AMERIPATH INC - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005

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

Commission File Number: 000-22313

AMERIPATH, INC.

(Exact Name of Registrant as Specified in its Charter)


Delaware		65-0642485
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

7111 Fairway Drive, Suite 400 Palm Beach Gardens, Florida		33418
(Address of Principal Executive Offices)		(Zip Code)

(561) 712-6200

(Registrant’s Telephone Number, Including Area Code)

Not Applicable

(Former Name, Former Address and Formal Fiscal Year, if Changed Since Last Report)

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 ¨ No x

All of the voting and non-voting common equity of the Registrant is held by affiliates.

The number of shares of Common Stock of the Registrant outstanding as of May 13, 2005 was 100.

AMERIPATH, INC. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

INDEX


			Page
PART I— FINANCIAL INFORMATION

	Item 1.	Financial Statements

		Condensed Consolidated Balance Sheets as of March 31, 2005 (Unaudited) and December 31, 2004	1

		Condensed Consolidated Statements of Operations for the three months ended March 31, 2005 and 2004 (Unaudited)	2

		Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and 2004 (Unaudited)	3

		Notes to Condensed Consolidated Financial Statements (Unaudited)	4

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28

	Item 4.	Controls and Procedures	28

PART II— OTHER INFORMATION

	Item 1.	Legal Proceedings	29

	Item 5.	Other Information	29

	Item 6.	Exhibits	29

SIGNATURES			30

EXHIBIT INDEX			31

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AMERIPATH, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)


	March 31, 2005		December 31, 2004
	(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	16,172	$	20,980
Restricted cash		17,804		17,940
Accounts receivable, net		85,110		76,567
Inventories		2,379		2,335
Deferred tax assets, net		13,345		13,345
Other current assets		4,436		4,823

Total current assets		139,246		135,990

PROPERTY AND EQUIPMENT, NET		34,207		30,964

OTHER ASSETS:
Goodwill		598,953		591,819
Identifiable intangibles, net		177,109		179,903
Other		25,149		25,633

Total other assets		801,211		797,355

TOTAL ASSETS	$	974,664	$	964,309

LIABILITIES AND STOCKHOLDER’S EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses	$	48,487	$	52,620
Accrued interest		18,560		9,456
Current portion of long-term debt		2,920		2,682
Other current liabilities		966		1,164

Total current liabilities		70,933		65,922

LONG-TERM LIABILITIES:
Long-term debt		488,014		495,171
Other liabilities		32,890		29,220
Deferred tax liabilities, net		15,904		15,904

Total long-term liabilities		536,808		540,295

COMMITMENTS AND CONTINGENCIES
STOCKHOLDER’S EQUITY:
Common stock, $.01 par value, 100 shares issued and outstanding at March 31, 2005 and December 31, 2004		1		1
Additional paid-in capital		359,795		352,723
Retained earnings		7,127		5,368

Total stockholder’s equity		366,923		358,092

TOTAL LIABILITIES AND STOCKHOLDER’S EQUITY	$	974,664	$	964,309

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

AMERIPATH, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands)

(Unaudited)


	Three Months Ended March 31,
	2005			2004
NET REVENUES:
Net patient service revenues	$	128,525		$	119,620
Net management service revenues		5,355			6,180

Net revenues		133,880			125,800

OPERATING COSTS AND EXPENSES:
Costs of services:
Net patient service revenues		70,189			62,734
Net management service revenues		3,311			3,959

Total costs of services		73,500			66,693
Selling, general and administrative expenses		25,190			24,272
Provision for doubtful accounts		17,636			17,353
Amortization expense		2,794			2,814
Asset impairment and related charges		—			586

Total operating costs and expenses		119,120			111,718

INCOME FROM OPERATIONS		14,760			14,082

OTHER INCOME (EXPENSES):
Interest expense		(11,739	)		(11,146	)
Write-off of deferred financing costs		—			(3,488	)
Gain on sale of managed practice		454			—
Change in value of derivative		(620	)		—
Other income, net		104			70

Total other expenses, net		(11,801	)		(14,564	)

INCOME (LOSS) BEFORE INCOME TAXES		2,959			(482	)
PROVISION (BENEFIT) FOR INCOME TAXES		1,200			(178	)

NET INCOME (LOSS)	$	1,759		$	(304	)

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

AMERIPATH, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)


	Three Months Ended March 31, 2005			Three Months Ended March 31, 2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)	$	1,759		$	(304	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation		2,499			2,210
Amortization		3,222			3,413
Loss on disposal of assets		88			10
Asset impairment and related charges		—			586
Gain on sale of managed practice		(454	)		—
Change in value of derivative		620			—
Provision for doubtful accounts		17,636			17,353
Write-off of deferred financing costs		—			3,488
Changes in assets and liabilities (net of effects of acquisitions):
Increase in accounts receivable		(26,426	)		(20,974	)
Increase in inventories		(58	)		(283	)
Decrease in other current assets		387			1,556
Increase in other assets		(200	)		(3,260	)
Increase in accrued interest		9,104			11,295
(Decrease) increase in accounts payable and accrued expenses		(322	)		3,113

Net cash provided by operating activities		7,855			18,203

CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of property and equipment		(5,318	)		(2,663	)
Cash paid for acquisitions and acquisition costs, net of cash acquired		212			(496	)
Decrease (increase) in restricted cash		136			(1,261	)
Payments of contingent notes		(7,295	)		(7,927	)

Net cash used in investing activities		(12,265	)		(12,347	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Debt issuance costs		(27	)		—
Net payments on long-term debt and capital leases		(142	)		(763	)
Payments under revolver facility		(7,000	)		—
Payments under term loan facility		(300	)		(88,312	)
Contingent note proceeds		7,071			7,927
Proceeds from sale of senior subordinated notes		—			79,500

Net cash used in financing activities		(398	)		(1,648	)

(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(4,808	)		4,208
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		20,980			23,536

CASH AND CASH EQUIVALENTS, END OF PERIOD	$	16,172		$	27,744

SUPPLEMENTAL NON-CASH TRANSACTIONS:

Property and equipment acquired pursuant to capital leases	$	522			—

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

AMERIPATH, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(in thousands, unless otherwise indicated)

Note 1—Basis of Presentation

The accompanying unaudited condensed consolidated financial statements, which include the accounts of AmeriPath, Inc. and its subsidiaries (collectively, “AmeriPath” or the “Company”), have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial reporting and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the financial statements do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, such interim financial statements contain all adjustments (consisting of normal recurring items) considered necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods presented. The results of operations and cash flows for any interim period are not necessarily indicative of results that may be expected for the full year.

The accompanying unaudited interim financial statements should be read in conjunction with the audited consolidated financial statements, and the notes thereto, included in the Company’s Form 10-K for the year ended December 31, 2004 and filed with the Securities and Exchange Commission (“SEC”) on March 18, 2005.

In order to maintain consistency and comparability between periods presented, certain amounts in the prior year’s financial statements have been reclassified to conform to the financial statement presentation of the current period.

Note 2—The March 2003 Transaction

On December 8, 2002, Amy Holding Company and its wholly-owned subsidiary, Amy Acquisition Corp., entered into a merger agreement with AmeriPath, pursuant to which Amy Acquisition Corp. merged with and into AmeriPath, with AmeriPath continuing as the surviving corporation (the “March 2003 Transaction”). Amy Holding Company and Amy Acquisition Corp. are Delaware corporations formed at the direction of Welsh, Carson, Anderson & Stowe IX, L.P. (“WCAS”). The March 2003 Transaction was approved by the then Company’s stockholders and subsequently consummated on March 27, 2003. As a result of the March 2003 Transaction, AmeriPath became a wholly-owned subsidiary of Amy Holding Company, which was renamed AmeriPath Holdings, Inc. (“Holdings”).

The March 2003 Transaction was accounted for under the purchase method of accounting prescribed in Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations,” (SFAS No. 141), with intangible assets recorded in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, (SFAS No. 142). In accordance with the provisions of SFAS No. 142, no amortization of indefinite-lived intangible assets or goodwill is recorded.

As permitted under current guidance, any amounts recorded or incurred (such as goodwill or debt) by our parent as a result of the March 2003 Transaction can be “pushed down” and recorded on our financial statements. The following table summarizes the final allocation of the March 2003 Transaction based upon a valuation completed by an independent third-party valuation firm during September 2003.


Cash and equity contributed by WCAS	$	319,667
Total liabilities assumed		587,801
Fair value of assets acquired		(676,458	)

Excess purchase price (goodwill)	$	231,010

In addition, Holdings issued to WCAS Capital Partners III, L.P., an investment fund affiliated with WCAS, $67.0 million in principal amount of Holdings’ senior subordinated notes and an agreed-upon number of shares of its common stock, for an aggregate purchase price of $67.0 million. The proceeds from this transaction were deposited into a Holdings company cash collateral account, which cash, subject to some exceptions, will be contributed to the Company from time to time to fund up to $67.0 million of future payments under the Company’s contingent notes relating to acquisitions consummated prior to the March 2003 Transaction. As of March 31, 2005, approximately $35.9 million of the $67.0 million has been contributed to the Company to fund contingent note payments. The lenders under the Company’s Credit Facility have a first-priority security interest in all funds held in such cash collateral account.

Note 3—Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), Share-Based Payment, which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation. Statement 123(R) supersedes APB

AMERIPATH, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—

(Continued)

Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. SFAS 123(R) is effective for annual periods beginning after June 15, 2005. The Company expects to adopt SFAS 123(R) effective January 1, 2006, but has not yet determined if it will use the modified prospective method or one of the modified-retrospective methods. As permitted by SFAS 123, the Company currently accounts for share-based payments to employees using the intrinsic value method in accordance with the recognition and measurement principles of APB Opinion No. 25, and, as such, generally recognizes no compensation cost for employee stock options, as options granted under the Company’s plan have an exercise price equal to the fair value of the underlying common stock on the date of grant. The impact of adoption of Statement 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. Statement 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. The Company cannot estimate what those amounts will be in the future because they depend on, among other things, when employees exercise stock options.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS No. 149”). SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. It is effective for contracts entered into or modified after June 30, 2003. In April 2004, the Company entered into an interest rate swap agreement. In accordance with SFAS No. 149, the Company is recording this derivative instrument at market value and is reflecting the change in the market value in the condensed consolidated statements of operations.

Note 4—Acquisitions

During the first three months of 2005, the Company did not acquire any new practices. During the three months ended March 31, 2004, the Company acquired one hospital-based practice in Bountiful, Utah. In December 2004, the Company acquired a dermatopathology practice located in New Rochelle, New York for a total purchase price of $44.0 million, which included cash of $34.0 million and 1,666,667 shares of our parent’s company common stock valued at $10.0 million. The practice provides outpatient services to the Northeast region, and expands our geographical presence in this area. The following table summarizes the preliminary fair value of the assets acquired and liabilities assumed in connection with this acquisition as of the date of the acquisition as accounted for under SFAS No. 141 “Business Combinations”, which requires the use of the purchase method of accounting. The Company expects the final purchase price allocation to be completed in June 2005. The purchase price of the acquisition is summarized below:


Cash paid	$	34,000
Holdings common stock issued		10,000

Total purchase price	$	44,000

The preliminary allocation of the purchase price is summarized below:


Cash	$	382
Accounts receivable, net		2,018
Property & equipment, net		236
Deposits		270
Goodwill		41,211

Total assets	$	44,117

Accounts payable		5
Accrued liabilities		112

Total liabilities	$	117

Net assets acquired	$	44,000

During the three months ended March 31, 2005 and 2004, the Company made contingent note payments of approximately $7.3 million and $7.9 million, respectively, relating to previous acquisitions. If the maximum specified levels of income from operations

AMERIPATH, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—

(Continued)

for all acquired operations are achieved, we estimate that we would make aggregate maximum principal payments of approximately $38.1 million over the next four years. A lesser amount or no payments at all would be made if the stipulated levels of income from operations or other evaluation factors specified in each agreement were not met.

