on sale of assets
    
    
    
    
    
    
    
    
    
    
    62
    
    
    
    
    
    
    
    
    
    
    
    62Tax benefit from options exercised
    
    
    
    
    
    
    323
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    323Minority interest in income of subsidiaries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    416
    
    
    
    416Distributions to minority interest partners
    
    
    
    
    
    
    (374
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (374
    )Increase in accounts receivable
    
    
    
    
    
    
    (1
    )
    
    
    (4,400
    )
    
    
    (84
    )
    
    
    
    
    
    
    (4,485
    )Decrease (increase) in inventory, prepaid
expenses and other assets
    
    
    
    
    
    
    145
    
    
    
    (156
    )
    
    
    53
    
    
    
    
    
    
    
    42Increase (decrease) in accounts payable
and other accrued liabilities
    
    
    
    
    
    
    (71
    )
    
    
    537
    
    
    
    7
    
    
    
    
    
    
    
    473Increase (decrease) in accrued payroll and
related liabilities
    
    
    
    
    
    
    3,242
    
    
    
    (1,458
    )
    
    
    
    
    
    
    
    
    
    
    1,784Increase (decrease) in accrued interest
    
    
    
    
    
    
    4,093
    
    
    
    
    
    
    
    (1
    )
    
    
    
    
    
    
    4,092Decrease in prepaid income taxes
    
    
    
    
    
    
    6,038
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,038Increase in deferred income tax assets
    
    
    
    
    
    
    (393
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (393
    )Increase in deferred income tax liabilities
    
    
    
    
    
    
    2,386
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,386Increase in intercompany payable/(receivable)
    
    
    (423
    )
    
    
    16,764
    
    
    
    (14,314
    )
    
    
    (2,027
    )
    
    
    
    
    
    
    Net cash provided by (used in) operating
activities
    
    
    (422
    )
    
    
    27,970
    
    
    
    1,978
    
    
    
    10
    
    
    
    
    
    
    
    29,536
 17




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##### Table of Contents



VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS  (Continued) CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS  (Continued)
For the Three Months Ended March 31, 2004
(In thousands) Non-Guarantor
    
    
    GuarantorVCA
    
    
    Vicar
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Elimination
    
    
    ConsolidatedCash flows used in investing activities:Business acquisitions, net of cash acquired
    
    $
    
    
    
    $
    (14,113
    )
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (14,113
    )Property and equipment additions, net
    
    
    
    
    
    
    (2,719
    )
    
    
    (746
    )
    
    
    
    
    
    
    
    
    
    
    (3,465
    )Proceeds from sale of assets
    
    
    
    
    
    
    178
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    178Other
    
    
    
    
    
    
    12
    
    
    
    83
    
    
    
    
    
    
    
    
    
    
    
    95Net cash used in investing activities
    
    
    
    
    
    
    (16,642
    )
    
    
    (663
    )
    
    
    
    
    
    
    
    
    
    
    (17,305
    )Cash flows from financing activities:Repayment of long-term obligations
    
    
    
    
    
    
    (529
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (529
    )Proceeds from issuance of common
stock under stock option plans
    
    
    422
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    422Net cash provided by (used in) financing
activities
    
    
    422
    
    
    
    (529
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (107
    )Increase in cash and cash equivalents
    
    
    
    
    
    
    10,799
    
    
    
    1,315
    
    
    
    10
    
    
    
    
    
    
    
    12,124Cash and cash equivalents at beginning
of period
    
    
    
    
    
    
    14,883
    
    
    
    2,244
    
    
    
    110
    
    
    
    
    
    
    
    17,237Cash and cash equivalents at end of period
    
    $
    
    
    
    $
    25,682
    
    
    $
    3,559
    
    
    $
    120
    
    
    $
    
    
    
    $
    29,361
 18




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##### Table of Contents



10. Subsequent Events From April 1, 2005 through May 6, 2005, we acquired two animal hospitals, one of which was
merged into an existing VCA animal hospital, for an aggregate consideration of $1.4 million,
consisting of $1.3 million in cash and the assumption of liabilities of $90,000. On April 19, 2005, we announced our proposal to enter into a new senior credit facility
providing for up to $425.0 million in senior term notes and a $75.0 million revolving credit
facility. If consummated, the facility will provide for up to $475.0
million in senior term notes. The new senior credit facility is
intended, among other uses, to refinance the $220.3 million of total
outstanding senior term F notes and to provide the financing for a tender offer and consent
solicitation for any and all of our outstanding $170.0 million principal amount of 9.875% senior
subordinated notes due 2009. If the existing senior term F notes are refinanced and the tender
offer is consummated, we expect to incur debt retirement costs in the second quarter of 2005
related to the write-off of deferred financing costs and additional charges, including tender
consideration, related to expenses with respect to both the refinancing of the senior term F notes
and the purchase of the senior subordinated notes. The tender offer is contingent on the satisfaction of several conditions,
including the receipt of sufficient funds from the anticipated new senior credit facility. Our
intention to enter into the new senior credit facility and consummate the tender offer is dependent
on final pricing of the senior credit facility, which will depend on market conditions. If we do
not consider the pricing to be favorable, we will not consummate these transactions. 19




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS PageNumberIntroduction
    
    21Executive Overview
    
    21Subsequent Event
    
    22Results of Operations
    
    23Liquidity and Capital Resources
    
    30Significant Accounting Policies
    
    33New Accounting Pronouncements
    
    36Forward-Looking Statements
    
    36Risk Factors
    
    36
 20




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##### Table of Contents



Introduction The following discussion should be read in conjunction with our condensed, consolidated
financial statements provided under Part I, Item I of this quarterly report onForm 10-Q. We have
included herein statements that constitute forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. We generally identify forward-looking statements
in this report using words like believe, intend, expect, estimate, may, plan, should
plan, project, contemplate, anticipate, predict, potential, continue, or similar
expressions. You may find some of these statements below and elsewhere in this report. These
forward-looking statements are not historical facts and are inherently uncertain and outside of our
control. Any or all of our forward-looking statements in this report may turn out to be wrong.
They can be affected by inaccurate assumptions we might make or by known or unknown risks and
uncertainties. Many factors mentioned in our discussion in this report will be important in
determining future results. Consequently, no forward-looking statement can be guaranteed. Actual
future results may vary materially. Factors that may cause our plans, expectations, future
financial condition and results to change include those summarized in the section of this report
captioned Risk Factors. The forward-looking information set forth in this quarterly report onForm 10-Qis as of May
6, 2005, and we undertake no duty to update this information. Shareholders and prospective
investors can find information filed with the SEC after May 6, 2005 at our website at
www.investor.vcaantech.comor at the SECs website atwww.sec.gov. The following Managements Discussion and Analysis of Financial Condition and Results of
Operations describes the principal factors affecting the results of our operations for the quarter
ended March 31, 2005 as well as our overall liquidity, capital resources and contractual cash
obligations. In addition, we will discuss our significant accounting policies and estimates. We are a leading animal healthcare services company operating primarily in the United States.
We provide veterinary care and diagnostic testing to support veterinary care and we sell diagnostic
imaging equipment and other medical technology products and services to veterinarians. Our
activities are divided into three segments: Laboratory.We operate the largest network of veterinary diagnostic laboratories in the
nation. Our laboratories provide sophisticated testing and consulting services used by
veterinarians in the detection, diagnosis, evaluation, monitoring, treatment and prevention of
diseases and other conditions affecting animals. At March 31, 2005 our laboratory network
consisted of 28 laboratories serving all 50 states. Animal hospitals.We operate the largest network of freestanding, full-service animal
hospitals in the nation. Our animal hospitals offer a full range of general medical and surgical
services for companion animals. We treat diseases and injuries, offer pharmaceutical products and
perform a variety of pet wellness programs, including health examinations, diagnostic testing,
routine vaccinations, spaying, neutering and dental care. At March 31, 2005 our animal hospital
network consisted of 320 animal hospitals in 37 states. Medical technology.We sell ultrasound and digital radiography imaging equipment, related
computer hardware, software and ancillary services to veterinarians. This segment is a new segment
for our company and it is considerably smaller than our other two segments. 
 Executive Overview We had a strong first quarter marked by continued growth in our laboratory and animal hospital
segments. Consolidated revenue increased 29.5% to a first quarter record of $186.9 million and diluted
earnings per common share increased to $0.21. Our laboratory internal revenue growth, adjusted for
one less billing day, was 10.1% for the first quarter of 2005. Our laboratory gross profit
increased 11.2% to $23.9 million and our laboratory gross profit margin increased to 44.7% from
43.6% in the first quarter of 2004. Our consolidated animal hospital revenue for the first quarter
of 2005 grew 36.1%, primarily the result of animal hospital same-store revenue growth, adjusted for
one less business day, of 7.3% and the additional revenue of the animal hospitals acquired from
National PetCare Centers, Inc., or NPC, in June of 2004. NPC operated 67 animal hospitals in 11
states at the date of acquisition. The increase in animal hospital revenue increased animal
hospital gross profit 42.2% with gross profit margin growing to 19.3% from 18.5% in the first
quarter of 2004. 21




