VCA ANTECH INC - 10-Q Quarterly Report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


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

For the quarterly period ended September 30, 2003


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

Commission File Number: 001-16783

VCA ANTECH, INC.

(Exact name of registrant as specified in its charter)


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

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

(310) 571-6500
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ].

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

Indicate the number of shares outstanding of each of the issuer’s class of common stock as of the latest practicable date: common stock, $0.001 par value 40,669,436 shares as of November 10, 2003.

TABLE OF CONTENTS


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

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

TABLE OF CONTENTS


		Page Number

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

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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


			September 30,			December 31,
			2003			2002

ASSETS
Current assets:
	Cash and cash equivalents		$	18,445		$	6,462
	Trade accounts receivable, less allowance for uncollectible accounts of $7,111 and $6,408 at September 30, 2003 and December 31, 2002, respectively			23,931			20,727
	Inventory, prepaid expenses and other			9,275			8,643
	Deferred income taxes			11,697			9,528
	Prepaid income taxes			—			7,614

		Total current assets		63,348			52,974
Property and equipment, net				98,410			95,303
Other assets:
	Goodwill, net			370,009			342,614
	Covenants not to compete, net			5,031			4,735
	Deferred financing costs, net			4,766			6,778
	Other			4,284			5,024

		Total assets	$	545,848		$	507,428

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Current portion of long-term obligations		$	2,445		$	9,622
	Accounts payable			8,925			10,223
	Accrued payroll and related liabilities			15,855			14,734
	Accrued interest			5,757			1,565
	Income taxes payable			1,232			—
	Other accrued liabilities			17,883			13,464

		Total current liabilities		52,097			49,608
Long-term obligations, less current portion				315,507			371,935
Deferred income taxes				19,316			15,376
Other liabilities				2,007			2,007
Minority interest				5,431			5,416
Stockholders’ equity:
	Common stock, par value $0.001, 75,000 shares authorized, and 40,650 and 36,765 shares outstanding as of September 30, 2003 and December 31, 2002, respectively			41			37
	Additional paid-in capital			243,345			188,941
	Accumulated deficit			(91,732	)		(125,754	)
	Accumulated comprehensive loss - unrealized loss on hedging instruments			(82	)		—
	Notes receivable from stockholders			(82	)		(138	)

		Total stockholders’ equity		151,490			63,086

		Total liabilities and stockholders’ equity	$	545,848		$	507,428

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

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


		Three Months Ended						Nine Months Ended
		September 30,						September 30,

		2003			2002			2003		2002

Revenue		$	132,903		$	114,972		$	381,266	$	336,892
	Direct costs (excludes operating depreciation of $2,734 and $2,399 for the three months ended September 30, 2003 and 2002, respectively, and $8,153 and $7,007 for the nine months ended September 30, 2003 and 2002, respectively)		88,710			77,157			254,965		226,749

			44,193			37,815			126,301		110,143
Selling, general and administrative expense			8,931			8,732			27,384		25,893
Depreciation and amortization			3,579			3,028			10,653		9,330
Write down and loss (gain) on sale of assets			442			(80	)		282		(80	)

	Operating income		31,241			26,135			87,982		75,000
Interest expense, net			6,361			10,208			19,771		30,541
Debt retirement costs			1,701			3,391			9,118		3,391
Other (income) expense			(129	)		(5	)		129		(159	)
Minority interest in income of subsidiaries			456			430			1,279		1,360

	Income before provision for income taxes		22,852			12,111			57,685		39,867
Provision for income taxes			9,363			5,076			23,663		16,702

	Net income	$	13,489		$	7,035		$	34,022	$	23,165

Basic earnings per common share		$	0.33		$	0.19		$	0.85	$	0.63

Diluted earnings per common share		$	0.33		$	0.19		$	0.84	$	0.63

Shares used for computing basic earnings per share			40,641			36,756			40,095		36,744

Shares used for computing diluted earnings per share			41,334			37,094			40,650		37,088

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

VCA ANTECH, INC. AND SUBSIDIARIES

CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2003 and 2002
(Unaudited)
(In thousands)


				Nine Months Ended
				September 30,

				2003			2002

Cash flows from operating activities:
	Net income			$	34,022		$	23,165
	Adjustments to reconcile net income to net cash provided by operating activities:
		Depreciation and amortization			10,653			9,330
		Amortization of deferred financing costs and debt discount			669			1,264
		Provision for uncollectible accounts			2,371			2,347
		Debt retirement costs			9,118			3,391
		Interest paid in kind on 15.5% senior notes			—			7,045
		Write-down of assets			392			—
		Gain on sale of assets			(110	)		(80	)
		Minority interest in income of subsidiaries			1,279			1,360
		Distributions to minority interest partners			(1,245	)		(1,339	)
		Increase in trade accounts receivable			(4,399	)		(5,055	)
		Increase in inventory, prepaid expenses and other assets			(438	)		(918	)
		Increase (decrease) in accounts payable and other accrued liabilities			(552	)		3,945
		Increase in accrued payroll and related liabilities			1,121			2,792
		Increase in accrued interest			4,192			3,405
		Decrease in prepaid income taxes			7,614			2,782
		Increase in income taxes payable			1,232			2,035
		Increase in deferred income taxes asset			(2,169	)		(2,318	)
		Increase in deferred income taxes liability			3,940			7,687

			Net cash provided by operating activities		67,690			60,838

Cash flows from investing activities:
	Business acquisitions, net of cash acquired				(27,177	)		(17,845	)
	Real estate acquired in connection with business acquisitions				(589	)		—
	Property and equipment additions, net				(11,040	)		(13,405	)
	Proceeds from sale of assets				363			1,391
	Other				447			583

			Net cash used in investing activities		(37,996	)		(29,276	)

Cash flows from financing activities:
	Repayment of long-term obligations, including redemption fees				(217,492	)		(145,978	)
	Proceeds from the issuance of long-term debt				146,442			143,061
	Payment of deferred financing and recapitalization costs				(1,069	)		(3,415	)
	Proceeds from issuance of common stock under stock option plans				85			25
	Proceeds from issuance of common stock				54,323			—

			Net cash used in financing activities		(17,711	)		(6,307	)

Increase in cash and cash equivalents					11,983			25,255
Cash and cash equivalents at beginning of period					6,462			7,103

Cash and cash equivalents at end of period				$	18,445		$	32,358

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

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

(1) General

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

(2) Acquisitions

During the three months ended September 30, 2003, the Company purchased three animal hospitals and one veterinary diagnostic laboratory. The acquired laboratory was merged into an existing VCA facility upon acquisition. Including acquisition costs, the Company paid an aggregate consideration of $7.2 million, consisting of $6.8 million in cash and $423,000 in certain obligations to sellers and other liabilities assumed. The $7.2 million aggregate purchase price was allocated as follows: $429,000 to tangible assets, $6.3 million to goodwill and $451,000 to other intangible assets. Goodwill was assigned to the animal hospital and laboratory reporting units in the amounts of $5.4 million and $942,000, respectively. The Company expects that $4.5 million of the goodwill recorded will be fully deductible for income tax purposes.

During the nine months ended September 30, 2003, the Company purchased 19 animal hospitals and four veterinary diagnostic laboratory companies with a total of seven laboratory facilities. Five of the acquired animal hospitals and three of the acquired laboratories were merged into existing VCA facilities upon acquisition. Including acquisition costs, the Company paid an aggregate consideration of $29.8 million, consisting of $26.2 million in cash, $2.3 million in an obligation to be settled in either cash or shares of the Company’s common stock, and $1.3 million in certain obligations to sellers and other liabilities assumed. The $29.8 million aggregate purchase price was allocated as follows: $1.7 million to tangible assets, $26.4 million to goodwill and $1.7 million to other intangible assets. Goodwill was assigned to the animal hospital and laboratory reporting units in the amounts of $19.2 million and $7.2 million, respectively. The Company expects that $15.5 million of the goodwill recorded will be fully deductible for income tax purposes.

During the nine months ended September 30, 2003, the Company purchased the total ownership interest of partners in three non-wholly owned subsidiaries of the Company for approximately $1.0 million, consisting of $244,000 in cash, $763,000 in a note payable, and $41,000 in the forgiveness of a note owed to the Company by one of the partners. The Company recorded goodwill of $295,000 related to these purchases and expects that it will be fully deductible for income tax purposes.

(3) Calculation of Earnings per Common Share

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


			Three Months Ended				Nine Months Ended
			September 30,				September 30,

			2003		2002		2003		2002

Net income			$	13,489	$	7,035	$	34,022	$	23,165

Weighted average common shares outstanding:
	Basic			40,641		36,756		40,095		36,744
	Effect of dilutive common shares:
		Stock options		589		338		508		344
		Contracts that may be settled in stock or cash		104		—		47		—

	Diluted			41,334		37,094		40,650		37,088

Earnings per common share:
	Basic		$	0.33	$	0.19	$	0.85	$	0.63

	Diluted		$	0.33	$	0.19	$	0.84	$	0.63

(4) Comprehensive Income

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


		Three Months Ended						Nine Months Ended
		September 30,						September 30,

		2003			2002			2003			2002

Net income		$	13,489		$	7,035		$	34,022		$	23,165
	Unrealized gain (loss) on hedging instruments		150			645			(211	)		1,695
	Less portion of unrealized loss (gain) recognized		(129	)		(5	)		129			(159	)

Net comprehensive income		$	13,510		$	7,675		$	33,940		$	24,701

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

(5) Interest Rate Hedging Agreements

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

Swap #1

Swap #2

Swap #3

Fixed interest rate

2.22%

1.72%

1.51%

Notional amount

$40.0 million

$20.0 million

Effective date

11/29/2002

05/30/2003

Expiration date

11/29/2004

05/31/2005

Counter party

Wells Fargo Bank

Goldman Sachs

Swap #2 and Swap #3 qualify for hedge accounting and the Company considers these to be cash-flow hedging instruments. Prior to May 2003, Swap #1 was also considered to be a cash-flow hedging instrument. At that time, management determined that Swap #1 was no longer an effective tool for mitigating interest rate risk within an acceptable degree of variance because the projected LIBOR rates at May 2003 for the remaining term of the contract, June 2003 through November 2004, were materially different from the LIBOR projections made at the inception of the contract for this same time period. This difference in LIBOR projections was a result of changes in the interest rate environment which occurred from November 2002 through May 2003. As a result of this determination, Swap #1 no longer qualifies for hedge accounting and all changes in its market value are recognized as income or expense in the period of change.

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

The valuations of the Swap Agreements and the Collar Agreement were determined by the counter parties. At September 30, 2003 and December 31, 2002, the fair market values of the Swap Agreements resulted in a liability from interest rate hedging activities of $524,000 and $313,000, respectively. As a result of the Company’s interest rate hedging activities, it recognized an unrealized gain of $129,000 and $5,000 during the three months ended September 30, 2003 and 2002, respectively, and it recognized an unrealized loss of $129,000 and an unrealized gain of $159,000 during the nine months ended September 30, 2003 and 2002, respectively. These charges have been reported as part of other (income) expense.

The Company made payments under the Swap Agreements amounting to $165,000 for the three months ended September 30, 2003 and $352,000 for the nine months ended September 30, 2003, resulting from LIBOR being below the fixed interest rate. The Company made payments under the Collar Agreement amounting to $666,000 for the three months ended September 30, 2002 and $1.9 million for the nine months ended September 30, 2002 resulting from LIBOR being below the floor interest rate of 5.9%. These payments have been reported as part of interest expense.

