ITEM 1. BUSINESS
General
We are a leading animal health care services company and operate the largest networks of veterinary diagnostic laboratories and free-standing, full-service animal hospitals in the United States. Our network of veterinary diagnostic laboratories provides sophisticated testing and consulting services used by veterinarians in the detection, diagnosis, evaluation, monitoring, treatment and prevention of diseases and other conditions affecting animals. With the only nationwide veterinary laboratory network serving all 50 states, we provide diagnostic testing for an estimated 13,000 animal hospitals. Our network of animal hospitals offers a full range of general medical and surgical services for companion animals, as well as specialized treatments including advanced diagnostic services, internal medicine, oncology, ophthalmology, dermatology and cardiology. In addition, we provide pharmaceutical products and perform a variety of pet wellness programs including routine vaccinations, health examinations, diagnostic testing, spaying, neutering and dental care. The more than 770 veterinarians supporting our 229 animal hospitals had over three million patient visits in 2002.
Industry Overview
The U.S. population of companion animals has reached approximately 214 million, including about 131 million dogs and cats. Industry data show that over $18 billion was spent on animal health care services in 2001, with an annual growth rate of over 10.6% from 1996 through 2001 for spending on dogs, cats and birds. The ownership of pets is widespread, with over 58% of U.S. households owning at least one pet, including companion and other animals. Pet ownership is highest among households with children under 18 and empty-nesters whose pets have become their new “children.”
Among this expanding number of pet owners is a growing awareness of pet health and wellness, including the benefits of preventive care and specialized services. As technology continues to migrate from the human health care sector into the practice of veterinary medicine, more sophisticated treatments and diagnostic tests are becoming available to treat companion animals. These new and increasingly complex procedures, diagnostic tests and pharmaceuticals are gaining wider acceptance as pet owners are exposed to these previously unconsidered treatment programs through literature and marketing programs sponsored by large pharmaceutical and pet nutrition companies. We believe this is evidenced by an industry survey revealing that 69% of pet owners view their animals as important members of the family and are willing to pay for more veterinary services to promote the good health and extend the life of their pet.
Even as treatments available in veterinary medicine become more complex, prices for veterinary services typically remain a low percentage of a pet-owner’s income, facilitating payment at the time of service. Unlike the human health care industry, providers of veterinary services are not dependent on third-party payers in order to collect fees. As a consequence, providers of veterinary services do not have the problems of extended payment collection cycles or pricing pressures from third party-payers faced by human health care providers. Outsourced laboratory testing is a wholesale business that collects payments directly from animal hospitals, generally on terms requiring payment within 30 days of the date the charge is invoiced. Fees for animal hospital services are due at the time of service. For example, over 95% of our animal hospital services are paid for in cash or by credit card at the time of service. In addition, over the past three fiscal years our bad debt expense has averaged only 1% of total revenue.
The practice of veterinary medicine is subject to seasonal fluctuation. In particular, demand for veterinary services is significantly higher during the warmer months because pets spend a greater amount of time outdoors, where they are more likely to be injured and are more susceptible to disease and parasites. In addition, use of veterinary services may be affected by levels of infestation of fleas, heartworm and ticks and the number of daylight hours.
Diagnostic Laboratories. Laboratory tests are used by veterinarians to diagnose, monitor and treat illnesses and conditions in animals through the detection of substances in urine, tissue, fecal and blood samples and
other specimens. As is the case with the physician treating a human patient, laboratory diagnostic testing is becoming a routine diagnostic tool used by the veterinarian.
Veterinary laboratory tests are performed primarily at free-standing veterinary diagnostic laboratories, universities or animal hospitals using on-site diagnostic equipment. For particular types of tests, on-site diagnostic equipment can provide more timely results than outside laboratories, but this in-house testing requires the animal hospital or veterinarian to purchase or lease the equipment, maintain and calibrate the equipment periodically to avoid testing errors, and employ trained personnel to operate it. Conversely, veterinary diagnostic laboratories can provide a wider range of tests than generally are available on-site at most animal hospitals and do not require any up-front investment on the part of the animal hospital or veterinarian. Also, leading veterinary diagnostic laboratories employ highly trained individuals who specialize in the detection and diagnosis of diseases and thus are a valuable resource for the veterinarian.
Within the outsourcing market, our laboratories specialize in the veterinary market and offer a broad spectrum of standard and customized tests, convenient sample pick-up times, rapid test reporting and access to professional consulting services provided by trained specialists. Providing the customer with this level of service at competitive prices requires high throughput volumes due to the operating leverage associated with the laboratory business. As a result, larger laboratories likely maintain a competitive advantage relative to smaller laboratories.
We believe that the outsourced laboratory testing market is one of the fastest growing segments of the animal health care services industry and expect continued growth as a result of:
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the increased focus on wellness and monitoring programs in veterinary medicine, which is increasing the overall number of tests being performed;
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the emphasis in veterinary education on diagnostic tests and the trend toward specialization in veterinary medicine, which are causing veterinarians to increasingly rely on tests for more accurate diagnoses;
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the continued technological developments in veterinary medicine, which are increasing the breadth of tests offered; and
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the trend toward outsourcing tests because of the relative low cost, the high accuracy rates and the diagnostic support provided by specialists employed by the laboratory.
Animal Hospitals. Animal health care services are provided predominately by the veterinarian practicing as a sole practitioner, or as part of a larger animal medical group or hospital. Veterinarians diagnose and treat animal illnesses and injuries, perform surgeries, provide routine medical exams and prescribe medication. Some veterinarians specialize by type of medicine, such as orthopedics, dentistry, ophthalmology or dermatology. Others focus on a particular type of animal. The principal factors in a pet owner’s decision as to which veterinarian to use include convenient location and hours, recommendation of friends, reasonable fees and quality of care.
The U.S. market for veterinary services is highly fragmented with more than 35,000 veterinarians practicing at over 18,000 companion animal hospitals. Although most animal hospitals are single site, sole practitioner facilities, we believe veterinarians are increasingly gravitating toward animal hospitals that provide state-of-the-art facilities, treatments, methods and pharmaceuticals to enhance the services they can provide their clients.
Well-capitalized animal hospital operators have the opportunity to supplement their internal growth with selective acquisitions. We believe the extremely fragmented animal hospital industry is consolidating due to:
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the purchasing, marketing and administrative cost advantages that can be realized by a large, multiple location, multi-practitioner veterinary provider;
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the cost of financing equipment purchases and upgrading technology necessary for a successful practice;
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the desire of veterinarians to focus on practicing veterinary medicine, rather than spending large portions of their time at work performing the administrative tasks necessary to operate an animal hospital;
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the choice of some owners of animal hospitals to diversify their investment portfolio by selling all or a portion of their investment in the animal hospital; and
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the appeal to many veterinarians of the benefits and work scheduling flexibility that is not typically available to a sole practitioner or single-site provider.
Business Strategy
Our business strategy is to continue to expand our market leadership in animal health care services through our diagnostic laboratories and animal hospitals. Key elements to our strategy include:
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Capitalizing on our Leading Market Position to Generate Revenue Growth. Our leading market position in each of our business segments positions us to capitalize on favorable growth trends in the animal health care services industry. In our laboratories, we seek to generate revenue growth by taking advantage of the growing number of outsourced diagnostic tests and by increasing our market share. We continually educate veterinarians on new and existing technologies and test offerings available to diagnose medical conditions. Further, we leverage the knowledge of our specialists by providing veterinarians with extensive client support in promoting and understanding these diagnostic tests. In our animal hospitals, we seek to generate revenue growth by capitalizing on the growing emphasis on pet health and wellness.
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Leveraging Established Infrastructure to Improve Margins. We intend to leverage our established laboratory and animal hospital infrastructure to continue to increase our operating margins. Due to our established networks and the fixed cost nature of our business model, we are able to realize high margins on incremental revenue from both laboratory and animal hospital customers. For example, given that our nationwide transportation network servicing our laboratory customers is a relatively fixed cost, we are able to achieve significantly higher margins on most incremental tests ordered by the same customer when picked up by our couriers at the same time.
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Utilizing Enterprise-Wide Information Systems to Improve Operating Efficiencies. Animal hospital operations utilize an enterprise-wide management information system. We believe that this common system enables us to more effectively manage the key operating metrics that drive our business. With the aid of this system, we seek to standardize pricing, expand the services our veterinarians provide, capture unbilled services and increase volume through targeted marketing programs.
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Pursuing Selected Acquisitions. Although we have substantially completed our laboratory infrastructure, we may make selective strategic laboratory acquisitions. Additionally, the fragmentation of the animal hospital industry provides us with significant expansion opportunities in our animal hospital segment. Depending upon the attractiveness of the candidates and the strategic fit with our existing operations, we intend to acquire approximately 15 to 25 animal hospitals per year, primarily using internally generated cash. In addition, if presented with a favorable opportunity, we may pursue acquisitions of other networks of animal hospitals or laboratories, which may warrant a higher acquisition price, in which case we would consider stock and debt as additional forms of consideration.
Diagnostic Laboratories
We operate the only full-service, veterinary diagnostic laboratory network serving all 50 states. In 2002, we performed approximately 20.5 million tests and handled roughly 7.3 million requisitions in our state-of-the-art,
automated diagnostic laboratories. Our laboratory network services a diverse customer base of over 13,000 animal hospitals, and non-affiliated animal hospitals generated approximately 94% of our laboratory revenue in 2002.
Services. Our diagnostic spectrum includes over 300 different tests in the area of chemistry, pathology, endocrinology, hematology and microbiology, as well as tests specific to particular diseases. We do not conduct experiments on animals and are not engaged in animal research.
Although modified to address the particular requirements of the species tested, the tests performed in our veterinary laboratories are similar to those performed in human clinical laboratories and utilize similar laboratory equipment and technologies. The growing concern for animal health, combined with the movement of veterinary medicine toward increasing specialization, should spur the migration of additional areas of human testing into the veterinary field. For example, we now provide cancer testing for household pets whereas several years ago these tests were not available.
Given the recent advancements in veterinary medical technology and the increased breadth and depth of knowledge required for the practice of veterinary medicine, many veterinarians solicit the knowledge and experience of our 85 specialists to interpret test results, consult on the diagnosis of illnesses and suggest possible treatment alternatives. This resource includes veterinarians, chemists and other scientists with expertise in pathology, internal medicine, oncology, cardiology, dermatology, neurology and endocrinology. This depth of experience and expertise enables our specialists to suggest additional testing or provide diagnostic advice that assists the veterinarian in developing an appropriate treatment plan.
Together with our specialist support, we believe the quality of our service further distinguishes our laboratory services. We maintain quality assurance programs to ensure that specimens are collected and transported properly, that tests are performed accurately and that client, patient and test information is reported and billed correctly. Our quality assurance programs include quality control testing of specimens of known concentration or reactivity to ensure accuracy and precision, routine checks and preventive maintenance of laboratory testing equipment, and personnel standards ensuring that only qualified personnel perform testing. As a result, we believe that our accuracy rate is over 99%.
Laboratory Network. We operate 20 diagnostic laboratories. Our laboratory network includes:
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primary hubs that are open 24 hours per day and offer a full testing menu;
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secondary laboratories that service large metropolitan areas, are open 24 hours per day and offer a wide testing menu; and
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STAT laboratories that service other locations with demand sufficient to warrant nearby laboratory facilities and are open primarily during daytime hours.
We connect our laboratories to our customers with what we believe is the industry’s largest transportation network, which picks up an average of 20,000 to 25,000 requisitions daily through an extensive network of drivers and independent couriers. In 2002, we derived approximately 70% of our laboratory revenue from major metropolitan areas, where we offer twice-a-day pick-up service and same-day results. In addition, in these areas we generally offer to report results within three hours of pick-up. Outside of these areas, we typically provide test results to veterinarians before 8:00 a.m. the following day.
Veterinarian customers located outside the areas covered by our transportation network are serviced using our Test Express service. Users of the Test Express service send patient specimens by Federal Express to our laboratory just outside of Memphis, the proximity of which to the Federal Express primary sorting facility permits speedy and cost-efficient testing.
Sales, Marketing and Client Service. We employ over 45 full-time sales and field service representatives who market laboratory services and maintain relationships with existing customers. The sales force is commission-based and organized along geographic regions. We support our sales efforts by strengthening our industry-leading team of specialists, developing marketing literature, attending trade shows, participating in trade associations and
providing educational services to veterinarians. In addition, we employ over 85 client service representatives who respond to customer inquiries, provide test results and, when appropriate, introduce the customer to other services offered by the laboratory.
Personnel. We employ a staff of approximately 1,100 full-time-equivalent employees in our laboratory network. We employ some of our specialists and enter into consulting arrangements with others. Our laboratory network consists of an eastern and western division and we employ a vice president to manage each region. We employ a manager at each of our laboratories and supervisors for each department within the laboratories.
Animal Hospitals
At December 31, 2002, we operated 229 animal hospitals in 34 states that were supported by over 770 veterinarians. Our nationwide network of free-standing, full-service animal hospitals has facilities located in the following states:
*
States in which we manage animal hospitals owned by veterinary medical groups.
We seek to provide quality care in clean, attractive facilities that are open on average between 10 and 15 hours per day, six to seven days per week. Our typical animal hospital:
In addition to general medical and surgical services, we offer specialized treatments for companion animals, including advanced diagnostic services, internal medicine, oncology, ophthalmology, dermatology and cardiology. We also provide pharmaceutical products for use in the delivery of treatments by our veterinarians and pet owners. Many of our animal hospitals offer additional services, including grooming, bathing and boarding. We also sell specialty pet products at our hospitals, including pet food, vitamins, therapeutic shampoos and conditioners, flea collars and sprays, and other accessory products.