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##### Table of Contents



The acquisition of Sound Technologies, Inc., or STI, in October 2004 allowed us to enter into
the digital diagnostic imaging segment of the animal healthcare industry, which we believe is an
emerging and growing segment of animal healthcare. Our medical technology revenue and gross profit
for the first quarter of 2005 was $4.5 million and $1.0 million, respectively. Our growth strategy includes the acquisition of animal hospitals. In accord with that
strategy, we acquired eight animal hospitals, one of which was merged into an existing animal
hospital, in the first quarter of 2005. In accordance with our NPC merger plan, we closed two animal hospital facilities in the first
quarter of 2005. In the first quarter of 2005, we opened a new laboratory facility in North Carolina to better
service our customers in that region. The following table summarizes our laboratory and animal hospital facilities growth and animal
hospital closures: Three Months EndedMarch 31,2005
    
    

2004Laboratories:Beginning of period
    
    
    27
    
    
    
    23New facilities
    
    
    1
    
    
    
    End of period
    
    
    28
    
    
    
    23Animal hospitals:Beginning of period
    
    
    315
    
    
    
    241Acquisitions
    
    
    8
    
    
    
    9Relocated into hospitals operated by us
    
    
    (1
    )
    
    
    (2
    )Sold or closed
    
    
    (2
    )
    
    
    (1
    )End of period
    
    
    320
    
    
    
    247
 Though our operating results were strong for the first quarter of 2005, there are a variety of
factors that could cause our future performance to soften. Such factors include, but are not
limited to, the items discussed herein in the Risk Factorssection. 
 Subsequent Event On April 19, 2005, we announced our proposal to enter into a new senior credit facility
providing for up to $425.0 million in senior term notes and a $75.0 million revolving credit
facility. If consummated, the facility will provide for up to $475.0
million in senior term notes. The new senior credit facility is
intended, among other uses, to refinance the $220.3 million of total
outstanding senior term F notes and to provide the financing for a tender offer and consent
solicitation for any and all of our outstanding $170.0 million principal amount of 9.875% senior
subordinated notes due 2009. If the existing senior term F notes are refinanced and the tender
offer is consummated, we expect to incur debt retirement costs in the second quarter of 2005
related to the write-off of deferred financing costs and additional charges, including tender
consideration, related to expenses with respect to both the refinancing of the senior term F notes
and the purchase of the senior subordinated notes. The tender offer is contingent on the satisfaction of several conditions,
including the receipt of sufficient funds from the anticipated new senior credit facility. Our
intention to enter into the new senior credit facility and consummate the tender offer is dependent
on final pricing of the senior credit facility, which will depend on market conditions. If we do
not consider the pricing to be favorable, we will not consummate these transactions. 22




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##### Table of Contents



Results of Operations The following is a summary of the operating results for each of our segments (in thousands): Animal
    
    
    Medical
    
    
    
    
    
    
    Inter-
companyLaboratory
    
    
    Hospital
    
    
    Technology
    
    
    Corporate
    
    
    Eliminations
    
    
    TotalThree Months Ended March 31, 2005Revenue
    
    $
    53,439
    
    
    $
    133,354
    
    
    $
    4,484
    
    
    $
    
    
    
    $
    (4,414
    )
    
    $
    186,863Direct costs
    
    
    29,570
    
    
    
    107,619
    
    
    
    3,445
    
    
    
    
    
    
    
    (4,298
    )
    
    
    136,336Gross profit
    
    
    23,869
    
    
    
    25,735
    
    
    
    1,039
    
    
    
    
    
    
    
    (116
    )
    
    
    50,527Selling, general and administrative
expense
    
    
    3,365
    
    
    
    3,703
    
    
    
    1,567
    
    
    
    5,497
    
    
    
    
    
    
    
    14,132Loss (gain) on sale of assets
    
    
    
    
    
    
    (10
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10
    )Operating income (loss)
    
    $
    20,504
    
    
    $
    22,042
    
    
    $
    (528
    )
    
    $
    (5,497
    )
    
    $
    (116
    )
    
    $
    36,405Depreciation and amortization
    
    $
    902
    
    
    $
    2,744
    
    
    $
    299
    
    
    $
    397
    
    
    $
    
    
    
    $
    4,342Three Months Ended March 31, 2004Revenue
    
    $
    49,182
    
    
    $
    97,956
    
    
    $
    
    
    
    $
    
    
    
    $
    (2,788
    )
    
    $
    144,350Direct costs
    
    
    27,715
    
    
    
    79,863
    
    
    
    
    
    
    
    
    
    
    
    (2,788
    )
    
    
    104,790Gross profit
    
    
    21,467
    
    
    
    18,093
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    39,560Selling, general and administrative
expense
    
    
    3,173
    
    
    
    2,748
    
    
    
    
    
    
    
    2,780
    
    
    
    
    
    
    
    8,701Loss (gain) on sale of assets
    
    
    (1
    )
    
    
    63
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    62Operating income (loss)
    
    $
    18,295
    
    
    $
    15,282
    
    
    $
    
    
    
    $
    (2,780
    )
    
    $
    
    
    
    $
    30,797Depreciation and amortization
    
    $
    821
    
    
    $
    2,401
    
    
    $
    
    
    
    $
    394
    
    
    $
    
    
    
    $
    3,616
 23




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##### Table of Contents



The following table sets forth components of our condensed, consolidated income statements
expressed as a percentage of revenue: Three Months EndedMarch 31,2005
    
    
    2004Revenue:Laboratory
    
    
    28.6
    %
    
    
    34.1
    %Animal hospital
    
    
    71.4
    
    
    
    67.9Medical technology
    
    
    2.4
    
    
    
    Intercompany
    
    
    (2.4
    )
    
    
    (2.0
    )Total revenue
    
    
    100.0
    
    
    
    100.0Direct costs
    
    
    73.0
    
    
    
    72.6Gross profit
    
    
    27.0
    
    
    
    27.4Selling, general and administrative expense
    
    
    7.5
    
    
    
    6.0Loss (gain) on sale of assets
    
    
    
    
    
    
    0.1Operating income
    
    
    19.5
    
    
    
    21.3Interest expense, net
    
    
    3.6
    
    
    
    4.1Other expense
    
    
    
    
    
    
    0.1Minority interest in income of subsidiaries
    
    
    0.4
    
    
    
    0.3Income before provision for income taxes
    
    
    15.5
    
    
    
    16.8Provision for income taxes
    
    
    6.3
    
    
    
    6.6Net income
    
    
    9.2
    %
    
    
    10.2
    %
 Revenue The following table summarizes our revenue (in thousands, except percentages): Three Months Ended March 31,2005
    
    
    2004
    
    
    % ChangeLaboratory
    
    $
    53,439
    
    
    $
    49,182
    
    
    
    8.7
    %Animal hospital
    
    
    133,354
    
    
    
    97,956
    
    
    
    36.1
    %Medical technology
    
    
    4,484
    
    
    
    Intercompany
    
    
    (4,414
    )
    
    
    (2,788
    )Total revenue
    
    $
    186,863
    
    
    $
    144,350
    
    
    
    29.5
    %
 24




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##### Table of Contents



Laboratory Revenue Laboratory revenue increased $4.3 million for the three months ended March 31, 2005 as
compared to the same period in the prior year. The components of the increase in laboratory
revenue are detailed below (in thousands, except percentages and average price per requisition): Three Months Ended March 31,Laboratory Revenue:
    
    2005
    
    
    2004
    
    
    % ChangeInternal growth:Number of requisitions (2)
    
    
    2,263
    
    
    
    2,103
    
    
    
    7.6
    %Average revenue per requisition (1)
    
    $
    23.61
    
    
    $
    23.08
    
    
    
    2.3
    %Total internal revenue (2)
    
    $
    53,439
    
    
    $
    48,543
    
    
    
    10.1
    %Billing day adjustment (3)
    
    
    
    
    
    
    639Total
    
    $
    53,439
    
    
    $
    49,182
    
    
    
    8.7
    %
   (1)
    
    Computed by dividing total internal revenue by the number of requisitions.(2)
    