(6) Lines of Business

During the three and nine months ended September 30, 2003 and 2002, the Company had three reportable segments: Laboratory, Animal Hospital and Corporate. These segments are strategic business units that have different products, services and functions. The segments are managed separately because each is a distinct and different business venture with unique challenges, rewards and risks. The Laboratory segment provides testing services for veterinarians both associated with the Company and independent of the Company. The Animal Hospital segment provides veterinary services for companion animals and sells related retail and pharmaceutical products. Corporate provides selling, general and administrative support for the other two segments.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies as detailed in the Company’s consolidated financial statements and footnotes thereto included in the 2002 Annual Report on Form 10-K. The Company evaluates performance of segments based on operating income. For purposes of reviewing the operating performance of the segments, all intercompany sales and purchases are accounted for as if they were transactions with independent third parties at current market prices.

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


					Animal					Intercompany
			Laboratory		Hospital		Corporate			Eliminations			Total

Three Months Ended September 30, 2003
	Revenue		$	46,429	$	89,079	$	—		$	(2,605	)	$	132,903
	Direct costs (excluding operating depreciation)			25,870		65,445		—			(2,605	)		88,710
	Selling, general and administrative			2,826		2,492		3,613			—			8,931
	Depreciation and amortization			823		2,387		369			—			3,579
	Write-down and loss on sale of assets			39		403		—			—			442

		Operating income (loss)	$	16,871	$	18,352	$	(3,982	)	$	—		$	31,241

	Capital expenditures		$	621	$	3,900	$	351		$	—		$	4,872
Three Months Ended September 30, 2002
	Revenue		$	38,650	$	78,118	$	500		$	(2,296	)	$	114,972
	Direct costs (excluding operating depreciation)			21,849		57,604		—			(2,296	)		77,157
	Selling, general and administrative			2,563		2,359		3,810			—			8,732
	Depreciation and amortization			715		1,961		352			—			3,028
	Loss (gain) on sale of assets			24		9		(113	)		—			(80	)

		Operating income (loss)	$	13,499	$	16,185	$	(3,549	)	$	—		$	26,135

	Capital expenditures		$	4,501	$	2,417	$	283		$	—		$	7,201
Nine Months Ended September 30, 2003
	Revenue		$	134,818	$	254,231	$	—		$	(7,783	)	$	381,266
	Direct costs (excluding operating depreciation)			74,142		188,606		—			(7,783	)		254,965
	Selling, general and administrative			8,330		7,514		11,540			—			27,384
	Depreciation and amortization			2,376		7,168		1,109			—			10,653
	Write-down and loss (gain) on sale of assets			58		225		(1	)		—			282

		Operating income (loss)	$	49,912	$	50,718	$	(12,648	)	$	—		$	87,982

	Capital expenditures		$	2,385	$	7,258	$	1,397		$	—		$	11,040
Nine Months Ended September 30, 2002
	Revenue		$	116,911	$	225,383	$	1,500		$	(6,902	)	$	336,892
	Direct costs (excluding operating depreciation)			65,545		168,106		—			(6,902	)		226,749
	Selling, general and administrative			7,632		7,351		10,910			—			25,893
	Depreciation and amortization			2,138		6,166		1,026			—			9,330
	Loss (gain) on sale of assets			24		9		(113	)		—			(80	)

		Operating income (loss)	$	41,572	$	43,751	$	(10,323	)	$	—		$	75,000

	Capital expenditures		$	5,931	$	6,372	$	1,102		$	—		$	13,405


				Animal				Intercompany
		Laboratory		Hospital		Corporate		Eliminations		Total

At September 30, 2003
	Identifiable assets	$	131,132	$	371,865	$	42,851	$	—	$	545,848
At December 31, 2002
	Identifiable assets	$	117,443	$	350,980	$	39,005	$	—	$	507,428

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


	Three Months Ended						Nine Months Ended
	September 30,						September 30,

	2003			2002			2003		2002

Total segment operating income after eliminations	$	31,241		$	26,135		$	87,982	$	75,000
Interest expense, net		6,361			10,208			19,771		30,541
Debt retirement costs		1,701			3,391			9,118		3,391
Other (income) expense		(129	)		(5	)		129		(159	)
Minority interest in income of subsidiaries		456			430			1,279		1,360

Income before provision for income taxes	$	22,852		$	12,111		$	57,685	$	39,867

(7) Refinancing, Secondary Offering and Debt Retirement

In August 2003, the Company refinanced its senior credit facility retiring $166.4 million principal balance outstanding under the senior term C notes with $20.0 million of cash on-hand and $146.4 million received from the issuance of new senior term D notes, with an interest rate margin of 2.5% compared to 3.0% for the senior term C notes. In conjunction with that transaction, the Company recorded debt retirement costs of $1.7 million.

In February 2003, the Company completed a secondary offering of 10.1 million shares of its common stock. As part of this offering, the Company granted its underwriters an over-allotment option to purchase an additional 1.5 million shares of its common stock that was exercised in full in February 2003. In conjunction with these transactions, the Company sold 3.8 million primary shares of its common stock in exchange for net proceeds of approximately $54.3 million. The Company used approximately $42.7 million of the net proceeds to voluntarily retire the remaining principal amount outstanding of its 15.5% senior notes due 2010 at a price of 110% of the principal amount plus accrued and unpaid interest resulting in debt retirement costs of approximately $7.4 million.

(8) Goodwill and Other Intangible Assets

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

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


			Animal
	Laboratory		Hospital		Total

Balance as of January 1, 2003	$	87,313	$	255,301	$	342,614
Goodwill acquired and purchase price adjustments		7,263		20,132		27,395

Balance as of September 30, 2003	$	94,576	$	275,433	$	370,009

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


		As of September 30, 2003

		Gross Carrying		Accumulated			Net Carrying
		Amount		Amortization			Amount

Covenants not to compete		$	13,374	$	(8,343	)	$	5,031
Client lists			594		(515	)		79

	Total	$	13,968	$	(8,858	)	$	5,110

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


	Three Months Ended				Nine Months Ended
	September 30,				September 30,

	2003		2002		2003		2002

Aggregate amortization expense	$	476	$	277	$	1,391	$	1,297

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


2003	$	1,849
2004	$	1,568
2005	$	1,177
2006	$	802
2007	$	591

(9) Accounting Pronouncements

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

In May 2003, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 clarifies the accounting for certain financial instruments with characteristics of both liabilities and equity and requires that those instruments be classified as liabilities. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company currently has a $2.3 million obligation to be settled in either cash or common stock that is classified as a liability. In addition, the Company has certain partnerships in non-wholly owned subsidiaries whereby the Company is required under the terms of the respective partnership agreements to purchase the partner’s equity in the partnership in the event of the partner’s death. Under SFAS No. 150, the Company is required to recognize these obligations as liabilities in its financial statements at fair market value. Currently, the Company is recognizing these liabilities as a component of minority interest.

b. Accounting for Derivative Instruments and Hedging Activities

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

c. Consolidations of Variable Interest Entities

In January 2003, the FASB issued FASB Interpretation (“FIN”) No. 46, Consolidation of Variable Interest Entities, requiring that companies consolidate variable interest entities if they are the primary beneficiaries, as defined under FIN No. 46, of the activities of the variable interest entities. Companies are required to apply FIN No. 46 immediately for all variable interest entities created after January 31, 2003 and per FASB Staff Position FIN No. 46-6 issued in October 2003, as of the first annual period ending after December 15, 2003 for all other variable interest entities.

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

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


	For the Nine Months Ended September 30, 2003

	As Reported		As Consolidated		Difference

Revenue	$	381,266	$	412,224	$	30,958
Direct costs (excluding operating depreciation)	$	254,965	$	285,923	$	30,958
Operating income	$	87,982	$	87,982	$	—

d. Guarantor’s Accounting and Disclosure Requirements for Guarantees

In January 2003, the FASB issued FIN No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 requires a company to recognize a liability for the obligations it has undertaken in issuing a guarantee. This liability would be recorded at the inception of a guarantee and would be measured at fair value. The measurement provisions of this statement apply prospectively to guarantees issued or modified after December 31, 2002 for periods ending after December 15, 2002.

The Company has guaranteed all liabilities for certain veterinary medical groups for which it provides management services. All of these liabilities have been included in the Company’s condensed, consolidated financial statements. The Company pays these liabilities and recovers money spent through the management fee charged to the veterinary medical groups. The Company does not expect FIN No. 45 to have a material impact on its financial statements in the future.

e. Consideration Received from a Vendor

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

• cash received from a vendor is presumed to be a reduction of the cost of the vendor’s products or services, however that presumption is overcome when the consideration is either a) payment for assets or services, in which case the consideration is characterized as revenue, or b) a reimbursement of

specific and identifiable costs incurred on behalf of the vendor in selling the vendor’s products or services, in which case the consideration is a reduction of that cost; and

• rebates offered to a customer or reseller should be recognized as a reduction of the cost of sales based on a systematic and rational allocation provided that the amounts recognized are probable and reasonably estimable.

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

f. Costs Associated with Exit or Disposal Activities

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

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

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

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

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

During the nine months ended September 30, 2003, the Company made two significant changes to its capital structure:

• in August 2003, the Company refinanced its senior credit facility voluntarily repaying $20.0 million of senior term C notes and retiring the remaining senior term C notes with senior term D notes, resulting in debt retirement costs of approximately $1.7 million; and

• in February 2003, the Company redeemed the remaining principal amount outstanding of its 15.5% senior notes with proceeds from its secondary offering resulting in debt retirement costs of approximately $7.4 million.

Management has concluded that these debt retirement costs do not qualify for extraordinary treatment under APB No. 30 because management has historically changed the Company’s capital structure to take advantage of favorable market conditions and it is probable that it will continue to do so in the future. As a result, these costs for all periods presented have been included as a component from recurring operations in the Condensed, Consolidated Income Statements.

SFAS No. 145 also amends SFAS No. 13, Accounting for Leases. Under SFAS No. 145, if a capital lease is modified such that it becomes an operating lease, a gain or loss must be recognized similar to the accounting used for sale-leaseback transactions as provided in SFAS No. 28 and No. 98. At September 30, 2003, the Company had capital lease obligations of $333,000; however, the Company currently has no plans to modify these or any future capital leases.

h. Asset Retirement Obligations

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

(10) Stock-Based Compensation

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


		Three Months Ended						Nine Months Ended
		September 30,						September 30,

		2003			2002			2003			2002

As reported		$	13,489		$	7,035		$	34,022		$	23,165
	Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(216	)		(25	)		(644	)		(62	)

	Pro forma net income available to common stockholders	$	13,273		$	7,010		$	33,378		$	23,103

Earnings per common share:
	Basic - as reported	$	0.33		$	0.19		$	0.85		$	0.63
	Basic - pro forma	$	0.33		$	0.19		$	0.83		$	0.63
	Diluted - as reported	$	0.33		$	0.19		$	0.84		$	0.63
	Diluted - pro forma	$	0.32		$	0.19		$	0.82		$	0.62

(11) Commitments and Contingencies

a. State Laws

The laws of many states prohibit business corporations from providing, or holding themselves out as providers of, veterinary medical care. These laws vary from state to state and are enforced by the courts and by regulatory authorities with broad discretion. The Company operates 64 animal hospitals in 11 states with these laws. The Company may experience difficulty in expanding operations into other states with similar laws. Given varying and uncertain interpretations of the veterinary laws of each state, the Company may not be in compliance with restrictions on the corporate practice of veterinary medicine in all states. A determination that the Company is in violation of applicable restrictions on the practice of veterinary medicine in any state in which it operates could have

a material adverse effect, particularly if the Company were unable to restructure its operations to comply with the requirements of that state.