The accompanying unaudited condensed consolidated financial statements include the results of operations of the Company’s acquisitions accounted for under the purchase method from the date acquired through March 31, 2005. The following unaudited pro forma information presents the consolidated results of operations for the three months ended March 31, 2005 and 2004 as if the acquisitions had been consummated on January 1, 2005 and 2004, respectively. Such unaudited pro forma information is based on historical financial information and does not include operational or other changes that might have been effected by the Company.

The unaudited pro forma information presented below is for illustrative information purposes only and is not necessarily indicative of results which would have been achieved or results which may be achieved in the future.


	Three months ended March 31, 2005		Three months ended March 31, 2004
Net revenues	$	133,880	$	131,770
Net income	$	1,759	$	1,511

Note 5—Intangible Assets

Amortization expense of identifiable intangibles was $2.8 million for both the three months ended March 31, 2005 and 2004.

Amortization expense related to identifiable intangibles for each of the five succeeding fiscal years and thereafter as of March 31, 2005 is as follows:


Remainder of 2005	$	8,381
2006		7,975
2007		6,909
2008		6,129
2009		5,869
2010		5,868
Thereafter		99,578

The weighted average amortization period for identifiable intangible assets is approximately 14.6 years.

Note 6—Long-term Debt

Senior Subordinated Notes—On March 27, 2003, in connection with the March 2003 Transaction, Amy Acquisition Corp. issued $275.0 million of 10¹/2% Senior Subordinated Notes due 2013. The Company assumed Amy Acquisition Corp.’s obligations with respect to the notes upon consummation of the March 2003 Transaction. Interest became payable semi-annually in arrears beginning in October 2003. The notes are unconditionally guaranteed, jointly and severally and on an unsecured senior subordinated basis, by certain of the Company’s current and former subsidiaries. The notes and guarantees rank junior to all of the Company’s and the subsidiary guarantors’ existing and future senior indebtedness, on par with all of the Company’s and the subsidiary guarantors’ existing and future senior subordinated indebtedness and senior to all of the Company’s and the subsidiary guarantors’ existing and future subordinated indebtedness. On April 1, 2005, the Company made its semi-annual interest payment of approximately $18.4 million.

The Company may redeem any of the notes at any time and from time to time beginning on April 1, 2008, in whole or in part, in cash at the specified redemption prices, plus accrued and unpaid interest to the date of redemption.

If a change in control of the Company occurs, subject to certain conditions, the Company must give holders of the notes an opportunity to sell the notes to the Company at a purchase price of 101% of the principal amount of the notes, plus accrued and unpaid interest to the date of the purchase of the notes by the Company.

AMERIPATH, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—

(Continued)

The indenture governing the notes contains covenants that, among other things, limit the Company’s ability and the ability of the Company’s restricted subsidiaries to incur or guarantee additional indebtedness, pay dividends or make other equity distributions, purchase or redeem capital stock, make certain investments, enter into arrangements that restrict dividends from subsidiaries, transfer and sell assets, engage in certain transactions with affiliates and effect a consolidation or merger.

In February 2004, the Company issued an additional $75.0 million of its 10¹/2% Senior Subordinated Notes due 2013 at a premium price of 106% plus accrued interest. In February 2004, the Company paid down $88.2 million of the term loan borrowings. As a result of the paydown, the Company recognized a $3.5 million write-off of deferred financing costs during the three months ended March 31, 2004. There were no write-offs of deferred financing costs during the three months ended March 31, 2005.

Credit Facility—On March 27, 2003, in connection with our consummation of the March 2003 Transaction, the Company terminated its existing senior credit facility and entered into a new senior credit facility (the “Credit Facility”) with a syndicate of financial institutions led by Credit Suisse First Boston and Deutsche Bank Securities, Inc.

The Credit Facility provided for senior secured financing of up to $290.0 million, consisting of a $225.0 million term loan facility with a maturity of seven years that was drawn in full in connection with the consummation of the March 2003 Transaction and a $65.0 million revolving credit facility with a maturity of six years. In February 2004, the Company paid down the term loan facility of the Credit Facility to $125.0 million with proceeds from the issuance of $75.0 million of additional 10¹/2% Senior Subordinated Notes due 2013 and the Company’s cash on hand. In connection with this reduction of the term facility, the interest rate of the term loan facility and the terms and covenants of the facility were modified as reflected in the following paragraphs.

The interest rates per annum applicable to loans under the Credit Facility are, at the Company’s option, equal to either an alternate base rate or an adjusted LIBOR rate for a one, two, three or six month interest period chosen by the Company, or a nine or twelve month period if agreed to by all participating lenders, plus an applicable margin percentage in each case.

The alternate base rate is the greater of (1) the prime rate or (2) one-half of 1% over the weighted average of rates on overnight federal funds as published by the Federal Reserve Bank of New York. The adjusted LIBOR rate will be determined by reference to settlement rates established for deposits in dollars in the London interbank market for a period equal to the interest period of the loan and the maximum reserve percentages established by the Board of Governors of the United States Federal Reserve to which our lenders are subject. Beginning approximately six months after the closing of the March 2003 Transaction, the applicable margin percentage under the term loan facility was subject to adjustments based upon the ratio of the Company’s total indebtedness to the Company’s consolidated EBITDA (as defined in the Credit Facility) being within certain defined ranges. The interest rate at March 31, 2005 was approximately 6.1%. The revolving credit facility also requires a commitment fee to be paid quarterly equal to 0.50% of any unused commitments under the revolving loan facility.

Subject to exceptions, the Credit Facility requires mandatory prepayments of the term loan in amounts equal to 100% of the net cash proceeds from asset sales which are not reinvested by the Company within specific periods, 50% of the net cash proceeds from the issuance of equity securities by the Company or Holdings, 100% of the net cash proceeds from the issuance of debt securities by the Company or Holdings if the leverage ratio is 5.25 times or greater or 50% if the leverage ratio is less than 5.25 times, and 50% of our annual excess cash flow, less all voluntary prepayments made during the year.

The Credit Facility required scheduled quarterly payments on the term loan in amounts equal to $312,500 on each of June 30, September 30, December 31 and March 31, beginning on June 30, 2004. On June 30, 2004, the Company made its mandatory payment of $312,500 and also made a voluntary prepayment of $9,687,500. The voluntary prepayment was applied chronologically to the future mandatory quarterly payments. Therefore, the next mandatory payment on the facility will not be until 2009.

Indebtedness under the Credit Facility is guaranteed by all of the Company’s current restricted subsidiaries, certain of its future restricted subsidiaries and by Holdings. It is secured by a first priority security interest in substantially all of the Company’s existing and future property and assets, including accounts receivable, inventory, equipment, general intangibles, intellectual property, investment property, other personal property, owned and material leased real property, cash and cash proceeds of the foregoing and a first priority pledge of the Company’s capital stock and the capital stock of the guarantor subsidiaries.

The Credit Facility requires that the Company comply on a quarterly basis with certain financial covenants, including an interest coverage ratio calculation, a fixed charge coverage ratio calculation and a maximum net senior leverage ratio calculation, which become more restrictive over time. In addition, the Credit Facility includes negative covenants restricting or limiting the Company’s ability and the ability of its subsidiaries to, among other things, incur, assume or permit to exist additional indebtedness or guarantees;

AMERIPATH, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—

(Continued)

incur liens and engage in sale leaseback transactions; make capital expenditures; make loans and investments; declare dividends, make payments or redeem or repurchase capital stock; engage in mergers, acquisitions and other business combinations; prepay, redeem or purchase certain indebtedness; amend or otherwise alter terms of our indebtedness; sell assets; transact with affiliates and alter the business that it conducts.

Such negative covenants are subject to exceptions, including, with respect to restrictions on dividends from the Company to Holdings, certain allowable dividends to pay cash interest on its parent’s Holding company notes which began in the fiscal year ended December 31, 2004.

Letters of Credit

As of March 31, 2005, the Company had letters of credit outstanding totaling $3.3 million. The letters of credit secure payments under certain operating leases and insurance policies and expire at various dates in 2005 through 2009. Some of the letters of credit automatically decline in value over various lease terms. The letters of credit have annual fees averaging 3.5%. Available borrowings under the $65.0 million revolving credit facility are reduced by the balance outstanding on these letters of credit. In addition, the Company had $300,000 of surety bonds outstanding on March 31, 2005 to satisfy Florida Medicaid requirements.

Note 7—Derivative Instrument

In April 2004, the Company entered into a 2¹/2 year interest rate swap transaction which involves the exchange of fixed for floating rate interest payments without the exchange of the underlying principal amount. The interest differential to be paid or received is accrued and is recognized as an adjustment to interest expense. The change in the market value of the derivative instrument is recognized in the condensed consolidated statements of operations. For the three months ended March 31, 2005, the change in the value of the derivative was a loss of approximately $0.6 million. The agreement has a notional amount of $75.0 million. The Company receives interest on the notional amount if the LIBOR rate is less than 2.405% and pays interest on the notional amount if the LIBOR rate exceeds 2.405%. The floating rate resets every October 1 and April 1. In August 2004, the Company locked in to a forward LIBOR rate contract for October 2004 through March 2005 at a rate of 2.08%. In April 2005, the floating rate was reset to 3.39% until October 2005. This derivative instrument is being used by the Company to reduce interest rate volatility and associated risks arising from the fixed rate structure of our Senior Subordinated Notes, and is not held or issued for trading purposes.

Note 8—Commitments and Contingencies

During the ordinary course of business, the Company has become and may in the future become subject to legal actions and proceedings. The Company may have liability with respect to its employees and its pathologists and with respect to hospital employees who are under the supervision of its hospital-based pathologists. The majority of these pending legal proceedings involve claims of medical malpractice and most of those suits relate to cytology services. Based upon investigations conducted to date, the Company believes the outcome of any pending legal actions and proceedings, individually or in the aggregate, will not have a material adverse effect on the Company’s financial condition, results of operations or liquidity. If the Company is ultimately found liable under the outstanding medical malpractice claims, there can be no assurance that medical malpractice insurance arrangements will be adequate to cover all such liabilities. The Company also may, from time to time, be involved with legal actions related to the acquisition of anatomic pathology operations, the prior conduct of acquired operations or the employment and restriction on competition of physicians. There can be no assurance that any costs or liabilities for which the Company becomes responsible in connection with these claims or actions will not be material or will not exceed the limitations of any applicable indemnification provisions or the financial resources of the indemnifying parties.

