0001011438-01-500230.txt : 20011019 0001011438-01-500230.hdr.sgml : 20011019 ACCESSION NUMBER: 0001011438-01-500230 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 3 FILED AS OF DATE: 20011015 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VETERINARY CENTERS OF AMERICA INC CENTRAL INDEX KEY: 0000817366 STANDARD INDUSTRIAL CLASSIFICATION: AGRICULTURE SERVICES [0700] IRS NUMBER: 954097995 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-67128 FILM NUMBER: 1759489 BUSINESS ADDRESS: STREET 1: 12401 WEST OLYMPIC BOULEVARD CITY: LOS ANGELES STATE: CA ZIP: 90064-1022 BUSINESS PHONE: 310-584-65 MAIL ADDRESS: STREET 1: 12401 WEST OLYMPIC BOULEVARD CITY: LOS ANGELES STATE: CA ZIP: 90064-1022 S-1/A 1 form_s-1a.txt VCA ANTECH - FORM S-1/A AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 15, 2001 REGISTRATION NO. 333-67128 =============================================================================== SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 AMENDMENT NO. 1 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 -------------------------- VCA ANTECH, INC. (Exact Name of Registrant as Specified in its Charter) DELAWARE 0742 95-4097995 (State or Other (Primary Standard Industrial (I.R.S. Employer Jurisdiction of Classification Code Number) Identification No.) Incorporation or Organization) 12401 West Olympic Boulevard Los Angeles, California 90064-1022 (310) 571-6500 (Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant's Principal Executive Offices) Robert L. Antin Chief Executive Officer and President 12401 West Olympic Boulevard Los Angeles, California 90064-1022 (310) 571-6500 --------------------------------- (Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service) COPIES TO: C.N. FRANKLIN REDDICK III, ESQ. GREGG A. NOEL, ESQ. JULIE M. KAUFER, ESQ. Skadden, Arps, Slate, JAMES TSAI, ESQ. Meagher & Flom LLP Akin, Gump, Strauss, Hauer & Feld, LLP 300 South Grand Avenue 2029 Century Park East Los Angeles, California 90071 Los Angeles, California 90067 (213) 687-5000 (310) 229-1000 ----------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: AS SOON AS PRACTICABLE AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT. ----------- If any of the securities being registered in this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [ ] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If the delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] ------------------------------------ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. =============================================================================== SUBJECT TO COMPLETION, DATED OCTOBER 15, 2001 [ ] Shares [Logo] VCA ANTECH, INC. Common Stock Prior to this offering, there has been no public market for our common stock. The initial public offering price of the common stock is expected to be between $ and $ per share. We will apply to have our common stock approved for quotation on The Nasdaq Stock Market's National Market under the symbol "____." The underwriters have an option to purchase a maximum of additional shares to cover over-allotments of shares. INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" ON PAGE .
UNDERWRITING PROCEEDS TO PRICE TO DISCOUNTS AND VCA ANTECH, PUBLIC COMMISSIONS INC. ------------ ------------- ----------- Per Share.................. $ $ $ Total ..................... $ $ $
Delivery of the shares of common stock will be made on or about , 2001. Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense. ------------------------ CREDIT SUISSE FIRST BOSTON GOLDMAN, SACHS & CO. ------------------------ BANC OF AMERICA SECURITIES LLC TUCKER ANTHONY SUTRO CAPITAL MARKETS WELLS FARGO VAN KASPER, LLC The date of this prospectus is , 2001. --------------------- The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. Page 2 DESCRIPTION OF ARTWORK: The gatefold includes the VCA logo and pictures of a VCA laboratory, a VCA animal hospital, VCA laboratory workers, and a veterinarian with a dog. The following text is contained on this gatefold: Antech Diagnostics: Largest network of veterinary diagnostic laboratories in the nation; Established infrastructure serving 15,000 animal hospitals in all 50 states; 85 veterinary specialist consultants; Capitalizing on growing demand for diagnostics in veterinary medicine. VCA animal hospitals: Largest network of free-standing animal hospitals in the nation; 214* hospitals in 33 states. * as of August 31, 2001. Page 3
TABLE OF CONTENTS PAGE PAGE ---- ---- Prospectus Summary........................... Management................................... Risk Factors................................. Principal Stockholders....................... Cautionary Note Regarding Forward- Related Party Transactions................... Looking Statements..................... Description of Capital Stock................. Use of Proceeds.............................. Description of Indebtedness.................. Dividend Policy.............................. Shares Eligible For Future Sale.............. Dilution..................................... Underwriting................................. Capitalization............................... Notice to Canadian Residents................. Selected Historical Consolidated Financial Data................................... Legal Matters................................ Management's Discussion and Analysis of Experts...................................... Financial Condition and Results of Operations............................. Where You Can Find More Information.......... Business..................................... Index to Consolidated Financial Statements...