As part of the growth strategy of our animal hospital business, we intend to continue our disciplined acquisition strategy by identifying high quality practices that may have value to be unlocked through the services and scale we can provide. We contemplate the acquisition of 15 to 25 animal hospitals per year. Our typical
candidate mirrors the profile of our existing hospital base. Acquisitions will be used to both expand in existing markets and enter new geographical areas. We intend primarily to use cash in our acquisitions, but we may use debt or stock to the extent we deem appropriate. By undertaking prudent acquisitions, we are able to grow our hospital business without diluting the local market for veterinary services.
Personnel. Our animal hospitals generally employ a staff of between 10 and 30 full-time equivalent employees, depending upon the facility’s size and customer base. The staff includes administrative and technical support personnel, three to five veterinarians, an office manager who supervises the day-to-day activities of the facility, and a small office staff. We employ a relatively small corporate staff to provide centralized administrative services to all of our animal hospitals.
We actively recruit qualified veterinarians and technicians and are committed to supporting continuing education for our professional staff. We operate post-graduate teaching programs for veterinarians at eight of our facilities, which train approximately 46 veterinarians each year. We believe that these programs enhance our reputation in the veterinary profession and further our ability to continue to recruit the most talented veterinarians.
We seek to establish an environment that supports the veterinarian in the delivery of quality medicine and fosters professional growth through increased patient flow and a diverse case mix, continuing education, state-of-the-art equipment and access to specialists. We believe our hospitals offer attractive employment opportunities to veterinarians because of this professional environment, competitive compensation programs, management opportunities, employee benefits not generally available to a sole practitioner, scheduling flexibility to accommodate personal lifestyles and the ability to relocate to different regions of the country. Further, we permit some of our veterinarians to participate with us in the ownership and operation of selected animal hospitals. In these circumstances, the veterinarian purchases an equity position in our animal hospital and is our partner in its operation. As of December 31, 2002, we operated 25 hospitals under a partnership structure. Typically, the salary of the veterinarian partner is based on a percentage of the revenue of the animal hospital that is generated by the veterinarian. The operating income of the partnership that is distributed to the veterinarian partner is based on the veterinarian partner’s percentage interest in the partnership, which is typically between 10% and 25%.
We have established a Medical Advisory Board to support our operations. The Medical Advisory Board’s function, under the direction of our Chief Medical Officer, is to recommend medical standards for our network of animal hospitals. The committee is comprised of leading veterinarians representing both the different geographic regions in which we operate and the medical specialties practiced by our veterinarians. Currently, four members of the Medical Advisory Board are faculty members at leading veterinary colleges in the United States. These members serve as medical consultants to us. Additionally, our regional medical directors, a group of highly experienced clinicians, are also closely involved in the development and implementation of our medical programs.
Marketing. Our marketing efforts are primarily directed toward our existing clients through customer education efforts. We inform and educate our clients about pet wellness and quality care through mailings of the Healthy Pet Magazine, a magazine focused on pet care and wellness published by an affiliate of ours, targeted demographic mailings regarding specific pet health issues and collateral health material available at each animal hospital. With these internal marketing programs, we seek to leverage our existing customer base by increasing the number of existing clients and intensity of the services used during each visit. Further, reminder notices are used to increase awareness of the advantages of regular, comprehensive veterinary medical care, including preventive care such as vaccinations, dental screening and geriatric care.
We also enter into referral arrangements with local pet shops and humane societies to increase our client base. In addition, we seek to obtain referrals from veterinarians by promoting our specialized diagnostic and treatment capabilities to veterinarians and veterinary practices that cannot offer their clients these services.
Ownership Limitations. Some states have laws that prohibit business corporations from providing veterinary services through the direct employment of veterinarians. At December 31, 2002, we operated 60 animal hospitals in 11 states with these types of ownership restrictions. In these states, instead of owning an animal practice, we provide management services to veterinary medical groups. We do not consolidate the operating results of these hospitals for financial statement purposes. We provide our management services pursuant to long-term management agreements with the veterinary medical groups, ranging from 10 to 40 years, with non-binding renewal
options where allowable. Pursuant to the management agreements, the veterinary medical groups are each solely responsible for all aspects of the practice of veterinary medicine as defined by their respective state. We are responsible for providing the following services:
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availability of all facilities and equipment;
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day-to-day financial and administrative supervision and management;
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maintenance of patient records;
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recruitment of veterinarians and animal hospital staff;
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marketing; and
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malpractice and general insurance.
As compensation for these services, we receive management fees, which are included in animal hospital revenue.
Systems
Laboratory
We maintain a nationwide management information system to support our veterinary laboratories. All of our financial and customer records and laboratory results are stored in computer databases. Laboratory technicians and specialists are able to electronically access test results from remote testing sites, enabling our specialists from varying fields of veterinary medicine to assist in the interpretation of test results and help structure potential treatment programs. In 2002, we completed the development and implementation of software that can gather data in a data warehouse enabling us to provide immediate faxing of diagnostic laboratory results to clients. We also have substantially completed software that facilitates the collection and delivery of laboratory results to an internet website for access by our clients. The website will also offer additional services, such as online ordering which generates barcode requisitions, the ability to order client supplies, request consultations or purchase add-on tests to samples previously collected. These additional services will be available to our clients by late 2003. We are in the process of migrating our large clients with access to our internet website. This phase of our client migration is anticipated to be completed by early 2004.
Animal Hospital
Our animal hospital operations utilize an enterprise-wide management information network. Substantially all of our animal hospitals utilize consistent patient accounting/point-of-sale software and we are able to track performance of hospitals on a per-service, per-veterinarian basis. We recently implemented an upgrade of this system to improve our ability to track performance data on a per-client basis. In 2003, we are continuing to develop the functionality of the system to provide better service to our clients and to enhance management information and efficiency.
Competition
The companion animal health care services industry is highly competitive and subject to continual change in the manner in which services are delivered and providers are selected. We believe that the primary factors influencing a customer’s selection of an animal hospital are convenient location and hours, recommendation of friends, reasonable fees and quality of care. Our primary competitors for our animal hospitals in most markets are individual practitioners or small, regional multi-clinic practices. In addition, some national companies in the pet care industry, including the operators of super-stores, are developing multi-regional networks of animal hospitals in markets that include our animal hospitals. Among veterinary diagnostic laboratories, we believe that quality, price, specialist support and the time required to report results are the major competitive factors. Although there are many
individual clinical laboratories that provide a broad range of diagnostic testing services in the same markets serviced by us, few outsourced laboratory companies compete on a national level. In addition to competing with dedicated veterinary laboratories, we face competition from several providers of on-site diagnostic equipment that allows veterinarians to perform their own laboratory tests.
Government Regulation
The laws of many states prohibit business corporations from providing, or holding themselves out as providers of, veterinary medical care. These laws vary from state to state and are enforced by the courts and by regulatory authorities with broad discretion. At December 31, 2002, we operated 60 hospitals in 11 states with these laws. Although we seek to structure our operations to comply with veterinary medicine laws of each state in which we operate, given the varying and uncertain interpretations of these laws, we may not be in compliance with restrictions on the corporate practice of veterinary medicine in all states. A determination that we are in violation of applicable restrictions on the practice of veterinary medicine in any state in which we operate could have a material adverse effect on us, particularly if we were unable to restructure our operations to comply with the requirements of that state.
In addition, all of the states in which we operate impose various registration requirements. To fulfill these requirements, we have registered each of our facilities with appropriate governmental agencies and, where required, have appointed a licensed veterinarian to act on behalf of each facility. All veterinarians practicing in our clinics are required to maintain valid state licenses to practice.
Acquisitions may be subject to pre-merger or post-merger review by governmental authorities for antitrust and other legal compliance. Adverse regulatory action could negatively affect our operations through the assessment of fines or penalties against us or the possible requirement of divestiture of one or more of our operations.
Employees
At December 31, 2002, we had approximately 3,600 full-time-equivalent employees, including approximately 635 licensed veterinarians. At December 31, 2002, none of our employees were a party to a collective bargaining agreement with the exception of 49 employees whom we employ as courier drivers and facilities personnel in the State of New York. These employees are subject to a collective bargaining agreement expiring on July 10, 2004 with the Teamsters Local Union 813.
Website Availability of Our Reports Filed with the Securities and Exchange Commission
We maintain a website with the address www.vcaantech.com. We are not including the information contained on our website as a part of, or incorporating it by reference into, this annual report on Form 10-K. We make available free of charge through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file that material with, or furnish such material to, the Securities and Exchange Commission.
ITEM 2.
ITEM 2. PROPERTIES
Our corporate headquarters and principal executive offices are located in West Los Angeles, California, in approximately 30,000 square feet of leased space. As of March 24, 2003, we maintain leased and owned facilities at 253 other locations that house our animal hospitals and laboratories. We own 64 facilities and the remainder are leased. We believe that our real property facilities are adequate for our current needs.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Ohio Attorney General’s office filed a lawsuit on December 14, 1998, in the Franklin County Court of Common Pleas in the State of Ohio in which the state alleged that our management of a veterinary medical group licensed to practice veterinary medicine in that state violates the Ohio statute prohibiting business corporations from providing, or holding themselves out as providers of, veterinary medical care. On March 20, 2001, the trial court in
the case entered summary judgment in favor of the State of Ohio and issued an order enjoining us from operating in the State of Ohio in a manner that is in violation of the state statute. Subsequently, we reached an agreement with the Attorney General’s office that our management services agreement, as amended, does not constitute the practice of veterinary medicine by a corporation. We have filed our agreement with the court, which completes our settlement with the State of Ohio. We were not required to pay any fines or penalties in connection with the settlement.
On November 30, 2001, two majority stockholders of a company that merged with Zoasis Corporation in June 2000 filed a civil complaint against VCA, Zoasis and Robert Antin. Robert Antin, VCA’s Chief Executive Officer, President and Chairman of the Board, is the majority stockholder of Zoasis and serves on its Board of Directors. The complaint alleges securities fraud under California law, common law fraud, negligent misrepresentation and declaratory judgment arising from the plaintiffs’ investment in Zoasis. Zoasis filed a counter claim alleging breach of contract and claim and delivery. On March 25, 2003, the parties finally settled all claims in the litigation and executed a Settlement Agreement, Mutual Release and Covenant Not to Sue. Under the settlement, the parties will dismiss their claims in the litigation with prejudice and VCA shall pay to plaintiffs $2,000,000. Concurrently with the settlement, plaintiffs will surrender all of their Zoasis common stock.
We are a party to various other legal proceedings that arise in the ordinary course of business. Although we cannot determine the ultimate disposition of these proceedings, we can use judgment to reasonably estimate our liability for legal settlement costs that may arise as a result of these proceedings. Based on our prior experience, the nature of the current proceedings, including the settlement payment referenced above, and our insurance policy coverage for such matters, we have accrued $3.1 million as of December 31, 2002 for legal settlements as part of other accrued liabilities.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDINGS
No matters were submitted to a vote of security holders of the Company during the fourth quarter of 2002.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S EQUITY AND RELATED STOCKHOLDER MATTERS
Since November 21, 2001, our common stock has traded on the Nasdaq Stock Market’s National Market under the symbol “WOOF”. From September 20, 2000 through November 20, 2001, our common stock was not publicly traded. The following table sets forth the range of high and low bid information per share for our common stock as quoted on the Nasdaq Stock Market’s National Market for the periods indicated.
At March 24, 2003, the closing price of the common stock on the Nasdaq Stock Market’s National Market was $15.16 and there were approximately 93 holders of record of the Company’s common stock.
Dividends
We have not paid cash dividends on our common stock, and we do not anticipate paying cash dividends in the foreseeable future. In addition, our credit facility and the indenture governing our outstanding senior subordinated notes place limitations on our ability to pay dividends or make other distributions in respect of our common stock. Any future determination as to the payment of dividends on our common stock will be restricted by these limitations, will be at the discretion of our Board of Directors and will depend on our results of operations, financial condition, capital requirements and other factors deemed relevant by the Board of Directors, including the General Corporation Law of the State of Delaware, which provides that dividends are only payable out of surplus or current net profits.
Equity Compensation Plans
The following table summarizes information about the equity securities authorized for issuance under our compensation plans as of December 31, 2002. For a description of these plans, please see Footnote 10, Stock-Based Compensation Plans, in our consolidated financial statements.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Our selected consolidated financial data as of and for the years ended December 31, 2002, 2001, 2000, 1999, and 1998 have been derived from our audited financial statements. Our financial statements for each of the fiscal years ended December 31, 2002, 2001, 2000 and 1999 were audited by KPMG LLP. Our financial statements for the fiscal year ended December 31, 1998 were audited by Arthur Andersen LLP. You should read the selected financial data presented below together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes. Our audited consolidated financial statements as of December 31, 2002 and 2001 and for each of the three years in the period ended December 31, 2002 are included in this Annual Report on Form 10-K.
(1)
Other revenue includes consulting fees of $1.5 million, $2.0 million, $925,000, $5.1 million and $5.1 million for the years ended December 31, 2002, 2001, 2000, 1999 and 1998, respectively.
(2)
EBITDA is operating income before depreciation and amortization. Adjusted EBITDA (and its components, Adjusted Laboratory EBITDA and Adjusted Animal Hospital EBITDA) for the periods presented represent EBITDA for the applicable operating unit adjusted to exclude recapitalization costs, management fees paid pursuant to our management services agreement with Leonard Green & Partners, which was terminated in November 2001, write-down of assets, non-cash compensation expenses and certain other significant items itemized in the reconciliations presented below as (4) and (5).
EBITDA and adjusted EBITDA are not measures of financial performance under generally accepted accounting principles, or GAAP. Neither EBITDA nor adjusted EBITDA should be considered in isolation or as a substitute for net income, cash flows from operating activities and other income or cash flow statement data prepared in accordance with GAAP, or as a measure of profitability or liquidity. We believe EBITDA and adjusted EBITDA are useful measures of our operating performance as they reflect earnings before the impact of items that may change from period to period for reasons not directly related to our operations, such as depreciation and amortization, interest and taxes and other certain significant items. EBITDA also is an important component of the financial ratios included in our debt covenants and provides us with a measure of our ability to service our debt and meet capital expenditure requirements from our operating results. Our calculation of EBITDA may not be comparable to similarly titled measures reported by other companies.