Healthcare Regulatory Environment and Reliance on Government Programs — The healthcare industry in general, and the services that the Company provides, are subject to extensive federal and state laws and regulations. Additionally, a significant portion of the Company’s net revenue is from payments by government-sponsored health care programs, principally Medicare and Medicaid, and is subject to audits and adjustments by applicable regulatory agencies. Failure to comply with any of these laws or regulations, the results of increased regulatory audits and adjustments, or changes in the interpretation of the coding of services or the amounts payable for the Company’s services under these programs could have a material adverse effect on the Company’s financial position and results of operations. The Company’s operations are continuously subject to review and inspection by regulatory authorities.

The Company has received subpoenas issued by the United States Attorney’s office in Tampa, Florida seeking information with respect to an investigation relating to Medicare billing and possible financial inducements in connection with a Florida physician who is not an AmeriPath pathologist but is a client of AmeriPath. In addition, certain affiliates of the Company have received an

AMERIPATH, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—

(Continued)

investigative subpoena from the Florida Attorney General Medicaid Fraud Control Unit requesting copies of agreements that we have with certain hospitals and certain patient records. To our knowledge, numerous other hospitals and facilities have received similar subpoenas, which may indicate a state-wide audit of pathology operations. The Company is providing information to both the United States Attorney’s office and the Florida Attorney General’s Office and intends to cooperate in the investigations. The Company is conducting its own internal investigation of the matters. It is not possible at this point in either investigation to determine whether the government will pursue action against AmeriPath or to assess the merits of possible defenses AmeriPath might have to any such action. Accordingly, no assurances can be given regarding the ultimate outcome of these investigations.

Office Lease — The Company executed a new 60 month lease effective October 1, 2004 for 22,525 square feet of office space for its Corporate offices located in Palm Beach Gardens, Florida. The lease payments began upon the occupancy of the office space, which was in December 2004. This space replaces its prior facility in Riviera Beach, Florida, which was under a lease that the Company terminated in August 2004 for a fee of approximately $91,000.

Note 9—Comprehensive Income

In accordance with SFAS No. 130, “Reporting Comprehensive Income” (“SFAS 130”), the Company is required to report and display certain information related to comprehensive income. For the three months ended March 31, 2005 and 2004, net income equaled comprehensive income.

Note 10—Segment Reporting

The Company has two reportable segments, owned operations and managed operations. The segments were determined based on the type of service performed and customers. Owned operations provide anatomic pathology services to hospitals and referring physicians, while the Company’s managed operations provide management services to the affiliated physician groups. The accounting policies of the segments are the same as those described in the summary of accounting policies in the Company’s year-end audited financial statements. The Company evaluates performance based on net revenues and income from operations.

The following is a summary of financial information for the three months ended March 31, 2005 and 2004 for the Company’s business segments and corporate offices:


	Three months ended March 31,
	2005			2004
Owned
Net patient service revenues	$	128,525		$	119,620
Income from operations		25,975			25,409
Segment assets		785,288			766,617
Managed
Net management service revenues	$	5,355		$	6,180
Income from operations		601			690
Segment assets		17,163			15,874
Corporate
Loss from operations	$	(11,816	)	$	(12,017	)
Segment assets		167,471			133,483
Elimination of intercompany accounts		4,742			9,542

Note 11—Income Taxes

The Company’s effective income tax rate was 40.6% and 37.0% for the three-month periods ended March 31, 2005 and 2004, respectively.

AMERIPATH, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—

(Continued)

Note 12—Subsequent Events

On April 1, 2005, Joseph A. Sonnier, M.D., resigned as President of our Company to become Medical Director of our Dallas lab.

In April 2005, the Company borrowed $25.0 million on its revolving credit facility. Also in April 2005, the Company paid down $6.3 million on its Term B loan facility and $6.3 million on the revolver facility. In May 2005, the Company paid down an additional $5.7 million on the revolver facility.

In April 2005, the Company made its semi-annual interest payment of approximately $18.4 million to the holders of its Senior Subordinated Notes.

In April 2005, the Company entered into an agreement with our Utah practice for the prepayment in full of their contingent note for a sum of approximately $1.5 million.

In May 2005, in connection with the exercise of the Company’s anti-dilution rights, the Company increased its investment in preferred stock of Molecular Profiling, Inc. by investing an additional $150,000.

Note 13—Guarantor Subsidiaries

The following information is presented as required by regulations of the Securities and Exchange Commission in connection with the Company’s 10¹/2% Senior Subordinated Notes due 2013. This information is not routinely prepared for use by management. The operating and investing activities of the separate legal entities included in the Company’s condensed consolidated financial statements are fully interdependent and integrated. Accordingly, consolidating the operating results of those separate legal entities is not representative of what the actual operating results of those entities would be on a stand-alone basis. Operating expenses of those separate legal entities include intercompany charges for management fees and other services. Certain expense items and asset and liability balances that are applicable to the Company’s subsidiaries are typically recorded in the books and records of AmeriPath, Inc. For purposes of this footnote disclosure, such balances and amounts have been “pushed down” to the respective subsidiaries either on a specific identification basis, or when such items cannot be specifically attributed to an individual subsidiary, have been allocated on an incremental or proportional cost basis to AmeriPath, Inc. and the Company’s subsidiaries.

The following tables present condensed consolidated financial information at March 31, 2005 and 2004 for (i) AmeriPath, (ii) on a combined basis, the subsidiaries of AmeriPath that are guarantors of the Company’s 10¹/2% Senior Subordinated Notes due 2013 (the “Subsidiary Guarantors”) and (iii) on a combined basis, the subsidiaries of AmeriPath that are not guarantors of the Company’s 10¹/2% Senior Subordinated Notes due 2013 (the “Non-Guarantor Subsidiaries”). The maximum potential amount of future payments the Subsidiary Guarantors could be required to make under the Guarantee is $350.0 million. There is no recourse available to the Subsidiary Guarantors from any third party.

Condensed Consolidating Balance Sheets:


As of March 31, 2005	AmeriPath, Inc.			Subsidiary Guarantors			Non— Guarantor Subsidiaries			Consolidating Adjustments			Consolidated Total
Assets
Current assets:
Cash and cash equivalents	$	—		$	13,366		$	2,806					$	16,172
Restricted cash		—			17,804			—						17,804
Accounts receivable, net		593			66,054			18,463						85,110
Inventories		139			2,208			32						2,379
Other current assets		1,020			12,046			4,715						17,781

Total current assets		1,752			111,478			26,016						139,246
Property & equipment, net		7,169			26,640			398						34,207
Goodwill		—			463,709			135,244						598,953
Identifiable intangibles, net		19,800			122,632			34,677						177,109
Investment in subsidiaries		729,614			(6,632	)		—			(722,982	)		—
Other assets		17,614			6,260			1,275			—			25,149

Total assets	$	775,949		$	724,087		$	197,610		$	(722,982	)	$	974,664

Liabilities and Stockholder’s Equity
Current liabilities:
Accounts payable and accrued expenses	$	35,564		$	23,991		$	7,492					$	67,047
Current portion of long-term debt		474			2,446			—						2,920
Other current liabilities		—			966			—						966

Total current liabilities		36,038			27,403			7,492						70,933
Long-term debt		487,700			314			—						488,014
Other liabilities		4,030			25,708			1,517						31,255
Fair value of derivative hedge		1,635			—			—						1,635
Deferred tax liabilities, net		535			18,689			(3,320	)					15,904

Total long-term liabilities		493,900			44,711			(1,803	)					536,808
Intercompany payable (receivable)		267,379			(264,828	)		(2,551	)					—
Stockholder’s equity:
Common stock		(1,272	)		1,271			25			(23	)		1
Additional paid-in capital		325,168			31,635			2,992			—			359,795
Retained earnings (deficit)		(345,264	)		883,895			191,455			(722,959	)		7,127

Total stockholder’s equity		(21,368	)		916,801			194,472			(722,982	)		366,923

Total liabilities and stockholder’s equity	$	775,949		$	724,087		$	197,610		$	(722,982	)	$	974,664

AMERIPATH, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—

(Continued)


As of December 31, 2004	AmeriPath, Inc.			Subsidiary Guarantors			Non— Guarantor Subsidiaries			Consolidating Adjustments			Consolidated Total
Assets
Current assets:
Cash and cash equivalents	$	—		$	19,513		$	1,467					$	20,980
Restricted cash		—			17,940			—						17,940
Accounts receivable, net		32			59,483			17,052						76,567
Inventories		123			2,157			55						2,335
Other current assets		1,040			12,527			4,601						18,168

Total current assets		1,195			111,620			23,175						135,990
Property & equipment, net		5,275			25,586			103						30,964
Goodwill		—			458,364			133,455						591,819
Identifiable intangibles, net		19,900			127,387			32,616						179,903
Investment in subsidiaries		721,337			(6,632	)		—			(714,705	)		—
Other assets		18,129			6,216			1,288			—			25,633

Total assets	$	765,836		$	722,541		$	190,637		$	(714,705	)	$	964,309

Liabilities and Stockholder’s Equity
Current liabilities:
Accounts payable and accrued expenses	$	21,596		$	34,534		$	5,946					$	62,076
Current portion of long-term debt		—			2,682			—						2,682
Other current liabilities		—			1,164			—						1,164

Total current liabilities		21,596			38,380			5,946						65,922
Long-term debt		495,000			171			—						495,171
Other liabilities		5,128			23,282			810						29,220
Deferred tax liabilities, net		536			18,689			(3,321	)					15,904

Total long-term liabilities		500,664			42,142			(2,511	)					540,295
Intercompany payable (receivable)		252,842			(257,269	)		4,427						—
Stockholder’s equity:
Common stock		(1,272	)		1,271			25			(23	)		1
Additional paid-in capital		318,100			31,633			2,990			—			352,723
Retained earnings (deficit)		(326,094	)		866,384			179,760			(714,682	)		5,368

Total stockholder’s equity		(9,266	)		899,288			182,775			(714,705	)		358,092

Total liabilities and stockholder’s equity	$	765,836		$	722,541		$	190,637		$	(714,705	)	$	964,309

AMERIPATH, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—

(Continued)

Condensed Consolidating Statements of Operations:


For the three months ended March 31, 2005	AmeriPath, Inc.			Subsidiary Guarantors			Non— Guarantor Subsidiaries			Consolidated Total
Net revenues	$	—		$	103,654		$	30,226		$	133,880
Costs of services		—			(61,380	)		(12,120	)		(73,500	)
Selling, general and administrative expense		(737	)		(36,663	)		(5,426	)		(42,826	)
Amortization expense		—			(2,472	)		(322	)		(2,794	)

Total operating costs and expenses		(737	)		(100,515	)		(17,868	)		(119,120	)
(Loss) income from operations		(737	)		3,139			12,358			14,760
Other income (expenses):
Interest expense		(11,686	)		(53	)		—			(11,739	)
Management fee (A)		—			12,359			(12,359	)		—
Change in value of derivative		(620	)		—			—			(620	)
Gain on sale of managed practice		—			454			—			454
Other income, net		34			69			1			104

Total other (expenses) income		(12,272	)		12,829			(12,358	)		(11,801	)

(Loss) income before income taxes		(13,009	)		15,968			—			2,959
Benefit (provision) for income taxes		5,268			(6,468	)		—			(1,200	)

Net (loss) income	$	(7,741	)	$	9,500		$	—		$	1,759

(A)	In accordance with the applicable management fee agreements, the Subsidiary Guarantors are the direct beneficiaries of substantially all of the pre-tax income of the Non-Guarantor Subsidiaries.