---------------------------------- YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS DOCUMENT OR TO WHICH WE HAVE REFERRED YOU. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION THAT IS DIFFERENT. THIS DOCUMENT MAY ONLY BE USED WHERE IT IS LEGAL TO SELL THESE SECURITIES. THE INFORMATION IN THIS DOCUMENT MAY ONLY BE ACCURATE ON THE DATE OF THIS DOCUMENT. We use market data and industry forecasts and projections throughout this prospectus, which we have obtained from market research, publicly available information and industry publications. These sources generally state that the information they provide has been obtained from sources believed to be reliable, but that the accuracy and completeness of such information are not guaranteed. The forecasts and projections are based on industry surveys and the preparers' experience in the industry and there is no assurance that any of the projected amounts will be achieved. Similarly, we believe that the surveys and market research others have performed are reliable, but we have not independently verified this information. DEALER PROSPECTUS DELIVERY OBLIGATION UNTIL __________ (25 DAYS AFTER COMMENCEMENT OF THIS OFFERING), ALL DEALERS THAT EFFECT TRANSACTIONS IN THESE SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE DEALER'S OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS AN UNDERWRITER AND WITH RESPECT TO UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. Page i PROSPECTUS SUMMARY THIS SUMMARY HIGHLIGHTS SOME OF THE INFORMATION CONTAINED ELSEWHERE IN THIS PROSPECTUS. WE URGE YOU TO READ THIS ENTIRE PROSPECTUS CAREFULLY, INCLUDING THE "RISK FACTORS" SECTION. VCA ANTECH, INC. OUR BUSINESS 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 veterinary diagnostic laboratories provide sophisticated testing and consulting services used by veterinarians in the detection, diagnosis, evaluation, monitoring, treatment and prevention of diseases and other conditions affecting animals. Our animal hospitals offer a full range of general medical and surgical services for companion animals. We treat diseases and injuries, provide pharmaceutical products and offer a variety of pet wellness programs, including routine vaccinations, health examinations, diagnostic testing, spaying, neutering and dental care. DIAGNOSTIC LABORATORIES We operate the only full-service, veterinary diagnostic laboratory network serving all 50 states and have a client base over two times that of our largest competitor. Our 15 state-of-the-art, automated diagnostic laboratories service a diverse customer base of over 15,000 animal hospitals, and non-affiliated animal hospitals generated approximately 95% of our laboratory revenue in 2000. We support our laboratories with the industry's largest transportation network, which picks up an average of 20,000 to 25,000 samples daily. In the six months ended June 30, 2001, we derived approximately 65.2% of our laboratory revenue from our customers in major metropolitan areas, where we offer twice-a-day pick-up service and same-day results. Outside of these areas, we typically provide test results to veterinarians before 8:00 a.m. the following day. Our diagnostic spectrum includes over 300 different tests in the areas of chemistry, pathology, serology, endocrinology, hematology and microbiology, as well as tests specific to particular diseases. In 2000, we handled approximately 6.4 million requisitions and performed approximately 19.8 million tests. 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. From 1998 through the twelve months ended June 30, 2001, our laboratory revenue, laboratory operating income before depreciation and amortization, and laboratory operating income increased at compounded annual growth rates of 14.8%, 24.5% and 28.0%, respectively. We will refer to operating income before depreciation and amortization as "EBITDA." In the twelve months ended June 30, 2001, our laboratory EBITDA was $41.9 million, or 33.0% of our laboratory revenue, and our laboratory operating income was $37.3 million, or 29.4 % of our laboratory revenue. ANIMAL HOSPITALS At August 31, 2001, we operated 214 animal hospitals in 33 states that were supported by over 750 veterinarians. 