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

b. Other Contingencies

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

(12) Reclassifications

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

(13) Subsequent Events

From October 1, 2003 through November 10, 2003, the Company acquired two animal hospitals, one of which was merged into an existing animal hospital upon acquisition. Including acquisition costs, the Company paid an aggregate consideration of $2.6 million, consisting of $2.5 million in cash and $65,000 in certain obligations to sellers and other liabilities assumed.

(14) Condensed, Consolidating Information

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

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

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

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

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

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


											Non-
									Guarantor		Guarantor
			VCA			Vicar			Subsidiaries		Subsidiaries			Elimination			Consolidated

Current assets:
	Cash and cash equivalents		$	—		$	16,401		$	1,922	$	122		$	—		$	18,445
	Trade accounts receivable, net			—			10			23,378		543			—			23,931
	Inventory, prepaid expenses and other			—			2,464			6,267		544			—			9,275
	Deferred income taxes			—			11,697			—		—			—			11,697

		Total current assets		—			30,572			31,567		1,209			—			63,348
	Property and equipment, net			—			7,055			89,534		1,821			—			98,410
	Goodwill, net			—			—			347,904		22,105			—			370,009
	Covenants not to compete, net			—			—			4,394		637			—			5,031
	Deferred financing costs, net			—			4,766			—		—			—			4,766
	Other			31			427			2,445		2,296			(915	)		4,284
	Investment in subsidiaries			193,740			298,288			23,733		—			(515,761	)		—

		Total assets	$	193,771		$	341,108		$	499,577	$	28,068		$	(516,676	)	$	545,848

Current liabilities:
	Current portion of long-term obligations		$	—		$	1,543		$	902	$	—		$	—		$	2,445
	Accounts payable			—			6,560			2,365		—			—			8,925
	Accrued payroll and related liabilities			—			9,546			5,992		317			—			15,855
	Accrued interest			—			5,713			42		2			—			5,757
	Income taxes payable			—			1,232			—		—			—			1,232
	Other accrued liabilities			—			11,826			5,980		77			—			17,883

		Total current liabilities		—			36,420			15,281		396			—			52,097
Long-term obligations, less current portion				—			314,837			1,585		—			(915	)		315,507
Deferred income taxes				—			19,316			—		—			—			19,316
Other liabilities				—			2,007			—		—			—			2,007
Intercompany payable/(receivable)				42,281			(225,212	)		184,423		(1,492	)		—			—
Minority interest				—			—			—		—			5,431			5,431
Stockholders’ equity:
	Common stock			41			—			—		—			—			41
	Additional paid-in capital			243,345			—			—		—			—			243,345
	Accumulated equity (deficit)			(91,732	)		193,822			298,288		29,164			(521,274	)		(91,732	)
	Accumulated comprehensive loss - unrealized loss on hedging instruments			(82	)		(82	)		—		—			82			(82	)
	Notes receivable from stockholders			(82	)		—			—		—			—			(82	)

		Total stockholders’ equity		151,490			193,740			298,288		29,164			(521,192	)		151,490

		Total liabilities and stockholders’ equity	$	193,771		$	341,108		$	499,577	$	28,068		$	(516,676	)	$	545,848

VCA ANTECH, INC. AND SUBSIDIARIES

NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

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


											Non-
									Guarantor		Guarantor
			VCA			Vicar			Subsidiaries		Subsidiaries			Elimination			Consolidated

Current assets:
	Cash and cash equivalents		$	—		$	5,083		$	1,233	$	146		$	—		$	6,462
	Trade accounts receivable, net			—			5			20,085		637			—			20,727
	Inventory, prepaid expenses and other			—			2,684			5,414		545			—			8,643
	Deferred income taxes			—			9,528			—		—			—			9,528
	Prepaid income taxes			—			7,614			—		—			—			7,614

		Total current assets		—			24,914			26,732		1,328			—			52,974
	Property and equipment, net			—			6,727			86,077		2,499			—			95,303
	Goodwill, net			—			—			321,887		20,727			—			342,614
	Covenants not to compete, net			—			—			4,098		637			—			4,735
	Deferred financing costs, net			386			6,392			—		—			—			6,778
	Other			139			447			2,679		1,759			—			5,024
	Investment in subsidiaries			155,115			239,671			23,403		—			(418,189	)		—

		Total assets	$	155,640		$	278,151		$	464,876	$	26,950		$	(418,189	)	$	507,428

Current liabilities:
	Current portion of long-term obligations		$	—		$	9,240		$	382	$	—		$	—		$	9,622
	Accounts payable			—			6,706			3,517		—			—			10,223
	Accrued payroll and related liabilities			—			7,068			7,339		327			—			14,734
	Accrued interest			—			1,547			18		—			—			1,565
	Other accrued liabilities			—			10,325			3,124		15			—			13,464

		Total current liabilities		—			34,886			14,380		342			—			49,608
Long-term obligations, less current portion				35,145			335,895			895		—			—			371,935
Deferred income taxes				—			15,376			—		—			—			15,376
Other liabilities				—			2,007			—		—			—			2,007
Intercompany payable/(receivable)				57,409			(265,128	)		209,930		(2,211	)		—			—
Minority interest				—			—			—		—			5,416			5,416
Stockholders’ equity:
	Common stock			37			—			—		—			—			37
	Additional paid-in capital			188,941			—			—		—			—			188,941
	Accumulated equity (deficit)			(125,754	)		155,115			239,671		28,819			(423,605	)		(125,754	)
	Notes receivable from stockholders			(138	)		—			—		—			—			(138	)

		Total stockholders’ equity		63,086			155,115			239,671		28,819			(423,605	)		63,086

		Total liabilities and stockholders’ equity	$	155,640		$	278,151		$	464,876	$	26,950		$	(418,189	)	$	507,428

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

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


											Non-
									Guarantor		Guarantor
			VCA			Vicar			Subsidiaries		Subsidiaries			Elimination			Consolidated

Revenue			$	—		$	—		$	123,810	$	9,342		$	(249	)	$	132,903
Direct costs				—			—			82,206		6,753			(249	)		88,710

				—			—			41,604		2,589			—			44,193
Selling, general and administrative				—			3,613			4,917		401			—			8,931
Depreciation and amortization				—			369			3,052		158			—			3,579
Write-down and loss (gain) on sale of assets				—			—			442		—			—			442

		Operating income (loss)		—			(3,982	)		33,193		2,030			—			31,241
Interest expense, net				(2	)		6,354			38		(29	)		—			6,361
Debt retirement costs				—			1,701			—		—			—			1,701
Other income				—			(129	)		—		—			—			(129	)
Equity interest in income of subsidiaries				13,488			20,541			1,603		—			(35,632	)		—

	Income before minority interest and provision for income taxes			13,490			8,633			34,758		2,059			(35,632	)		23,308
Minority interest in income of subsidiaries				—			—			—		—			456			456

	Income before provision for income taxes			13,490			8,633			34,758		2,059			(36,088	)		22,852
Provision (benefit) for income taxes				1			(4,855	)		14,217		—			—			9,363

	Net income		$	13,489		$	13,488		$	20,541	$	2,059		$	(36,088	)	$	13,489

VCA ANTECH, INC. AND SUBSIDIARIES

NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

CONDENSED, CONSOLIDATING INCOME STATEMENTS
For the Three Months Ended September 30, 2002
(Unaudited)
(In thousands)


										Non-
								Guarantor		Guarantor
		VCA			Vicar			Subsidiaries		Subsidiaries			Elimination			Consolidated

Revenue		$	—		$	500		$	105,480	$	9,228		$	(236	)	$	114,972
Direct costs			—			—			70,573		6,820			(236	)		77,157

			—			500			34,907		2,408			—			37,815
Selling, general and administrative			—			3,810			4,551		371			—			8,732
Depreciation and amortization			—			352			2,497		179			—			3,028
Loss (gain) on sale of assets			—			(113	)		33		—			—			(80	)

	Operating income (loss)		—			(3,549	)		27,826		1,858			—			26,135
Interest expense, net			2,408			7,813			21		(34	)		—			10,208
Debt retirement costs			—			3,391			—		—			—			3,391
Other income			—			(5	)		—		—			—			(5	)
Equity interest in income of subsidiaries			8,507			17,123			1,462		—			(27,092	)		—

	Income before minority interest and provision for income taxes		6,099			2,375			29,267		1,892			(27,092	)		12,541
Minority interest in income of subsidiaries			—			—			—		—			430			430

	Income before provision for income taxes		6,099			2,375			29,267		1,892			(27,522	)		12,111
Provision (benefit) for income taxes			(936	)		(6,132	)		12,144		—			—			5,076

	Net income	$	7,035		$	8,507		$	17,123	$	1,892		$	(27,522	)	$	7,035

VCA ANTECH, INC. AND SUBSIDIARIES

NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

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


											Non-
									Guarantor		Guarantor
			VCA			Vicar			Subsidiaries		Subsidiaries			Elimination			Consolidated

Revenue			$	—		$	—		$	355,113	$	26,877		$	(724	)	$	381,266
Direct costs				—			—			236,076		19,613			(724	)		254,965

				—			—			119,037		7,264			—			126,301
Selling, general and administrative				—			11,540			14,714		1,130			—			27,384
Depreciation and amortization				—			1,109			9,070		474			—			10,653
Write-down and (gain) on sale of assets				—			(1	)		283		—			—			282

		Operating income (loss)		—			(12,648	)		94,970		5,660			—			87,982
Interest expense, net				524			19,247			104		(104	)		—			19,771
Debt retirement costs				7,417			1,701			—		—			—			9,118
Other expense				—			129			—		—			—			129
Equity interest in income of subsidiaries				38,707			58,617			4,485		—			(101,809	)		—

	Income before minority interest and provision for income taxes			30,766			24,892			99,351		5,764			(101,809	)		58,964
Minority interest in income of subsidiaries				—			—			—		—			1,279			1,279

	Income before provision for income taxes			30,766			24,892			99,351		5,764			(103,088	)		57,685
Provision (benefit) for income taxes				(3,256	)		(13,815	)		40,734		—			—			23,663

	Net income		$	34,022		$	38,707		$	58,617	$	5,764		$	(103,088	)	$	34,022

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

CONDENSED, CONSOLIDATING INCOME STATEMENTS
For the Nine Months Ended September 30, 2002
(Unaudited)
(In thousands)


											Non-
									Guarantor		Guarantor
			VCA			Vicar			Subsidiaries		Subsidiaries			Elimination			Consolidated

Revenue			$	—		$	1,500		$	309,421	$	26,642		$	(671	)	$	336,892
Direct costs				—			—			208,057		19,363			(671	)		226,749

				—			1,500			101,364		7,279			—			110,143
Selling, general and administrative				—			10,910			13,935		1,048			—			25,893
Depreciation and amortization				—			1,026			7,776		528			—			9,330
Loss (gain) on sale of assets				—			(113	)		33		—			—			(80	)

		Operating income (loss)		—			(10,323	)		79,620		5,703			—			75,000
Interest expense, net				6,935			23,614			83		(91	)		—			30,541
Debt retirement costs				—			3,391			—		—			—			3,391
Other income				—			(159	)		—		—			—			(159	)
Equity interest in income of subsidiaries				27,257			48,854			4,434		—			(80,545	)		—

	Income before minority interest and provision for income taxes			20,322			11,685			83,971		5,794			(80,545	)		41,227
Minority interest in income of subsidiaries				—			—			—		—			1,360			1,360

	Income before provision for income taxes			20,322			11,685			83,971		5,794			(81,905	)		39,867
Provision (benefit) for income taxes				(2,843	)		(15,572	)		35,117		—			—			16,702