The reconciliation of net income (loss) before extraordinary item to Adjusted EBITDA is shown below (in thousands):
(3) Adjusted EBITDA is the sum of adjusted laboratory EBITDA, adjusted animal hospital EBITDA, other revenue and gain on sale of corporate assets, less corporate selling, general and administrative expense, excluding litigation charges, non-cash compensation and management fees.
The calculation of Adjusted EBITDA is shown below (in thousands):
(4) The following table reconciles laboratory operating income to adjusted laboratory EBITDA (in thousands):
(5) The following table reconciles animal hospital operating income to adjusted animal hospital EBITDA (in thousands):
(6) The following table reconciles corporate selling, general and administrative expense to adjusted corporate selling, general and administrative expense (in thousands):
(7) Adjusted EBITDA margin is calculated by dividing adjusted EBITDA by total revenue. Adjusted laboratory EBITDA margin is calculated by dividing adjusted laboratory EBITDA by laboratory revenue. Adjusted animal hospital EBITDA margin is calculated by dividing adjusted animal hospital EBITDA by animal hospital revenue.
ITEM 7.
ITEM 7. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of December 31, 2002, we had borrowings of $174.8 million under our senior credit facility with fluctuating interest rates based on market benchmarks such as LIBOR. To reduce the risk of increasing interest rates, we entered into a no-fee interest rate swap agreement on November 7, 2002 effective November 29, 2002 and expiring November 29, 2004. Under the swap agreement we receive payments equal to the annual LIBOR rate times $40.0 million in exchange for paying a fixed annual rate of 2.22% times $40.0 million. The swap agreement has the effect of reducing the amount of our debt exposed to variable interest rates from $174.8 million to $134.8 million. Accordingly, for the year ending December 31, 2003, for every 1.0% increase in the LIBOR rate we will pay an additional $1.4 million in interest expense and for every 1.0% decrease in the LIBOR rate we will save $1.4 million in interest expense.
We are considering entering into additional interest rate strategies to take advantage of the current rate environment. We have not yet determined what those strategies may be or their possible impact.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
VCA ANTECH, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of VCA Antech, Inc.:
We have audited the consolidated financial statements of VCA Antech, Inc. and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of VCA Antech, Inc. and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note 3 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, on January 1, 2002.
/s/ KPMG LLP
KPMG LLP
Los Angeles, California
February 20, 2003
VCA ANTECH, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of December 31, 2002 and 2001
(In thousands, except par value)
The accompanying notes are an integral part of these consolidated financial statements.
VCA ANTECH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, 2002, 2001 and 2000
(In thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
VCA ANTECH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
For the Years Ended December 31, 2002, 2001 and 2000
(In thousands)
[Additional columns below]
[Continued from above table, first column(s) repeated]
The accompanying notes are an integral part of these consolidated financial statements.
VCA ANTECH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
For the Years Ended December 31, 2002, 2001 and 2000
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
VCA ANTECH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2002, 2001 and 2000
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
VCA ANTECH, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)
For the Years Ended December 31, 2002, 2001 and 2000
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002
1. The Company
Based in Los Angeles, California, VCA Antech, Inc. (“VCA”), a Delaware corporation, is an animal health care service company with positions in two core businesses, veterinary diagnostic laboratories (“Laboratory”) and animal hospitals (“Animal Hospital”). In 2000, the Company established a new legal structure comprised of a holding company and an operating company. VCA is the holding company. Vicar Operating, Inc. (“Vicar”) is wholly-owned by VCA and owns the capital stock of all the Company’s subsidiaries. Collectively, VCA and Vicar are referred to as “the Company.” Prior to September 24, 2001, VCA was known as Veterinary Centers of America, Inc.
The Company operates a full-service veterinary diagnostic laboratory network serving all 50 states. The laboratory network provides sophisticated testing and consulting services used by veterinarians in the detection, diagnosis, evaluation, monitoring, treatment and prevention of diseases and other conditions affecting animals.
As of December 31, 2002, the Company operated 19 full-service laboratories. The Laboratory network includes:
•
primary hubs that are open 24 hours per day and offer a full testing menu;
•
secondary laboratories that service large metropolitan areas, are open 24 hours per day and offer a wide testing menu; and
•
STAT laboratories that service other locations with demand sufficient to warrant nearby laboratory facilities and are open primarily during daytime hours.
The Animal Hospitals offer a full range of general medical and surgical services for companion animals. The Animal Hospitals treat diseases and injuries, provide pharmaceutical products and perform a variety of pet wellness programs, including routine vaccinations, health examinations, spaying, neutering and dental care.
At December 31, 2002, the Company operated 229 animal hospitals throughout 34 states as follows:
*
States in which the Company manages animal hospitals owned by veterinary medical groups.
The Company was formed in 1986 and during the 1990s, established a position in the veterinary diagnostic laboratory and animal hospital markets through both internal growth and acquisitions. By 1997, the Company had built a laboratory network of 12 laboratories servicing animal hospitals in all 50 states and operated a total of 160 animal hospitals.
The Company was publicly traded from 1991 until September 20, 2000, when the Company completed a recapitalization transaction (the “Recapitalization”) with certain investors who are affiliated with Leonard Green & Partners. The Company purchased 99% of its outstanding shares of common stock for $1.00 per share for a total consideration of $314.5 million and such shares were subsequently retired. The Company also repaid $172.9 million in principal of its debt obligations. The Recapitalization was financed by:
The Recapitalization did not result in a change in the historical cost basis of the Company’s assets and liabilities because certain management shareholders retained their ownership of the Company’s common stock, which aggregated 2,656,335 shares of the Company’s common stock. Concurrent with the Recapitalization, an additional 517,995 shares of common stock were issued to certain members of management.
The Company incurred $34.3 million of Recapitalization costs for the year ended December 31, 2000, which consisted of $24.1 million associated with the buy-out of stock options held by employees, $1.2 million paid to employees for services rendered in connection with the Recapitalization, $7.6 million in professional fees and $1.4 million of other expenses. Additionally, the Company paid $15.6 million out of the Recapitalization proceeds for covenants not to compete to the following executive officers: Robert Antin, Chief Executive Officer; Arthur Antin, Chief Operating Officer; Tomas Fuller, Chief Financial Officer; and Neil Tauber, Senior Vice President of Development. The payments made for the covenants not to compete were being amortized over a three-year period commencing on September 20, 2000. Following the closing of the Company’s initial public offering of its common stock in November 2001 (described below), the Company terminated the non-competition agreements with certain members of management and recorded a non-cash charge of $9.6 million.
On November 27, 2001, the Company completed an initial public offering of its common stock (the “initial public offering”). As a result of this offering and the underwriters’ exercise of its over-allotment option, the Company issued 17,370,000 shares of common stock and received net proceeds of $161.5 million. Concurrent with the initial public offering, the Company issued $170.0 million in principal amount of 9.875% senior subordinated notes due 2009. The Company applied the net proceeds from the initial public offering and the sale of the notes, plus cash on hand, as follows:
Affiliates of Leonard Green & Partners and Robert Antin, CEO, President and Chairman of the Board of the Company, purchased 2,000,000 and 40,000 additional shares of common stock, respectively, in the initial public offering.
In subsequent transactions, we:
2. Summary of Significant Accounting Policies
a. Principles of Consolidation
The consolidated financial statements include the accounts of the Company and all those majority-owned subsidiaries where the Company has control. Significant intercompany transactions and balances have been eliminated.
The Company provides management services to certain veterinary medical groups in states with laws that prohibit business corporations from providing veterinary services through the direct employment of veterinarians. As of December 31, 2002, the Company operated in eleven of these states. In these states, instead of owning an animal hospital, the Company provides management services to veterinary medical groups. The Company provides management services pursuant to long-term management agreements (the “Management Agreements”) with the veterinary medical groups, ranging from 10 to 40 years with non-binding renewal options, where allowable. Pursuant to the Management Agreements, the veterinary medical groups are each solely responsible for all aspects of the practice of veterinary medicine, as defined by their respective state. The Company is responsible for providing the following services:
•
availability of all facilities and equipment;
•
day-to-day financial and administrative supervision and management;
•
maintenance of patient records;
•
recruitment of veterinary and hospital staff;
•
marketing; and
•
malpractice and general insurance.
The Company does not consolidate the operations of the veterinary medical groups since it has no control over the practice of veterinary medicine at these hospitals. As compensation for the Company’s services, it receives management fees which are included in revenue and were $43.9 million, $37.8 million, and $31.1 million for the years ended December 31, 2002, 2001 and 2000, respectively.
b. Cash and Cash Equivalents
For purposes of the balance sheets and statements of cash flows, the Company considers only highly liquid investments with original maturities of less than 90 days to be cash equivalents. At December 31, 2002 and 2001, the entire balance was cash.
c. Marketable Securities
During the year ended December 31, 2000, the Company realized a loss on the sale of an investment of $1.3 million. As of December 31, 2002 and 2001, the Company had no marketable securities.
d. Property and Equipment
Property and equipment is recorded at cost. Equipment held under capital leases is recorded at the lower of the present value of the minimum lease payments or the fair value of the equipment at the beginning of the lease term.
Depreciation and amortization are provided for on the straight-line method over the following estimated useful lives:
Buildings and improvements
5 to 40 years
Leasehold improvements
Lesser of lease term or 15 years
Furniture and equipment
3 to 7 years
Equipment held under capital leases
5 to 10 years
Property and equipment at December 31, consisted of (in thousands):
Accumulated depreciation on equipment held under capital leases amounted to $1.5 million at December 31, 2001.
e. Goodwill
Goodwill relating to acquisitions represents the purchase price paid and liabilities assumed in excess of the fair market value of net assets acquired.
The Company continually evaluates whether events, circumstances or net losses on the entity level have occurred that indicate the remaining estimated useful life of goodwill may warrant revision or that the remaining balance of goodwill may not be recoverable. When factors indicate that goodwill should be evaluated for possible impairment, the Company uses an estimate of the related facility’s undiscounted, tax adjusted net income over the remaining life of the goodwill to measure whether the goodwill is recoverable. If it is determined that goodwill on a given entity is partially or totally unrecoverable, losses will be recognized to the extent that projected aggregate tax-adjusted net income over the life of the goodwill does not cover the goodwill balance at the date of impairment. Accumulated amortization of goodwill was $43.3 million at December 31, 2002 and 2001.
The Company recorded a write-down of goodwill of $7.3 million during the year ended December 31, 2001. See Footnote 2.n., Write-down and Gain on Sale of Assets, for additional information.
As discussed in Footnote 3, Recent Accounting Pronouncements, under SFAS No. 142, Goodwill and Other Intangible Assets, goodwill relating to acquisitions effective June 30, 2001 is not amortized and is evaluated on a periodic basis for impairment. Goodwill acquired prior to June 30, 2001 was amortized through December 31, 2001 on a straight-line basis over the expected period to be benefited, not to exceed 40 years; however, this goodwill was no longer amortized beginning January 1, 2002, in accordance with SFAS No. 142.
The following table presents net income (loss) available to common stockholders, earnings (loss) per share and income (loss) before extraordinary item as if SFAS No. 142 had been adopted as of January 1, 2000 (in thousands):
The following table presents the changes in the carrying amount of goodwill for the year ended December 31, 2002 (in thousands):
In addition to goodwill, the Company has other intangible assets as follows (in thousands):
The aggregate amortization related to other intangible assets was as follows (in thousands):
Estimated amortization expense for other intangible assets for the next five years is as follows (in thousands):
f. Covenants Not to Compete
Covenants not to compete are amortized on a straight-line basis over the term of the agreements, usually three to ten years. Accumulated amortization of covenants not to compete was $8.2 million and $6.5 million at December 31, 2002 and 2001, respectively.
g. Notes Receivable
Notes receivable are not market traded financial instruments. The amounts recorded approximate fair value and are shown net of valuation allowances of $63,000 as of December 31, 2002 and 2001. The notes bear interest at rates varying from 7% to 10% per annum.
h. Other Revenue
As part of a partnership with Heinz Pet Products (“HPP”), the Company agreed to provide certain consulting and management services for a three-year period that commenced on February 1, 1997 and ended on January 31, 2000. The agreement was for an aggregate fee of $15.3 million payable in semi-annual installments over a five-year period.
In October 2000, after the expiration of the above-mentioned consulting and management services agreement, HPP bought out the Company’s interest in the partnership and entered into a two-year consulting agreement with the Company. The agreement called for an aggregate fee of $5.0 million, $4.0 million of which was recognized as revenue ratably over the life of the agreement and $1.0 million of which will be used for certain marketing obligations under the agreement.
Fees earned under these agreements are included in revenue and amounted to $1.5 million, $2.0 million and $925,000 for the years ended December 31, 2002, 2001 and 2000, respectively. At December 31, 2001, the Company had deferred revenue of $1.5 million included in other accrued liabilities. The Company had no deferred revenue at December 31, 2002.
i. Deferred Financing Costs
In connection with the initial public offering during the year ended December 31, 2001, the Company recorded $4.8 million and wrote-off $4.7 million in deferred financing costs. In connection with certain debt transactions during the year ended December 31, 2002, the Company recorded $1.0 million and wrote-off $4.0 million in deferred financing costs. Deferred financing costs are amortized using the effective interest method over the life of the related debt. Accumulated amortization of deferred financing costs was $854,000 and $1.6 million for the years ended December 31, 2002 and 2001, respectively.
j. Investment in VPI and Zoasis Corporation
During portions of 2000 and 1999, the Company had investments in Veterinary Pet Insurance, Inc. (“VPI”) and Zoasis Corporation (“Zoasis”), both of which were accounted for on the cost basis. See Footnote 6, Joint Ventures and Investments, for a description of these investments.
k. Fair Value of Financial Instruments and Concentration of Credit Risk
The carrying amount reported in the consolidated balance sheets for cash, accounts receivable, accounts payable and accrued liabilities approximates fair value because of the immediate or short-term maturity of these financial instruments. Concentration of credit risk with respect to accounts receivable is limited due to the diversity of the Company’s customer base.
l. Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and contingent liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates.
m. Interest Rate Hedging Agreements
In June 1998, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133, which as amended is for fiscal years which began after June 15, 2000, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities (collectively referred to as “derivatives”). It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. The Company adopted SFAS No. 133 effective January 1, 2001.