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. Our facilities typically are located in high-traffic, densely populated areas and have an established reputation in the community with a stable customer base. Since 2000, our animal hospitals have been connected to an enterprise-wide management information system. This system provides us opportunities to manage our animal hospitals more effectively and to implement throughout our animal hospital network veterinarian practices and procedures which we have identified, tested and believe to provide a high level of customer care. From 1998 through the twelve months ended June 30, 2001, our animal hospital revenue, animal hospital EBITDA and our animal hospital operating income increased at compounded annual growth rates of 12.7%, 19.0% Page 2 and 18.6%, respectively. In the twelve months ended June 30, 2001, our animal hospital EBITDA was $49.4 million, or 19.1% of our animal hospital revenue, and our animal hospital operating income was $36.0 million, or 13.9% of our animal hospital revenue. OUR OPPORTUNITY We intend to continue to grow by capitalizing on the following market opportunities: o LARGE, GROWING MARKET. According to the 2001-2002 American Pet Products Manufacturers Association Pet Owners Survey, the ownership of pets is widespread, with over 62% of U.S. households owning at least one pet, including companion and other animals. The U.S. population of companion animals is approximately 188 million, including about 141 million dogs and cats. According to the U.S. Pet Ownership & Demographics Sourcebook published by the American Veterinary Medical Association, over $11 billion was spent on companion animal health care services in 1996, with an annual growth rate of over 9.5% from 1991 through 1996 for spending on dogs and cats. We believe this growth has continued, primarily driven by an increased emphasis on pet health and wellness, continued technological developments driving new and previously unconsidered diagnostic tests, procedures and treatments, and favorable demographic trends supporting a growing pet population. o RAPIDLY GROWING VETERINARY DIAGNOSTIC TESTING SERVICES. We believe that outsourced diagnostic testing is among the fastest growing segments of the animal health care services industry. Reflecting this trend, our laboratory internal revenue growth has averaged 13.1% over the last three fiscal years. The growth in outsourced diagnostic testing resulted from an overall increase in the number of tests requisitioned by veterinarians and from veterinarians' increased reliance on outsourced diagnostic testing rather than in-house testing. The overall increase in the number of tests performed is primarily due to the growing focus by veterinarians on wellness and monitoring programs, the emphasis in veterinary education on utilizing diagnostic tests for more accurate diagnoses and continued technological developments in veterinary medicine leading to new and improved tests. The increased utilization of outsourced testing is primarily due to the relative low cost and high accuracy rates provided by outside laboratories and the diagnostic consulting provided by experts employed by the leading outside laboratories. o ATTRACTIVE CUSTOMER PAYMENT DYNAMICS. The animal health care services industry does not experience the problems of extended payment collection cycles or pricing pressures from third-party payors 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 and typically paid for at the time of the service. For example, over 95% of our animal hospital services are paid for in cash or by credit card at the time of the service. In addition, over the past three fiscal years, our bad debt expense has averaged only 1% of total revenue. COMPETITIVE STRENGTHS We believe we are well positioned for profitable growth due to the following competitive strengths: o MARKET LEADER. We are the market leader in each of the business segments in which we operate. We believe that it would be difficult, time consuming and expensive for new entrants or existing competitors to assemble a comparable nationwide laboratory or animal hospital network. It would be particularly difficult to replicate our team of specialists, transportation network, management and systems infrastructure, the size of our veterinarian group and our customer relationships. o COMPELLING BUSINESS MODEL. Our business is characterized by a stable, recurring and diversified revenue base, high operating margins and strong cash flow. The growth in our laboratory revenue, combined with greater utilization of our infrastructure, enabled us to improve our laboratory EBITDA Page 3 margin from 26.9% in 1998 to 33.0% for the twelve months ended June 30, 2001, and our laboratory operating margin from 22.4% to 