	Net income		$	23,165		$	27,257		$	48,854	$	5,794		$	(81,905	)	$	23,165

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

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


												Non-
									Guarantor			Guarantor
			VCA			Vicar			Subsidiaries			Subsidiaries			Elimination			Consolidated

Cash flows from operating activities:
	Net income		$	34,022		$	38,707		$	58,617		$	5,764		$	(103,088	)	$	34,022
	Adjustments to reconcile net income to net cash provided by (used in) operating activities:
	Equity interest in earnings of subsidiaries			(38,707	)		(58,617	)		(4,485	)		—			101,809			—
	Depreciation and amortization			—			1,109			9,070			474			—			10,653
	Amortization of deferred financing costs and debt discount			14			655			—			—			—			669
	Provision for uncollectible accounts			—			—			2,134			237			—			2,371
	Debt retirement costs			7,417			1,701			—			—			—			9,118
	Write-down of assets			—			—			392			—			—			392
	Gain of sale of assets			—			(1	)		(109	)		—			—			(110	)
	Minority interest in income of subsidiaries			—			—			—			—			1,279			1,279
	Distributions to minority interest partners			—			(1,245	)		—			—			—			(1,245	)
	Increase in trade accounts receivable			—			(5	)		(4,251	)		(143	)		—			(4,399	)
	Decrease (increase) in inventory, prepaid expenses and other assets			108			100			(647	)		1			—			(438	)
	Increase (decrease) in accounts payable and other accrued liabilities			—			1,233			(1,847	)		62			—			(552	)
	Decrease in accrued payroll and related liabilities			—			2,478			(1,347	)		(10	)		—			1,121
	Increase in accrued interest			—			4,166			24			2			—			4,192
	Decrease in prepaid income taxes			—			7,614			—			—			—			7,614
	Increase in income taxes payable			—			1,232			—			—			—			1,232
	Increase in deferred income taxes asset			—			(2,169	)		—			—			—			(2,169	)
	Increase in deferred income taxes liability			—			3,940			—			—			—			3,940
	Increase in intercompany payable/(receivable)			(15,067	)		76,234			(54,756	)		(6,411	)		—			—

		Net cash provided by (used in) operating activities		(12,213	)		77,132			2,795			(24	)		—			67,690

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

CONDENSED, CONSOLIDATING STATEMENTS OF CASH FLOWS - (Continued)
For the Nine Months Ended September 30, 2003
(Unaudited)
(In thousands)


												Non-
									Guarantor			Guarantor
			VCA			Vicar			Subsidiaries			Subsidiaries			Elimination		Consolidated

Cash flows from investing activities:
	Business acquisitions, net of cash acquired		$	—		$	(27,177	)	$	—		$	—		$	—	$	(27,177	)
	Real estate acquired in connection with acquisitions			—			(589	)		—			—			—		(589	)
	Property and equipment additions, net			—			(8,655	)		(2,385	)		—			—		(11,040	)
	Proceeds from sale of assets			—			355			8			—			—		363
	Other			(5	)		181			271			—			—		447

		Net cash used in investing activities		(5	)		(35,885	)		(2,106	)		—			—		(37,996	)

Cash flows from financing activities:
	Repayment of long-term obligations, including redemption fees			(41,808	)		(175,684	)		—			—			—		(217,492	)
	Proceeds from issuance of long-term debt			—			146,442			—			—			—		146,442
	Payment of financing costs			(382	)		(687	)		—			—			—		(1,069	)
	Proceeds from issuance of common stock under stock option plans			85			—			—			—			—		85
	Proceeds from issuance of common stock			54,323			—			—			—			—		54,323

		Net cash provided by (used in) financing activities		12,218			(29,929	)		—			—			—		(17,711	)

Increase (decrease) in cash and cash equivalents				—			11,318			689			(24	)		—		11,983
Cash and cash equivalents at beginning of period				—			5,083			1,233			146			—		6,462

Cash and cash equivalents at end of period			$	—		$	16,401		$	1,922		$	122		$	—	$	18,445

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

CONDENSED, CONSOLIDATING STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2002
(Unaudited)
(In thousands)


												Non-
									Guarantor			Guarantor
			VCA			Vicar			Subsidiaries			Subsidiaries			Elimination			Consolidated

Cash flows from operating activities:
	Net income		$	23,165		$	27,257		$	48,854		$	5,794		$	(81,905	)	$	23,165
	Adjustments to reconcile net income to net cash provided by (used in) operating activities:
	Equity interest in earnings of subsidiaries			(27,257	)		(48,854	)		(4,434	)		—			80,545			—
	Depreciation and amortization			—			1,026			7,776			528			—			9,330
	Amortization of deferred financing costs and debt discount			(84	)		1,348			—			—			—			1,264
	Provision for uncollectible accounts			—			—			2,068			279			—			2,347
	Debt retirement costs			—			3,391			—			—			—			3,391
	Interest paid in kind on 15.5% senior notes			7,045			—			—			—			—			7,045
	Loss (gain) on sale of assets			—			(80	)		—			—			—			(80	)
	Minority interest in income of subsidiaries			—			—			—			—			1,360			1,360
	Distributions to minority interest partners			—			(1,339	)		—			—			—			(1,339	)
	Increase in trade accounts receivable			—			—			(4,413	)		(642	)		—			(5,055	)
	Decrease (increase) in inventory, prepaid expenses and other assets			74			(155	)		(817	)		(20	)		—			(918	)
	Increase (decrease) in accounts payable and other accrued liabilities			—			1,358			2,544			43			—			3,945
	Increase (decrease) in accrued payroll and related liabilities			—			3,157			(365	)		—			—			2,792
	Increase (decrease) in accrued interest			—			3,395			10			—			—			3,405
	Decrease in prepaid income taxes			—			2,782			—			—			—			2,782
	Increase in income taxes payable			—			2,035			—			—			—			2,035
	Increase in deferred income taxes asset			—			(2,318	)		—			—			—			(2,318	)
	Increase in deferred income taxes liability			—			7,687			—			—			—			7,687
	Increase in intercompany payable/(receivable)			(3,392	)		56,117			(46,548	)		(6,177	)		—			—

		Net cash provided by (used in) operating activities		(449	)		56,807			4,675			(195	)		—			60,838

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

CONDENSED, CONSOLIDATING STATEMENTS OF CASH FLOWS - (Continued)
For the Nine Months Ended September 30, 2002
(Unaudited)
(In thousands)


											Non-
								Guarantor			Guarantor
			VCA		Vicar			Subsidiaries			Subsidiaries			Elimination		Consolidated

Cash flows from investing activities:
	Business acquisitions, net of cash acquired		$	—	$	(17,845	)	$	—		$	—		$	—	$	(17,845	)
	Property and equipment additions, net			—		(7,475	)		(5,930	)		—			—		(13,405	)
	Proceeds from sale of assets			—		1,391			—			—			—		1,391
	Other			424		447			(288	)		—			—		583

		Net cash provided by (used in) investing activities		424		(23,482	)		(6,218	)		—			—		(29,276	)

Cash flows from financing activities:
	Repayment of long-term obligations			—		(145,978	)		—			—			—		(145,978	)
	Proceeds from the issuance of long-term debt			—		143,061			—			—			—		143,061
	Payment of deferred financing and recapitalization costs			—		(3,415	)		—			—			—		(3,415	)
	Proceeds from issuance of common stock under stock option plans			25		—			—			—			—		25

		Net cash provided by (used in) financing activities		25		(6,332	)		—			—			—		(6,307	)

Increase (decrease) in cash and cash equivalents				—		26,993			(1,543	)		(195	)		—		25,255
Cash and cash equivalents at beginning of period				—		3,467			3,260			376			—		7,103

Cash and cash equivalents at end of period			$	—	$	30,460		$	1,717		$	181		$	—	$	32,358


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

The following discussion should be read in conjunction with our condensed, consolidated financial statements provided under Part I, Item 1 of this quarterly report on Form 10-Q. Certain statements contained herein may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, as discussed more fully herein.

The forward-looking information set forth in this quarterly report on Form 10-Q is as of November 10, 2003, and we undertake no duty to update this information. Shareholders and prospective investors can find information filed with the Securities and Exchange Commission after November 10, 2003 at our website at www.investor.vcaantech.com or at the Securities and Exchange Commission’s website at www.sec.gov. More information about potential factors that could affect our business and financial results is included in the section entitled “Risk Factors.”

Overview

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

Our company was formed in 1986 by Robert Antin, Arthur Antin and Neil Tauber, who have served since our inception as our Chief Executive Officer, Chief Operating Officer and Senior Vice President of Development, respectively. During the 1990s, we established a premier position in the veterinary diagnostic laboratory and animal hospital markets through both internal growth and acquisitions. At September 30, 2003, our laboratory network consisted of 23 laboratories serving all 50 states and our animal hospital network consisted of 241 animal hospitals in 34 states. We primarily focus on generating internal growth to increase revenue and profitability. In order to augment internal growth, we may selectively acquire laboratories and intend to acquire approximately 15 to 25 animal hospitals per year, depending upon the attractiveness of candidates and the strategic fit with our existing operations.

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


		Three Months Ended						Nine Months Ended
		September 30,						September 30,

		2003			2002			2003			2002

Laboratories:
	Beginning of period		23			18			19			16
	Acquisitions and new facilities		1			1			7			3
	Relocated into other labs operated by us		(1	)		—			(3	)		—

	End of period		23			19			23			19

Animal hospitals:
	Beginning of period		238			220			229			214
	Acquisitions		3			7			19			18
	Relocated into other hospitals operated by us		—			(2	)		(5	)		(7	)
	Sold or closed		—			—			(2	)		—

	End of period		241			225			241			225

Owned at end of period			177			167			177			167
Managed at end of period			64			58			64			58

Basis of Reporting

General

Our discussion and analysis of our financial condition and results of operations are based upon our condensed, consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States, or GAAP. We report our operations in three segments: laboratory, animal hospital and corporate. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expense, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates due to changes in future conditions.

Revenue Recognition

We recognize revenue only after the following criteria are met:

• there exists adequate evidence of the transaction;

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

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

We report our revenue net of discounts.

Laboratory Revenue

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

Laboratory internal revenue growth for the three and nine months ended September 30, 2003 was calculated using laboratory revenue as reported, adjusted to exclude both revenue for the newly acquired laboratories that we did not own for the entire period presented and the impact resulting from differences in the number of billing days in comparable periods.

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

Animal Hospital Revenue

Animal hospital revenue is comprised of revenue of the animal hospitals that we own and the management fees for animal hospitals that we manage. Certain states prohibit business corporations from providing, or holding themselves out as providers of, veterinary medical care. In these states, we provide administrative and support services to veterinary medical groups pursuant to management agreements. The veterinary medical groups are each solely responsible for all aspects of the practice of veterinary medicine. In return for our services, the veterinary medical group pays us a management fee. We do not consolidate the operations of animal hospitals that we manage.

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

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

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

Other Revenue

In 2002, we earned consulting fees under an agreement with Heinz Pet Products related to the marketing of its proprietary pet food. This agreement expired in September 2002.

Direct Costs

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

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

There is a material limitation associated with the use of this non-GAAP financial measure, as it does not reflect the consolidated results for animal hospitals owned and managed as reported in our consolidated financial statements. To compensate for this limitation, we ensure that our disclosures provide a complete understanding of all adjustments found in non-GAAP financial measures, and we provide a reconciliation between GAAP financial measures and non-GAAP financial measures in “Results of Operations.”