For the three months ended March 31, 2004	AmeriPath, Inc.			Subsidiary Guarantors			Non— Guarantor Subsidiaries			Consolidated Total
Net revenues	$	—		$	97,112		$	28,688		$	125,800
Costs of services		—			(54,791	)		(11,902	)		(66,693	)
Selling, general and administrative expense		(2,638	)		(34,191	)		(4,796	)		(41,625	)
Amortization expense		—			(2,489	)		(325	)		(2,814	)
Asset impairment & related charges		—			—			(586	)		(586	)

Total operating costs and expenses		(2,638	)		(91,471	)		(17,609	)		(111,718	)
(Loss) income from operations		(2,638	)		5,641			11,079			14,082
Other income (expenses):
Interest expense		(11,086	)		(60	)		—			(11,146	)
Management fee (A)		—			11,079			(11,079	)		—
Write-off of deferred financing costs		(3,488	)		—			—			(3,488	)
Other income, net		1			69			—			70

Total other (expenses) income		(14,573	)		11,088			(11,079	)		(14,564	)

(Loss) income before income taxes		(17,211	)		16,729			—			(482	)
Benefit (provision) for income taxes		6,663			(6,485	)		—			178

Net (loss) income	$	(10,548	)	$	10,244		$	—		$	(304	)

(A)	In accordance with the applicable management fee agreements, the Subsidiary Guarantors are the direct beneficiaries of substantially all of the pre-tax income of the Non-Guarantor Subsidiaries.

AMERIPATH, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—

(Continued)

Condensed Consolidating Statements of Cash Flows:


For the three months ended March 31, 2005	AmeriPath, Inc.			Subsidiary Guarantors			Non— Guarantor Subsidiaries			Consolidated Total
Cash flows from operating activities:
Net (loss) income	$	(7,741	)	$	9,500		$	—		$	1,759
Adjustments to reconcile net (loss) income to net cash provided by operating activities		1,358			18,077			4,176			23,611
Changes in assets and liabilities, net of effects of acquisitions		8,321			(25,364	)		(472	)		(17,515	)

Net cash provided by operating activities		1,938			2,213			3,704			7,855
Cash flows used in investing activities		(1,682	)		(8,218	)		(2,365	)		(12,265	)
Cash flows used in financing activities		(256	)		(142	)		—			(398	)

Increase (decrease) in cash and cash equivalents		—			(6,147	)		1,339			(4,808	)
Cash and cash equivalents, beginning of period		—			19,513			1,467			20,980

Cash and cash equivalents, end of period	$	—		$	13,366		$	2,806		$	16,172


For the three months ended March 31, 2004	AmeriPath, Inc.			Subsidiary Guarantors			Non— Guarantor Subsidiaries			Consolidated Total
Cash flows from operating activities:
Net (loss) income	$	(10,548	)	$	10,244		$	—		$	(304	)
Adjustments to reconcile net (loss) income to net cash provided by operating activities		4,301			18,222			4,537			27,060
Changes in assets and liabilities, net of effects of acquisitions		8,632			(14,054	)		(3,131	)		(8,553	)

Net cash provided by operating activities		2,385			14,412			1,406			18,203
Cash flows used in investing activities		(1,500	)		(8,930	)		(1,917	)		(12,347	)
Cash flows used in financing activities		(885	)		(763	)		—			(1,648	)

Increase (decrease) in cash and cash equivalents		—			4,719			(511	)		4,208
Cash and cash equivalents, beginning of period		—			22,652			884			23,536

Cash and cash equivalents, end of period	$	—		$	27,371		$	373		$	27,744

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

General

The condensed consolidated financial statements contained in Item 1 include the accounts of AmeriPath, Inc. and subsidiaries (collectively, “AmeriPath” or the “Company”) as of and for the three months ended March 31, 2005 and 2004.

The following discussion of our financial condition and results of operations should be read together with our condensed consolidated financial statements and the accompanying notes included elsewhere in Item 1. Our fiscal year is the calendar year ending December 31.

AmeriPath is one of the leading anatomic pathology laboratory companies in the United States. We offer a broad range of anatomic pathology laboratory testing and information services used by physicians in the detection, diagnosis, evaluation and treatment of cancer and other diseases and medical conditions. We service an extensive referring physician base through our 15 regional laboratories and 36 satellite laboratories, and we provide inpatient diagnostic and medical director services at more than 200 hospitals. Our services are performed by over 400 pathologists.

Because the laws of many states restrict corporations from directly employing physicians or owning corporations that employ physicians, we often conduct our business through affiliated entities that we manage and control but do not own. In states where we are under these restrictions, we perform only non-medical administrative and support services, do not represent to the public or our clients that we offer medical services and do not exercise influence or control over the practice of medicine by our physicians. Because of the degree of non-medical managerial control we exercise over our affiliated entities, we consolidate the financial results of these entities with those of our wholly-owned operations. We collectively refer to these consolidated entities and our wholly-owned operations as our “owned operations.” In addition, we have also entered into management agreements with a few anatomic pathology laboratory operations over which we do not exercise non-medical managerial control and, accordingly, do not consolidate with our owned operations. We refer to these operations as our “managed operations.” For the three months ended March 31, 2005, our revenues from owned operations and managed operations accounted for 96.0% and 4.0% of our total net revenues, respectively.

Acquisitions. We did not make any acquisitions during the first quarter of 2005. During the first three months of 2004, we acquired one hospital-based practice in Bountiful, Utah. The total consideration paid by us in connection with this acquisition included cash and contingent notes. During the three months ended March 31, 2005 and 2004, we made contingent note payments of approximately $7.3 and $7.9 million, respectively, relating to previous acquisitions.

Medical Malpractice Insurance Costs. In June 2002, we replaced our existing medical malpractice insurance coverage by third party insurance companies with a new self-insurance, or captive, arrangement. We entered into this self-insurance arrangement because we were unable to renew our existing coverage at acceptable rates, which we believe was an industry-wide situation. Under our self-insurance structure, we retain more risk for medical malpractice costs, including settlements and claims expense, than under our previous coverage. While we have obtained excess liability coverage for medical malpractice costs, we have no aggregate excess stop loss protection, meaning there is no aggregate limitation on the amount of risk we retain under these arrangements. Our medical malpractice costs are based on actuarial estimates of our medical malpractice settlement and claims expense and the costs of maintaining our captive insurance program and excess coverage. We periodically review and update the appropriateness of our accrued liability for medical malpractice costs. Because we retain these risks, in addition to an actual increase in claims or related expenses, a change in the actuarial assumptions upon which our medical malpractice costs are based could materially affect results of operations in a particular period even if we do not experience an actual increase in claims or related expenses. For fiscal year 2004, our medical malpractice costs were approximately $13.5 million. For the three months ended March 31, 2005, our medical malpractice costs were approximately $3.6 million.

Financial Statement Presentation

The following paragraphs provide a brief description of the most important items that appear in our financial statements and general factors that impact these items.

Net revenues. Net revenues consist of revenues received from patients, third-party payors and others for services rendered. Our same store net revenue is affected by changes in customer volume, payor mix and reimbursement rates. References to “same store” refer to operations that have been included in our financial statements throughout the periods compared.

Costs of services. Costs of services consists principally of the compensation and fringe benefits of pathologists, medical malpractice insurance, licensed technicians and support personnel, laboratory supplies, shipping and distribution costs and facility costs. Historically, acquisitions, and the costs associated with additional personnel and facilities, have been the most significant factor driving increases in our costs of services. Also, increases in medical malpractice insurance have affected our costs of services.

Selling, general and administrative expenses. Selling, general and administrative expenses primarily include the cost of field operations, corporate support, sales and marketing, information technology and billing and collections. As we have developed our national sales and marketing infrastructure, our selling, general and administrative expenses have increased. In addition, spending on new information technology initiatives historically has contributed to increased expenses in this category.

Provision for doubtful accounts. Provision for doubtful accounts is affected by our mix of revenue from outpatient and inpatient services. Provision for doubtful accounts typically is higher for inpatient services than for outpatient services due primarily to a larger concentration of indigent and private pay patients, greater difficulty gathering complete and accurate billing information and longer billing and collection cycles for inpatient services. Management service revenue generally does not include a provision for doubtful accounts.

Amortization expense. Our acquisitions have resulted in significant net identifiable intangible assets and goodwill. We record net identifiable intangible assets at fair value on the date of acquisition. Effective January 1, 2002, we adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” which required us to cease amortizing goodwill and instead perform a transitional impairment test as of January 1, 2002 and an annual impairment analysis to assess the recoverability of goodwill. The results of the transitional and annual impairment tests indicated no impairment of goodwill or other indefinite lived intangibles. We continually evaluate whether events or circumstances have occurred that may warrant revisions to the carrying values of our goodwill and other identifiable intangible assets or to the estimated useful lives assigned to such assets. Any significant impairment recorded on the carrying values of our goodwill or other identifiable intangible assets would be recorded as a charge to income from operations and a reduction of intangible assets and could materially reduce our profitability in the period in which the charge is recorded.

Critical Accounting Policies

Our critical accounting policies remain consistent with those reported in our Annual Report on Form 10-K for the year ended December 31, 2004.

Principles of Consolidation

Our condensed consolidated financial statements include our accounts and those of our owned operations. As part of the consolidation process, we have eliminated intercompany accounts and transactions. We do not consolidate the results of operations of our managed operations.

Segments

Our two reportable segments are our owned operations and our managed operations. We determine our segments based upon the type of service performed and our customers. Our owned operations provide anatomic pathology services to hospitals and referring physicians, while our managed operations provide management services to the affiliated physician groups.

Results of Operations

The following table outlines, for the periods indicated, selected operating data as a percentage of net revenues.


	Three Months Ended March 31,
	2005		2004
Net revenues	100.0	%	100.0	%
Operating costs and expenses:
Costs of services	54.9	%	53.0	%
Selling, general and administrative expenses	18.8	%	19.3	%
Provision for doubtful accounts	13.2	%	13.8	%
Amortization expense	2.1	%	2.2	%
Asset impairment and related charges	—		0.5	%

Total operating costs and expenses	89.0	%	88.8	%
Income from operations	11.0	%	11.2	%
Interest expense	(8.8	)%	(8.9	)%
Change in value of derivative	(0.4	)%	—
Gain on sale of practice	0.3	%	—
Write-off of deferred financing costs	—		(2.8	)%
Other income, net	0.1	%	0.1	%

Income (loss) before income taxes	2.2	%	(0.4	)%
Provision (benefit) for income taxes	0.9	%	(0.1	)%

Net income (loss)	1.3	%	(0.3	)%

Net Revenues.

Net revenues increased by $8.1 million, or 6.4%, from $125.8 million for the three months ended March 31, 2004 to $133.9 million for the three months ended March 31, 2005. Same store net revenue increased $3.4 million or 2.7% from $123.7 million for the three months ended March 31, 2004 to $127.1 million for the three months ended March 31, 2005. Our mix of revenue for the first quarter of 2005 was 58.2% outpatient, 37.8% inpatient (hospital-based), and 4.0% management services. This compares to a mix of 51% outpatient, 44% inpatient (hospital-based) and 5% management services for the first quarter in 2004.