    Internal revenue and requisitions were calculated using laboratory operating results adjusted
for the impact resulting from any differences in the number of billing days in comparable
periods.(3)
    
    The 2004 billing day adjustment reflects the impact of one additional billing day for the
three months ended March 31, 2004 as compared to the three months ended March 31, 2005. The increase in requisitions from internal growth is the result of a continued trend in
veterinary medicine to focus on the importance of laboratory diagnostic testing in the diagnosis,
early detection and treatment of diseases. This trend is driven by an increase in the number of
specialists in the veterinary industry relying on diagnostic testing, the increased focus on
diagnostic testing in veterinary schools and general increased awareness through ongoing marketing
and continuing education programs provided by ourselves, pharmaceutical companies and other service
providers in the industry. In addition, we continue to see the impact from the recent migration of
diagnostic testing from the human healthcare industry and the advent of medicine in the veterinary
industry that requires diagnostic assessment and monitoring. The increase in the average revenue per requisition is attributable to price increases and
changes in the mix, type and number of tests performed per requisition. The prices of most tests
were increased 2% to 4% in February 2005 and in February 2004. 25




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##### Table of Contents



Animal Hospital Revenue Animal hospital revenue increased $35.4 million for the three months ended March 31, 2005 as
compared to the same period in the prior year. The components of the increase are summarized in
the following table (in thousands, except percentages and average price per order): Three Months Ended March 31,Animal Hospital Revenue:
    
    2005
    
    
    2004
    
    
    % ChangeSame-store facility:Orders (2)
    
    
    855
    
    
    
    863
    
    
    
    (0.9
    )%Average revenue per order (1)
    
    $
    119.15
    
    
    $
    109.91
    
    
    
    8.4
    %Same-store revenue (2)
    
    $
    101,837
    
    
    $
    94,945
    
    
    
    7.3
    %Business day adjustment (3)
    
    
    
    
    
    
    1,073Net acquired revenue
    
    
    31,517
    
    
    
    1,938Total
    
    $
    133,354
    
    
    $
    97,956
    
    
    
    36.1
    %
   (1)
    
    Computed by dividing same-store revenue by same-store orders.(2)
    
    Same-store revenue and orders were calculated using animal hospital operating results,
adjusted to exclude the operating results for the newly acquired animal hospitals that we did
not own for the entire period presented and adjusted for the impact resulting from any
differences in the number of business days in comparable periods.(3)
    
    The 2004 business day adjustment reflects the impact of one additional business day for the
three months ended March 31, 2004 as compared to the three months ended March 31, 2005. Over the last few years, some pet-related products, including medication prescriptions,
traditionally sold at animal hospitals have become more widely available in retail stores and other
distribution channels, and, as a result, we have fewer customers coming to our animal hospitals
solely to purchase those items. In addition, there has been a decline in the number of
vaccinations as some recent professional literature and research has suggested that vaccinations
can be given to pets less frequently. Orders for these pet-related products and vaccinations
generally generate revenue that is less than the average revenue for other orders. In addition,
our business strategy has placed greater emphasis on high-quality veterinary care and wellness
programs, which typically generate higher-priced orders. These trends have resulted in a decrease
in the number of orders and an increase in the average revenue per order. Price increases also contributed to the increase in the average revenue per order, which
approximated 2.5% to 6% on services at most hospitals in February 2005 and 2.5% to 5% in February

2004. Prices are reviewed on an annual basis for each hospital and adjustments are made based on
market considerations, demographics and our costs. Net acquired revenue represents the revenue from those animal hospitals acquired, net of
revenue from those animal hospitals sold or closed, on or after the beginning of the comparative
period, which was January 1, 2004 for the three months ended March 31, 2005. Fluctuations in net
acquired revenue occur due to the volume, size, and timing of acquisitions and disposals during the
periods compared. 26




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##### Table of Contents



Medical Technology Revenue The components of revenue for our medical technology segment for the three months ended March
31, 2005 are summarized in the following table (in thousands): Three Months EndedMarch 31, 2005Medical Technology Revenue:Ultrasound equipment
    
    $
    2,209Digital radiography
    
    
    865Education and installation services
    
    
    482Consulting and mobile imaging services
    
    
    928Total revenue
    
    $
    4,484
 We acquired our medical technology business on October 1, 2004 and consequently do not have
comparative operating results for prior periods. At March 31, 2005, we had not fully integrated
our medical technology division into our operations. As we complete the integration of this
business we may make changes to its operations and the terms on which we sell the equipment,
software and services that we offer. As a result of our integration plan and the seasonality of
the medical technology industry, results for the three months ended March 31, 2005 may not be
indicative of results experienced in future periods. Gross Profit The following table summarizes our gross profit and our gross profit as a percentage of
applicable revenue, or gross profit margin (in thousands, except percentages): Three Months Ended March 31,2005
    
    
    2004Gross
    
    
    
    
    
    
    GrossProfit
    
    
    
    
    
    
    Profit
    
    
    %$
    
    
    Margin
    
    
    $
    
    
    Margin
    
    
    ChangeLaboratory
    
    $
    23,869
    
    
    
    44.7
    %
    
    $
    21,467
    
    
    
    43.6
    %
    
    
    11.2
    %Animal hospital
    
    
    25,735
    
    
    
    19.3
    %
    
    
    18,093
    
    
    
    18.5
    %
    
    
    42.2
    %Medical technology
    
    
    1,039
    
    
    
    23.2
    %
    
    
    Intercompany
    
    
    (116
    )
    
    
    
    
    
    
    Total gross profit
    
    $
    50,527
    
    
    
    27.0
    %
    
    $
    39,560
    
    
    
    27.4
    %
    
    
    27.7
    %
 Laboratory Gross Profit Laboratory gross profit is calculated as laboratory revenue less laboratory direct costs.
Laboratory direct costs are comprised of all costs of laboratory services, including but not
limited to, salaries of veterinarians, specialists, technicians and other laboratory-based
personnel, facilities rent, occupancy costs, depreciation and amortization, and supply costs. The increase in laboratory gross profit margin was primarily attributable to increases in
laboratory revenue combined with operating leverage associated with our laboratory business. Our
operating leverage comes from the incremental margins we realize on additional tests ordered by the
same client, as well as when more comprehensive tests are ordered. We are able to benefit from
these incremental margins due to the relative fixed cost nature of our laboratory business. Animal Hospital Gross Profit Animal hospital gross profit is calculated as animal hospital revenue less animal hospital
direct costs. Animal hospital direct costs are comprised of all costs of services and products at
the animal hospitals, including, but not limited to, salaries of veterinarians, technicians and all
other animal hospital-based personnel, facilities rent, 27




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##### Table of Contents



occupancy costs, supply costs, depreciation
and amortization, certain marketing and promotional expense and costs of goods sold associated with
the retail sales of pet food and pet supplies. The increase in animal hospital gross profit margin was primarily attributable to increases in
animal hospital revenue combined with operating leverage associated with our laboratory business. Medical Technology Gross Profit Medical technology gross profit is calculated as medical technology revenue less medical
technology direct costs. Medical technology direct costs are comprised of all products and
services costs, including, but not limited to, all costs of equipment, related products and
services, salaries of technicians, support personnel, trainers, diagnostic specialists and other
non-administrative personnel, facilities rent, occupancy costs, depreciation and amortization and
supply costs. We acquired our medical technology division on October 1, 2004 and consequently do not have
comparative operating results for prior periods. At March 31, 2005, we had not fully integrated
our medical technology division into our operations. As we complete the integration of this
division we may make changes to operations and the terms on which we sell the equipment, software
and services that we offer. Consequently, our gross profit margins for the three months ended
March 31, 2005 may not be indicative of results experienced in future periods. 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, except percentages): Three Months Ended March 31,2005
    
    
    2004% of
    
    
    
    
    
    
    % of
    
    
    %$
    
    
    Revenue
    
    
    $
    
    
    Revenue
    
    
    ChangeLaboratory
    
    $
    3,365
    
    
    
    6.3
    %
    
    $
    3,173
    
    
    
    6.5
    %
    
    
    6.1
    %Animal hospital
    
    
    3,703
    
    
    
    2.8
    %
    
    
    2,748
    
    
    
    2.8
    %
    
    
    34.8
    %Medical technology
    
    
    1,567
    
    
    
    34.9
    %
    
    
    
    
    
    
    0.0
    %Corporate
    
    
    5,497
    
    
    
    2.9
    %
    
    
    2,780
    
    
    
    1.9
    %
    
    
    97.7
    %Total SG&A
    
    $
    14,132
    
    
    
    7.6
    %
    
    $
    8,701
    
    
    