Under the provisions of the Credit and Guaranty Agreement, dated September 20, 2000, the Company was required to enter into an arrangement to hedge interest rate exposure for a minimum notional amount of $62.0 million and a minimum term of two years. On November 13, 2000, the Company entered into a no-fee interest rate collar agreement with Wells Fargo Bank effective November 15, 2000 and expiring November 15, 2002, (the “Collar Agreement”). The Collar Agreement is based on the London interbank offer rate (“LIBOR”), which resets monthly, and has a cap and floor notional amount of $62.5 million, with a cap and floor interest rate of 7.5% and 5.9%, respectively. The Collar Agreement qualifies for hedge accounting and the Company considers it a cash flow hedging instrument. The Company has made payments under this agreement amounting to $2.2 million and $1.2 million for the years ending December 31, 2002 and 2001, respectively, resulting from LIBOR rates being below the floor interest rate of 5.9%. These payments have been reported as part of interest expense.
On November 7, 2002, the Company entered into a no-fee swap agreement with Wells Fargo Bank effective November 29, 2002 and expiring November 29, 2004, (“Swap Agreement”). The Swap Agreement swaps monthly variable LIBOR rates for a fixed rate of 2.22% on a notional amount of $40.0 million. The Swap Agreement qualifies for hedge accounting and the Company considers it a cash flow hedging instrument. During 2002, the Company has made payments under this agreement of $30,000 resulting from LIBOR rates being below the fixed interest rate of 2.22%.
The valuation of the Swap Agreement and the Collar Agreement were determined by Wells Fargo Bank. At December 31, 2002 and 2001, the Company reported a liability from interest rate hedging activities of $313,000 and $2.0 million, respectively. During the years ended December 31, 2002 and 2001, the Company recognized expense related to interest rate hedging activities of $145,000 and $168,000, respectively, which is included in other expense.
n. Write-down and Gain on Sale of Assets
During the year ended December 31, 2002, the Company recognized a gain on the sale of assets of $100,000 as a result of entering into several transactions, which consisted of the sale of certain assets with a carrying value of $1.7 million for cash proceeds of $1.8 million. In connection with these transactions, the Company:
During the year ended December 31, 2001, the Company recognized a gain on the sale of assets of $118,000 as a result of entering into several transactions, which consisted of the sale of certain assets with a carrying value of $1.6 million for cash proceeds of $1.7 million. In connection with these transactions, the Company:
During the year ended December 31, 2001, the Company recognized a write-down of assets of $9.2 million as a result of certain events or circumstances. In connection with these certain events or circumstances, the Company:
o. Reclassifications
Certain prior year balances have been reclassified to conform with the 2002 financial statement presentation.
p. Revenue Recognition
Revenue is recognized only after the following criteria are met: (i) there exists adequate evidence of the transactions; (ii) delivery of goods has occurred or services have been rendered; and (iii) the price is not contingent on future activity and collectibility is reasonably assured.
q. Marketing and Advertising
Marketing and advertising production costs are expensed as incurred or the first time the advertisement is run. Media (primarily print) placement costs are expensed in the month the advertising appears. Total marketing and advertising expense is included in direct costs and amounted to $5.0 million, $5.0 million and $5.6 million for the years ended December 31, 2002, 2001 and 2000, respectively.
r. Workers’ Compensation Liability
Historically, the major component of workers’ compensation expense has been the cost of the insurance premium. However, commencing in the third quarter of 2001, the Company restructured its workers’ compensation insurance policies to a self-insurance retention program. The effect of this restructuring was a shift of the financial risk associated with claims losses from the insurance carrier to the Company, as the insurance carrier bears only the financial risk of large individual losses and large aggregate losses (the “maximum loss pick”).
As a result of the shift to a self-insurance retention program, the Company must estimate what it will ultimately pay out for losses associated with workers’ compensation claims incurred during the policy period and estimate the related expense to be recognized in that period. Claims losses can vary substantially, and because they can take years to develop fully, can be difficult to estimate. These estimates are based on complex judgments regarding the probable number of claims that will be filed and the nature of those claims. The estimate is made as a percentage of payroll and is referred to as the “loss pick.” The estimate of the loss pick is made by reviewing historical data, current trends, the safety environment in the workplace and the effectiveness of the claims handling process.
The loss pick used to recognize the claims loss portion of workers’ compensation expense for the annual policies ended September 30, 2002 was 2.04%, or approximately $3.4 million. The maximum loss pick set by the insurance carrier on these policies was 2.49%, or approximately $4.2 million.
The loss pick used for claims losses for the annual policies ending September 30, 2003, of which expense was only recognized in the fourth quarter of 2002, was 2.00%, or $887,000 on a pro-rata basis. The maximum loss pick set by the insurance carrier on these policies was 2.55%, or approximately $1.1 million on a pro-rata basis.
The Company pre-funded claims losses to the insurance carrier at a rate less than the Company’s estimated loss pick, resulting in an accrual which is included in other liabilities. If the estimate proves to be incorrect as the claims losses develop over several years, the Company may have to record additional expense up to the maximum loss pick or could experience a reduction in expense if losses are less than estimated.
The insurance policies in place for 2000 and prior years did not have large deductibles and the Company has accrued for the maximum possible expense under these policies.
s. Accounting for Stock-Based Compensation
The Company has issued stock options to various employees under multiple stock option plans and is accounting for those options under the intrinsic value method as prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Under that method of accounting, when options are issued with a
strike price equal to or greater than market price on date of issuance, there is no impact on earnings either on the date of issuance or thereafter regardless of strike price.
3. Recent Accounting Pronouncements
a. Goodwill and Other Intangible Assets
In June 2001, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives. SFAS No. 142 requires that these assets be reviewed for impairment at least annually, or whenever there is an indication of impairment. Intangible assets with finite lives will continue to be amortized over their estimated useful lives and reviewed for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
SFAS No. 142 requires companies to allocate their goodwill to identifiable reporting units, which are then tested for impairment using a two-step process detailed in the statement. The first step requires comparing the fair value of each reporting unit with its carrying amount, including goodwill. If that fair value exceeds the carrying amount, the second step of the process is not necessary and there are no impairment issues. If that fair value does not exceed the carrying amount, companies must perform the second step that requires a hypothetical allocation of the fair value of the reporting unit to the reporting unit’s assets and liabilities as if the unit were just purchased by the company at the fair value price. In this hypothetical purchase, the excess of the fair value of the reporting unit over its re-evaluated, marked-to-market net assets would be the new basis for the reporting unit’s goodwill and a write down to this new value would be recognized as an expense.
The Company adopted SFAS No. 142 on January 1, 2002. In doing so, it determined that it had two reporting units, Laboratory and Animal Hospital. On April 15, 2002, an independent valuation group concluded that the fair value of the Company’s reporting units exceeded it’s carrying value and accordingly, as of that date, there were no goodwill impairment issues. The Company plans to perform a valuation of its reporting units in December of each year, or upon significant changes in the Company’s business environment.
b. Asset Retirement Obligations
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The Company will adopt SFAS No. 143 in the first quarter of fiscal year 2003, and does not expect the adoption of SFAS No. 143 to have a material impact on its financial statements.
c. Impairment of Long-Lived Assets
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which establishes one accounting model to be used for long-lived assets to be disposed of by sale and broadens the presentation for discontinued operations to include more disposal transactions. SFAS No. 144 supercedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets to be Disposed of by Sale, and the accounting and reporting provisions of Accounting Principles Board Opinion No. 30 (“APB No. 30”), Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. The Company adopted SFAS No. 144 on January 1, 2002 without material impact on our financial statements.
The Company will continually evaluate whether events, circumstances or net losses at the entity level have occurred that indicate the remaining estimated useful life of long-lived assets may warrant revision or that the remaining balance of these assets may not be recoverable. When factors indicate that these assets should be evaluated for possible impairment, the Company will estimate the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the long-lived assets in question. If that estimate is less than the carrying value of the assets under review, we will recognize an impairment loss equal to that difference.
d. Gains and Losses from Extinguishment of Debt and Capital Leases
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, to be applied in fiscal years beginning after May 15, 2002 with early adoption encouraged.
Under SFAS No. 145, gains and losses from extinguishment of debt should be classified as extraordinary items only if they meet the criteria of APB No. 30. Under APB No. 30, events are considered extraordinary only if they possess a high degree of abnormality and are not likely to recur in the foreseeable future. Any gains or losses on extinguishment of debt that do not meet the criteria of APB No. 30 shall be classified as a component of income from recurring operations. In addition, any gains or losses on extinguishment of debt that were classified as an extraordinary item in prior periods presented that do not meet the criteria of APB No. 30 shall be reclassified as a component of income from recurring operations.
The Company will adopt SFAS No. 145 at the beginning of fiscal year 2003. As detailed in Footnote 7, Long-Term Obligations, the Company recognized extraordinary losses related to the early extinguishment of debt of approximately $12.8 million, before taxes, during the year ended December 31, 2002. In addition, the Company recognized extraordinary losses related to the early extinguishment of debt, before taxes, in the amount of approximately $17.2 million and $4.5 million during years 2001 and 2000, respectively. The Company does not believe these losses on extinguishment of debt meet the criteria of APB No. 30 as it has historically and may continue to change its capital structure to take advantage of current market conditions. As a result of adopting SFAS No. 145, the Company will reclassify the losses on extinguishment of debt from extraordinary losses to a component
of income from recurring operations for filings subsequent to January 1, 2003. This reclassification will not impact net income (loss).
SFAS No. 145 also amends SFAS No. 13, Accounting for Leases. Under SFAS No. 145, if a capital lease is modified such that it becomes an operating lease, a gain or loss must be recognized similar to the accounting used for sale-leaseback transactions as provided in SFAS No. 28 and No. 98. At December 31, 2002, the Company had no capital lease obligations. Although the Company may enter into capital leases in the future, management does not expect SFAS No. 145 to have a material impact on its financial statements.
e. Costs Associated with Exit or Disposal of Activities
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 requires that liabilities associated with exit or disposal activities be recognized when a company is committed to future payment of those liabilities under a binding, legal obligation. SFAS No. 146 nullifies Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring), which required that exit and disposal costs be recognized as liabilities when a company formalized its plan for exiting or disposing of an activity even if no legal obligation had been established.
SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002, however early adoption is encouraged. Currently, the Company has no plans to exit or dispose of any of its business activities that would require the use of SFAS No. 146 nor does it anticipate that SFAS No. 146 will change any of its business practices.
f. Accounting for Stock-Based Compensation
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, an Amendment of FASB Statement No. 123. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation, as prescribed under SFAS No. 123. Under the fair value based method of accounting, compensation expense is recognized annually equal to the fair value of the options granted divided by their vesting period. In addition, SFAS No. 148 requires prominent disclosure in the footnotes to both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method on reported results.
The Company has issued stock options to various employees under multiple stock option plans and is accounting for those options under the intrinsic value method as prescribed in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Under that method of accounting, when options are issued with a strike price equal to or greater than market price on date of issuance, there is no impact on earnings either on the date of issuance or thereafter. The Company adopted the disclosure requirements of SFAS No. 148 on December 31, 2002 and has made the necessary disclosures in Footnote 10, Stock-Based Compensation Plans. At this time, the Company does not plan to adopt the fair value accounting model for stock-based employee compensation.
g. Goodwill Impairment Test
In August 2002, the FASB’s Emerging Issues Task Force (“EITF”) issued EITF Issue No. 02-13, Deferred Income Tax Considerations in Applying the Goodwill Impairment Test in FASB Statement No. 142, Goodwill and Other Intangible Assets. EITF Issue No. 02-13 was issued to provide guidance on how to account for deferred tax balances in determining a reporting unit’s fair value, a reporting unit’s carrying amount and the implied fair value of goodwill. In the review of the Animal Hospital and Laboratory reporting units at December 31, 2002, it was concluded that the deferred tax balances associated with each of the reporting units did not have a material impact on the reporting units’ fair value relative to its carrying value.
h. Guarantor’s Accounting and Disclosure Requirements for Guarantees
In January 2003, the FASB issued FASB Interpretation (FIN) No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN No. 45 requires a company to recognize a liability for the obligations it has undertaken in issuing a guarantee. This liability would be recorded at the inception of a guarantee and would be measured at fair value. The measurement provisions of this statement apply prospectively to guarantees issued or modified after December 31, 2002. The disclosure provisions of the statement apply to financial statements for periods ending after December 15, 2002. The Company does not have any obligations subject to the provisions of Fin No. 45.
i. Consolidation of Variable Interest Entities
In January 2003, the FASB issued Fin No. 46, Consolidation of Variable Interest Entities. Fin No. 46 requires a company to consolidate a variable interest entity if it is designated as the primary beneficiary of that entity even if the company does not have a majority of voting interests. A variable interest entity is generally defined as an entity where its equity is unable to finance its activities or where the owners of the entity lack the risk and rewards of ownership. The provisions of this statement apply at inception for any entity created after January 31, 2003. For an entity created before February 1, 2002, the provisions of this Interpretation must be applied at the beginning of the first interim or annual period beginning after June 15, 2003. The Company does not have any existing entities that are within the scope of this interpretation.