Costs of Services.

Costs of services increased by $6.8 million, or 10.2%, from $66.7 million for the three months ended March 31, 2004 to $73.5 million for the three months ended March 31, 2005. Costs of services as a percentage of net revenues increased from 53.0% for the three months ended March 31, 2004 to 54.9% for the three months ended March 31, 2005. The increase in costs of services as a percentage of net revenues is primarily due to increased physician compensation and increased courier and distribution costs associated with the increased revenue from physicians’ offices. Gross margin decreased from 47.0% for the three months ended March 31, 2004 to 45.1% for the three months ended March 31, 2005.

Selling, General and Administrative Expenses.

Selling, general and administrative expenses increased by $0.9 million from $24.3 million for the three months ended March 31, 2004 to $25.2 million for the three months ended March 31, 2005. As a percentage of net revenues, selling, general and administrative expenses decreased from 19.3% for the three months ended March 31, 2004 to 18.8% for the three months ended March 31, 2005. Selling, general and administrative expenses for the first quarter of 2004 included severance of approximately $1.4 million for the Company’s former Chief Executive Officer. The increases in the first quarter of 2005 are primarily due to increased investments in information technology and expansion of sales and marketing efforts.

Provision for Doubtful Accounts.

Our provision for doubtful accounts increased by $0.2 million from $17.4 million for the three months ended March 31, 2004 to $17.6 million for the same period of 2005. The provision for doubtful accounts as a percentage of net revenues decreased from 13.8% for the three months ended March 31, 2004 to 13.2% for the same period of 2005.

Amortization Expense.

Amortization expense remained constant at $2.8 million for the three months ended March 31, 2004 and 2005.

Write-off of Deferred Financing Costs.

In February 2004, the Company wrote-off a portion of the balance of its deferred debt financing costs totaling approximately $3.5 million related to the amendment of its term B credit facility and the related reduction in the facility to $125.0 million. The remaining balance is being amortized over the life of the term loan facility.

Asset Impairment and Related Charges.

In March 2004, the Company sold a practice in Michigan resulting in an impairment charge of approximately $0.6 million.

Interest Expense.

Interest expense increased by $0.6 million from $11.1 million from the three-months ended March 31, 2004 to $11.7 million for the three months ended March 31, 2005. Our effective interest rate was 9.5% and 9.2% for the three months ended March 31, 2005 and 2004, respectively.

Gain on Sale of Managed Practice.

In February 2005, the Company sold a managed practice in Los Gatos, California resulting in a gain of approximately $0.5 million.

Change in Value of Derivative.

In April 2004, the Company entered into a 2¹/2 year interest rate swap transaction with a notional amount of $75.0 million. The market valuation is performed quarterly by an independent third party and the change in market value of the derivative instrument is recognized in the condensed consolidated statements of operations. For the three months ended March 31, 2005, the Company recognized a $0.6 million decrease in the value of the derivative.

Provision for Income Taxes.

Our effective income tax rate was 40.6% and 37.0% for the three-month period ended March 31, 2005 and 2004, respectively.

Net Income (Loss).

Net income for the three months ended March 31, 2005, was $1.8 million, compared with a net loss of $0.3 million for the three months ended March 31, 2004.

Liquidity and Capital Resources

At March 31, 2005, we had working capital of approximately $68.3 million, a decrease of $1.8 million from working capital of $70.1 million at December 31, 2004.

Net cash provided by operating activities was $7.9 million and $18.2 million for the three months ended March 31, 2005 and 2004, respectively. For the three months ended March 31, 2005, cash flows from operations were primarily used to make voluntary revolver payments of $7.0 million, and to acquire property and equipment of $5.3 million.

Our Credit Facility provides for senior secured financing of up to $190.0 million, consisting of a $125.0 million term loan facility with a maturity of March 27, 2010 and a $65.0 million revolving loan facility with a maturity of March 27, 2009.

The interest rates per annum applicable to loans under our Credit Facility are, at our option, equal to either an alternate base rate or an adjusted LIBOR for a one, two, three or six month interest period chosen by us, or a nine or twelve month period if agreed to by all participating lenders, in each case, plus an applicable margin percentage. The interest rate at March 31, 2005 was approximately 6.1%. The Credit Facility also requires a commitment fee to be paid quarterly equal to 0.5% of any unused commitments under the revolving loan facility.

The Credit Facility required scheduled quarterly payments on the term loan in amounts equal to $312,500 on each of June 30, September 30, December 31 and March 31, beginning on June 30, 2004. On June 30, 2004, we made the mandatory payment of $312,500 and also made a voluntary prepayment of $9,687,500. The voluntary prepayment was applied chronologically to the future mandatory quarterly payments. Therefore, the next mandatory payment on the facility will not be until 2009.

On March 27, 2003, in connection with the March 2003 Transaction, Amy Acquisition Corp. issued $275.0 million of 10¹/2% Senior Subordinated Notes due 2013. We assumed Amy Acquisition Corp.’s obligations under these notes upon consummation of the March 2003 Transaction. Interest became payable semi-annually in arrears beginning in October 2003. In February 2004, we issued an additional $75.0 million of our 10¹/2% Senior Subordinated Notes due 2013 at a premium price of 106%. The notes are unconditionally guaranteed, jointly and severally and on an unsecured senior subordinated basis, by certain of our current and former subsidiaries. The notes and guarantees rank junior to all of our and the guarantors’ existing and future senior indebtedness, on par with all of our and the guarantors’ existing and future senior subordinated indebtedness and senior to all of our and the guarantors’ existing and future subordinated indebtedness. We may redeem any of the notes at any time and from time to time beginning on April 1, 2008, in whole or in part, in cash at the specified redemption prices, plus accrued and unpaid interest to the date of redemption.

The Credit Facility and the indenture governing the notes contain covenants that, among other things, limit our ability and the ability of our restricted subsidiaries to incur or guarantee additional indebtedness, pay dividends or make other equity distributions, purchase or redeem capital stock, make certain investments, transfer and sell assets, engage in certain transactions with affiliates and effect a consolidation or merger.

In connection with our acquisitions prior to the March 2003 Transaction, we generally agreed to pay a base purchase price plus additional contingent purchase price consideration to the sellers of the acquired operations. The additional payments generally were contingent upon the achievement of specified levels of income from operations (as defined by the specific purchase agreements with the seller) by the acquired operations over periods of three to five years from the date of acquisition. In certain cases, the payments were contingent upon other factors such as the retention of certain hospital contracts or relationships for periods ranging from three to five years. The amount of the payments cannot be determined until the final determination of the income from operations levels or other performance targets during the relevant periods of the respective agreements. If the maximum specified levels of income from operations for all acquired operations are achieved, we estimate that we would make aggregate maximum principal payments of approximately $38.1 million over the next four years. A lesser amount or no payments at all would be made if the stipulated levels of income from operations or other evaluation factors specified in each agreement were not met. During the first three months of 2005, we made contingent note payments, including interest, aggregating $7.3 million. In addition, we intend to fund future payments under our contingent payment obligations relating to acquisitions completed prior to the March 2003 Transaction from contributions made to us by Holdings out of the funds from the remaining cash collateral account balance of $31.3 million and, if needed, cash flows from operations. We do not expect to use contingent notes on future acquisitions.

Historically, our capital expenditures have been primarily for laboratory equipment, information technology equipment and leasehold improvements. Total capital expenditures were $5.3 million and $2.7 million for the three months ended March 31, 2005 and 2004, respectively.

We expect to use our revolving loan facility to fund internal growth, for acquisitions and for working capital. We anticipate that funds generated by operations, funds available under our revolving loan facility and funds in the cash collateral account will be sufficient to meet working capital requirements and anticipated contingent note obligations and to finance capital expenditures over the next twelve months. Further, in the event payments under the contingent payment obligations exceed the amounts held in the cash collateral account, we believe that the incremental cash generated from operations would exceed the cash required to satisfy those additional payments.

Off-Balance Sheet Arrangements

We had no off-balance sheet arrangements as of March 31, 2005.

Contractual Obligations

The following is a summary of our contractual cash obligations, excluding contingent note payments, as of March 31, 2005, for our term loan, our revolving loan, other indebtedness and senior subordinated notes, and as of December 31, 2004 for our operating leases, the balance of which has not changed substantially since year end:


	Payments Due By Period (in millions)
Contractual Obligations	1 year		1-2 years		3-5 years		After 5 years		Total
Term loan	$	—	$	—	$	114.7	$	—	$	114.7
Revolver loan		—		—		23.0		—		23.0
Other indebtedness		2.9		0.2		0.1		—		3.2
Operating leases		7.5		6.5		14.9		18.1		47.0
Senior subordinated notes		—		—		—		350.0		350.0

Total contractual cash obligations	$	10.4	$	6.7	$	152.7	$	368.1	$	537.9

Interest Rate Risk

The Company is subject to market risk associated principally with changes in interest rates. Our principal interest rate exposure relates to the amount outstanding under the Company’s credit facility. The balances outstanding under the credit facility are at floating rates. Based on the outstanding credit facility balance of $137.7 million at March 31, 2005, each quarter point increase or decrease in the floating rate increases or decreases interest expense by approximately $0.3 million per year.

In April 2004, the Company entered into a 2¹/2 year interest rate swap transaction which involves the exchange of fixed for floating rate interest payments without the exchange of the underlying principal amount. The interest differential to be paid or received is accrued and is recognized as an adjustment to interest expense. The change in the market value of the derivative instrument is recognized in the condensed consolidated statements of operations. For the three months ended March 31, 2005, the change in the value of the derivative was a loss of approximately $0.6 million. The agreement has a notional amount of $75.0 million. The Company receives interest on the notional amount if the LIBOR rate is less than 2.405% and pays interest on the notional amount if the LIBOR rate exceeds 2.405%. The floating rate resets every October 1 and April 1. In August 2004, the Company locked in to a forward LIBOR rate contract for October 2004 through March 2005 at a rate of 2.08%. In April 2005, the floating rate reset at 3.39% until October 2005. This derivative instrument is being used by the Company to reduce interest rate volatility and associated risks arising from the fixed rate structure of our Senior Subordinated Notes, and is not held or issued for trading purposes.

Inflation

Inflation was not a material factor in either revenue or operating expenses during the first three months of 2005.

Qualification of Forward-Looking Statements

This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act, Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, and the Private Securities Litigation Reform Act of 1995 that are subject to risks and uncertainties. All statements other than statements of historical facts included in this Form 10-Q that address activities, events or developments that we expect, believe or anticipate will or may occur in the future are forward-looking statements. Forward-looking statements give our current expectations and projections relating to the financial condition, results of operations, plans, objectives, future performance and business of AmeriPath, and its subsidiaries. You can identify these statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events.

These forward-looking statements are based on our expectations and beliefs concerning future events affecting us. They are subject to uncertainties and factors relating to our operations and business environment, all of which are difficult to predict and many of which are beyond our control. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we do not know whether our expectations will prove correct. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Many factors mentioned in our discussion in this Form 10-Q, including the risks outlined under “Risk Factors,” will be important in determining future results.