29.4% over the same period. Our animal hospitals have generated six consecutive years of positive annual same-facility revenue growth. Due to the operating leverage in our animal hospitals, the increase in animal hospital revenue enabled us to improve our animal hospital EBITDA margin from 16.7% in 1998 to 19.1% for the twelve months ended June 30, 2001, and our animal hospital operating margin from 12.2% to 13.9% over the same period. These high margins, combined with our modest working capital needs and low maintenance capital expenditures, provide cash that we can use for acquisitions or to reduce indebtedness. o LEADING TEAM OF SPECIALISTS. Our network of 85 veterinary medicine experts, which we refer to as specialists, provides us with a significant competitive advantage. Our specialists include veterinarians, chemists and other scientists with expertise in pathology, internal medicine, oncology, cardiology, dermatology, neurology and endocrinology. These specialists are available to consult with our laboratory customers, providing a compelling reason for them to use our laboratories rather than those of our competitors, most of whom offer no comparable service. Our team of specialists represents the largest interactive source for readily available diagnostic advice in the veterinary industry and interacts with animal health care professionals over 90,000 times a year. o HIGH QUALITY SERVICE PROVIDER. We believe we have built a reputation as a valuable diagnostic resource for veterinarians and a trusted animal health brand among pet owners. In our laboratories, we maintain rigorous quality assurance programs to ensure the accuracy of the reported results. We calibrate our laboratory equipment several times daily, use only qualified personnel to perform testing and our specialists review all test results outside the range of established norms. As a result, we believe our diagnostic accuracy rate is over 99%. In our animal hospitals, we provide continuing education programs, promote the sharing of professional knowledge and expertise and have developed and implemented a program of best practices to promote quality medical care. o SHARED EXPERTISE AMONG VETERINARIANS. We believe the continued accumulation of veterinary medical knowledge and experience among our veterinarian group enables us to offer new services more rapidly than our competitors, offer higher quality services and remain the leading source of veterinary information for interested companies such as pharmaceutical and pet food companies. 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 of our strategy include: o CAPITALIZING ON OUR LEADING MARKET POSITION TO GENERATE REVENUE GROWTH. Our leading market position in each of our business segments positions us to take advantage of favorable growth trends in the animal health care services industry. In our laboratories, we seek to generate revenue growth by capitalizing on the growing number of outsourced diagnostic tests and by increasing our market share. In our animal hospitals, we seek to generate revenue growth by capitalizing on the growing emphasis on pet health and wellness and favorable demographic trends supporting a growing pet population. For example, in 2000 we implemented a senior pet wellness program. The program seeks to promote recurring visits and to increase the average amount spent per visit by bundling laboratory tests and animal hospital services. o LEVERAGING ESTABLISHED INFRASTRUCTURE TO IMPROVE MARGINS. Due to our established networks and the fixed cost nature of our business model, we are able to realize higher 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. We estimate that in most cases, we realize a gross margin between 60% and 75% on these incremental tests. Page 4 o UTILIZING ENTERPRISE-WIDE SYSTEM TO IMPROVE OPERATING EFFICIENCIES. We recently completed the migration of all animal hospital operations to an enterprise-wide management information system. We believe that this common system will enable 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, increase volume and implement targeted marketing programs. o 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 candidates and the strategic fit with our existing operations, we intend to acquire approximately 15-25 animal hospitals per year primarily utilizing internally generated cash. BUSINESS RISKS Some of the key risks associated with our business strategy include: o CONTINUED GROWTH. Our success depends in part on our ability to