    6.0
    %
    
    
    62.4
    %
 Laboratory SG&A Laboratory SG&A consists primarily of salaries of sales, customer support, administrative and
accounting personnel, selling, marketing and promotional expense. The decrease in laboratory SG&A as a percentage of laboratory revenue was primarily
attributable to an increase in laboratory revenue combined with operating leverage associated with
our laboratory business. Animal Hospital SG&A Animal hospital SG&A consists primarily of salaries of field management, certain
administrative and accounting personnel, recruiting and certain marketing expense. Medical Technology SG&A Medical technology SG&A consists primarily of salaries of sales, customer support,
administrative and accounting personnel, selling, marketing and promotional expense, and research
and development costs. We acquired our medical technology division on October 1, 2004 and consequently do not have
comparative operating results for prior periods. At March 31, 2005, we had not fully integrated
our medical technology division into our operations. As we complete the integration of this
division we may make changes to operations and the 28




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##### Table of Contents



terms on which we sell the equipment, software
and services that we offer. Consequently, results for the three months ended March 31, 2005
(including selling, general and administrative expense as a percentage of revenue) for the medical
technology division may not be indicative of results experienced in future periods. Corporate SG&A Corporate SG&A consists of administrative expense at our headquarters, including the salaries
of corporate officers, administrative and accounting personnel, rent, accounting, finance, legal
and other professional expense and occupancy costs as well as corporate depreciation. During the three months ended March 31, 2004, we resolved an outstanding claim with our
insurance company related to a legal settlement and received reimbursement of $1.9 million. The
following table reconciles corporate SG&A as reported to corporate SG&A excluding the partial
reimbursement (in thousands, except percentages): Three Months Ended March 31,2005
    
    
    2004% of
    
    
    
    
    
    
    % of
    
    
    %$
    
    
    Revenue
    
    
    $
    
    
    Revenue
    
    
    ChangeCorporate SG&A as reported
    
    $
    5,497
    
    
    
    2.9
    %
    
    $
    2,780
    
    
    
    1.9
    %
    
    
    97.7
    %Impact of certain items:Litigation settlement reimbursement
    
    
    
    
    
    
    
    
    
    
    (1,124
    )Legal fees reimbursement
    
    
    
    
    
    
    
    
    
    
    (801
    )Corporate SG&A excluding the
impact of certain items:
    
    $
    5,497
    
    
    
    2.9
    %
    
    $
    4,705
    
    
    
    3.3
    %
    
    
    16.8
    %
 Corporate SG&A, excluding the impact of certain items, as a percentage of total revenue
decreased primarily as a result of an increase in total revenue combined with operating leverage. Interest Expense, Net The following table summarizes our interest expense, net of interest income (in thousands): Three Months EndedMarch 31,2005
    
    
    2004Interest expense:Senior term notes
    
    $
    2,420
    
    
    $
    1,3429.875% senior subordinated notes
    
    
    4,197
    
    
    
    4,197Interest rate hedging agreements
    
    
    (94
    )
    
    
    164Amortization of deferred financing costs and debt discount
    
    
    209
    
    
    
    184Secured and unsecured seller notes
    
    
    61
    
    
    
    33Capital leases and other
    
    
    148
    
    
    
    1556,941
    
    
    
    6,075Interest income
    
    
    274
    
    
    
    90Total interest expense, net of interest income
    
    $
    6,667
    
    
    $
    5,985
 The increase in interest expense related to our senior term notes was attributable to $79.7
million in additional borrowings used to fund the NPC acquisition on June 1, 2004 and an increase
in LIBOR. Provision for Income Taxes Our effective tax rate was 40.5% and 39.3% for the three months ended March 31, 2005 and 2004,
respectively. The effective tax rate for the three months ended March 31, 2004 is slightly lower
than our statutory rate primarily due to a litigation settlement reimbursement in the amount of
$1.1 million, which we discuss above in the Corporate 29




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##### Table of Contents



SG&Asection, which had no related tax
expense. The effective tax rate for the three months ended March 31, 2005 approximates the
statutory rate. 
 Liquidity and Capital Resources The following table summarizes our cash flows (in thousands): Three Months EndedMarch 31,2005
    
    
    2004Cash provided by (used in):Operating activities
    
    $
    35,368
    
    
    $
    29,536Investing activities
    
    
    (21,583
    )
    
    
    (17,305
    )Financing activities
    
    
    (3,223
    )
    
    
    (107
    )Increase in cash and cash equivalents
    
    
    10,562
    
    
    
    12,124Cash and cash equivalents at beginning of year
    
    
    30,964
    
    
    
    17,237Cash and cash equivalents at end of year
    
    $
    41,526
    
    
    $
    29,361
 Cash Flows from Operating Activities Net cash provided by operating activities increased $5.8 million in the three months ended
March 31, 2005 as compared to the comparable period in the prior year primarily due to improved
operating performance and acquisitions. Our cash flows from operating activities for the three
months ended March 31, 2005 as compared to the comparable period in the prior year were negatively
impacted by an increase in interest paid of $742,000 and a litigation settlement reimbursement
received during the three months ended March 31, 2004. On a prospective basis, we anticipate cash flow from operating activities to continue growing
in line with increases in operating income resulting from improved operating performance and
acquisitions. However, we also anticipate that operating cash flow may be negatively impacted by
an increase in cash paid for interest as a result of interest rates rising. Interest rates have
been at historical lows and are projected to increase over the next several years. Significant
increases in interest rates may materially impact our operating cash flows because of the variable
rate nature of our senior credit facility. In addition, our cash interest payments will change if
we are successful in refinancing our existing senior credit facility and are able to pay off our
outstanding $170.0 million principal amount of 9.875% senior subordinated notes due 2009 as
discussed further in Subsequent Event under Item 2 of
this quarterly report. Cash Flows used in Investing Activities Net cash used in investing activities primarily consisted of cash used for the acquisition of
animal hospitals and expenditures for property and equipment. Depending upon the attractiveness of the candidates and the strategic fit with our existing
operations, we intend to acquire approximately 20 to 25 independent animal hospitals per year with
aggregate annual revenues of approximately $25.0 million to $30.0 million. In addition, we also
evaluate the acquisition of animal hospital chains, laboratories or related businesses if favorable
opportunities are presented. For example, in 2004 we acquired 85 animal hospitals, 67 of which
were part of a chain operated by NPC, which we acquired in June 2004. We intend to primarily use
cash in our acquisitions but, depending on the timing and amount of our acquisitions, we may use
stock or debt. In 2005, we also intend to spend approximately $25.0 million for property and
equipment. Cash Flows from Financing Activities Net cash used in financing activities primarily consisted of cash used to repay our long-term
obligations. 30




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Future Cash Requirements The following table sets forth the scheduled principal, interest and other contractual cash
obligations due by us for each of the years indicated (in thousands): Total
    
    
    2005 (1)
    
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    ThereafterLong-term debt
    
    $
    393,142
    
    
    $
    2,536
    
    
    $
    29,214
    
    
    $
    109,056
    
    
    $
    81,714
    
    
    $
    170,086
    
    
    $
    536Capital lease obligations
    
    
    333
    
    
    
    114
    
    
    
    129
    
    
    
    64
    
    
    
    26
    
    
    
    
    
    
    
    Operating leases
    
    
    360,840
    
    
    
    17,345
    
    
    
    23,036
    
    
    
    22,943
    
    
    
    22,720
    
    
    
    22,243
    
    
    
    252,553Fixed cash interest expense
    
    
    85,347
    
    
    
    17,240
    
    
    
    17,250
    
    
    
    16,913
    
    
    
    17,049
    
    
    
    16,840
    
    
    
    55Variable cash interest expense (2)
    
    
    33,938
    
    
    
    8,759
    
    
    
    13,065
    
    
    
    9,470
    
    
    
    2,644
    
    
    
    
    
    
    
    Swap agreements (2)
    
    
    (99
    )
    
    
    (99
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Purchase obligations
    
    
    12,912
    
    
    
    8,189
    
    
    
    4,008
    
    
    
    330
    
    
    
    330
    
    
    
    55
    
    
    
    Other long-term liabilities
    
    
    41,344
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    41,344$
    927,757
    
    
    $
    54,084
    
    
    $
    86,702
    
    
    $
    158,776
    
    
    $
    124,483
    
    
    $
    209,224
    
    
    $
    294,488
   (1)
    
    Consists of the period April 1 through December 31, 2005.(2)
    