Selling, General and Administrative Expense

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

Software Development Costs

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

Critical Accounting Policies and Significant Estimates

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

Workers’ Compensation Expense

Workers’ compensation expense is the cost to insure our company against losses related to injuries incurred by our employees in the normal course of their duties. Our workers’ compensation insurance policies are self-insurance retention programs, which means that we bear the significant portion of the financial risk associated with claims losses, while the insurance company bears only the financial risk of large individual losses and large aggregate losses.

As a result of utilizing self-insurance retention policies, we must estimate the amount that we will ultimately pay for losses associated with workers’ compensation claims, or claims losses for the policy period. These estimated claims losses must be recorded as expense during the policy period. Claims losses can vary substantially and, because they can take years to develop fully, can be difficult to estimate. These estimates are based on complex judgments regarding the probable number of claims that will be filed and the nature of those claims. Both of those variables are highly uncertain and combine to form a factor referred to as the “loss pick.” The loss pick factor is multiplied by our payroll cost to determine what the projected costs for claims and our related expense will be.

We estimate the loss pick by reviewing a minimum of five years of our historical claims loss data and analyzing the trend of the development of claims over time. We also review and adjust the loss pick for other major factors such as the risk control environment and claims handling. The risk control environment includes proper safety training, safe working environment, availability of safety equipment for specific tasks, and management emphasis and monitoring of safe practices. Claims handling includes proper reporting of claims, proper care given to injured employees, availability of return-to-work programs, and oversight of the claims process by both the insurance claims handler and our own management. We review our loss pick on a quarterly basis considering the current loss trend and any changes in the environment as indicated above. The loss pick is then applied to our actual payroll costs to estimate the claims loss portion of our workers’ compensation expense for the given period.

Our insurance carrier required us to pre-fund claims losses at a loss pick of 1.59% for the policy year ended September 30, 2003 and gave us a maximum loss pick of 2.55%, above which the carrier is responsible for paying all claims. For the policy year ended September 30, 2002, we were required to pre-fund claims losses at a loss pick of 1.54% and have a maximum loss pick of 2.49%. The ranges set forth by the insurance carrier reflect the most probable potentials for our workers’ compensation claims losses. The increase in the insurance carriers’ range reflects the trend over the last several years toward increasing workers’ compensation costs. Based on these ranges and the factors described above, we used a loss pick of 2.10% for the policy year ended September 30, 2003 and 2.04% for the policy year ended September 30, 2002. The increase in our loss pick reflects an increase in our claims loss trend during the past year.

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


							Probable Expense Range
		Estimated		Expense
		Payroll		Recorded			Low-end			High-end

Policy year ending September 30, 2003:
Loss pick percentage					2.10	%		1.59	%		2.55	%

Calculated loss pick in dollars		$	185,907	$	3,904		$	2,931		$	4,741
Premiums and other fees					1,618			1,578			1,652

	Total workers’ compensation expense			$	5,522		$	4,509		$	6,393

Policy year ended September 30, 2002:
Loss pick percentage					2.04	%		1.54	%		2.49	%

Calculated loss pick in dollars		$	169,022	$	3,441		$	2,603		$	4,208
Premiums and other fees					1,387			1,353			1,419

	Total workers’ compensation expense			$	4,828		$	3,956		$	5,627

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

Impairment of Goodwill

Our goodwill represents the purchase price paid and liabilities assumed for animal hospital and laboratory acquisitions in excess of the fair market value of the net assets acquired. The total amount of our net goodwill at September 30, 2003 was $370.0 million, consisting of $94.6 million for our laboratory operating segment and $275.4 million for our animal hospital operating segment.

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

Legal Settlements

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

Allowance for Uncollectible Accounts

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

Income Taxes

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

We operate in multiple states with varying tax laws. Our Federal income tax returns have been examined by the Internal Revenue Service through our fiscal year 1998 without an adjustment to our financial statements.

Results of Operations

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


			Three Months Ended						Nine Months Ended
			September 30,						September 30,

			2003			2002			2003			2002

Revenue:
	Laboratory			34.9	%		33.6	%		35.4	%		34.7	%
	Animal hospital			67.1			68.0			66.6			66.9
	Other			—			0.4			—			0.4
	Intercompany			(2.0	)		(2.0	)		(2.0	)		(2.0	)

		Total revenue		100.0			100.0			100.0			100.0
Direct costs (excluding operating depreciation)				66.7			67.1			66.9			67.3
Selling, general and administrative				6.7			7.6			7.2			7.7
Depreciation and amortization				2.8			2.6			2.7			2.7
Write-down of assets				0.3			—			0.1			—

		Operating income		23.5			22.7			23.1			22.3
Interest expense, net				4.8			8.9			5.2			9.1
Debt retirement costs				1.3			2.9			2.4			1.0
Other (income) expense				—			—			0.1			(0.1	)
Minority interest in income of subsidiairies				0.3			0.4			0.3			0.4
Provision for income taxes				7.0			4.4			6.2			5.0

		Net income		10.1	%		6.1	%		8.9	%		6.9	%

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


												Inter-
						Animal						company
			Laboratory			Hospital			Corporate			Eliminations			Total

Three Months Ended September 30, 2003
	Revenue		$	46,429		$	89,079		$	—		$	(2,605	)	$	132,903
	Direct costs (excluding operating depreciation)			25,870			65,445			—			(2,605	)		88,710
	Selling, general and administrative			2,826			2,492			3,613			—			8,931
	Depreciation and amortization			823			2,387			369			—			3,579
	Write-down and loss on sale of assets			39			403			—			—			442

		Operating income (loss)	$	16,871		$	18,352		$	(3,982	)	$	—		$	31,241

		Operating margin		36.3	%		20.6	%		(3.0	)%					23.5	%

Three Months Ended September 30, 2002
	Revenue		$	38,650		$	78,118		$	500		$	(2,296	)	$	114,972
	Direct costs (excluding operating depreciation)			21,849			57,604			—			(2,296	)		77,157
	Selling, general and administrative			2,563			2,359			3,810			—			8,732
	Depreciation and amortization			715			1,961			352			—			3,028
	Loss (gain) on sale of assets			24			9			(113	)		—			(80	)

		Operating income (loss)	$	13,499		$	16,185		$	(3,549	)	$	—		$	26,135

		Operating margin		34.9	%		20.7	%		(3.1	)%					22.7	%

Nine Months Ended September 30, 2003
	Revenue		$	134,818		$	254,231		$	—		$	(7,783	)	$	381,266
	Direct costs (excluding operating depreciation)			74,142			188,606			—			(7,783	)		254,965
	Selling, general and administrative			8,330			7,514			11,540			—			27,384
	Depreciation and amortization			2,376			7,168			1,109			—			10,653
	Write-down and loss (gain) on sale of assets			58			225			(1	)		—			282

		Operating income (loss)	$	49,912		$	50,718		$	(12,648	)	$	—		$	87,982

		Operating margin		37.0	%		19.9	%		(3.3	)%					23.1	%

Nine Months Ended September 30, 2002
	Revenue		$	116,911		$	225,383		$	1,500		$	(6,902	)	$	336,892
	Direct costs (excluding operating depreciation)			65,545			168,106			—			(6,902	)		226,749
	Selling, general and administrative			7,632			7,351			10,910			—			25,893
	Depreciation and amortization			2,138			6,166			1,026			—			9,330
	Loss (gain) on sale of assets			24			9			(113	)		—			(80	)

		Operating income (loss)	$	41,572		$	43,751		$	(10,323	)	$	—		$	75,000

		Operating margin		35.6	%		19.4	%		(3.1	)%					22.3	%

Revenue

The following table summarizes our revenue (in thousands):


		Three Months Ended September 30,									Nine Months Ended September 30,

		2003			2002			% Change			2003			2002			% Change

Laboratory		$	46,429		$	38,650			20.1	%	$	134,818		$	116,911			15.3	%
Animal hospital			89,079			78,118			14.0	%		254,231			225,383			12.8	%
Other			—			500						—			1,500
Intercompany			(2,605	)		(2,296	)					(7,783	)		(6,902	)

	Total revenue	$	132,903		$	114,972			15.6	%	$	381,266		$	336,892			13.2	%

Laboratory Revenue

Laboratory revenue increased $7.8 million for the three months ended September 30, 2003 and increased $17.9 million for the nine months ended September 30, 2003 compared to the same periods in the prior year. The components of the increase in laboratory revenue are detailed below (in thousands, except average price per requisition):


		Three Months Ended September 30,							Nine Months Ended September 30,

		2003		2002		% Change			2003		2002		% Change

Laboratory Revenue:
Internal growth:
	Number of requisitions		1,929		1,799		7.2	%		5,956		5,664		5.2	%
	Average revenue per requisition (1)	$	22.51	$	21.48		4.8	%	$	22.00	$	20.64		6.6	%

Total internal revenue (2)		$	43,422	$	38,650		12.3	%	$	131,024	$	116,911		12.1	%
Billing day adjustment			571		—					—		—
Acquired revenue			2,436		—					3,794		—

	Total	$	46,429	$	38,650		20.1	%	$	134,818	$	116,911		15.3	%

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

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

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

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

The increase in the average revenue per requisition during the three and nine months ended September 30, 2003 is attributable to our sales and marketing efforts of our pet health and wellness programs, which have contributed to an increase in the number of tests performed per requisition, as well as a change in the mix of tests to include more comprehensive and expensive tests. Also contributing to our increase in average revenue per requisition are price increases. The prices of most tests were increased 3% to 5% in February 2003.

As the result of acquiring eight laboratory facilities between November 2002 and September 2003, we generated an additional $2.4 million of revenue (referred to in the above table as “acquired revenue”) during the

three months ended September 30, 2003 and $3.8 million of revenue during the nine months ended September 30, 2003 compared to the same periods in the prior year.

The billing day adjustment, referred to in the above table, reflects the impact of one additional billing day for the three months ended September 30, 2003 compared to the same period in the prior year.

Animal Hospital Revenue

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


		Three Months Ended September 30,									Nine Months Ended September 30,

		2003			2002			% Change			2003			2002			% Change

Animal Hospital Revenue:
As reported		$	89,079		$	78,118			14.0	%	$	254,231		$	225,383			12.8	%
Less: Management fees (1)			(13,027	)		(11,520	)					(37,627	)		(33,713	)
Add: Revenue of animal hospitals managed			24,008			21,246						68,585			61,501

	Combined animal hospital (2)	$	100,060		$	87,844			13.9	%	$	285,189		$	253,171			12.6	%

(1) Paid to us by veterinary medical groups.

(2) Represents the combined animal hospital revenue of hospitals owned and managed.

The combined animal hospital revenue increased $12.2 million for the three months ended September 30, 2003 and increased $32.0 million for the nine months ended September 30, 2003 compared to the same periods in the prior year. The components of the increase are summarized in the following table (in thousands, except average price per order):


		Three Months Ended September 30,							Nine Months Ended September 30,

		2003		2002		% Change			2003		2002		% Change

Animal Hospital Revenue:
Adjusted same-facility:
	Orders (1)		851		865		(1.6	)%		2,413		2,456		(1.8	)%
	Average price per order (2)	$	106.56	$	100.31		6.2	%	$	106.40	$	100.95		5.4	%

Adjusted same-facility revenue (1) (3)		$	90,680	$	86,764		4.5	%	$	256,746	$	247,939		3.6	%
Net acquired revenue (1)			9,380		1,080					28,443		5,232

	Combined animal hospital (4)	$	100,060	$	87,844		13.9	%	$	285,189	$	253,171		12.6	%

(1) Adjusted same-facility revenue, orders and net acquired revenue are non-GAAP measures of combined animal hospitals owned and managed. These non-GAAP measures are reconciled to the GAAP measures in tables below.

(2) Computed by dividing adjusted same-facility revenue by adjusted same-facility orders.