4. Related Party Transactions
Management believes, based on reasonable judgment, but without further investigation, that the terms of each of the following transactions or arrangements between the Company and its affiliates, officers, directors or stockholders which were parties to the transactions were, on an overall basis, at least as favorable to the Company as could then have been obtained from unrelated parties.
a. Acquisitions
As part of an often-used acquisition strategy, the Company hires the selling doctor upon purchase of their practice. The Company may lease facilities from the selling doctor; however, the related lease agreements are negotiated at prevailing market rates as part of the acquisition before the doctor is hired. These lease arrangements are not contingent upon the current or future employment of the doctors.
b. Recapitalization, Initial Public Offering and Debt Issuance
On September 20, 2000, the Company completed the Recapitalization with an entity controlled by Leonard Green & Partners. In the Recapitalization, each outstanding share of our common stock, other than shares retained by management and employees, was cancelled and converted into the right to receive $1.00. The Recapitalization was financed by:
Prior to the initial public offering on November 27, 2001, affiliates of Leonard Green & Partners owned 2,826,000 shares of 14% series A redeemable preferred stock and 2,800,000 shares of 12% series B redeemable stock. Affiliates of Goldman, Sachs & Co. owned 122,123 shares of 14% series A redeemable preferred stock and 121,000 shares of 12% series B redeemable preferred stock and held approximately $82.5 million aggregate principal amount of senior notes and approximately $14.2 million aggregate principal amount of the senior subordinated notes, and warrants to purchase 814,575 shares of common stock at an exercise price of $0.0007 per share. An affiliate of Goldman, Sachs & Co. was the syndication agent and a lender under the senior credit facility. Melina Higgins served as one of the Company’s directors until January 9, 2003. She is an executive of Goldman, Sachs & Co. and the Chief Financial Officer of GS Mezzanine Partners II, L.P. and GS Mezzanine Partners II Offshore, L.P., both of which held investments in the preferred stock and debt of the Company. The following partners of Leonard Green & Partners also serve on the Company’s Board of Directors: John Baumer, John Danhakl and Peter Nolan.
c. Purchase of Common Stock
Affiliates of Leonard Green & Partners purchased 2,000,000 shares of the Company’s common stock at the initial public offering price of $10.00 per share. These shares were subject to lock-up agreements under which these affiliates of Leonard Green & Partners agreed not to offer, sell, contract to sell, pledge or otherwise dispose of, directly or indirectly, any share of common stock or any securities convertible into or exchangeable or exercisable for any shares of common stock without the prior written consent of Credit Suisse First Boston until May 20, 2002.
Robert Antin purchased 40,000 of the 725,000 shares of the Company’s common stock reserved by the underwriters for sale to employees and other persons associated with the Company. These shares were subject to lock-up agreements under which Mr. Antin agreed not to offer, sell, contract to sell, pledge or otherwise dispose of, directly or indirectly, any share of common stock or any securities convertible into or exchangeable or exercisable for any shares of common stock without the prior written consent of Credit Suisse First Boston until May 20, 2002.
d. Amendment to the Company’s Senior Credit Facility
On August 29, 2002, the Company amended its senior credit facility to repay $143.1 million, or the entire outstanding principal amount, of the Company’s existing senior term A and senior term B notes by issuing under the senior credit facility an equal principal amount of senior term C notes, which bear a lower interest rate than the weighted average interest rate for the senior term A and B notes. An affiliate of Goldman, Sachs & Co. is the syndication agent and a lender under the senior credit facility. Affiliates of Goldman, Sachs & Co. held approximately $16.4 million aggregate principal amount of the Company’s senior term C notes. In addition, Melina Higgins was a managing director of Goldman, Sachs & Co. and was one of the Company’s directors during the year ended December 31, 2002.
e. Repayment of Senior Notes and Senior Subordinated Notes
On October 24, 2002, the Company borrowed an additional $25.0 million of senior term C notes under the senior credit facility and used $25.2 million of cash on hand to:
Affiliates of Goldman, Sachs & Co. held approximately $34.3 million aggregate principal amount of the Company’s 15.5% senior notes at December 31, 2002. An affiliate of Goldman, Sachs & Co. is the syndication agent and a lender under our senior credit facility. Melina Higgins was a managing director of Goldman, Sachs & Co. and was one of the Company’s directors during the year ended December 31, 2002.
f. Stockholders Agreement
On September 20, 2000, the Company entered into a stockholders agreement with each of its stockholders. Under the stockholders agreement, each party to the stockholders agreement has call rights with respect to shares of common stock and stock options held by members of management in the event of termination of employment for any reason. The call rights permit the Company to repurchase callable shares at $1.00 per share. In connection with the initial public offering, the stockholders agreement was amended such that effective October 1, 2001:
•
call rights expired on one-half of Robert Antin’s shares that initially were subject to the stockholders agreement. Of the remaining shares, call rights expired ratably over a six-month period commencing October 1, 2001;
•
call rights expired on one-half of Arthur Antin’s, Neil Tauber’s and Tomas Fuller’s shares that initially were subject to the stockholders agreement. Of the remaining shares, call rights expired on one-half of those shares on April 1, 2002, and on the remaining one-half on October 1, 2002; and
•
call rights expired on one-half of the other employees’ shares that initially were subject to the stockholders agreement. Of the remaining shares, call rights will expire ratably over a 12-month period commencing May 1, 2002.
The stockholders agreement also provided for the discharge of $580,000 and $108,000 of indebtedness owed to the Company by Robert Antin and Arthur Antin, respectively, including interest accrued thereon. This indebtedness was forgiven as part of the Recapitalization.
g. Notes Receivable from Stockholders
In 2001, certain non-executive employees exercised their options to purchase shares of the Company’s common stock. As consideration for the exercise of their options, the Company received notes with an aggregate value of approximately $100,000. Each note earns interest at the rate of 10.125% per annum and is due and payable
on August 1, 2004. These notes are collateralized by the Company’s common stock that was purchased by the stockholders and are an unconditional obligation of the employee. The total outstanding principal and interest of these notes at December 31, 2002 and 2001 was approximately $42,000 and $104,000, respectively.
Concurrent with the Recapitalization, the Company sold 517,995 common shares to certain non-executive employees of the Company. As consideration for the issuance of common stock, the Company received notes with an aggregate value approximating $518,000. Each note earns interest at the rate of 6.2% per annum, is compounded annually and is due and payable on September 16, 2007. The notes are collateralized by the Company’s common stock that was purchased by certain non-executive employees of the Company. The total outstanding principal and interest of these notes at December 31, 2002 and 2001 was $96,000 and $560,000, respectively.
h. Management Services Agreement
On September 20, 2000, the Company entered into a 10-year management services agreement with Leonard Green & Partners. The agreement provides that Leonard Green & Partners would provide general investment banking services, management, consulting and financial planning services and transaction-related financial advisory and investment banking services to the Company. The Company paid a one-time structuring fee of $7.5 million to Leonard Green & Partners in September 2000 under the agreement. Leonard Green & Partners may receive an annual fee of up to $2.5 million as compensation for the general services and normal and customary fees for transaction-related services. In the years ended December 31, 2001 and 2000, the Company paid management fees in an aggregate amount of $2.3 million and $620,000, respectively. Upon the consummation of the initial public offering, the parties agreed to terminate the management services agreement. In connection with the termination, the Company paid Leonard Green & Partners $8.0 million.
i. Non-Competition Agreements
On September 20, 2000, Robert Antin, Arthur Antin, Neil Tauber and Tomas Fuller each entered into non-competition agreements with the Company for a term of three years.
In consideration for the execution of the non-competition agreements, the Company paid approximately $6.2 million, $4.0 million, $2.7 million and $2.5 million to Robert Antin, Arthur Antin, Neil Tauber and Tomas Fuller, or their affiliates, respectively. Upon the consummation of the initial public offering, these non-competition agreements were terminated.
j. Investment in and Transactions with Zoasis
During 2000, the Company made a $5.0 million investment in Zoasis, an internet start-up business, majority owned by Robert Antin, the Company’s Chief Executive Officer and Chairman of the Board. In December 2000, the Company determined that the value of this investment was impaired and, as a result, recognized a loss of $5.0 million on the write-down of its investment in Zoasis.
The Company incurred marketing expense for vaccine reminder services provided by Zoasis of $850,000, $709,000 and $81,000 for the years ended December 31, 2002, 2001 and 2000, respectively. The pricing of these services is comparable to prices paid by the Company to independent third parties.
In 2001, the Company began development of software that can gather data in order to be able to automatically fax diagnostic laboratory results to the laboratory clients. The Company initially used an independent outside contractor to begin programming this software but now intends to use an in-house programmer working in conjunction with Zoasis. Zoasis will not be paid for this programming effort but will be able to use and amend the software to market it to other veterinary hospitals and laboratories. In relation to this project, Zoasis is also working with the Company to facilitate the collection and delivery of laboratory results to its clients.
k. Related Party Vendors
Patricia Antin, wife of Arthur Antin, is an independent sales representative for Citi Print and Westpro Graphics, both local printing companies. The Company used these companies’ services to print forms and
marketing materials for the Company’s hospitals nationwide. Transactions are based on arms-length market prices and the Company has no, nor has the Company ever had, any contractual obligation binding the Company to their services. The Company paid Citi Print $339,000, $345,000, and $321,000 for the years ended December 31, 2002, 2001 and 2000, respectively. The Company paid Westpro Graphics $7,000 and $17,000 for the years ended December 31, 2001 and 2000, respectively. Effective December 31, 2002, Patricia Antin no longer serves as an independent sales representative for any printing arrangement with the Company.
l. Investment in Vet’s Choice and the Wisdom Group, L.P.
In September 2000, the Company sold its entire equity interest in Vet’s Choice, which had zero-cost basis, to HPP. VCA received $500,000 in proceeds from the sale. At the time of the sale, one of the Company’s directors, Mr. John Heil, served as president of an affiliate of HPP. In connection with the sale, HPP also paid VCA $1.0 million which was transferred to the Wisdom Group, L.P. and used to redeem the limited partnership interests in the Wisdom Group, L.P. Members of the Company’s executive management had a 30.5% ownership interest in the Wisdom Group, L.P. as limited partners and one of the Company’s subsidiaries owned a 1% ownership interest as the general partner. The Wisdom Group, L.P. was dissolved in November 2000 upon redemption of all the partnership interests. The Wisdom Group, L.P. was to provide consulting services to Vet’s Choice with respect to the development, marketing and sale of premium pet food products.
During 2002, the Company purchased 25 animal hospitals and one veterinary diagnostic laboratory. Nine of the acquired animal hospitals and the laboratory were merged into existing VCA facilities upon acquisition. Including acquisition costs, VCA paid an aggregate consideration of $26.8 million, consisting of $24.9 million in cash and $1.9 million in certain obligations to sellers and other liabilities assumed. The aggregate purchase price was allocated as follows: $899,000 to tangible assets, $24.3 million to goodwill and $1.6 million to other intangibles. Goodwill was assigned to the animal hospital and laboratory reporting units in the amounts of $22.1 million and $2.2 million, respectively. The Company expects that $12.7 million of the goodwill recorded will be fully deductible for income tax purposes.
Also during 2002, the Company purchased the partnership interest of several partners that held an interest in certain non-wholly owned subsidiaries of the Company. VCA paid an aggregate consideration of approximately $1.0 million, consisting of $960,000 in cash and $65,000 in notes payable.
During 2001, the Company purchased 21 animal hospitals, six of which were merged into existing VCA facilities upon acquisition. Including acquisition costs, VCA paid an aggregate consideration of $24.4 million, consisting of $20.9 million cash, $1.0 million in debt, and $2.5 million in certain obligations to sellers and other liabilities assumed. The aggregate purchase price was allocated as follows: $747,000 to tangible assets, $22.5 million to goodwill and $1.2 million to other intangibles.
During 2000, the Company purchased 24 animal hospitals and one veterinary diagnostic laboratory. Three of the acquired animal hospitals and the laboratory were merged into existing VCA facilities upon acquisition. Including acquisition costs, VCA paid an aggregate consideration of $27.8 million, consisting of $16.5 million cash, $11.1 million in debt, and $315,000 in other liabilities assumed. The aggregate purchase price was allocated as follows: $914,000 to tangible assets, $21.6 million to goodwill and $5.3 million to other intangibles.
The Company also made payments of $2.0 million, $2.9 million and $1.2 million during 2002, 2001 and 2000, respectively, related to certain other obligations to sellers incurred on the date of acquisition.
In connection with certain acquisitions, the Company assumed certain contractual arrangements whereby cash may be issued to former owners of acquired hospitals upon attainment of specified financial criteria over periods of one to three years (“Earn-Out Payments”), as set forth in the respective agreements (the “Earn-Out Arrangements”). The Earn-Out Arrangements provide for contingent Earn-Out Payments if the acquired entity achieves or exceeds contractually defined revenue targets during the defined earn-out period. The payments are either fixed in amount or are based on a multiple of revenue. When the contingency is resolved and the additional consideration is distributed, the Company records the consideration issued as an additional cost of the acquired
entity. The additional consideration of affected assets, usually goodwill, is amortized over the remaining life of the asset. Earn-Out Payments in 2002, 2001 and 2000 consisted entirely of cash approximating $540,000, $496,000, and $486,000, respectively.
If specified financial criteria are attained, the Company will be obligated to make cash payments in 2003, 2004 and 2005 of approximately $290,000, $90,000 and $90,000, respectively.
The pro forma results listed below are unaudited and reflect purchase price accounting adjustments assuming 2002 and 2001 acquisitions occurred at January 1, 2001. The pro forma results are not necessarily indicative of what actually would have occurred if the acquisitions had been in effect for the entire periods presented. In addition, they are not intended to be a projection of future results and do not reflect any efficiencies that might be achieved from the combined operation.