Because of these factors, we caution that investors should not place undue reliance on any of our forward-looking statements. Further, any forward-looking statement speaks only as of the date on which it is made and except as required by law we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made or to reflect the occurrence of anticipated or unanticipated events or circumstances.

RISK FACTORS

The risks described below are not the only ones we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business, financial condition or results of operations. Any of the following risks could materially and adversely affect our business, financial condition or results of operations.

Our substantial indebtedness could adversely affect our financial condition and prevent us from fulfilling our obligations under our term loan and subordinated debt.

We have a significant amount of indebtedness. As of March 31, 2005, our total debt was $490.9 million, excluding unused revolving loan commitments under our senior credit facility, which would have represented approximately 57.2% of our total anticipated capitalization. This debt does not include our obligations under our existing contingent notes.

Our substantial indebtedness could have important consequences by adversely affecting our financial condition and thus making it more difficult for us to satisfy our obligations. Our substantial indebtedness could:

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increase our vulnerability to adverse general economic and industry conditions,

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require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, payments under our contingent notes, research and development efforts and other general corporate purposes,

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limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate,

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place us at a competitive disadvantage compared to our competitors that have less debt and

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limit our ability to borrow additional funds.

Despite our level of indebtedness, we will be able to incur substantially more debt. This could further exacerbate the risks to our financial condition described above.

We will be able to incur significant additional indebtedness in the future. Although the indenture governing the notes and the credit agreement governing our senior credit facility contain restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of qualifications and exceptions and the indebtedness incurred in compliance with these restrictions could be substantial. Moreover, the restrictions also do not prevent us from incurring obligations that do not constitute indebtedness. To the extent new debt is added to our currently anticipated debt levels, the substantial leverage risks described above would increase.

The terms of our senior credit facility and the indenture relating to our notes may restrict our current and future operations, particularly our ability to respond to changes or to take certain actions.

Our senior credit facility contains a number of restrictive covenants that impose significant operating and financial restrictions on us and may limit our ability to engage in acts that may be in our long-term best interests. Our senior credit facility includes covenants restricting, among other things, our ability to:

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incur additional debt,

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pay dividends and make restricted payments,

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create liens,

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use the proceeds from sales of assets and subsidiary stock,

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enter into sale and leaseback transactions,

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make capital expenditures,

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change our business,

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enter into transactions with affiliates and

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transfer all or substantially all of our assets or enter into merger or consolidation transactions.

The indenture relating to the notes also contains numerous operating and financial covenants including, among other things, restrictions on our ability to:

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incur additional debt,

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pay dividends or purchase our capital stock,

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make investments,

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enter into transactions with affiliates,

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sell or otherwise dispose of assets and

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merge or consolidate with another entity.

Our senior credit facility also includes financial covenants, including requirements that we maintain:

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a minimum interest coverage ratio,

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a minimum fixed charge coverage ratio and

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a maximum senior leverage ratio.

These financial covenants will become more restrictive over time.

A failure by us to comply with the covenants contained in our senior credit facility or the indenture could result in an event of default. In the event of any default under our senior credit facility, the lenders under our senior credit facility could elect to declare all borrowings outstanding, together with accrued and unpaid interest and fees, to be due and payable, enforce their security interest, require us to apply all of our available cash to repay these borrowings (even if the lenders have not declared a default) or prevent us from making debt service payments on the notes, any of which would result in an event of default under the notes. In addition, future indebtedness could contain financial and other covenants more restrictive than those applicable to our senior credit facility and the notes.

We may not be able to generate sufficient cash flow to meet our debt service obligations.

Our ability to generate sufficient cash flow from operations to make scheduled payments on our debt obligations will depend on our future financial performance, which will be affected by a range of economic, competitive, regulatory, legislative and business factors, many of which are outside of our control. If we do not generate sufficient cash flow from operations to satisfy our debt obligations, including payments on the notes, we may have to undertake alternative financing plans, such as refinancing or restructuring our debt, selling assets, reducing or delaying capital investments or seeking to raise additional capital. We cannot assure you that any refinancing would be possible or that any assets could be sold on acceptable terms or otherwise. Our inability to generate sufficient cash flow to satisfy our debt obligations, or to refinance our obligations on commercially reasonable terms, would have an adverse effect on our business, financial condition and results of operations, as well as on our ability to satisfy our obligations under the notes.

We conduct business in a heavily regulated industry, and changes in regulations or violations of regulations may, directly or indirectly, reduce our revenues and harm our business.

The healthcare industry is highly regulated, and there can be no assurance that the regulatory environment in which we operate will not change significantly and adversely in the future. Several areas of regulatory compliance that may affect our ability to conduct business include:

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federal and state anti-kickback laws,

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federal and state self-referral and financial inducement laws, including the federal physician anti-self referral law, or the Stark Law,

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federal and state false claims laws,

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state laws regarding prohibitions on the corporate practice of medicine,

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state laws regarding prohibitions on fee-splitting,

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federal and state anti-trust laws,

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the Health Insurance Portability and Accountability Act of 1996, or HIPAA,

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federal and state regulations of privacy, security and electronic transactions and code sets and

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federal, state and local laws governing the handling and disposal of medical and hazardous waste.

These laws and regulations are extremely complex. In many instances, the industry does not have the benefit of significant regulatory or judicial interpretation of these laws and regulations. It also is possible that the courts could ultimately interpret these laws in a manner that is different from our interpretations. While we believe that we are currently in material compliance with applicable laws and regulations, a determination that we have violated these laws, or the public announcement that we are being investigated for possible violations of these laws, would have an adverse effect on our business, financial condition and results of operations. For a more complete description of these regulations, see “Business – Government Regulation” in our Form 10-K for the year ended December 31, 2004.

Our business could be materially harmed by future interpretation or implementation of state laws regarding prohibitions on the corporate practice of medicine.

The manner in which licensed physicians can be organized to perform and bill for medical services is governed by state laws and regulations. Under the laws of some states, business corporations generally are not permitted to employ physicians or to own corporations that employ physicians or to otherwise exercise control over the medical judgments or decisions of physicians.

We believe that we currently are in compliance with the corporate practice of medicine laws in the states in which we operate in all material respects. Nevertheless, there can be no assurance that regulatory authorities or other parties will not assert that we are engaged in the corporate practice of medicine or that the laws of a particular state will not change. If such a claim were successfully asserted in any jurisdiction, or as a result of such a change in law, we could be required to restructure our contractual and other arrangements, our Company and our pathologists could be subject to civil and criminal penalties and some of our existing contracts, including non-competition provisions, could be found to be illegal and unenforceable. In addition, expansion of our operations to other states may require structural and organizational modification of our form of relationship with pathologists, operations or hospitals. These results or the inability to successfully restructure contractual arrangements would have an adverse effect on our business, financial condition and results of operations.

We could be hurt by future interpretation or implementation of federal and state anti-kickback and anti-referral laws.

Federal and state anti-kickback laws prohibit the offer, solicitation, payment and receipt of remuneration in exchange for referrals of products and services for which payment may be made by Medicare, Medicaid or other federal and state healthcare programs. Federal and state anti-referral laws, including the Stark Law, prohibit physicians from referring their patients to healthcare providers with which the physicians or their immediate family members have a financial relationship for designated services when such services are subject to reimbursement by Medicare or Medicaid. A violation of any of these laws could result in monetary fines, civil and criminal penalties and exclusion from participation in Medicare, Medicaid and other federal or state healthcare programs, which accounted for approximately 21% of our revenues during the first three months of 2005.

We owe some of our physicians contingent payment obligations entered into in connection with acquisitions we have completed and some of our physicians are party to compensation arrangements with us and own common stock of our parent. Although we have attempted to structure our businesses so that our financial relationships with our physicians and our referral practices comply in all material respects with federal and state anti-referral laws, including the Stark Law, the government may take the position that they do not comply, or a prohibited referral may be made by one of our physicians without our knowledge. If our financial relationships with our physicians were found to be unlawful or unlawful referrals were found to have been made, we or they could be fined, become subject to government recoupment of fees previously paid to us and forfeiture of revenues due to us or become subject to civil and criminal penalties. In such situations, we also may be excluded from participation in Medicare, Medicaid and other federal and state healthcare programs. Any one of these consequences could have an adverse effect on our business, financial conditions and results of operations.

Our business could be harmed by future interpretation or implementation of state law prohibitions on fee-splitting.

Many states prohibit the splitting or sharing of fees between physicians and non-physicians. We believe our arrangements with pathologists and operations comply in all material respects with the fee-splitting laws of the states in which we operate. Nevertheless, it is possible that regulatory authorities or other parties could claim we are engaged in fee-splitting. If such a claim were successfully asserted in any jurisdiction, our pathologists could be subject to civil and criminal penalties, including loss of licensure, and we could be required to restructure our contractual and other arrangements. In addition, expansion of our operations to new states with fee-splitting prohibitions may require structural and organizational modification to the form of our current relationships which may be less profitable. A claim of fee-splitting or modification of our business to avoid such a claim could have an adverse effect on our business, financial condition and results of operations.

Federal and state regulation of privacy could cause us to incur significant costs.

The Federal Trade Commission, or FTC, pursuant to consumer protection laws, and the Department of Health and Human Services, or HHS, pursuant to HIPAA, regulates the use and disclosure of information we may have about our patients. Many states also have laws regarding privacy of health information. While we believe that we are in compliance with FTC and state laws regarding privacy, and with the HIPAA privacy regulations, these laws are complex and will have an impact upon our operations. Violations of the HIPAA privacy regulations are punishable by civil and criminal penalties. In addition, while individuals do not have a private right of action under HIPAA, the privacy regulations may be viewed by the courts as setting a standard of conduct, and the failure to comply could serve as the basis for a private claim. In addition, HIPAA regulations regarding the security of health information and standards for electronic transactions have also been issued. While many of our systems have already been configured to comply with these regulations, to achieve compliance we may need to modify or replace systems in certain of our locations and incur related expenses.

We are subject to significant professional or other liability claims and we cannot assure you that insurance coverage will be available or sufficient to cover such claims.

We may be sued under physician liability or other liability law for acts or omissions by our pathologists, laboratory personnel and hospital employees who are under the supervision of our hospital-based pathologists. We and our pathologists periodically become involved as defendants in medical malpractice and other lawsuits, some of which are currently ongoing, and are subject to the attendant risk of substantial damage awards.

Through June 30, 2002, we were insured for medical malpractice risks on a claims made basis under traditional professional liability insurance policies. In July 2002, we began using a captive insurance program to partially self-insure our medical malpractice risk. Under the captive insurance program we retain more risk for medical malpractice costs, including settlements and claims expenses, than under our prior coverage. We have no aggregate excess stop loss protection under our captive insurance arrangements, meaning there is no aggregate limitation on the amount of risk we retain under these arrangements. Because of our self-insurance arrangements and our lack of aggregate excess stop loss protection, professional malpractice claims could result in substantial uninsured losses. In addition, it is possible that the costs of our captive insurance arrangements and excess insurance coverage will rise, causing us either to incur additional costs or to further limit the amount of our coverage. Further, our insurance does not cover all potential liabilities arising from governmental fines and penalties, indemnification agreements and certain other uninsurable losses. For example, from time to time we agree to indemnify third parties, such as hospitals and national clinical laboratories, for various claims that may not be covered by insurance. As a result, we may become responsible for substantial damage awards that are uninsured. We are currently subject to indemnity claims, which if determined adversely to us, could result in substantial uninsured losses. Therefore, it is possible that pending or future claims will not be covered by or will exceed the limits of our insurance coverage and indemnification agreements or that third parties will fail or otherwise be unable to comply with their obligations to us.