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

(4) Represents the combined animal hospital revenue of hospitals owned and managed.

Our animal hospital segment has placed a greater emphasis on providing high-quality veterinary care and comprehensive wellness programs, which has contributed to the increase in the average price per order and the increase in adjusted same-facility revenue for the three and nine months ended September 30, 2003. The decrease in the number of orders for the three and nine months ended September 30, 2003 is partly attributable to a decrease in the number of orders for sales of vaccinations, flea and tick products and boarding. Sales of flea and tick products have decreased as a result of changes in the channels of distribution for these products.

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

Reconciliation Between Non-GAAP and GAAP Measures

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


		Three Months Ended September 30,									Nine Months Ended September 30,

		2003			2002			% Change			2003			2002			% Change

Animal Hospital Revenue:
Adjusted same-facility revenue (1)		$	90,680		$	86,764			4.5	%	$	256,746		$	247,939			3.6	%
Same-facility revenue of animal hospitals managed			(21,517	)		(21,036	)					(60,318	)		(59,728	)

Same-facility revenue of animal hospitals owned			69,163			65,728						196,428			188,211
Same-facility management fees (2)			11,633			11,423						32,990			32,752

	Same-facility revenue	$	80,796		$	77,151			4.7	%	$	229,418		$	220,963			3.8	%

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

(2) Paid to us by veterinary medical groups.

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


		Three Months Ended September 30,

		2003			2002			% Change

Same-facility:
	Orders for combined animal hospitals owned and managed		851			865
	Orders for animal hospitals managed		(213	)		(219	)

	Orders for animal hospitals owned		638			646			(1.2	)%
	Average price per order for animal hospitals owned (1)	$	108.41		$	101.75			6.5	%

Same-facility revenue for animal hospitals owned (2)		$	69,163		$	65,728			5.2	%
Same-facility management fees			11,633			11,423
Acquired revenue and management fees from acquired managed practices			8,283			967

	Animal hospital revenue as reported	$	89,079		$	78,118


		Nine Months Ended September 30,

		2003			2002			% Change

Same-facility:
	Orders for combined animal hospitals owned and managed		2,413			2,456
	Orders for animal hospitals managed		(589	)		(614	)

	Orders for animal hospitals owned		1,824			1,842			(1.0	)%
	Average price per order for animal hospitals owned (1)	$	107.69		$	102.18			5.4	%

Same-facility revenue for animal hospitals owned (2)		$	196,428		$	188,211			4.4	%
Same-facility management fees			32,990			32,752
Acquired revenue and management fees from acquired managed practices			24,813			4,420

	Animal hospital revenue as reported	$	254,231		$	225,383

(1) Computed by dividing same-facility revenue for animal hospitals owned by same-facility orders for animal hospitals owned.

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

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


		Three Months Ended						Nine Months Ended
		September 30,						September 30,

		2003			2002			2003			2002

Acquired revenue for combined animal hospitals owned and managed		$	9,380		$	1,080		$	28,443		$	5,232
Less: acquired revenue for animal hospitals managed			(2,491	)		(210	)		(8,267	)		(1,773	)

Acquired revenue for animal hospitals owned			6,889			870			20,176			3,459
Management fees from acquired managed practices			1,394			97			4,637			961

	Acquired revenue and management fees from acquired managed practices	$	8,283		$	967		$	24,813		$	4,420

Other Revenue

Other revenue consists of fees earned from a marketing consulting agreement with Heinz Pet Products, which paid a monthly fee of approximately $167,000 commencing October 1, 2000 through September 30, 2002. For the three and nine months ended September 30, 2002, we recognized revenue of $500,000 and $1.5 million, respectively, related to this agreement. There were no consulting agreements effective in 2003.

Direct Costs

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


		Three Months Ended September 30,															Nine Months Ended September 30,

		2003						2002									2003						2002

					% of						% of			%						% of						% of			%
		$			Revenue			$			Revenue			Change			$			Revenue			$			Revenue			Change

Laboratory		$	25,870			55.7	%	$	21,849			56.5	%		18.4	%	$	74,142			55.0	%	$	65,545			56.1	%		13.1	%
Animal hospital			65,445			73.5	%		57,604			73.7	%		13.6	%		188,606			74.2	%		168,106			74.6	%		12.2	%
Intercompany			(2,605	)					(2,296	)								(7,783	)					(6,902	)

	Total direct costs	$	88,710			66.7	%	$	77,157			67.1	%		15.0	%	$	254,965			66.9	%	$	226,749			67.3	%		12.4	%

Laboratory Direct Costs

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

Animal Hospital Direct Costs

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


		Three Months Ended September 30,

		2003						2002

					% of						% of
		$			Revenue			$			Revenue			% Change

Animal Hospital Direct Costs:
As reported		$	65,445			73.5	%	$	57,604			73.7	%		13.6	%
Add: Direct costs of animal hospitals managed			24,008						21,246
Less: Management fees (1)			(13,027	)					(11,520	)

	Combined animal hospital (2)	$	76,426			76.4	%	$	67,330			76.6	%		13.5	%


		Nine Months Ended September 30,

		2003						2002

					% of						% of
		$			Revenue			$			Revenue			% Change

Animal Hospital Direct Costs:
As reported		$	188,606			74.2	%	$	168,106			74.6	%		12.2	%
Add: Direct costs of animal hospitals managed			68,585						61,501
Less: Management fees (1)			(37,627	)					(33,713	)

	Combined animal hospital (2)	$	219,564			77.0	%	$	195,894			77.4	%		12.1	%

(1) Charged by us to veterinary medical groups.

(2) Represents the combined animal hospital direct costs of hospitals owned and managed.

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

Selling, General and Administrative Expense

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


		Three Months Ended September 30,													Nine Months Ended September 30,

		2003					2002								2003					2002

				% of					% of			%					% of					% of			%
		$		Revenue			$		Revenue			Change			$		Revenue			$		Revenue			Change

Laboratory		$	2,826		6.1	%	$	2,563		6.6	%		10.3	%	$	8,330		6.2	%	$	7,632		6.5	%		9.1	%
Animal hospital			2,492		2.8	%		2,359		3.0	%		5.6	%		7,514		3.0	%		7,351		3.3	%		2.2	%
Corporate			3,613		2.7	%		3,810		3.3	%		(5.2	)%		11,540		3.0	%		10,910		3.2	%		5.8	%

	Total SG&A	$	8,931		6.7	%	$	8,732		7.6	%		2.3	%	$	27,384		7.2	%	$	25,893		7.7	%		5.8	%

Laboratory SG&A

The decrease in laboratory SG&A as a percentage of laboratory revenue during the three and nine months ended September 30, 2003 as compared to the same periods in the prior year was primarily attributable to an increase in laboratory revenue combined with operating leverage associated with our laboratory business. The decrease in laboratory SG&A as a percentage of laboratory revenue during the nine months ended September 30, 2003 as compared to the same period in the prior year was also attributable to a $300,000 decrease in legal settlements and costs due to a specific litigative matter that occurred only in 2002.

Animal Hospital SG&A

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

Corporate SG&A

The decrease in corporate SG&A as a percentage of total revenue for the three months ended September 30, 2003 as compared to the same period in the prior year was primarily attributable to a $145,000 decrease in general legal settlements and costs. The decrease in corporate SG&A as a percentage of total revenue for the nine months ended September 30, 2003 as compared to the same period in the prior year was primarily attributable to a decrease in accounting fees. Corporate SG&A for the nine months ended September 30, 2002 included additional accounting fees of $300,000 incurred for the reaudit of prior year financial statements in connection with changing our independent auditors from Arthur Andersen LLP to KPMG LLP.

Depreciation and Amortization

Depreciation and amortization expense increased $551,000, or 18.2%, for the three months ended September 30, 2003 and increased $1.3 million, or 14.2%, for the nine months ended September 30, 2003 compared to the same periods in the prior year. The increase in depreciation and amortization was due to the purchase of property and equipment and the addition of non-competition agreements executed in connection with the acquisition of animal hospitals and laboratories.

Write-down of Assets

During the three and nine months ended September 30, 2003, we determined that the value of one of our parcels of real estate was impaired and recorded an impairment charge of $392,000.

Loss (Gain) on Sale of Assets

During the three and nine months ended September 30, 2003, we sold assets no longer needed in our operations for a loss of $50,000 and a gain of $110,000, respectively. The sales transactions consisted of real estate, one animal hospital practice and other fixed assets.

Interest Expense, Net

Interest expense, net of interest income decreased $3.8 million, or 37.7%, for the three months ended September 30, 2003 and decreased $10.8 million, or 35.3%, for the nine months ended September 30, 2003 compared to the same periods in the prior year. The change in net interest expense was attributable to a decrease in the average debt balances outstanding and a decrease in the weighted average interest rate.

Debt Retirement Costs

On August 19, 2003, we refinanced our senior credit facility retiring $166.4 million principal balance outstanding under our senior term C notes with $20.0 million of cash on-hand and $146.4 million received from the

issuance of new senior term D notes, with an interest rate margin of 2.5% compared to 3.0% for the senior term C notes. In conjunction with that transaction, we recorded debt retirement costs of $1.7 million.

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

All debt retirement costs have been reported as a component of continuing operations in our Condensed, Consolidated Income Statements.

Other (Income) Expense

Other income was $129,000 for the three months ended September 30, 2003 and other expense was $129,000 for the nine months ended September 30, 2003, representing non-cash gains and losses on our interest rate swap agreements. Other income was $5,000 and $159,000 for the three and nine months ended September 30, 2003, respectively, representing non-cash gains on our interest rate collar agreement.

Minority Interest in Income of Subsidiaries

Minority interest in income of the consolidated subsidiaries was $456,000 and $430,000 for the three months ended September 30, 2003 and 2002, respectively, and $1.3 million and $1.4 million for the nine months ended September 30, 2003 and 2002, respectively. Minority interest in income of subsidiaries represents our partners’ proportionate share of net income generated by those subsidiaries that we do not wholly own.

Provision for Income Taxes

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

Liquidity and Capital Resources

Discussion of the Nine Months Ended September 30, 2003

Our cash and cash equivalents increased to $18.4 million at September 30, 2003 compared to $6.5 million at December 31, 2002. The increase resulted from $67.7 million provided by operating activities offset by $38.0 million used in investing activities and $17.7 million used in financing activities.

Net cash provided by operating activities increased to $67.7 million during the nine months ended September 30, 2003 compared to $60.8 million during the nine months ended September 30, 2002. This increase was primarily attributable to an increase in operating income and a $4.0 million decrease in interest paid, offset by a $6.5 million increase in income taxes paid and changes in working capital.

We used net cash of $38.0 million from investing activities during the nine months ended September 30, 2003 in which we:

• paid $27.0 million related to the acquisition of 19 animal hospitals and four laboratory companies and the settlement of certain obligations incurred or agreed to on the date of acquisition;

• paid $244,000 to purchase the ownership interest held by two of our animal hospital partners;

• paid $589,000 for real estate acquired in connection with acquisitions;

• paid $11.0 million in property and equipment additions; and

• received $810,000 from the sale of assets and other activities.

We used net cash of $17.7 million from financing activities during the nine months ended September 30, 2003 in which we:

• received $54.3 million in net proceeds from the issuance of 3.8 million shares of our common stock;

• paid $41.8 million to voluntarily redeem the entire principal amount of our 15.5% senior notes at a redemption price of 110% of the principal amount;

• paid $166.4 million to retire the entire principal amount of our senior term C notes by using $20.0 million of cash on-hand and $146.4 million received from the issuance of new senior term D notes;

• paid $1.7 million for scheduled maturities of debt obligations;

• paid $7.5 million to repay the entire outstanding balance of our revolving credit facility; and

• paid $1.0 million of financing costs.