    We have both fixed-rate and variable-rate debt. The interest payments on our variable-rate
debt are based on a variable rate component plus a fixed 1.75%. Including the fixed 1.75%, we
estimate that the interest rate on our variable rate debt will be 3.28%, 4.25%, 4.60% and
4.75% for years 2005 through 2008, respectively. These estimates are based on interest rate
projections used to price our interest rate swap agreements. Our consolidated financial
statements included in our 2004 annual report on Form 10-K discuss these variable-rate notes
in more detail. Our future cash commitments will change if we are successful in refinancing our existing
senior credit facility and are able to pay off our outstanding $170.0 million principal amount of
9.875% senior subordinated notes due 2009, as discussed further in
Subsequent Event under Item 2 of this quarterly report. The table above excludes certain contractual arrangements whereby additional cash may be paid
to former owners of acquired companies, including STI, upon attainment of specified performance
targets. We may be required to pay up to $4.5 million in future periods if these performance
targets are achieved. We anticipate that our cash on-hand, net cash provided by operations and, if needed, our
revolving credit facility will provide sufficient cash resources to fund our contractual
obligations and other cash needs for operations for more than the next 12 months. If we consummate
one or more significant acquisition during this period we may need to seek additional debt or
equity financing. Debt Related Covenants Our senior credit facility contains certain financial covenants pertaining to interest
coverage, fixed charge coverage and leverage ratios. In addition, the senior credit facility has
restrictions pertaining to capital expenditures, acquisitions and the payment of cash dividends.
In particular, the covenants limit our acquisition spending, without a waiver, to $50.0 million per
year plus up to $5.0 million of any unused amount from the previous year. As of March 31, 2005, we
were in compliance with these covenants. We currently believe the most restrictive covenant is the
fixed charge coverage ratio. The senior credit facility defines the fixed charge coverage ratio as
that ratio which is calculated on a last 12-month basis by dividing pro forma earnings before
interest, taxes, depreciation and amortization, as defined by the agreement, by fixed charges.
Fixed charges are defined as cash interest expense, scheduled principal payments on debt
obligations, capital expenditures, and provision for income taxes. At March 31, 2005, we had a
fixed charge coverage ratio of 1.43 to 1.00, which was in compliance with the required ratio of no
less than 1.10 to 1.00. Interest Rate Hedging Agreements We entered into certain no-fee swap agreements whereby we pay to counterparties amounts based
on fixed interest rates and set notional principal amounts in exchange for the receipt of payments
from the counterparties 31




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based on London interbank offer rates, LIBOR, and the same set notional
principal amounts. A summary of these agreements is as follows: Swap AgreementsFixed interest rate
    
    
    1.72
    %
    
    
    1.51
    %Notional amount
    
    $20.0 million
    
    $20.0 millionEffective date
    
    
    5/30/2003
    
    
    
    5/30/2003Expiration date
    
    
    5/31/2005
    
    
    
    5/31/2005Counter party
    
    Wells Fargo Bank
    
    Goldman Sachs
 We entered into these swap agreements to hedge against the risk of increasing interest rates.
The contracts effectively convert a certain amount of our variable rate debt under our senior
credit facility to fixed rate debt for purposes of controlling cash paid for interest. That amount
is equal to the notional amount of the swap agreements and the fixed rate conversion period is
equal to the terms of the contract. The impact of these swap agreements has been factored into our
future contractual cash requirements table above. In the future, we may enter into additional interest rate strategies to take advantage of
favorable current rate environments. We have not yet determined what those strategies will be or
their possible impact. In addition, if we are successful in refinancing our existing senior credit
facility as discussed in Subsequent Event under Item 2 of
this quarterly report, we may be required by the new senior credit facility to
hedge a certain amount of our variable rate debt. Description of Indebtedness Senior Credit Facility At March 31, 2005, we had $220.3 million principal amount outstanding under our senior term F
notes and no borrowings outstanding under our revolving credit facility. We pay interest on our senior term F notes and our revolving credit facility based on the
interest rate offered to our administrative agent on the London interbank market, or LIBOR, plus an
applicable margin. For our senior term F notes, that margin is 1.75% per annum and for our
revolving credit facility that margin ranges from 2.00% to 3.25% per annum. The senior term F notes mature in September 2008 and the revolving credit facility matures in
September 2006. 32




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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 March 31, 2005, the outstanding principal balance of these senior subordinated notes
was $170.0 million. We and each existing 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
senior credit facility and any other indebtedness permitted to be incurred by Vicar under the terms
of the indenture agreement governing these notes. Beginning December 1, 2005, we can redeem all of our 9.875% senior subordinated notes at
104.9% of the principal amount. Pursuant to the terms of the indenture agreement, the redemption
price decreases to 103.3% on December 1, 2006, 101.6% on December 1, 2007 and 100.0% on December 1,
2008. If we are successful in refinancing our existing senior credit facility, we expect to use a
portion of those proceeds to purchase our outstanding $170.0 million principal amount of 9.875%
senior subordinated notes due 2009, as discussed further in
Subsequent Event under Item 2 of
this quarterly report, at a purchase price
of approximately 108.1%. Other Debt At March 31, 2005, we had seller notes secured by assets of animal hospitals, unsecured debt
and capital leases that totaled $3.2 million. 
 Significant Accounting Policies We believe that the application of the following accounting policies, which are important
to our financial position and results of operations, requires significant judgments and estimates
on the part of management. For a summary of all our accounting policies, including the accounting
policies discussed below, see our consolidated financial statements included in our 2004 annual
report on Form 10-K. Revenue Laboratory and Animal Hospital Revenue We recognize laboratory and animal hospital 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. Approximately 8% of laboratory revenue for the three months ended March 31, 2005 was
intercompany revenue that was generated by providing laboratory services to our animal hospitals.
For purposes of reviewing the operating performance of the business segments, all intercompany
revenue is accounted for as if the transaction was with an independent third-party at current
market prices. For financial reporting purposes, intercompany revenue is eliminated as part of our
consolidation. Our laboratories give discounts, such as those for prompt payment, to clients in periods
subsequent to the period the related revenue was recognized, however, we report the related revenue
net of those discounts. In order to net the discounts against the related revenue, we estimate the
discounts based on historical experience. We do not expect that revisions to these discounts would
have a material effect on our condensed, consolidated financial statements. 33




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Medical Technology Revenue Substantially all of our medical technology revenue is derived from the sale of ultrasound
imaging equipment and digital radiography equipment; however, we also derive additional revenue
from: (i) licensing our software; (ii) providing technical support and product updates related to
the equipment we sell and our software, otherwise known as maintenance; and (iii) providing
professional services related to the equipment we sell and our software, including installations,
on-site training and education services. We frequently sell equipment and license our software in
multiple element arrangements in which the customer may choose a combination of one or more of the
following elements: (i) ultrasound imaging equipment; (ii) digital radiography equipment; (iii)
software products; (iv) computer hardware; (v) maintenance; and (vi) professional services. While accounting for the sale of equipment is substantially governed by the requirements of
Staff Accounting Bulletin, SAB, No. 104, Revenue Recognition, as amended, and the sale of software
licenses and related items is governed by Statement of Position, SOP, No. 97-2, Software Revenue
Recognition,as amended, the determination of the amount of software license, maintenance and
professional service revenue to be recognized in each accounting period requires us to exercise
judgment and use estimates. We sell our ultrasound imaging equipment with and without related computer hardware and
software. We account for the sale of ultrasound imaging equipment on a stand-alone basis under
requirements of SAB No. 104. We account for the sale of ultrasound imaging equipment with related
computer hardware and software by bifurcating the transaction and accounting for the ultrasound
imaging equipment under SAB No. 104 and the computer hardware and software under SOP No. 97-2. The
consensus reached by Emerging Issues Task Force, EITF, No. 03-5, Applicability of AICPA Statement
of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental
Software,requires that arrangements that include software that is more than incidental to the
products or services as a whole are to be accounted for under SOP 97-2. We have concluded that our
software is incidental to the ultrasound imaging equipment because that equipment is manufactured
as an out-of-the-box solution and many of our customers purchase it as such. We have also
concluded that the software is more than incidental to the computer hardware we sell and therefore
account for that portion of the sale under SOP 97-2. We sell our digital radiography equipment with related computer hardware and software. The
digital radiography equipment requires the computer hardware and software to function. As a
result, we account for the digital radiography sales under SOP 97-2. Under the residual method prescribed by SOP 97-2, revenue is recognized when vendor-specific
objective evidence of fair value exists for all of the undelivered elements in the arrangement
(i.e. maintenance and professional services), but does not exist for one or more of the delivered
elements in the arrangement (i.e. the equipment, computer hardware or the software product). Each
transaction requires careful analysis to ensure that all of the individual elements in the license
transaction have been identified, along with the fair value of each element. We allocate revenue to each undelivered element based on its fair value, with the fair value
determined by the price charged when that element is sold separately. We are recognizing the
revenue on the computer hardware and software we sell with our ultrasound equipment when the
computer hardware is delivered, as there are no undelivered elements associated with the sale at
that point in time. We recognize the revenue on the sale of ultrasound imaging equipment upon
delivery as well as there are not undelivered elements associated with the sale. We are recognizing
the revenue on computer hardware and software we sell with our digital radiography equipment over
the period we are providing maintenance, ranging from one to four years. We are recognizing the
revenue for the sale of the digital radiography equipment over that same period because the
software and computer hardware we sell with this equipment is essential to its functionality. In determining whether or not to recognize revenue, we evaluate each of these criteria:  
    Evidence of an arrangement: We consider a non-cancelable agreement signed by
the customer and us to be evidence of an arrangement.
    Delivery: We consider delivery to have occurred when the ultrasound imaging
equipment is delivered and the digital radiography equipment is installed. We recognize
revenue for professional services when that 34