Government programs account for approximately 21% of our revenues, so a decline in reimbursement rates from government programs would harm our revenues and profitability.

We derived approximately 21% of our net revenue during the first three months of 2005 from payments made by government programs, principally Medicare and Medicaid. These programs are subject to substantial regulation by federal and state governments. Any changes in reimbursement policies, practices, interpretations or statutes that place limitations on reimbursement amounts or change reimbursement coding practices could materially harm our business by reducing revenues and lowering profitability. Increasing budgetary pressures at both the federal and state levels and concerns over escalating costs of healthcare have led, and may continue to lead, to significant reductions in healthcare reimbursements, which would have an adverse effect on our business, financial condition and results of operations.

We incur financial risk related to collections as well as potentially long collection cycles when seeking reimbursement from third-party payors.

Substantially all of our net revenues are derived from services for which our operations charge on a fee-for-service basis. Accordingly, we assume the financial risk related to collection, including potential write-offs of doubtful accounts, and long collection cycles for accounts receivable, including reimbursements by third-party payors, such as governmental programs, private insurance plans and managed care organizations. Our provision for doubtful accounts for the first three months of 2005 was 13.2% of net revenues, with net revenues from inpatient services having a provision for doubtful accounts of approximately 22.4%. If our revenue from hospital-based services increases as a percentage of our total net revenues, our provision for doubtful accounts as a percentage of total net revenues may increase. Increases in write-offs of doubtful accounts, delays in receiving payments or potential retroactive adjustments and penalties resulting from audits by payors could have an adverse effect on our business, financial condition and results of operations.

In addition to services billed on a fee-for-service basis, our hospital-based pathologists in their capacities as medical directors of hospitals’ clinical laboratories, microbiology laboratories and blood banking operations bill non-Medicare patients according to a fee schedule for their clinical professional component, or CPC, services. Our historical collection experience for CPC services is significantly lower than other anatomic pathology procedures. See “Business-Billing” in our Form 10-K for the year ended December 31, 2004. Hospitals and third party payors are continuing to increase pressure to reduce our revenues from CPC services, including but not limited to encouraging their patients not to pay us for such services.

The continued growth of managed care may have a material adverse effect on our business.

The number of individuals covered under managed care contracts or other similar arrangements has grown over the past several years and may continue to grow in the future. In addition, Medicare and Medicaid and other government healthcare programs may continue to shift to managed care. For the three month periods ended March 31, 2005 and 2004, approximately 55%, and 59%, respectively, of our net revenue was derived from reimbursements from managed care organizations and third party payors. Entities providing managed care coverage have reduced payments for medical services in numerous ways, including entering into arrangements under which payments to a service provider are capitated, limiting testing to specified procedures, denying payment for services performed without prior authorization and refusing to increase fees for specified services. These trends reduce our revenues and limit our ability to pass cost increases to our customers. Also, if these or other managed care organizations do not select us as a participating provider, we may lose some or all of that business, which could have an adverse effect on our business, financial condition and results of operations.

There has been an increasing number of state and federal investigations of healthcare companies, which may increase the likelihood of investigations of our business practices and the possibility that we will become subject to lawsuits.

Prosecution of fraudulent practices by healthcare companies is a priority of the United States Department of Justice, HHS’s Office of the Inspector General, or OIG, and state authorities. The federal government has become more aggressive in examining laboratory billing practices and seeking repayments and penalties allegedly resulting from improper billing practices, such as using an improper billing code for a test to realize higher reimbursement. While the primary focus of this initiative has been on hospital laboratories and on routine clinical chemistry tests, which comprise only a small portion of our revenues, the scope of this initiative could expand, and it is not possible to predict whether or in what direction the expansion might occur. In certain circumstances, federal and some state laws authorize private whistleblowers to bring false claim or qui tam suits against providers on behalf of the government and reward the whistleblower with a portion of any final recovery. In addition, the federal government has engaged a number of non-governmental audit organizations to assist in tracking and recovering false claims for healthcare services.

Since investigations relating to false claims have increased in recent years, it is more likely that companies in the healthcare industry, like us, could become the subject of a federal or state civil or criminal investigation or action. While we believe that we are in compliance in all material respects with federal and state fraud and abuse statutes and regulations, and we monitor our billing practices and hospital arrangements for compliance with prevailing industry practices under applicable laws, these laws are complex and constantly evolving, and it is possible that governmental investigators may take positions that are inconsistent with our practices. Moreover, even when the results of an investigation or a qui tam suit are favorable to a company, the process is time consuming and legal fees and diversion of company management focus are expensive. Any lengthy investigation could have an adverse effect on our business, financial condition and results of operations.

Investigations of entities with which we do business could adversely affect us.

HCA Inc., or HCA, has been under investigation with respect to fraud and abuse issues. As of March 31, 2005, we provided medical director services for 29 HCA hospital laboratories. As a result, the government’s investigation of HCA could result in investigations of one or more of our operations. Furthermore, we have received subpoenas from the United States Attorney’s office in

Tampa, Florida to deliver Medicare billing records and other documents relating to alleged financial inducements received by a Florida physician who is not a pathologist with our Company but is one of our clients. We also are conducting our own internal investigation of the matter. It is not possible at this point in the investigation to determine whether the government will pursue action against us or to assess the merits of possible defenses we may have to any such action. In addition, certain of our affiliates received subpoenas from the Florida Attorney General Medicaid Fraud Control Unit requesting copies of agreements that we have with certain hospitals and certain patient records. To our knowledge, numerous other hospitals and facilities have received similar subpoenas, which may indicate a state-wide audit of pathology operations. We are providing information to both the United States Attorney’s office and the Florida Attorney General’s office and intend to cooperate in the investigations. Accordingly, no assurances can be given regarding the ultimate outcome of the investigations.

We derive a significant portion of our revenues from short-term hospital contracts and hospital relationships that can be terminated without penalty.

Many of our hospital contracts may be terminated prior to the expiration of the initial or any renewal term by either party with relatively short notice and without cause. We also have business relationships with hospitals that are not governed by written contracts and may be terminated by the hospitals at any time. Loss of a hospital contract or relationship would not only result in a loss of net revenues but may also result in a loss of the outpatient net revenues derived from our association with the hospital and its medical staff. Any such loss could also result in an impairment of the balance sheet value of the assets we have acquired or may acquire, requiring substantial charges to earnings. Continuing consolidation in the hospital industry resulting in fewer hospitals and fewer laboratories enhances the risk that some of our hospital contracts and relationships may be terminated, which could have an adverse effect on our business, financial condition and results of operations.

If we cannot effectively implement our internal growth strategy, it would materially and adversely affect our business and results of operations.

Our focus on internal growth, which is based upon our existing relationships and services offered, is a departure from our prior focus on growth through acquisitions. The success of our strategy rests upon increasing testing volumes, improving the mix of our services and obtaining more favorable pricing, all of which will result in a greater focus on our sales and marketing function. The success of this strategy also is dependent upon our ability to hire and retain qualified personnel, including pathologists, to develop new areas of expertise and new customer relationships and to expand our current relationships with existing customers. There can be no assurance that we will be able to make our new strategy a success.

We may inherit significant liabilities from operations that we have acquired or acquire in the future.

We perform due diligence investigations with respect to potential liabilities of acquired operations and typically obtain indemnification from the sellers of such operations. Nevertheless, undiscovered claims may arise, and liabilities for which we become responsible may be material and may exceed either the limitations of any applicable indemnification provisions or the financial resources of the indemnifying parties. Claims or liabilities of acquired operations may include matters involving compliance with laws, including healthcare laws. While we believe, based on our due diligence investigations that our acquired operations were generally in compliance with applicable healthcare laws prior to their acquisition, they may not have been in full compliance and we may become accountable for their non-compliance. A violation of the healthcare laws could result in monetary fines, government recoupment of fees previously paid to us, forfeiture of revenues due to us, or civil and criminal penalties. In such situations, we may also be excluded from participation in Medicare, Medicaid and other federal and state healthcare programs. Any one of these consequences could have an adverse effect on our business, financial condition and results of operations.

We have significant contingent liabilities payable to many of the sellers of operations that we have acquired.

In connection with our past acquisitions, we typically have agreed to pay the sellers additional consideration in the form of contingent note obligations. Payment on these contingent notes typically depends upon the financial performance of the acquired operation or the retention of specified hospital contracts over periods ranging from three to five years after the acquisition. The amount of these contingent note payments cannot be determined until the contingency periods terminate and the level of the performance is ascertainable. As of March 31, 2005, if the minimum performance that would result in the maximum amount being payable for existing contingent notes were achieved, we would be obligated to make principal payments of approximately $38.1 million over the next four years. Lesser amounts would be paid if the maximum criteria are not met. Although we believe we will be able to make payments on contingent note obligations existing prior to the March 2003 Transaction from the remaining balance in the cash collateral account held by our parent, it is possible that such payments, or payments on additional contingent notes issued as part of subsequent acquisitions, could cause significant liquidity problems for us.

We have recorded a significant amount of intangible assets, which may never generate the returns we expect.

Our acquisitions have resulted in significant increases in net identifiable intangible assets and goodwill. Net identifiable intangible assets, which include hospital contracts, management service agreements and laboratory contracts acquired in acquisitions, were approximately $177.1 million at March 31, 2005, representing approximately 18.2% of our total assets. Goodwill, which relates to the excess of cost over the fair value of the net assets of the businesses acquired, was approximately $599.0 million at March 31, 2005, representing approximately 61.5% of our total assets. Goodwill and net identifiable intangible assets are recorded at fair value on the date of acquisition and, under Financial Accounting Standards Board Statement No. 142, will be reviewed at least annually for impairment. Impairment may result from, among other things, deterioration in performance of the acquired company, adverse market conditions, adverse changes in applicable laws or regulations, including changes that restrict the activities of the acquired business, and a variety of other circumstances. The amount of any impairment must be written off. We evaluated our recorded goodwill and identifiable intangible assets during December 2004 and determined that there was no asset impairment charge required with respect to our intangible assets. We may not ever realize the full value of our intangible assets. Any future determination requiring the write-off of a significant portion of intangible assets would have an adverse effect on our financial condition and results of operations.

Our business is highly dependent on the recruitment and retention of qualified pathologists.

Our business is dependent upon recruiting and retaining pathologists, particularly those with subspecialties, such as dermatopathology, hematopathology, immunopathology and cytopathology. While we have been able to recruit and retain pathologists in the past, we may be unable to continue to do so in the future as competition for the services of pathologists increases. In addition, we may need to provide more compensation to our pathologists in order to enhance our recruitment and retention efforts and may be unable to recover these increased costs through price increases. The relationship between the pathologists and their respective local medical communities is important to the operation and continued profitability of each of our local operations. Loss of even one of our pathologists could lead to the loss of hospital contracts or other sources of revenue derived from our relationship with the pathologist. For the years ending 2002, 2003 and 2004, turnover rates for our pathologists were 8.8%, 13.3% and 8.1%, respectively. If turnover rates were to increase, our revenues and earnings could be adversely affected.