Future Cash Requirements

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

Estimated future uses of cash for the remainder of 2003 include capital expenditures for land, buildings and equipment of approximately $5.0 million. In addition, we intend to use available liquidity to continue our growth through the selective acquisition of animal hospitals, primarily for cash. From October 1, 2003 through November 10, 2003, we acquired two animal hospitals using cash of approximately $2.5 million. We do not anticipate purchasing additional animal hospital or laboratory facilities during the remainder of 2003 because we have achieved our acquisition goals for the current year. Our acquisition program contemplates the acquisition of 15 to 25 animal hospitals per year and a planned cash commitment of up to $30.0 million. However, we may purchase either a fewer or greater number of animal hospital facilities and we may purchase laboratory facilities during any year depending upon opportunities that present themselves and our cash requirements may change accordingly. Although we intend to primarily use cash in our acquisitions, we may use debt or stock to the extent we deem it appropriate and to the extent we do not violate certain covenants in our senior credit facility.

In addition to the foregoing, we will use approximately $733,000 of cash for the remainder of 2003 to pay the mandatory principal payments due on our outstanding indebtedness. In addition, we may elect to prepay certain debt obligations.

Description of Indebtedness

Credit and Guaranty Agreement. On September 20, 2000, we entered into a credit and guaranty agreement, which included senior term notes and a $50.0 million revolving credit facility. On August 19, 2003, we refinanced our credit and guaranty agreement retiring $166.4 million principal balance outstanding under our senior term C notes with $20.0 million of cash on-hand and $146.4 million received from the issuance of new senior term D notes, with an interest rate margin of 2.5% compared to 3.0% for the senior term C notes. At September 30, 2003, we had $146.1 million principal amount outstanding under our senior term D notes and no borrowings outstanding under our revolving credit facility.

Borrowings under the credit and guaranty agreement bear interest, at our option, on either the base rate, which is the higher of the administrative agent’s prime rate or the Federal funds rate plus 0.5% plus a base rate margin, or the adjusted eurodollar rate, which is the rate per annum obtained by dividing (1) the rate of interest offered to the administrative agent on the London interbank market by (2) a percentage equal to 100% minus the stated maximum rate of all reserve requirements applicable to any member bank of the Federal Reserve System in respect of “eurocurrency liabilities” plus a eurodollar rate margin. The base rate margins for the revolving credit facility range from 1.00% to 2.25% per annum and the margin for the senior term D notes is 1.50%. The eurodollar rate margins for the revolving credit facility range from 2.00% to 3.25% per annum and the margin for the senior term D notes is 2.50%. The senior term D notes mature in September 2008 and the revolving credit facility matures in September 2006.

The credit and guaranty agreement contains certain financial covenants pertaining to interest coverage, fixed charge coverage and leverage ratios. In addition, the credit and guaranty agreement has restrictions pertaining to capital expenditures, acquisitions and the payment of dividends on all classes of stock. We currently believe the most restrictive covenant is the fixed-charge coverage ratio. Our credit agreement defines the fixed charge coverage ratio as that ratio which is calculated on a last twelve-month basis by dividing pro forma EBITDA, as defined by the agreement, by fixed charges. Fixed charges are defined as cash interest expense, scheduled principal payments on debt obligations, capital expenditures and provision for income taxes. At September 30, 2003, we had a fixed charge coverage ratio of 1.53 to 1.00, exceeding the required ratio of 1.10 to 1.00.

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 September 30, 2003, the outstanding principal balance of these senior subordinated notes was $170.0 million. We and each existing and future domestic wholly-owned subsidiary of Vicar have jointly and severally, fully and unconditionally guaranteed these notes. These guarantees are unsecured and subordinated in right of payment to all existing and future indebtedness outstanding under the credit and guaranty agreement and any other indebtedness permitted to be incurred by Vicar under the terms of the indenture agreement governing these notes.

Other Debt. We had seller notes secured by assets of animal hospitals, unsecured debt and capital leases that totaled $1.9 million at September 30, 2003.

Future Cash Obligations for Long-Term Debt, Interest and Leases

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


	Payments Due by Period

				Less than								More than
	Total			1 year (1)			1 - 3 years			3 - 5 years		5 years

Long-term debt	$	317,624		$	647		$	3,831		$	90,020	$	223,126
Fixed interest		110,589			8,525			34,520			33,945		33,599
Variable interest		42,298			2,228			19,492			18,454		2,124
Capital lease obligations		333			86			246			1		—
Operating leases		246,387			4,709			30,323			30,031		181,324
Swap agreements		(2,426	)		(337	)		(2,089	)		—		—

	$	714,805		$	15,858		$	86,323		$	172,451	$	440,173

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

We have both fixed-rate and variable-rate debt. The interest payments on our variable-rate debt are based on a variable-rate component plus a fixed 2.5%. Including the fixed 2.5%, we estimate that the total interest rate on our variable-rate debt will be 6.1%, 6.5%, 7.0%, 7.5%, 8.0% and 8.0% for years 2003 through 2008, respectively.

Our consolidated financial statements included in our 2002 Annual Report on Form 10-K discuss these variable-rate notes in more detail.

Interest Rate Hedging Agreements

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

Swap #1

Swap #2

Swap #3

Fixed interest rate

2.22%

1.72%

1.51%

Notional amount

$40.0 million

$20.0 million

Effective date

11/29/2002

5/30/2003

Expiration date

11/29/2004

5/31/2005

Counter party

Wells Fargo Bank

Goldman Sachs

Swap # 2 and Swap #3 qualify for hedge accounting and we consider them to be cash flow hedging instruments. Prior to May 2003, Swap #1 was also considered to be a cash-flow hedging instrument. At that time, we determined that Swap #1 was no longer an effective tool for mitigating interest rate risk within an acceptable degree of variance because the projected LIBOR rates at May 2003 for the remaining term of the contract, June 2003 through November 2004, were materially different from the LIBOR projections made at the inception of the contract for this same time period. This difference in LIBOR projections was a result of changes in the interest rate environment which occurred from November 2002 through May 2003. As a result of this determination, Swap #1 no longer qualifies for hedge accounting and all changes in its market value are recognized as income or expense in the period of change.

At September 30, 2003, the fair market values of our swap agreements resulted in a net liability to us of $524,000, which is included in other accrued liabilities. For the three and nine months ended September 30, 2003, we made payments of $165,000 and $352,000, respectively, as a result of LIBOR being below the fixed interest rates. These payments are included in interest expense.

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

New Accounting Pronouncements

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

In May 2003, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 clarifies the accounting for certain financial instruments with characteristics of both liabilities and equity and requires that those instruments be classified as liabilities. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We currently have a $2.3 million obligation to be settled in either cash or common stock that is classified as a liability. In addition, we have certain partnerships in non-wholly owned subsidiaries whereby we are required under the terms of the respective partnership agreements to purchase the partner’s equity in the partnership in the event of the partner’s death. Under SFAS No. 150, we are required to recognize these obligations as liabilities in our financial statements at fair market value. Currently, we are recognizing these liabilities as a component of minority interest. We do not anticipate that SFAS No. 150 will have a material impact on our future financial statements.

Accounting for Derivative Instruments and Hedging Activities

Consolidations of Variable Interest Entities

In January 2003, the FASB issued FASB Interpretation, or FIN, No. 46, Consolidation of Variable Interest Entities, requiring that companies consolidate variable interest entities if they are the primary beneficiaries, as defined under FIN No. 46, of the activities of the variable interest entities. Companies are required to apply FIN No. 46 immediately for all variable interest entities created after January 31, 2003 and per FASB Staff Position FIN No. 46-6 issued in October 2003, as of the first annual period ending after December 15, 2003 for all other variable interest entities.

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

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

Guarantor’s Accounting and Disclosure Requirements for Guarantees

We have guaranteed all liabilities for certain veterinary medical groups for which we provide management services. All of these liabilities have been included in our condensed, consolidated financial statements. We pay these liabilities and recover money spent through the management fee we charge the veterinary medical groups. We do not expect FIN No. 45 to have a material impact on our financial statements in the future.

Consideration Received from a Vendor

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

• cash received from a vendor is presumed to be a reduction of the cost of the vendor’s products or services, however that presumption is overcome when the consideration is either a) a payment for assets or services, or b) a reimbursement of specific and identifiable costs incurred on behalf of the

vendor in selling the vendor’s products or services, in which case the consideration is a reduction of that cost; and

• rebates offered to a customer or reseller should be recognized or new agreements entered into on or after January 1, 2003.

We have adopted EITF Issue No. 02-16 and it has not had, nor do we expect it to have a material impact on our financial statements in the future.

Costs Associated with Exit or Disposal Activities

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

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

Gains and Losses from Extinguishment of Debt and Capital Leases

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

During the nine months ended September 30, 2003, we made two significant changes to our capital structure:

• in August 2003, we refinanced our senior credit facility voluntarily repaying $20.0 million of senior term C notes and retiring the remaining senior term C notes with senior term D notes, resulting in debt retirement costs of approximately $1.7 million; and

• in February 2003, we redeemed the remaining principal amount outstanding of our 15.5% senior notes with proceeds from our secondary offering resulting in debt retirement costs of approximately $7.4 million.

We have concluded that these debt retirement costs do not qualify for extraordinary treatment under APB No. 30 because we have historically changed our capital structure to take advantage of favorable market conditions and it is probable that we will continue to do so in the future. As a result, these costs for all periods presented have been included as a component from recurring operations in the Condensed, Consolidated Income Statements.

SFAS No. 145 also amends SFAS No. 13, Accounting for Leases. Under SFAS No. 145, if a capital lease is modified such that it becomes an operating lease, a gain or loss must be recognized similar to the accounting used for sale-leaseback transactions as provided in SFAS No. 28 and No. 98. At September 30, 2003, we had capital lease obligations of $333,000; however, we currently have no plans to modify these or any future capital leases, and we do not expect SFAS No. 145 to have a material impact on our financial statements.

Asset Retirement Obligations

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

Risk Factors

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

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

Our success depends in part on our ability to build on our position as a leading animal health care services company through a balanced program of internal growth initiatives and selective acquisitions of established animal hospitals and laboratories. If we cannot implement or effectively execute these initiatives and acquisitions, our results of operations will be adversely affected. Even if we effectively implement our growth strategy, we may not achieve the economies of scale that we have experienced in the past or that we anticipate having in the future. Our internal growth rate may decline and could become negative. Our laboratory internal revenue growth has fluctuated between 12.5% and 14.1% for each fiscal year from 2000 through 2002. Similarly, our animal hospital adjusted same-facility revenue growth rate has fluctuated between 3.6% and 7.0% over the same fiscal years. Our internal growth may continue to fluctuate and may be below our historical rates. Any reductions in the rate of our internal growth may cause our revenues and margins to decrease. Our historical growth rates and margins are not necessarily indicative of future results.

Demand for certain products could decline as their product life cycle matures and the products become available in more 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 established by our veterinarians who use their independent professional judgment. Some of our veterinarians have changed their protocols and others may change their protocol in light of recent literature.

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

Since January 1, 1996, we have experienced rapid growth and expansion. Our failure to manage our growth effectively may increase our costs of operations and hinder our ability to execute our business strategy. Our rapid growth has placed, and will continue to place, a significant strain on our management and operational systems and resources. At January 1, 1996, we operated 59 animal hospitals, operated laboratories servicing approximately 9,000 customers in 27 states and had approximately 1,150 full-time equivalent employees. At September 30, 2003, we operated 241 animal hospitals, operated laboratories servicing approximately 14,000 customers in all 50 states and had approximately 4,000 full-time equivalent employees. If our business continues to grow, we will need to improve

and enhance our overall financial and managerial controls, reporting systems and procedures, and expand, train and manage our workforce in order to maintain control of expense and achieve desirable economies of scale. We also will need to increase the capacity of our current systems to meet additional demands.