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service is provided or on a straight-line basis over the service contract term, based on the
nature of the service or the terms of the contract.
    Fixed or determinable fee: We assess whether fees are fixed or determinable at
the time of sale and recognize revenue if all other revenue recognition requirements are
met. We generally consider payments that are due within six months to be fixed or
determinable based upon our successful collection history. We only consider fees to be
fixed or determinable if they are not subject to refund or adjustment.
    Collection is deemed probable: We conduct a credit review for all significant
transactions at the time of the arrangement to determine the credit worthiness of the
customer. Collection is deemed probable if we expect that the customer will be able to pay
amounts under the arrangement as payments become due. If we determine that collection is
not probable, we defer the revenue and recognize the revenue upon cash collection. Our software is ready to use by the customer upon receipt, and there is no significant
customization of the underlying software code required to meet the individual needs of customers.
We provide warranties for our software guaranteeing its performance for a defined period of time.
Historically, the costs to satisfy these warranties have been nominal and we expect this to be the
case in the future. Accordingly, we expense these costs as incurred. Approximately 6% of our medical technology revenue for the three months ended March 31, 2005
was intercompany that was generated by providing products and services to our animal hospitals. Valuation of Goodwill Our goodwill represents the excess of the cost of an acquired entity over the net of the
amounts assigned to identifiable assets acquired and liabilities assumed. The total amount of our
goodwill at March 31, 2005 was $513.5 million, consisting of $93.7 million for our laboratory
segment, $400.5 million for our animal hospital segment and $19.3 million for our medical
technology segment. Annually, and upon material changes in our operating environment, we test our goodwill for
impairment by comparing the fair market value of our reporting units, which equate to our
laboratory, animal hospital and medical technology operating segments, to their respective net book
value. At December 31, 2004 and 2003, the estimated fair market value of each of our operating
segments exceeded their respective net book value, resulting in a conclusion that our goodwill was
not impaired. Income Taxes We account for income taxes under SFAS 109, Accounting for Income Taxes.In accordance with
SFAS No. 109, we record deferred tax liabilities and deferred tax assets, which represent taxes to
be recovered or settled in the future. We adjust our deferred tax assets and deferred tax
liabilities to reflect changes in tax rates or other statutory tax provisions. Changes in tax
rates or other statutory provisions are recognized in the period the change occurs. We made judgments in assessing our ability to realize future benefits from our deferred tax
assets. As such, we record a valuation allowance to reduce our deferred tax assets for the portion
we believe will not be realized. At March 31, 2005 and 2004, we used valuation allowances to
offset net operating loss and capital loss carryforwards and investment related expenditures where
the realization of this deduction is uncertain. We have also recorded as other liabilities in our consolidated balance sheets a liability for
any differences between the probable tax bases and the as-filed tax bases of certain assets and
liabilities. Such liability relates to losses that to our best judgment are probable. Changes in
facts and circumstances may cause us to: (1) lower our estimates or determine that payments are no
longer probable resulting in a reduction of our future tax provision; or (2) increase our estimates
resulting in an increase in our future tax provision. In addition, there are certain tax
contingencies that represent a possible future payment but not a probable one. While we have not
recognized a liability for these possible future payments, they may result in future cash payments
and increase our tax provision. 35




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New Accounting Pronouncements Share-Based Compensation In
December 2004, the Financial Accounting Standards Board, or
FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 123R,
Share-Based Payment,which replaces SFAS No. 123 and supersedes APB Opinion No. 25. SFAS No. 123R
will require us to measure the cost of share-based payments to employees, including stock options,
based on the grant date fair value and to recognize the cost over the requisite service period. On April 19, 2005, the Securities and Exchange Commission amended the compliance date for SFAS
123R to fiscal years beginning after June 15, 2005. We intend to adopt SFAS 123R effective with
the compliance date applicable to us, which is currently scheduled for January 1,
2006. We are currently evaluating the method we will use to value
share-based payments and the impact of this standard on our consolidated financial statements. Inventory Costs In November 2004, the FASB issued SFAS No. 151, Inventory Costs  An Amendment of ARB No. 43,
Chapter 4, effective for fiscal years beginning after June 15, 2005, to clarify the accounting for
abnormal amounts of idle facility expense, freight, handling costs, and wasted material or spoilage
that may be incurred. Among other things, SFAS No. 151 requires that these items be recognized as
charges to expense in the periods incurred and clarifies that fixed production overhead costs be
allocated to inventory based on normal production capacity. Unallocated overhead costs associated
with abnormally low or high production in a given period should be charged to expense in that
period. SFAS No. 151 is effective for our company on January 1, 2006 and we do not expect it to
have a material impact on our consolidated financial statements or the way we conduct our
operations. Accounting for Preexisting Relationships between the Parties to a Business Combination In October 2004, the FASB ratified the Emerging Issues Task Force, or EITF, consensus on
Issue No. 04-1, Accounting for Preexisting Relationships between the Parties to a Business
Combination. This consensus will require parties in a business combination that had a preexisting
relationship to evaluate whether or not the acquisition resulted in the settlement of an existing
contract, thus requiring accounting treatment separate from the business combination. The consensus of EITF No. 04-1 must be applied as appropriate for our company beginning on
January 1, 2005. We generally do not have preexisting contracts with the parties we acquire, and
therefore, we do not expect that the application of EITF No. 04-1 will have a material impact on
our consolidated financial statements or the way we conduct our operations. 
 Forward-Looking Statements This quarterly report on Form 10-Q contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995, 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. We generally identify forward-looking statements in this report
using words like believe, intend, expect, estimate, may, plan, should plan,
project, contemplate, anticipate, predict, potential, continue, or similar expressions.
You may find some of these statements below and elsewhere in this report. These forward-looking
statements are not historical facts and are inherently uncertain and outside of our control. Any
or all of our forward-looking statements in this report may turn out to be wrong. They can be
affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties.
Many factors mentioned in our discussion in this report will be important in determining future
results. Consequently, no forward-looking statement can be guaranteed. Actual future results may
vary materially. Factors that may cause our plans, expectations, future financial condition and
results to change include those summarized in the section of this report captioned Risk Factors. 
 Risk Factors Because of the factors set forth below, and the other cautionary language contained above and
in other sections of this quarterly report, investors in our common stock should not assume that the
forward-looking statements 36