For the Years Ended December 31
(In thousands, except per share amount)
(Unaudited)
6. Joint Ventures and Investments
During fiscal year 2000, the Company invested $5.0 million for convertible preferred stock of Zoasis, an internet start-up business, majority-owned by Robert Antin. Zoasis was to develop and provide services to the veterinary industry such as consumer e-commerce, e-commerce of veterinary supplies for hospitals, internet diagnostic laboratory results, on-line continuing education for veterinarians, hosted websites for veterinarian clients, and a marketing reminder service. Due to the decline in the market value of many internet companies, Zoasis was not able to raise additional capital to continue its development. Zoasis scaled back its operations significantly. In December 2000, the Company determined that the value of this investment was impaired and, as a result, recognized a loss of $5.0 million on the write-down of its investment in Zoasis.
In September 2000, the Company sold its 50.5% equity interest in Vet’s Choice, which had a zero cost basis, to HPP. The Company received $500,000 in the sale. In connection with the sale, the Company also received $1.0 million, which was transferred to the Wisdom Group, L.P. in January 2001.
In December 1997 and January 1998, the Company made a combined $5.0 million investment in Veterinary Pet Insurance, the largest provider of pet health insurance in the United States. The Company sold its investment in VPI and received $8.2 million in cash in February 2000, resulting in a one-time gain of approximately $3.2 million.
7. Long-Term Obligations
Long-term obligations consisted of the following at December 31, (in thousands):
The annual aggregate scheduled maturities of long-term obligations for the five years subsequent to December 31, 2002 are presented below (in thousands):
Interest expense consisted of the following for the year ended December 31, 2002 (in thousands):
The Company has made multiple changes to its capital structure during fiscal years 2002, 2001 and 2000. The first change occurred in 2000 with the Recapitalization. The second change occurred in 2001 with the Company’s initial public offering and debt offering. The third and fourth changes occurred in 2002 with the Company’s amended Credit Agreement and voluntary repayment of certain debt. The following table summarizes the activity in the Company’s long-term obligations for the three years ended December 31, 2002 (in thousands):
The Company had extraordinary losses related to the major changes in its capital structure as follows (in thousands):
Senior Credit Facility
As part of the Recapitalization, Vicar entered into a Credit and Guaranty Agreement with various lenders for $300.0 million of Senior Secured Credit Facilities (the “Credit Agreement”) with Goldman Sachs Credit Partners, L.P. as the syndication agent, and Wells Fargo Bank, N.A. as the administrative agent. The original Credit Agreement included a $50 million revolving credit facility as well as the senior term A and B notes. The revolving credit facility allows the Company to borrow up to an aggregate principal amount of $50.0 million and may be used to borrow, on a same-day notice under a “swing line,” the lesser of (1) $5.0 million or (2) the aggregate unused amount of the revolving credit facility then in effect. As of December 31, 2002, the Company had borrowed $7.5 million under the revolving credit facility.
As part of the initial public offering and debt offering on November 27, 2001, the Company repaid $100.0 million in principal amount of the senior term A and B notes.
On August 29, 2002, the Company amended its Credit Agreement to refinance its existing senior term A and B notes with an equal principal amount of senior term C notes, which bear a lower interest rate than the weighted average interest rate for the senior term A and senior term B notes;
On October 24, 2002, the Company borrowed $25.0 million in principal amount of additional senior term C notes under the Credit Agreement. The proceeds from this borrowing and cash on hand were used to voluntarily repay other debt obligations as discussed below.
Interest Rate. In general, borrowings under the Credit Agreement bear interest, at the Company’s option, on either:
•
the base rate (as defined below) plus a margin, as defined in the Credit Agreement based on the Company’s leverage ratio, ranging from 1.00% to 2.25% per annum for the senior term A notes and the revolving credit facility, a margin of 2.75% per annum for the senior term B notes and a margin of 2.00% per annum for the senior term C notes; or
•
the adjusted eurodollar rate (as defined below) plus a margin, as defined in the Credit Agreement based on the Company’s leverage ratio, ranging from 2.00% to 3.25% per annum for the senior term A notes and the revolving credit facility, a margin of 3.75% per annum for the senior term B notes and a margin of 3.00% per annum for the senior term C notes.
The base rate is the higher of Wells Fargo’s prime rate or the Federal funds rate plus 0.5%. The adjusted eurodollar rate is defined as the rate per annum obtained by dividing (1) the rate of interest offered to Wells Fargo on the London interbank market by (2) a percentage equal to 100% minus the stated maximum rate of all reserve requirements applicable to any member bank of the Federal Reserve System in respect of “eurocurrency liabilities.”
Swing line borrowings bear interest at the base rate, plus a margin ranging from 1.00% to 2.25%, as defined in the Credit Agreement.
Maturity and Principal Payments. The revolving credit facility matures on September 20, 2006. The senior term C notes mature on September 30, 2008. Principal payments on the revolving credit facility are made at the Company’s discretion with the entire unpaid amount due at maturity. The remaining principal payments on the senior term C notes are paid quarterly with the annual aggregate scheduled maturities as follows (in thousands):
Starting December 31, 2002, as defined in the Credit Agreement, mandatory prepayments are due on the senior term C notes if the Company’s cash and cash equivalents exceed a defined amount. These payments are applied on a pro rata basis to the remaining scheduled principal payments. At December 31, 2002, the Company’s cash and cash equivalent did not exceed the defined amount. All outstanding indebtedness under the Credit Agreement may be voluntarily prepaid in whole or in part without premium or penalty.
Guarantees and Security. VCA and each of its wholly-owned subsidiaries guarantee the outstanding debt under the Credit Agreement. These borrowings, along with the guarantees of the subsidiaries, are further secured by substantially all of the Company’s consolidated assets. In addition, these borrowings are secured by a pledge of substantially all of the capital stock, or similar equity interests, of the Company’s wholly-owned subsidiaries.
Debt Covenants. The Credit Agreement contains certain financial covenants pertaining to interest coverage, fixed charge coverage and leverage ratios. In addition, the Credit Agreement has restrictions pertaining to capital expenditures, acquisitions and the payment of dividends on all classes of stock. Management of the Company believes the most restrictive covenant is the fixed charge coverage ratio. At December 31, 2002, the Company had a fixed charge coverage ratio of 1.38 to 1.00. The Credit Agreement requires a fixed charge coverage ratio of no less than 1.10 to 1.00.
13.5% Senior Subordinated Notes
As part of the Recapitalization, Vicar issued $20.0 million in principal amount of 13.5% senior subordinated notes due 2010 pursuant to an indenture dated September 20, 2000 with Chase Manhattan Bank and Trust Company, N.A., as trustee.
As part of the initial public offering and debt offering on November 27, 2001, the Company repaid $5.0 million in principal amount of the 13.5% senior subordinated notes at a redemption price of 110%.
On October 24, 2002, the Company borrowed $25.0 million in principal amount of additional senior term C notes under the Credit Agreement. Proceeds from this borrowing were used to voluntarily repay the remaining principal balance of $15.0 million of the 13.5% senior subordinated notes at a redemption price of 110%.
Interest Rate and Discounts. Interest on the 13.5% senior subordinated notes was payable in cash, semi-annually in arrears at the rate of 13.5% per annum; provided, however, that if the Company failed to meet specified
obligations to holders of the 13.5% senior subordinated notes, as set forth in an exchange and registration rights agreement dated as of September 20, 2000, interest on the 13.5% senior subordinated notes may have increased by up to 1% per annum.
The 13.5% senior subordinated notes had an effective interest rate of 16.2% for the years ended December 31, 2002 and 2001.
Guarantee. The 13.5% senior subordinated notes were general, unsecured and subordinated obligations, and were guaranteed by the Company’s wholly-owned subsidiaries.
9.875% Senior Subordinated Notes
Concurrent with the consummation of the initial public offering, Vicar issued $170.0 million in principal amount of 9.875% senior subordinated notes due 2009 with Chase Manhattan Bank and Trust Company, N.A., as trustee. On June 13, 2002, the notes were exchanged for substantially similar securities that are registered under the Securities Act.
Interest Rate. Interest is payable semi-annually in arrears on June 1 and December 1, commencing on June 1, 2002. Interest is computed on the basis of a 360-day year comprised of twelve 30-day months at the rate of 9.875% per annum.
Guarantee. The 9.875% senior subordinated notes are general, unsecured obligations of the Company. They are subordinated in right of payment to all existing and future debt incurred under the Credit Agreement and are equal in right of payment to Vicar’s other senior subordinated notes. They are unconditionally guaranteed on a senior subordinated basis by VCA, Vicar and its wholly-owned subsidiaries.
Maturity. The 9.875% senior subordinated notes are due on December 1, 2009.
15.5% Senior Notes
As part of the Recapitalization, VCA issued $100.0 million in principal amount of 15.5% senior notes due 2010 pursuant to an indenture dated September 20, 2000 with Chase Manhattan Bank and Trust Company, N.A., as trustee.
As part of the initial public offering and debt offering on November 27, 2001, the Company repaid $59.1 million in principal amount of the 15.5% senior notes at a redemption price of 110%.
On October 24, 2002, the Company borrowed $25.0 million in principal amount of additional senior term C notes under the Credit Agreement. Proceeds from this borrowing and cash on hand were used to voluntarily repay $30.0 million in principal amount of the 15.5% senior notes at a redemption price of 110%.
Interest Rate and Discounts. Interest on the 15.5% senior notes is payable semi-annually in arrears, at the rate of 15.5% per annum; provided that on any semi-annual interest payment date prior to September 20, 2005, the Company has the option to pay all or any portion of the interest payable on said date by issuing additional 15.5% senior notes in a principal amount equal to the interest; and further provided, however, that if the Company fails to meet specified obligations to holders of the 15.5% senior notes as set forth in a registration rights agreement dated as of September 20, 2000, interest on the 15.5% senior notes may increase by up to 1% per annum. The Company has issued an aggregate of $25.9 million in principal amount of additional 15.5% senior notes to pay interest since the issue date.
The notes had an effective interest rate of 17.5% and 16.8% and were reported net of a discount of $3.0 million and $5.4 million for and as of the years ended December 31, 2002 and 2001, respectively.
Guarantee. The 15.5% senior notes are general, unsecured and unsubordinated obligations that are not guaranteed by Vicar and its wholly-owned subsidiaries, nor is Vicar and its wholly-owned subsidiaries an obligor of these notes.
Maturity and Principal Payments. As discussed above, the Company is issuing additional notes to pay interest. The first principal payment on the aggregate balance is a balloon payment due September 20, 2005 of approximately $18.8 million and the remaining principal is due September 20, 2010.
Fair Value of the Company’s Debt
The following disclosure of the estimated fair value of the Company’s debt is made in accordance with the requirements of Statements of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments. The Company used available market information and appropriate valuation methodologies to determine the estimated fair value amounts. Considerable judgment is required to develop the estimates of fair value, and the estimates provided herein are not necessarily indicative of the amounts that could be realized in a current market exchange. The following table is as of December 31, 2002 and 2001 (in thousands):
The estimated fair value of the Company’s fixed-rate long-term debt is based on market value or LIBOR plus an estimated spread at December 31, 2002 and December 31, 2001 for similar securities with similar remaining maturities. The carrying value of variable-rate long-term debt is a reasonable estimate of its fair value.
8.
Redeemable Preferred Stocks
In 2000, the Company adopted an Amended and Restated Certificate of Incorporation, which authorized the issuance of up to 6,000,000 shares of preferred stock. In connection with the Recapitalization, the Company issued 2,998,408 shares of Series A Senior Redeemable Exchangeable Cumulative Preferred Stock (“Series A Preferred Stock”), par value $0.01 per share, and 2,970,822 shares of Series B Junior Redeemable Cumulative Preferred Stock (“Series B Preferred Stock”), par value $0.01 per share. In exchange for the issuance of the Series A Preferred Stock and Series B Preferred Stock, the Company received $75.0 million and $74.2 million, respectively. The Series A and Series B Preferred Stock earned dividends at the rate of 14% and 12% per annum of the liquidation preference, respectively. The liquidation preference and redemption value for both the Series A and Series B Preferred Stock was the sum of $25.00 per share plus accrued and unpaid dividends less any special dividend paid. Holders of Series A and Series B Preferred Stock were entitled to receive dividends, whether or not declared by the Board of Directors, out of funds legally available. Dividends were payable in cash on a quarterly basis. If dividends were not paid when due, the amount payable was added to the liquidation preference and redemption value. For the years ended December 31, 2001 and 2000, dividends earned but not paid were $19.2 million and $5.4 million, respectively. These dividends were recorded as an increase to preferred stock and a corresponding decrease to retained earnings.
As part of the initial public offering and debt offering on November 27, 2001, the Company redeemed all its outstanding Series A and Series B Preferred Stock.
The Company was publicly traded from 1991 until September 20, 2000, when the Company completed the Recapitalization. During 2000 and prior to the Recapitalization, the Company repurchased 7,715,000 shares of its common stock for $3.3 million. These shares, along with all other treasury shares held prior to 2000, were retired. As part of the Recapitalization, the Company paid $314.5 million to purchase 99% of its outstanding shares of common stock for $1.00 per share. The shares of common stock repurchased were immediately retired. Immediately following the Recapitalization, the following shares of common stock were outstanding:
Concurrent with the Recapitalization, the Company adopted an Amended and Restated Certificate of Incorporation, which authorized the issuance of up to 24,000,000 shares of common stock with a par value of $0.01 per share. Subsequent to the Recapitalization in 2000, the Company’s Board of Directors declared a fifteen-for-one stock split. The stock split has been retroactively reflected in the accompanying financial statements and footnotes.
Also in connection with the Recapitalization, the Company issued warrants to certain investors to purchase 1,149,990 shares of the Company’s common stock. The warrants allowed the holders to purchase the Company’s common stock at a price equal to $0.0007 per share. The Company valued these warrants at their fair market value on the date of issuance at $1.1 million, which was recorded as part of stockholders’ equity. In November 2001, the investors exercised their warrants to purchase 1,149,871 shares of the Company’s common stock. In lieu of paying cash to exercise the warrants, the investors opted to cancel 119 of the previously outstanding 1,149,990 warrants.