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

Approximately 57.2% of our expense, particularly rent and personnel costs, are fixed costs and are based in part on expectations of revenue. We may be unable to reduce spending in a timely manner to compensate for any significant fluctuations in our revenue. Accordingly, shortfalls in revenue may adversely affect our operating income.

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

Our success depends on our ability to timely and cost-effectively acquire, and integrate into our business, additional animal hospitals and laboratories. Any difficulties in the integration process may result in increased expense, loss of customers and a decline in profitability. We expect to acquire 15 to 25 animal hospitals per year, however, based on the opportunity, the number could be higher. Historically we have experienced delays and increased costs in integrating some hospitals primarily where we acquire a large number of hospitals in a single region at or about the same time. In these cases, our field management may spend a predominant amount of time integrating these new hospitals and less time managing our existing hospitals in those regions. During these periods, there may be less attention directed to marketing efforts or staffing issues. In these circumstances, we also have experienced delays in converting the systems of acquired hospitals into our systems, which results in increased payroll expense to collect our results and delays in reporting our results, both for a particular region and on a consolidated basis. These factors have resulted in decreased revenue, increased costs and lower margins. We continue to face risks in connection with our acquisitions including:

• negative effects on our operating results;

• impairments of goodwill and other intangible assets;

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

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

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

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

At September 30, 2003, our balance sheet reflected $370.0 million of goodwill, which is a substantial portion of our total assets of $545.8 million at that date. We expect that the aggregate amount of goodwill on our balance sheet will increase as a result of future acquisitions. We continually evaluate whether events or circumstances have occurred that suggest that the fair market value of each of our reporting units is below their carrying values. If we determine that the fair market value of one of our reporting units is less than its carrying value, this may result in an impairment write-down of the goodwill for that reporting unit. The impairment write-down would be reflected as expense and could have a material adverse effect on our results of operations during the period in which we recognize the expense. In 2002, we concluded that the fair value of our reporting units exceeded their carrying value and accordingly, as of that date, our net goodwill was fairly stated in our financial statements and there are currently no impairment issues. However, in the future we may incur impairment charges related to the goodwill already recorded or arising out of future acquisitions.

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 September 30, 2003, our debt, excluding unamortized discounts, consisted of:

• $146.1 million in principal amount outstanding under our senior credit facility;

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

• $1.9 million in principal amount outstanding under our other debt.

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


	Payments Due by Period

				Less than								More than
	Total			1 year (1)			1 - 3 years			3 - 5 years		5 years

Long-term debt	$	317,624		$	647		$	3,831		$	90,020	$	223,126
Fixed interest		110,589			8,525			34,520			33,945		33,599
Variable interest		42,298			2,228			19,492			18,454		2,124
Capital lease obligations		333			86			246			1		—
Swap agreements		(2,426	)		(337	)		(2,089	)		—		—

	$	468,418		$	11,149		$	56,000		$	142,420	$	258,849

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

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

Swap #1

Swap #2

Swap #3

Fixed interest rate

2.22%

1.72%

1.51%

Notional amount

$40.0 million

$20.0 million

Effective date

11/29/2002

5/30/2003

Expiration date

11/29/2004

5/31/2005

Swap #2 and Swap #3 qualify for hedge accounting and we consider them to be cash-flow hedging instruments. Prior to May 2003, Swap #1 was also considered to be a cash-flow hedging instrument. At that time, we determined that Swap #1 was no longer considered a cash-flow hedging instrument because the current rate environment was significantly different than the rate environment in existence at the effective date.

Our ability to make payments on our debt, and to fund acquisitions, will depend upon our ability to generate cash in the future. Insufficient cash flow could place us at risk of default under our debt agreements or could prevent

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

As the pet population continues to grow, the need for skilled veterinarians continues to increase. If we are unable to retain an adequate number of skilled veterinarians, we may lose customers, our revenue may decline and we may need to sell or close animal hospitals. As of September 30, 2003, there were 28 veterinary schools in the country accredited by the American Veterinary Medical Association. These schools graduate approximately 2,100 veterinarians per year. There is a shortage of skilled veterinarians across the country, particularly in some regional markets in which we operate animal hospitals. During these shortages in these regions, we may be unable to hire enough qualified veterinarians to adequately staff our animal hospitals, in which event we may lose market share and our revenues and profitability may decline.

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

The laws of many states prohibit business corporations from providing, or holding themselves out as providers of, veterinary medical care. These laws vary from state to state and are enforced by the courts and by regulatory authorities with broad discretion. As of September 30, 2003 we operated 64 animal hospitals in 11 states with these laws, including 21 in New York. We may experience difficulty in expanding our operations into other states with similar laws. Given varying and uncertain interpretations of the veterinary laws of each state, we may not be in compliance with restrictions on the corporate practice of veterinary medicine in all states. A determination that we are in violation of applicable restrictions on the practice of veterinary medicine in any state in which we operate could have a material adverse effect on us, particularly if we were unable to restructure our operations to comply with the requirements of that state.

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

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

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

Our computer systems are vulnerable to damage or interruption from a variety of sources, including telecommunications failures, electricity brownouts or blackouts, malicious human acts and natural disasters.

Moreover, despite network security measures, some of our servers are potentially vulnerable to physical or electrical break-ins, computer viruses and similar disruptive problems. Despite the precautions we have taken, unanticipated problems affecting our systems could cause interruptions in our information technology systems. Our insurance policies may not adequately compensate us for any losses that may occur due to any failures in our systems.

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

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

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

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

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

Our executive officers, directors and principal stockholders beneficially own, in the aggregate, 22.8% of our outstanding common stock. As a result, these stockholders are able to significantly affect our management, our policies and all matters requiring stockholder approval. The directors supported by these stockholders will be able to significantly affect decisions relating to our capital structure, including decisions to issue additional capital stock, implement stock repurchase programs and incur indebtedness. This concentration of ownership may have the effect of deterring hostile takeovers, delaying or preventing changes in control or changes in management, or limiting the ability of our other stockholders to approve transactions that they may deem to be in their best interests.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As of September 30, 2003, we had borrowings of $146.1 million under our senior credit facility with fluctuating interest rates based on market benchmarks such as LIBOR. To reduce the risk of increasing interest rates, we have entered into three separate no-fee interest rate swap agreements. The first agreement is for $40.0 million and commenced on November 29, 2002 and expires November 29, 2004. The second agreement is for $20.0 million and commenced on May 30, 2003 and expires May 31, 2005. The third agreement is for $20.0 million and commenced on May 30, 2003 and expires May 31, 2005. These swap agreements have the effect of reducing the amount of our debt exposed to variable interest rates from $146.1 million to $66.1 million. Accordingly, for the next 12-month period, for every 1.0% increase in the LIBOR rate we will pay an additional $661,000 in interest expense and for every 1.0% decrease in the LIBOR rate we will save $661,000 in interest expense.

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

ITEM 4. CONTROLS AND PROCEDURES

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

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

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

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

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

ITEM 2. CHANGES IN SECURITIES

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

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

None

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits:


31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

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

(b) Reports on Form 8-K:

(1) Report on Form 8-K, filed July 23, 2003, reporting under Item 5 updated financial guidance for fiscal year 2003, and under Item 9, earnings for the second quarter of fiscal year 2003.

(2) Report on Form 8-K, filed August 21, 2003, reporting under Item 5 the Eighth Amendment to the Credit and Guaranty Agreement, and the repayment of Senior Term C notes with $20.0 million of cash on-hand and $146.4 million received from the issuance of Senior Term D notes bearing a lower interest rate.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the City of Los Angeles, State of California, on today’s date, November 12, 2003.


By:		/s/ Tomas W. Fuller

		Tomas W. Fuller
Its:		Chief Financial Officer

EXHIBIT INDEX


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

			specific and identifiable costs incurred on behalf of the vendor in selling the vendor’s products or services, in which case the consideration is a reduction of that cost; and

	•		rebates offered to a customer or reseller should be recognized as a reduction of the cost of sales based on a systematic and rational allocation provided that the amounts recognized are probable and reasonably estimable.

	•		in August 2003, the Company refinanced its senior credit facility voluntarily repaying $20.0 million of senior term C notes and retiring the remaining senior term C notes with senior term D notes, resulting in debt retirement costs of approximately $1.7 million; and

	•		in February 2003, the Company redeemed the remaining principal amount outstanding of its 15.5% senior notes with proceeds from its secondary offering resulting in debt retirement costs of approximately $7.4 million.

	•		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.

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

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

(1)		Paid to us by veterinary medical groups.

(2)		Represents the combined animal hospital revenue of hospitals owned and managed.

(1)		Adjusted same-facility revenue, orders and net acquired revenue are non-GAAP measures of combined animal hospitals owned and managed. These non-GAAP measures are reconciled to the GAAP measures in tables below.

(2)		Computed by dividing adjusted same-facility revenue by adjusted same-facility orders.

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

(4)		Represents the combined animal hospital revenue of hospitals owned and managed.

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

(2)		Paid to us by veterinary medical groups.

(1)		Computed by dividing same-facility revenue for animal hospitals owned by same-facility orders for animal hospitals owned.

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

(1)		Charged by us to veterinary medical groups.

(2)		Represents the combined animal hospital direct costs of hospitals owned and managed.

	•		paid $27.0 million related to the acquisition of 19 animal hospitals and four laboratory companies and the settlement of certain obligations incurred or agreed to on the date of acquisition;

	•		paid $244,000 to purchase the ownership interest held by two of our animal hospital partners;

	•		paid $589,000 for real estate acquired in connection with acquisitions;

	•		paid $11.0 million in property and equipment additions; and

	•		received $54.3 million in net proceeds from the issuance of 3.8 million shares of our common stock;

	•		paid $41.8 million to voluntarily redeem the entire principal amount of our 15.5% senior notes at a redemption price of 110% of the principal amount;

	•		paid $166.4 million to retire the entire principal amount of our senior term C notes by using $20.0 million of cash on-hand and $146.4 million received from the issuance of new senior term D notes;

	•		paid $1.7 million for scheduled maturities of debt obligations;

	•		paid $7.5 million to repay the entire outstanding balance of our revolving credit facility; and

	•		paid $1.0 million of financing costs.

	•		in August 2003, we refinanced our senior credit facility voluntarily repaying $20.0 million of senior term C notes and retiring the remaining senior term C notes with senior term D notes, resulting in debt retirement costs of approximately $1.7 million; and

	•		in February 2003, we redeemed the remaining principal amount outstanding of our 15.5% senior notes with proceeds from our secondary offering resulting in debt retirement costs of approximately $7.4 million.

	•		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.

	•		$146.1 million in principal amount outstanding under our senior credit facility;

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

	•		$1.9 million in principal amount outstanding under our other debt.

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

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

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

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

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

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

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

	(1)		Report on Form 8-K, filed July 23, 2003, reporting under Item 5 updated financial guidance for fiscal year 2003, and under Item 9, earnings for the second quarter of fiscal year 2003.

	(2)		Report on Form 8-K, filed August 21, 2003, reporting under Item 5 the Eighth Amendment to the Credit and Guaranty Agreement, and the repayment of Senior Term C notes with $20.0 million of cash on-hand and $146.4 million received from the issuance of Senior Term D notes bearing a lower interest rate.