Our success is dependent on the ability of our new management team to work together effectively.

Our Chief Executive Officer, Donald E. Steen, has been with our Company for less than one year and a number of the other members of our senior management team have been with our Company for less than two years. Given the limited experience that our new management team has working together, it is possible that these officers will not integrate well within our organization. The failure of our new management team to integrate well within our organization would have a significant effect on our future operations.

We may be unable to enforce non-competition provisions with departed pathologists.

We either directly employ our pathologists or control a physician-owned entity that employs our pathologists. Each of our pathologists typically enters into an employment agreement with us or a company we control. Most of these employment agreements prohibit the pathologist from competing with our Company within a defined geographic area and prohibit solicitation of other pathologists, employees or clients for a period of one to two years after termination of employment. We attempt to structure all of these contracts in accordance with applicable laws and to maintain and enforce these contracts as necessary. However, agreements not to compete are subject to many limitations under state law and these limitations may vary from state to state. We cannot predict whether a court will enforce the non-competition covenants in our various employment agreements. A finding that these covenants are unenforceable could have an adverse effect on our business, financial condition and results of operations.

Competition from other providers of pathology services may materially harm our business.

We have numerous competitors, including anatomic pathology practices, large physician group practices, hospital laboratories, specialized commercial laboratories and the anatomic pathology divisions of some national clinical laboratories. Moreover, companies in other healthcare segments, some of which have previously been customers of ours, such as hospitals, national clinical laboratories, managed care organizations and other third-party payors, may enter our markets and begin to compete with us. For example, Quest Diagnostics, Incorporated, or Quest, a national clinical laboratory company and former customer of ours, competes with us in some markets. Some of our competitors may have greater financial resources than us, which could further intensify competition. Increasing competition may erode our customer base, reduce our sources of revenue, cause us to reduce prices, enter into more capitated contracts in which we take on greater pricing risks or increase our marketing and other costs of doing business. Increasing competition may also impede our growth objectives by making it more difficult or more expensive for us to acquire or affiliate with additional pathology operations.

We depend on numerous complex information systems, and any failure to successfully maintain those systems or implement new systems could materially harm our operations.

We depend upon numerous information systems for operational and financial information, test reporting for our physicians and our complex billing operations. We currently have several major information technology initiatives underway, including the integration of information from our operations. No assurance can be given that we will be able to enhance existing or implement new information systems that can integrate successfully our disparate operational and financial information systems. In addition to their integral role in helping our operations realize efficiencies, these new systems are critical to developing and implementing a comprehensive enterprise-wide management information database. To develop an integrated network, we must continue to invest in and administer sophisticated management information systems. We may experience unanticipated delays, complications and expenses in implementing, integrating and operating our systems. Furthermore, our information systems may require modifications, improvements or replacements as we expand and as new technologies become available. These modifications, improvements or replacements may require substantial expenditures and may require interruptions in operations during periods of implementation. Moreover, implementation of these systems is subject to the availability of information technology and skilled personnel to assist us in creating and implementing the systems. The failure to successfully implement and maintain operation, financial, test reports, billing and physician practice information systems would have an adverse effect on our business, financial condition and results of operations.

Failure to timely or accurately bill for our services may have a substantial negative impact on our revenues, cash flow and bad debt expense.

Billing for laboratory testing services involves numerous parties and complex issues and procedures. The industry practice is to perform tests in advance of payment and without certainty as to the outcome of the billing process. We bill various payors, such as patients, government programs, physicians, hospitals and managed care organizations. These various payors have different billing information requirements and typically reimburse us only for medically necessary tests and only after we comply with a variety of procedures, such as providing them with Current Procedural Terminology, or CPT, codes and other information. If we do not meet all of the payors’ stringent requirements, we may not be reimbursed, which would increase our bad debt expense.

Among many other factors complicating our billing are:

•

disputes between payors as to which party is responsible for payment,

•

disparity in coverage among various payors, and

•

difficulty satisfying the specific compliance requirements and CPT coding of and other procedures mandated by various payors.

The complexity of laboratory billing also tends to cause delays in our cash collections. Confirming incorrect or missing billing information generally slows down the billing process and increases the age of our accounts receivable. We assume the financial risk related to collection, including the potential write-off of doubtful accounts and delays due to incorrect or missing information.

Our tests and business processes may infringe on the intellectual property rights of others, which could cause us to engage in costly litigation, pay substantial damages or prohibit us from selling our services.

Other companies or individuals, including our competitors, may obtain patents or other property rights that would prevent, limit or interfere with our ability to develop, perform or sell our tests or operate our business. As a result, we may be involved in intellectual property litigation and may be found to infringe on the proprietary rights of others, which could force us to do one or more of the following:

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cease developing and performing services that incorporate the challenged intellectual property,

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obtain and pay for licenses from the holder of the infringed intellectual property right,

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redesign or reengineer our tests,

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change our business processes or

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pay substantial damages, court costs and attorneys’ fees, including potentially increased damages for any infringement determined to be willful.

Infringement and other intellectual property claims, whether with or without merit, can be expensive and time-consuming to litigate. In addition, any requirement to reengineer our tests or change our business processes could substantially increase our costs, force us to interrupt the delivery of our services or delay new test releases.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

In April 2004, the Company entered into a 2¹/2 year interest rate swap transaction which involves the exchange of fixed for floating rate interest payments without the exchange of the underlying principal amount. The interest differential to be paid or received is accrued and is recognized as an adjustment to interest expense. The change in the market value of the derivative instrument is recognized in the consolidated statements of income. For the three months ended March 31, 2005, the change in the value of the derivative was a loss of approximately $0.6 million. The agreement has a notional amount of $75.0 million. The Company receives interest on the notional amount if the LIBOR rate is less than 2.405% and pays interest on the notional amount if the LIBOR rate exceeds 2.405%. The floating rate resets every October 1 and April 1. In August 2004, the Company locked in to a forward LIBOR rate contract for October 2004 through March 2005 at a rate of 2.08%. In April 2005, the rate reset at 3.39% until October 2005. This derivative instrument is being used by the Company to reduce interest rate volatility and associated risks arising from the fixed rate structure of our Senior Subordinated Notes, and is not held or issued for trading purposes.

ITEM 4. CONTROLS AND PROCEDURES

We are currently in the process of reviewing and formalizing our internal controls and procedures for financial reporting in accordance with the SEC’s rules implementing the internal control reporting requirements included in Section 404 of the Sarbanes-Oxley Act of 2002. Changes have been and will be made to our internal controls over financial reporting as a result of these efforts. We are dedicating significant resources, including senior management time and effort, in connection with our ongoing Section 404 assessment in order to allow us to comply with applicable SEC rules and regulations by the filing deadline for our annual report for the calendar year ended December 31, 2006. The evaluation of our internal controls is being conducted under the direction of our senior management in consultation with an independent third party consulting firm. In addition, our senior management is regularly discussing the results of our testing and any proposed improvements to our control environment with our Audit Committee. We will continue to assess our controls and procedures on a regular basis and we will continue to work to improve our controls and procedures and educate and train our employees on our existing controls and procedures in connection with our efforts to maintain an effective controls infrastructure at our Company.

During the course of their audit of our consolidated financial statements for the calendar year ended December 31, 2004, our independent registered public accounting firm, Ernst & Young LLP, advised management and the Audit Committee of our Board of Directors that they had identified four deficiencies in internal controls that they considered to be “material weaknesses” as defined under standards established by the American Institute of Certified Public Accountants. The material weaknesses relate to the following: (i) number of audit differences and processes and controls in place to prevent or detect such differences given the number of different systems and processes within the Company, (ii) the Company’s information system limitations and the inherent subjectivity in estimating its allowance for doubtful accounts and contractual allowances, (iii) coordination and agreement with third party actuarial firms regarding the estimation of reserves for professional liability insurance, and (iv) the adequacy of general controls relating to an information technology system.

Prior to the identification of such deficiencies, we had already undertaken, or were in the process of undertaking, a number of steps to improve the Company’s control environment, including:

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Significant investments in new systems for the Company, including the recent purchase of an Oracle financial reporting system to replace the Company’s current system.

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Retention of outside consulting firms to assist in the Company’s Section 404 initiative, including the engagement of a firm to provide guidance specific to IT concerns.

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Development of an internal billing information system that will interface with the Oracle financial reporting system.

We have discussed our corrective actions and future plans with our Audit Committee and Ernst & Young LLP. While we believe that the remedial actions that have been or will be taken will result in correcting the conditions that are considered to be material weaknesses as soon as practicable, the exact timing of when the conditions will be corrected is dependent upon future events which may or may not occur.

Senior management of the Company, including our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2005. Our management, including our Chief Executive Officer and Chief Financial Officer, has concluded that, except for the internal control deficiencies described above and taking into account the efforts to address those deficiencies described above, as of the evaluation date, our disclosure controls and procedures are designed, and are effective, to give reasonable assurance that information we must disclose in reports filed with the SEC is properly recorded, processed, and summarized, and then reported within the time periods specified in the rules and forms of the SEC.

PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

From time to time, we receive subpoenas from government officials. While to date none of these investigations has resulted in liability, investigations are expensive and take valuable management time. In addition, during the ordinary course of business, we have become and may in the future become subject to legal actions and proceedings. We may have liability with respect to our employees and our pathologists and with respect to hospital employees who are under the supervision of our hospital-based pathologists. The majority of these pending legal proceedings involve claims of medical malpractice. Based upon investigations conducted to date, we believe the outcome of pending legal actions and proceedings, individually or in the aggregate, will not have a material adverse effect on our financial condition, results of operations or liquidity. There can be no assurance that our captive insurance arrangements and our excess liability insurance coverage will be adequate to cover all potential medical malpractice liabilities that we may incur. We have no aggregate excess stop loss protection, meaning once our claim limits have been reached, we are subject for any excess amounts. We also may, from time to time, be involved with legal actions related to the acquisition of anatomic pathology operations, the prior conduct of acquired operations or the employment and restriction on competition of physicians. There can be no assurance that any costs or liabilities for which we become responsible in connection with these claims or actions will not be material or will not exceed the limitations of any applicable indemnification provisions or the financial resources of the indemnifying parties.

ITEM 5. OTHER INFORMATION

On April 1, 2004, Joseph A. Sonnier, M.D. resigned as President of our Company to become Medical Director of our Dallas lab.

ITEM 6. EXHIBITS


31.1		Certification of Principal Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934

31.2		Certification of Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934

32.1		Certification of Principal Executive Officer pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350

32.2		Certification of Principal Financial Officer pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350

SIGNATURES

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.


		AMERIPATH, INC.

Date: May 13, 2005	By:	/S/ DONALD E. STEEN
		Donald E. Steen Chief Executive Officer

Date: May 13, 2005	By:	/S/ DAVID L. REDMOND
		David L. Redmond Executive Vice President and Chief Financial Officer

EXHIBIT INDEX


Exhibit Number		Description
31.1		Certification of Principal Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934

31.2		Certification of Principal Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934

32.1		Certification of Principal Executive Officer pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350

32.2		Certification of Principal Financial Officer, as required by Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350

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