In August 2001, certain employees exercised 691,875 options to purchase shares of the Company’s common stock granted in connection with the Recapitalization.
As part of the initial public offering on November 27, 2001, the Company sold 16,000,000 shares of its common stock at $10.00 per share, which generated net proceeds of approximately $148.7 million. In addition, during December 2001, the Company’s underwriters exercised their over-allotment option to purchase an additional 1,370,000 shares of the Company’s common stock at $10.00 per share, which generated net proceeds of approximately $12.8 million. Concurrent with the initial public offering, the Company adopted an Amended and Restated Certificate of Incorporation, which authorized the issuance of up to 75,000,000 shares of common stock with a par value of $0.001 per share.
During 2002, certain employees exercised 29,658 options to purchase shares of the Company’s common stock.
The Company has not paid cash dividends on the common stock and does not anticipate paying cash dividends in the foreseeable future. In addition, the senior credit facility and the indenture governing the outstanding senior subordinated notes place limitations on the ability to pay dividends or make other distributions in respect of the common stock. Any future determination as to the payment of dividends will depend on our results of operations, financial condition, capital requirements and other factors deemed relevant by the Board of Directors, including the General Corporation Law of the State of Delaware, which provides that dividends are only payable out of surplus or current net profits.
The Company has granted stock options to various employees. The Company accounts for these plans under APB Opinion No. 25.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, an Amendment of FASB Statement No. 123. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation, as prescribed under SFAS No. 123. Under the fair value based method of accounting, compensation expense is recognized annually equal to the fair value of the options granted divided by their vesting period. In addition, SFAS No. 148 requires prominent disclosure in the footnotes to both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method on reported results. The Company adopted the disclosure requirements of SFAS No. 148 on December 31, 2002.
The 1996 Stock Incentive Plan (the “1996 Plan”) was amended August 6, 2001. Under the amended plan, no additional incentive or nonqualified stock options may be granted to directors, officers, key employees or consultants. In 2000, the Company issued 633,795 stock options under the 1996 Plan. These options vest ratably over four years from the date of grant with an exercise price of $1.00 and expire in 2010.
In August 2001, the Company’s Board of Directors approved the 2001 Stock Incentive Plan (the “2001 Plan”) that provides for the granting of incentive or nonqualified stock options to directors, officers, key employees or consultants of the Company. The number of shares reserved and authorized for issuance under the 2001 Plan is 2,000,000 shares. During the year ended December 31, 2002, the Company issued the following stock options under the 2001 Plan:
Had compensation costs for these plans been determined consistent with SFAS No. 148, the Company’s net income (loss) and earnings (loss) per share would have been reduced to the following pro forma amounts (in thousands, except per share amounts):
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model for the year ended December 31, 2002 and the minimum value option pricing model for the years ended December 31, 2001 and 2000 with the following weighted-average assumptions:
In connection with the Recapitalization, certain of the Company’s employees elected to exchange their stock options for newly issued stock options. The number of stock options issued to each employee was equal to the intrinsic value of their old stock options divided by the strike price of the new stock options ($0.20). These stock options were accounted for as variable awards, and related non-cash compensation of $555,000 was recorded in 2000. An additional charge for non-cash compensation of $7,611,000 was recorded in 2001, as a result of the increase in the estimated market value of the common stock. In August 2001, 691,875 of the new options were exercised and 1,995 were cancelled, leaving none outstanding as of December 31, 2001.
The table below summarizes the transactions in the Company’s stock option plans (in thousands, except per share amounts):
The following table summarizes information about the options outstanding as of December 31, 2002 in accordance with SFAS No. 148 (in thousands, except per share amounts):
The Company operates many of its animal hospitals from premises that are leased from the hospitals’ previous owners under operating leases with terms, including renewal options, ranging from one to 35 years. Certain leases include purchase options which can be exercised at the Company’s discretion at various times within the lease terms.
The annual lease payments under the lease agreements have provisions for annual increases based on the Consumer Price Index or other amounts specified within the lease contracts.
The future minimum lease payments on operating leases at December 31, 2002, including renewal option periods, are as follows (in thousands):
Rent expense totaled $14.2 million, $12.6 million, and $11.7 million for the years ended December 31, 2002, 2001 and 2000, respectively. Rental income totaled $392,000, $176,000, and $259,000 for the years ended December 31, 2002, 2001 and 2000, respectively.
b. Earn-out Payments
In connection with certain acquisitions, the Company assumed certain contractual arrangements whereby additional cash may be paid to former owners of acquired hospitals upon attainment of specified financial criteria over periods of one to three years, as set forth in the respective agreements. The amount to be paid cannot be determined until the earn-out periods expire and the attainment of criteria is established. If the specified financial criteria are attained in the next twelve months, the Company will be obligated to make cash payments of approximately $290,000.
In connection with certain acquisitions, the Company withheld a portion of the purchase price (the “holdback”). The holdback is used to offset any costs the Company may pay on behalf of the former owner for any liabilities the Company did not assume at the time of acquisition. The amounts held accrue interest not to exceed 7% per annum and are payable within a twelve-month period. The total outstanding holdbacks at December 31, 2002 were approximately $1.5 million.
d. Officers’ Compensation
Each of the Company’s Chief Executive Officer, Chief Operating Officer, Chief Financial Officer and Senior Vice President of Development has entered into employment agreements with the Company. The aggregate annual salaries provided for under these employment agreements is $1.4 million and allow for upward adjustments to each annual salary based on the Consumer Price Index for Los Angeles County. The agreements also call for a maximum of $1.2 million to be paid as annual bonuses based on annual performance goals to be set by the compensation committee of the Board of Directors.
As of any given date, unless any of those agreements are sooner terminated pursuant to their respective provisions, the Chief Executive Officer has five years remaining under the term of his employment agreement, the Chief Operating Officer has three years remaining under the term of his employment agreement, and the Chief Financial Officer has two years remaining under the term of his employment agreement. The Senior Vice President’s current employment agreement expires in September 2003. In addition, these employment agreements provide for certain payments in the event an officer’s employment with the Company is terminated.
In the event any of these officers’ employment is terminated due to death or disability, each officer is entitled to receive the remaining base salary during the remaining scheduled term of his employment agreement, the acceleration of the vesting of his options, which options shall remain exercisable for the full term, and the right to continue receiving specified benefits and perquisites.
In the event any of these officers terminate their employment agreements for cause, we terminate any of their employment agreements without cause or a change of control occurs (in which case such employment agreements terminate automatically), each officer is entitled to receive the remaining base salary during the remaining scheduled term of his employment agreement, an amount based on past bonuses, the acceleration of the vesting of his options, which options shall remain exercisable for the full term, and the right to continue receiving specified benefits and perquisites.
In the event of a change of control, in which case all of these employment agreements would terminate simultaneously, the maximum amount of collective cash payments to these officers, which does not include gains from options or continued benefits or perquisites, would be approximately $8.9 million. In addition, if any of the amounts payable to these officers under these provisions constitute “excess parachute payments” under the Internal Revenue Code, each officer is entitled to an additional payment to cover the tax consequences associated with excess parachute payments.
The laws of many states prohibit business corporations from providing, or holding themselves out as providers of, veterinary medical care. These laws vary from state to state and are enforced by the courts and by regulatory authorities with broad discretion. The Company operates 60 animal hospitals in 11 states with these laws. The Company may experience difficulty in expanding operations into other states with similar laws. Given varying and uncertain interpretations of the veterinary laws of each state, the Company may not be in compliance with restrictions on the corporate practice of veterinary medicine in all states. A determination that the Company is in violation of applicable restrictions on the practice of veterinary medicine in any state in which it operates could have a material adverse effect, particularly if the Company were unable to restructure its operations to comply with the requirements of that state.
The Ohio Attorney General’s office filed a lawsuit on December 14, 1998, in the Franklin County Court of Common Pleas in the State of Ohio in which the state alleged that our management of a veterinary medical group licensed to practice veterinary medicine in that state violates the Ohio statute prohibiting business corporations from providing, or holding themselves out as providers of, veterinary medical care. On March 20, 2001, the trial court in the case entered summary judgment in favor of the State of Ohio and issued an order enjoining us from operating in the State of Ohio in a manner that is in violation of the state statute. Since that time, we have been engaged in discussions with the Attorney General’s office to restructure our operations. We have reached an agreement with the Attorney General’s office that our management services agreement, as amended, does not constitute the practice of veterinary medicine by a corporation. We have filed our agreement with the court, which completes our settlement with the State of Ohio.
All of the states in which the Company operates impose various registration requirements. To fulfill these requirements, each facility has been registered with appropriate governmental agencies and, where required, has appointed a licensed veterinarian to act on behalf of each facility. All veterinary doctors practicing in the Company’s clinics are required to maintain valid state licenses to practice.
f.
Other Contingencies
The Company has certain contingent liabilities resulting from litigation and claims incident to the ordinary course of its business. Management believes that the probable resolution of such contingencies will not affect the Company’s financial position or results of operations.
A reconciliation of the income (loss) and shares used in the computations of the basic and diluted earnings (loss) per share (“EPS”) for the years ended December 31, 2002, 2001 and 2000 follows (in thousands, except per share amounts):
As part of the Recapitalization on September 20, 2000, the Company paid $1.00 per share, for a total payment of $314.5 million, to repurchase 310,836,000 shares of its outstanding common stock, of which approximately $3.7 million was attributable to costs incurred in connection with the repurchase of the Company’s common stock. These per share and share amounts have been adjusted to reflect a 15-for-1 stock split which took place after the Recapitalization. Immediately after this repurchase, the Company issued 517,995 and 14,350,005 shares of common stock to its management and certain investors, respectively, for $1.00 per share.
As of December 31, 2001, 633,795 stock options with an exercise price of $1.00 were outstanding and at December 31, 2000, 1,327,670 stock options and warrants to purchase an aggregate 1,149,990 common shares were outstanding. These stock options and warrants were not included in the computation of diluted loss per share because conversion would have an antidilutive effect on diluted loss per share for these periods.
The provision (benefit) for income taxes is comprised of the following for the three years ended December 31, (in thousands):
The consolidated statements of operations for the years ended December 31, 2002, 2001 and 2000 include a provision for income taxes of $21.9 million, $445,000 and $2.2 million and a benefit for income taxes associated with the early extinguishment of debt of $5.3 million, $7.1 million and $1.8 million, respectively. The net provision (benefit) of approximately $16.6 million, $(6.6) million and $354,000, respectively, is reflected in the table above.
The Company accounts for income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes. SFAS No. 109 requires recognition of deferred tax liabilities and assets for the expected future consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates for the year in which the differences are expected to reverse.
The net deferred tax asset (liability) at December 31, is comprised of (in thousands):
Under the Tax Reform Act of 1986, the utilization of Federal net operating loss (“NOL”) carryforwards to reduce taxable income will be restricted under certain circumstances. Events that cause such a limitation include, but are not limited to, a cumulative ownership change of more than 50% over a three-year period. Management
believes that past mergers caused such a change of ownership and, accordingly, utilization of the NOL carryforwards may be limited in future years. Accordingly, the valuation allowance is principally related to subsidiaries’ NOL carryforwards as well as certain investment related expenditures where the realization of this deduction is uncertain at this time. Also, based on the weight of available evidence and pursuant to SFAS No. 109, we reduced and reclassified the valuation allowance by $2.0 million to other long-term liabilities. This amount accounts for the differences between the probable tax bases and as filed tax bases of assets and liabilities.
At December 31, 2002, the Company had NOL carryforwards of approximately $9.7 million, comprised mainly of NOL carryforwards acquired in the past. We expect to utilize all of these loss carryforwards. These NOLs expire at various dates through 2015.
A reconciliation of the provision (benefit) for income taxes to the amount computed at the Federal statutory rate for the three years ended December 31, is as follows:
During 1992, the Company established a voluntary retirement plan under Section 401(k) of the Internal Revenue Code. The plan covers all employees with at least six months of employment with the Company and provides the annual matching contributions by the Company at the discretion of the Company’s Board of Directors. In 2002, 2001 and 2000, the Company provided a total matching contribution approximating $746,000, $1.1 million, and $715,000, respectively.
During the three years ended December 31, 2002, the Company had three reportable segments: Laboratory, Animal Hospital and Corporate. These segments are strategic business units that have different products, services and functions. The segments are managed separately because each is a distinct and different business venture with unique challenges, rewards and risks. The Animal Hospital segment provides veterinary services for companion animals and sells related retail products. The Laboratory segment provides testing services for veterinarians both associated with the Company and independent of the Company. Corporate provides selling, general and administrative support for the other segments and recognizes revenue associated with consulting agreements.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance of segments based on profit or loss before income taxes, interest income, interest expense and minority interest, which are evaluated on a consolidated level. For purposes of reviewing the operating performance of the segments, all intercompany sales and purchases are accounted for as if they were transactions with independent third parties at current market prices.
The following is a summary of certain financial data for each of the three segments (in thousands):
Corporate operating loss includes salaries and other administrative expenses related to the executive, finance, accounting, human resources, marketing, purchasing, information technology and regional operational management functions that support the Laboratory and Animal Hospital segments.
The following is a reconciliation between total segment operating income after eliminations and consolidated income (loss) before provision for income taxes and extraordinary items as reported on the consolidated statements of operations (in thousands):
16. Condensed Consolidating Information
In connection with Vicar’s issuance in November 2001 of $170.0 million in principal amount of 9.875% senior subordinated notes, VCA and each existing and future domestic wholly-owned restricted subsidiary of Vicar (the “Guarantor”) have, jointly and severally, fully and unconditionally guaranteed the 9.875% senior subordinated notes. These guarantees are unsecured and subordinated in right of payment to all existing and future indebtedness outstanding under the Credit Agreement and any other indebtedness permitted to be incurred by Vicar under the terms of the indenture agreement for the 9.875% senior subordinated notes.