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contained in this quarterly report will prove to be a reliable indicator of future performance,
and investors should not use these forward-looking statements to anticipate results or trends in
future periods. 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
healthcare services company through a balanced program of internal growth initiatives and selective
acquisitions of established animal hospitals, laboratories and related businesses. 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. For example, the animal hospitals we acquired as part of the acquisition of NPC have not
achieved the same gross profit margin as our animal hospitals that existed at the time we acquired
NPC. In addition, our medical technology division, acquired in October 2004, operates at lower
gross profit margins than the combined gross profit margins for our laboratory and animal hospital
divisions. Our internal growth rate may decline and could become negative. Our laboratory
internal revenue growth has fluctuated between 9.8% and 14.1% for each fiscal year from 2002
through 2004. For the three months ended March 31, 2005, our laboratory internal revenue growth,
adjusted for one less billing day, was 10.1%. Similarly, our animal hospital same-store revenue
growth rate has fluctuated between 3.6% and 4.9% over the same fiscal years. For the three months
ended March 31, 2005, our animal hospital same-store revenue growth, adjusted for one less business
day, was 7.3%. 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. Investors should not assume that our historical growth rates and margins are reliable
indicators of results in future periods. Demand for certain products could decline as their product life cycle matures and the products
become available in other channels of distribution such as retail-oriented locations and through
Internet service providers. This cycle could affect the frequency of veterinary visits and may
result in a reduction in revenue. Demand for vaccinations may also be impacted in the future as
protocols for vaccinations change. Vaccinations have been recommended by some in the profession to
be given less frequently. This may result in fewer visits and potentially less revenue. Vaccine
protocols for our company are currently established by our veterinarians. Some of our
veterinarians have changed their protocols and others may change their protocol in light of recent
literature. Due to the fixed cost nature of our business, fluctuations in our revenue could adversely affect
our operating income. Significantly more than a majority of our expense in 2004, 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, laboratories and related businesses. In 2004, we
acquired 85 animal hospitals, 67 in a single acquisition of NPC, and a new medical technology
division, a new business segment for us. We expect to continue our acquisition program in all
segments of our business. If we acquire additional animal hospital chains in future periods, we
will likely acquire a number of animal hospitals in that fiscal year greater than the 20 to 25
animal hospitals that has been our goal in recent years. In addition, we may acquire animal
hospitals or laboratories in geographic territories where we do not have existing operations.
Further, we may consider acquisitions of related businesses, such as the medical technology
division we acquired in 2004, in future periods. Any difficulties in the integration process may
result in increased expense, loss of customers and a decline in profitability. In some cases, we
have experienced delays and increased costs in integrating acquired businesses, particularly where
we acquire a large number of animal hospitals in a single region at or about the same time.
Further, the expansion into new territories and new business segments result in risks to successful
integration of the acquired businesses that are new to our operations. As a consequence, our field
management may spend a greater amount of time integrating these new businesses and less time
managing our existing businesses. During these periods, there may be less attention directed to
marketing efforts or staffing issues. We also may experience delays in converting the systems of
acquired businesses into our systems, which could result in increased payroll expense to collect
our results and 37




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delays in reporting our results, both for a particular region and on a consolidated basis.
Further, the legal and business environment prevalent in new territories and with respect to new
businesses may pose risks that we do not anticipate and adversely impact our ability to integrate
newly acquired operations. For all of these reasons, our historical success in integrating
acquired businesses is not a reliable indicator of our ability to do so in the future. If we are
not successful in timely and cost-effectively integrating future acquisitions, it could result 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. We face numerous risks associated with our acquisition of our medical technology division. In October 2004 we acquired STI, which we now operate as our medical technology division.
This acquisition poses numerous risks, in addition to the risks discussed in the immediately
preceding paragraphs. STI sells medical imaging equipment and related software and services. At
the time of the acquisition, our existing management had no experience in this industry and
consequently may not be as effective in managing and overseeing these operations as in the case of
business segments where they have significant operating experience. Advanced medical imaging
equipment has not been widely adopted in the veterinary market and no clear market leader has
emerged. As advanced medical imaging equipment becomes more common in the veterinary industry and
generates more significant aggregate revenues, the competition may increase, along with greater
price pressures and demands for research and development and market differentiation. Our medical
technology division does not manufacture the principal products it distributes and is dependent
upon distribution agreements with the manufacturers of the equipment for its future business. If
these distribution agreements terminate and are not renewed, or if the manufacturers breach their
covenants under these agreements, or the equipment manufactured by these manufacturers becomes less
competitive, the demand for our products and services would decrease. Any reduction in demand
could lead to fewer customer orders, reduced revenues, pricing pressures, reduced margins, reduced
levels of profitability and loss of market share. STI was a relatively young company at the time
of our acquisition and lacked the financial and operating infrastructure and controls which we have
in our other operations. As part of the integration of STI into our operations, we will be
required to expand its financial and operating infrastructure and strengthen its control
environment to meet the standards that prevail in the remainder of our operations. The failure to
timely integrate this operation and achieve these objectives could result in an adverse impact on
our revenues, margins and profitability. The carrying value of our goodwill could be subject to impairment write-down. At March 31, 2005, our balance sheet reflected $513.5 million of goodwill, which was a
substantial portion of our total assets of $766.6 million at that date. We expect that the
aggregate amount of goodwill on our balance sheet will increase as a result of future acquisitions.
We continually evaluate whether events or circumstances have occurred that suggest that the fair
market value of each of our reporting units is below their carrying values. If we determine that
the fair market value of one of our reporting units is less than its carrying value, this may
result in an impairment write-down of the goodwill for that reporting unit. The impairment
write-down would be reflected as expense and could have a material adverse effect on our results of
operations during the period in which we recognize the expense. At December 31, 2004, we concluded
that the fair value of our reporting units exceeded their carrying value and accordingly, as of
that date, our goodwill was not impaired in our consolidated financial 38




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statements. However, in the future we may incur impairment charges related to the goodwill
already recorded or arising out of future acquisitions. We require a significant amount of cash to service our debt and expand our business as planned. We have, and will continue to have, a substantial amount of debt. Our substantial amount of
debt requires us to dedicate a significant portion of our cash flow from operations to pay down our
indebtedness and related interest, thereby reducing the funds available to use for working capital,
capital expenditures, acquisitions and general corporate purposes. At March 31, 2005, our debt consisted of:  
    $220.3 million in principal amount outstanding under our senior term F notes;
    $170.0 million in principal amount outstanding under our 9.875% senior subordinated notes; and
    $3.2 million in principal amount outstanding under our other debt. Our ability to make payments on our debt, and to fund acquisitions, will depend upon our
ability to generate cash in the future. Insufficient cash flow could place us at risk of default
under our debt agreements or could prevent us from expanding our business as planned. Our ability
to generate cash is subject to general economic, financial, competitive, legislative, regulatory
and other factors that are beyond our control. Our business may not generate sufficient cash flow
from operations, our strategy to increase operating efficiencies may not be realized and future
borrowings may not be available to us under our senior credit facility in an amount sufficient to
enable us to service our debt or to fund our other liquidity needs. In order to meet our debt
obligations, we may need to refinance all or a portion of our debt. We may not be able to
refinance any of our debt on commercially reasonable terms or at all. Our debt instruments may adversely affect our ability to run our business. Our substantial amount of debt, as well as the guarantees of our subsidiaries and the security
interests in our assets and those of our subsidiaries, could impair our ability to operate our
business effectively and may limit our ability to take advantage of business opportunities. For
example, our indenture and senior credit facility:  
    limit our funds available to repay the 9.875% senior subordinated notes;
    limit our ability to borrow additional funds or to obtain other financing in the future
for working capital, capital expenditures, acquisitions, investments and general corporate
purposes;
    limit our ability to dispose of our assets, create liens on our assets or to extend
credit;
    make us more vulnerable to economic downturns and reduce our flexibility in responding
to changing business and economic conditions;
    limit our flexibility in planning for, or reacting to, changes in our business or industry;
    place us at a competitive disadvantage to our competitors with less debt; and
    restrict our ability to pay dividends, repurchase or redeem our capital stock or debt,
or merge or consolidate with another entity. The terms of our indenture and senior credit facility allow us, under specified conditions, to
incur further indebtedness, which would heighten the foregoing risks. If compliance with our debt
obligations materially hinders our ability to operate our business and adapt to changing industry
conditions, we may lose market share, our revenue may decline and our operating results may suffer. 39




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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 healthcare services industry could cause us to
reduce prices or lose market share. The companion animal healthcare services industry is highly competitive with few barriers to
entry. To compete successfully, we may be required to reduce prices, increase our operating costs
or take other measures that could have an adverse effect on our financial condition, results of
operations, margins and cash flow. If we are unable to compete successfully, we may lose market
share. There are many clinical laboratory companies that provide a broad range of laboratory testing
services in the same markets we service. Our largest competitor for outsourced laboratory testing
services is Idexx Laboratories, Inc., or Idexx. Idexx currently competes or intends to compete in
most of the same markets in which we operate. In this regard, Idexx has recently acquired
additional laboratories in the markets in which we operate and has announced plans to continue this
expansion and aggressively bundles all of their products and services to compete with us.
Increased competition may lead to pressures on the revenues and margins of our laboratory
operations. Also, Idexx and several other national companies provide on-site diagnostic equipment
that allows veterinarians to perform their own laboratory tests. Our primary competitors for our animal hospitals in most markets are individual practitioners
or small, regional, multi-clinic practices. Also, regional pet care companies and some national
companies, including operators of super-stores, are developing multi-regional networks of animal
hospitals in markets in which we operate. Historically, when a competing animal hospital opens in
proximity to one of our hospitals, we have reduced prices, expanded our facility, retained
additional qualified personnel, increased our marketing efforts or taken other actions designed to
retain and expand our client base. As a result, our revenue may decline and our costs may
increase. Our medical technology division is a relatively new entrant in the market for medical imaging
equipment in the animal healthcare industry. Our primary competitors are companies that are much
larger than us and have substantially greater capital, manufacturing, marketing and research and
development resources than we do, including companies such as Siemens, Phillips and Canon. The
success of our medical technology division, in part, is due to its focus on the veterinary market,
which allows it to differentiate its products and services to meet the unique needs of this market.
If this market receives more focused attention from these larger competitors, we may find it
difficult to compete and as a result our revenues and operating margins could decline. If we fail
to compete successfully in this market, the demand for our products and services would decrease.
Any reduction in demand could lead to fewer customer orders, reduced revenues, pricing pressures,
reduced margins, reduced levels of profitability and loss of market share. These competitive
pressures could adversely affect our business and operating results. We may experience difficulties hiring skilled veterinarians due to shortages that could disrupt
our business. As the pet population continues to grow, the need for skilled veterinarians continues to
increase. If we are unable to retain an adequate number of skilled veterinarians, we may lose
customers, our revenue may decline and we may need to sell or close animal hospitals. As of March
31, 2005, there were 28 veterinary schools in the country accredited by the American Veterinary
Medical Association. These schools graduate approximately 2,100 veterinarians per year. There is
a shortage of skilled veterinarians in some regional markets in which we operate animal hospitals.
During shortages in these regions, we may be unable to hire enough qualified veterinarians to
adequately staff our animal hospitals, in which event we may lose market share and our revenues and
profitability may decline. 40




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If we fail to comply with governmental regulations applicable to our business, various
governmental agencies may impose fines, institute litigation or preclude us from operating in
certain states. The laws of many states prohibit business corporations from providing, or holding themselves
out as providers of, veterinary medical care. These laws vary from state to state and are enforced
by the courts and by regulatory authorities with broad discretion. As of March 31, 2005, we
operated 102 animal hospitals in 13 states with these laws, including 24 in New York and 26 in
Texas. In addition, our mobile imaging service also operates in states with these laws. We may
experience difficulty in expanding our operations into other states with similar laws. Given
varying and uncertain interpretations of the veterinary laws of each state, we may not be in
compliance with restrictions on the corporate practice of veterinary medicine in all states. A
determination that we are in violation of applicable restrictions on the practice of veterinary
medicine in any state in which we operate could have a material adverse effect on us, particularly
if we were unable to restructure our operations to comply with the requirements of that state. All of the states in which we operate impose various registration requirements. To fulfill
these requirements, we have registered each of our facilities with appropriate governmental
agencies and, where required, have appointed a licensed veterinarian to act on behalf of each
facility. All veterinarians practicing in our clinics are required to maintain valid state
licenses to practice. Any failure in our information technology systems or disruption in our transportation network
(including disruption resulting from terrorist activities) could significantly increase testing
turn-around time, reduce our production capacity and otherwise disrupt our operations. Our laboratory operations depend, in part, on the continued and uninterrupted performance of
our information technology systems and transportation network. Our growth has necessitated
continued expansion and upgrade of our information technology systems and transportation network.
Sustained system failures or interruption in our transportation network or in one or more of our
laboratory operations could disrupt our ability to process laboratory requisitions, perform
testing, provide test results in a timely manner and/or bill the appropriate party. We could lose
customers and revenue as a result of a system or transportation network failure. Our computer systems are vulnerable to damage or interruption from a variety of sources,
including telecommunications failures, electricity brownouts or blackouts, malicious human acts and
natural disasters. Moreover, despite network security measures, some of our servers are
potentially vulnerable to physical or electrical break-ins, computer viruses and similar disruptive
problems. Despite the precautions we have taken, unanticipated problems affecting our systems
could cause interruptions in our information technology systems. Our insurance policies may not
adequately compensate us for any losses that may occur due to any failures in our systems. In addition, over time we have significantly customized the computer systems in our laboratory
business. We rely on a limited number of employees to upgrade and maintain these systems. If we
were to lose the services of some or all of these employees, it may be time-consuming for new
employees to become familiar with our systems, and we may experience disruptions in service during
these periods. Any substantial reduction in the number of available flights or delays in the departure of
flights, whether as a result of severe weather conditions, a terrorist attack or any other type of
disruption, will disrupt our transportation network and our ability to provide test results in a
timely manner. Any change in government regulation related to transporting samples or specimens
could also have an impact on our business. In addition, our Test Express service, which services
customers outside of major metropolitan areas, is dependent on flight services in and out of
Memphis and the transportation network of Federal Express. Any sustained interruption in either
flight services in Memphis or the transportation network of Federal Express would result in
increased turn-around time for the reporting of test results to customers serviced by our Test
Express service. Our use of a self-insurance program and a large-deductible insurance program to cover certain
claims for losses suffered and costs or expenses incurred could negatively impact our business
upon the occurrence of an uninsured and/or significant event. We have adopted a program of self-insurance with regard to certain risks such as earthquakes
and other natural disasters. In addition, our other insurance programs including, but not limited
to, hurricanes, floods, health benefits and workers compensation include large deductible
provisions. We self-insure and use large-deductible insurance 41




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programs when the lack of
availability and/or high cost of commercially available insurance products do not make
the transfer of this risk a reasonable approach. In the event that the frequency of losses
experienced by us increased unexpectedly, the aggregate of such losses could materially increase
our liability and adversely affect our financial condition, liquidity, cash flows and results of
operations. In addition, while the insurance market continues to limit the availability of certain
insurance products while increasing the costs of such products, we will continue to evaluate the
levels of claims we include in our self-insurance program and large-deductible insurance program.
Any increases to these programs increase our risk of exposure and therefore increases the risk of a
possible material adverse effect on our financial condition, liquidity, cash flows and results of
operations. In addition, we have made certain judgments as to the limits on our existing insurance
coverage that we believe are in line with industry standards, as well as in light of economic and
availability considerations. Unforeseen catastrophic loss scenarios could prove our limits to be
inadequate, and losses incurred in connection with the known claims we self-insure could be
substantial. Either of these circumstances could materially adversely affect our financial and
business condition. 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 that may be
terminated at the option of Mr. Antin. We do not maintain any key man life insurance coverage for
Mr. Antin. The loss of Mr. Antin could materially adversely affect our business. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK As of March 31, 2005, we had borrowings of $220.3 million under our senior credit facility
with fluctuating interest rates based on market benchmarks such as LIBOR. To reduce the risk of
increasing interest rates, we enter into no-fee interest rate swap agreements. Currently, we are
engaged in two agreements, both agreements are for $20.0 million and commenced on May 30, 2003 and
expire on May 31, 2005. These swap agreements have the effect of reducing the amount of our debt
exposed to variable interest rates. Accordingly, for the 12-month period ending March 31, 2006,
for every 1.0% increase in LIBOR we will pay an additional $2.1 million in interest expense and for
every 1.0% decrease in LIBOR we will save $2.1 million in interest expense. We are considering entering into additional interest rate strategies to take advantage of the
current rate environment. We have not yet determined what those strategies may be or their
possible impact. 
 ITEM 4. CONTROLS AND PROCEDURES As of the end of the period covered by this report, we have carried out an evaluation, under
the supervision and with the participation of our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure controls and
procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures are effective in timely alerting them to
material information required to be included in our periodic reports with the SEC. In accordance with the requirements of the SEC, our Chief Executive Officer and Chief
Financial Officer note that, since the date of the most recent evaluation of our disclosure
controls and procedures to the date of this quarterly report on Form 10-Q, there have been no
significant changes in our internal controls over financial reporting or in other factors that could significantly affect
internal controls over financial reporting. 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 42




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management override of the
controls. Because of the inherent limitations in a cost-effective control system, misstatements
due to error or fraud may occur and not be detected. 
 PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS We are not subject to any legal proceedings other than ordinarily routine litigation
incidental to the conduct of our business. 
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES None 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None 
 ITEM 5. OTHER INFORMATION  (a)
    On April 15, 2005, Dawn Olsen, our Principal Accounting
Officer, was awarded a discretionary bonus of $60,000 for services
performed during 2004(b)
    None 
 ITEM 6. EXHIBITS  (a)
    Exhibits:  31.1
    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.31.2
    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.32.1
    Certification of Chief Executive Officer and Chief Financial Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002. 43




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SIGNATURE Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized on May 6, 2005. Date: May 6, 2005
    By:
    /s/ Tomas W. FullerTomas W. FullerChief Financial Officer 44




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EXHIBIT INDEX Exhibit No.
    
    Description31.1
    
    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.31.2
    
    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.32.1
    
    Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
 45