Vicar’s subsidiaries are composed of wholly-owned restricted subsidiaries and partnerships. The partnerships may elect to serve as guarantors of Vicar’s obligations, however, none of the partnerships have elected
to do so. Vicar conducts all of its business through and derives virtually all of its income from its subsidiaries. Therefore, Vicar’s ability to make required payments with respect to its indebtedness (including the 9.875% senior subordinated notes) and other obligations depends on the financial results and condition of its subsidiaries and its ability to receive funds from its subsidiaries.
Pursuant to Rule 3-10 of Regulation S-X, the following condensed consolidating information is for VCA, Vicar, the wholly-owned Guarantors and the non-Guarantor subsidiaries with respect to the 9.875% senior subordinated notes. This condensed financial information has been prepared from the books and records maintained by VCA, Vicar, the Guarantors and the non-Guarantor subsidiaries. The condensed financial information may not necessarily be indicative of results of operations or financial position had the Guarantors and non-Guarantor subsidiaries operated as independent entities. The separate financial statements of the Guarantors are not presented because management has determined they would not be material to investors.
VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
CONDENSED CONSOLIDATING BALANCE SHEETS
As of December 31, 2002
(In thousands)
VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
CONDENSED CONSOLIDATING BALANCE SHEETS
As of December 31, 2001
(In thousands)
VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
For the Year Ended December 31, 2002
(In thousands)
VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
For the Year Ended December 31, 2001
(In thousands)
VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
For the Year Ended December 31, 2000
(In thousands)
VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the Year Ended December 31, 2002
(In thousands)
VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the Year Ended December 31, 2001
(In thousands)
VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
For the Year Ended December 31, 2000
(In thousands)
17. Subsequent Events
Acquisitions
From January 1, 2003 through March 24, 2003, the Company has acquired five animal hospitals and one veterinary diagnostic laboratory for an aggregate consideration (including acquisition costs) of $5.8 million for the animal hospitals, consisting of $5.3 million in cash and the assumption of liabilities of $512,000, and $298,000 for the laboratory, consisting of $288,000 in cash and the assumption of liabilities of $10,000.
Secondary Offering
In February 2003, the Company completed a secondary offering of 10.1 million shares of its common stock and the underwriters exercised their over-allotment option to purchase an additional 1.5 million shares. In connection with these transactions, the Company sold 3.8 million shares of common stock. As a result of this offering, the Company received net proceeds of approximately $54.3 million. Approximately $42.7 million of the net proceeds received were used to redeem the entire principal amount of its 15.5% senior notes due 2010 at a redemption price of 110% of the principal amount, plus accrued and unpaid interest. The use of the remaining $11.6 million of net proceeds received has not been determined. As a result of repaying these notes, the Company will recognize early debt redemption costs of approximately $7.4 million during the first quarter of 2003.
Litigation Settlement
On November 30, 2001, two majority stockholders of a company that merged with Zoasis in June 2000 filed a civil complaint against VCA, Zoasis and Robert Antin. Robert Antin, VCA's Chief Executive Officer, President and Chairman of the Board, is the majority stockholder of Zoasis and serves on its Board of Directors. The complaint alleges securities fraud under California law, common law fraud, negligent misrepresentation and declaratory judgment arising from the plaintiff's investment in Zoasis. Zoasis filed a counter claim alleging breach of contract and claim and delivery. On March 25, 2003, the parties finally settled all claims in the litigation and executed a Settlement Agreement, Mutual Release and Covenant Not to Sue. Under the settlement, the parties will dismiss their claims in the litigation with prejudice and VCA shall pay to plaintiffs $2,000,000. Concurrently with the settlement, plaintiffs will surrender all of their Zoasis common stock.
VCA ANTECH, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
For the Year Ended December 31, 2002, 2001 and 2000
(In thousands)
(1)
“Other” changes in the allowance for uncollectible accounts include allowances acquired with animal hospitals and laboratory acquisitions.
(2)
Balance includes allowance for trade accounts receivable and notes receivable.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors and executive officers of the Company will appear in the proxy statement for the 2003 annual meeting of stockholders and is incorporated herein by this reference. The proxy statement will be filed with the SEC within 120 days following December 31, 2002.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information regarding executive compensation will appear in the proxy statement for the 2003 annual meeting of stockholders and is incorporated herein by this reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership of certain beneficial owners and management will appear in the proxy statement for the 2003 annual meeting of stockholders and is incorporated herein by this reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions will appear in the proxy statement for the 2003 annual meeting of stockholders and is incorporated herein by this reference.
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
Information regarding principal accountant fees and services will appear in the proxy statement for the 2003 annual meeting of stockholders and is incorporated herein by this reference.
ITEM 15.
ITEM 15. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information regarding principal accountant fees and services will appear in the proxy statement for the 2003 annual meeting of stockholders and is incorporated herein by this reference.
PART IV
ITEM 16.
EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
List of Exhibits
Number Exhibit Description
3.1
Amended and Restated Certificate of Incorporation of Registrant. Incorporated by reference to Exhibit 3.1 to the Registrant’s annual report on Form 10-K filed March 29, 2002.
3.2
Amended and Restated Bylaws of Registrant. Incorporated by reference to Exhibit 3.2 to the Registrant’s annual report on Form 10-K filed March 29, 2002.
4.1
Stockholders Agreement, dated as of September 20, 2000, by and among Registrant, Green Equity Investors III, L.P., Co-Investment Funds and Stockholders. Incorporated by reference to Exhibit 4.1 to the Registrant’s registration statement on Form S-1 filed August 9, 2001.
4.2
Amendment No. 1 to Stockholders Agreement, dated as of November 27, 2001, by and among Registrant, Green Equity Investors III, L.P., GS Mezzanine Partners II, L.P. and Robert Antin. Incorporated by reference to Exhibit 4.2 to Amendment No. 2 to the registrant’s registration statement on form S-1 field October 31, 2001.
4.3
Amendment No. 2 to Stockholders Agreement, dated as of November 27, 2001, by and among Registrant, Green Equity Investors III, L.P., GS Mezzanine Partners II, L.P., Robert L. Antin, Arthur J. Antin and Tomas W. Fuller. Incorporated by reference to Exhibit 4.3 to Amendment No. 1 to the Registrant’s registration statement on Form S-3 filed January 17, 2003.
4.4
Indenture, dated as of November 27, 2001, by and between Vicar Operating, Inc., the Guarantors (as defined therein), and Chase Manhattan Bank and Trust Company, National Association. Incorporated by reference to Exhibit 4.1 to the Registrant’s registration statement on Form S-4 filed February 1, 2002.
4.5
Credit and Guaranty Agreement, dated as of September 20, 2000, by and among Registrant, Vicar Operating, Inc., certain subsidiaries of Registrant as Guarantors, Goldman Sachs Credit Partners L.P., and Wells Fargo Bank, National Association as Administrative and Collateral Agent. Incorporated by reference to Exhibit 4.5 to the Registrant’s registration statement on Form S-1 filed August 9, 2001.
4.6
First Amendment to Credit and Guaranty Agreement, dated as of October 23, 2000, by and among Registrant, Vicar Operating, Inc., certain subsidiaries of Registrant as Guarantors, Goldman Sachs Credit Partners L.P., and Wells Fargo Bank, National Association as Administrative and Collateral Agent. Incorporated by reference to Exhibit 4.10 to the Registrant’s annual report on Form 10-K filed March 29, 2002.
4.7
Second Amendment to Credit and Guaranty Agreement, dated as of November 16, 2001, by and among Registrant, Vicar Operating, Inc., certain subsidiaries of Registrant as Guarantors, Goldman Sachs Credit Partners L.P., and Wells Fargo Bank, National Association as Administrative and Collateral Agent. Incorporated by reference to Exhibit 4.11 to the Registrant’s annual report on Form 10-K filed March 29, 2002.
4.8
Third Amendment to Credit and Guaranty Agreement, dated as of March 20, 2002, by and among Registrant, Vicar Operating, Inc., certain subsidiaries of Registrant as Guarantors, Goldman Sachs Credit Partners L.P., and Wells Fargo Bank, National Association as Administrative and Collateral Agent. Incorporated by reference to Exhibit 4.12 to the Registrant’s registration statement on Form S-3 filed January 10, 2003.
4.9
Fourth Amendment to Credit and Guaranty Agreement, dated as of August 29, 2002, by and among Registrant, Vicar Operating, Inc., certain subsidiaries of Registrant as Guarantors, Goldman Sachs Credit Partners L.P., and Wells Fargo Bank, National Association as Administrative and Collateral Agent. Incorporated by reference to Exhibit 99.2 to the Registrant’s current report on Form 8-K filed September 3, 2002.
4.10
Fifth Amendment to Credit and Guaranty Agreement, dated as of October 24, 2002, by and among Registrant, Vicar Operating, Inc., certain subsidiaries of Registrant as Guarantors, Goldman Sachs Credit Partners L.P., and Wells Fargo Bank, National Association as Administrative and Collateral Agent. Incorporated by reference to Exhibit 10.1 to the Registrant’s current report on Form 8-K filed October 25, 2002.
4.11
Sixth Amendment to Credit and Guaranty Agreement, dated as of December 20, 2002, by and among Registrant, Vicar Operating, Inc., certain subsidiaries of Registrant as Guarantors, Goldman Sachs Credit Partners L.P., and Wells Fargo Bank, National Association as Administrative and Collateral Agent. Incorporated by reference to Exhibit 4.15 to the Registrant’s registration statement on Form S-3 filed January 10, 2003.
4.12
Seventh Amendment to Credit and Guaranty Agreement, dated as of January 29, 2003, by and among Registrant, Vicar Operating, Inc., certain subsidiaries of Registrant as Guarantors, Goldman Sachs Credit Partners L.P., and Wells Fargo Bank, National Association as Administrative and Collateral Agent. Incorporated by reference to Exhibit 4.17 to the Registrant’s registration statement on Form S-3 filed January 17, 2003.
4.13
Specimen Certificate for shares of common stock of Registrant. Incorporated by reference to Exhibit 4.9 to Amendment No. 3 to the Registrant’s registration statement on Form S-1 filed November 16, 2001.
10.1
Employment Agreement, dated as of November 27, 2001, by and between VCA Antech, Inc. and Robert Antin. Incorporated by reference to Exhibit 10.5 to the Registrant’s registration statement on Form S-4 filed February 1, 2002.
10.2
Employment Agreement, dated as of November 27, 2001, by and between VCA Antech, Inc. and Arthur J. Antin. Incorporated by reference to Exhibit 10.6 to the Registrant’s registration statement on Form S-4 filed February 1, 2002.
10.3
Employment Agreement, dated as of November 27, 2001, by and between VCA Antech, Inc. and Tomas W. Fuller. Incorporated by reference to Exhibit 10.7 to the Registrant’s registration statement on Form S-4 filed February 1, 2002.
10.4
Employment Agreement, dated as of November 27, 2001, by and between VCA Antech, Inc. and Neil Tauber. Incorporated by reference to Exhibit 10.4 to Amendment No. 2 to the Registrant’s registration statement on Form S-1 filed October 31, 2001.
10.5
Letter Agreement, dated as of March 3, 2003, by and between VCA Antech, Inc. and Neil Tauber.
10.6
Amendment No. 1 to Employment Agreement, dated March 25, 2003, by and between VCA Antech, Inc. and Neil Tauber.
10.7
Amended and Restated 1996 Stock Incentive Plan of VCA Antech, Inc. Incorporated by reference to Exhibit 10.9 to Amendment No. 2 to the Registrant’s registration statement on Form S-1 filed October 31, 2001.
10.8
2001 Stock Incentive Plan of VCA Antech, Inc. Incorporated by reference to Exhibit 10.10 to Amendment No. 2 to the Registrant’s registration statement on Form S-1 filed October 31, 2001.
10.9
Corporate Headquarters Lease, dated as of January 1, 1999, by and between VCA Antech, Inc. and Werner Wolfen, Michael Duritz, Nancy Bruch, Dorothy A. Duritz, Harvey Rosenberg and Judy Rosenberg (Landlords). Incorporated by reference to Exhibit 10.11 to Amendment No. 1 to the Registrant’s registration statement on Form S-1 filed October 15, 2001.
10.10
Form of Indemnification Agreement. Incorporated by reference to Exhibit 10.13 to the Registrant’s registration statement on Form S-1 filed August 9, 2001.
21.1
Subsidiaries of Registrant.
23.1
Consent of KPMG LLP.
24.1
Power of Attorney (included in signature page).
99.1
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2
Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Los Angeles, State of California, on today’s date, March 24, 2003.
By:
/s/
Tomas W. Fuller
Its:
Chief Financial Officer, Principal Accounting
Officer, Vice President and Assistant Secretary
KNOWN BY ALL MEN THESE PRESENTS, that each person whose signature appears below constitutes and appoints Robert L. Antin and Tomas W. Fuller, or any one of them, his attorney-in-fact and agents with full power of substitution and re-substitution, for him and his name, place and stead, in any and all capacities, to sign any or all amendments to this Form 10-K and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the foregoing, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or either of them, or their substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.
Certification of
Chief Executive Officer
of VCA Antech, Inc.
I, Robert L. Antin, certify that:
1.
I have reviewed this annual report on Form 10-K of VCA Antech, Inc.;
2.
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.
Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4.
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a.
Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b.
Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and
c.
Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
a.
All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b.
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6.
The registrant’s other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 24, 2003
By: /s/ Robert L. Antin
Robert L. Antin
Chief Executive Officer
Certification of
Chief Financial Officer
of VCA Antech, Inc.
I, Tomas W. Fuller, certify that:
1.
I have reviewed this annual report on Form 10K of VCA Antech, Inc.;
2.
Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.
Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4.
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a.
Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b.
Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
c.
Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
a.
All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b.
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6.
The registrant’s other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 24, 2003
By: /s/ Tomas W. Fuller
Tomas W. Fuller
Chief Financial Officer