build on our position as a leading animal health care services company through a balanced program of internal growth initiatives and selective acquisitions of established animal hospitals and laboratories. We may be unable to successfully execute our growth strategy and, as a result, our business may be harmed. o MANAGEMENT OF GROWTH. Our business and results of operations may be adversely affected if we are unable to manage our growth effectively, which may increase our costs of operations and hinder our ability to execute our business strategy. o SUBSTANTIAL DEBT. Our substantial amount of debt, including senior and secured debt, as well as the guarantees of our subsidiaries and the security interests in our assets, could impair our ability to operate our business effectively and may limit our ability to take advantage of business opportunities. o CONCENTRATION OF OWNERSHIP. Concentration of ownership among our existing executive officers, directors and principal stockholders may prevent new investors from influencing significant corporate decisions. These stockholders will be able to exercise control over all matters requiring stockholder approval and will have significant control over our management and policies. o FIXED COSTS. A significant percentage of our expenses, particularly rent and personnel costs, are fixed costs and are based in part on expectations of revenue. We may be unable to reduce spending in a timely manner to compensate for any significant fluctuations in our revenues. Our principal offices are located 12401 West Olympic Boulevard, Los Angeles, California 90064. Our telephone number is (310) 571-6500. Page 5 THE OFFERING Common stock offered .................. _____________ shares Common stock to be outstanding after this offering................. _____________ shares Use of proceeds........................ We intend to use the net proceeds from this offering to redeem our outstanding shares of preferred stock and to repay indebtedness. Listing................................ We intend to file an application to have our common stock approved for quotation on The Nasdaq Stock Market's National Market under the symbol "____." ---------------- Unless otherwise indicated, all share information in this prospectus is based on the number of shares outstanding as of June 30, 2001 and: o excludes 1,325,670 shares of common stock issuable upon exercise of outstanding options under our stock incentive plans, at a weighted average exercise price of $0.58 per share; o excludes 1,149,990 shares of common stock issuable upon exercise of outstanding warrants, at a weighted average exercise price of $0.0007 per share; o excludes 2,000,000 shares available for future issuance under our stock incentive plans; and o assumes no exercise of the underwriters' over-allotment option. Page 6 SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA The summary financial data for the years in the period ended December 31, 2000, 1999 and 1998 have been derived from our audited financial statements. The summary financial data for the six months ended June 30, 2001 and 2000 and as of June 30, 2001 have been derived from our unaudited interim financial statements and include, in the opinion of management, all adjustments necessary for a fair presentation of our financial position and operating results for these periods and as of such date. Our results for interim periods are not necessarily indicative of our results for a full year's operations. The pro forma data adjusts the financial data to give effect to this offering and the anticipated use of proceeds. You should read the following information together with "Selected Historical Consolidated Financial Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and related notes included elsewhere in this prospectus.
SIX MONTHS ENDED JUNE 30, YEAR ENDED DECEMBER 31, ------------------------- -------------------------------- 2001 2000 2000 1999 1998 -------- --------- -------- -------- --------- (dollars in thousands, except per share amounts) STATEMENTS OF OPERATIONS DATA: Laboratory revenue................ $68,384 $ 60,726 $119,300 $103,282 $ 89,896 Animal hospital revenue........... 137,134 119,267 240,624 217,988 191,888 Total revenue (1)................. 202,729 177,285 354,687 320,560 281,039 Direct costs...................... 141,644 126,517 254,787 232,493 209,380 Operating income.................. 23,362 28,599 19,205 47,016 38,834 Net income (loss) available to common stockholders............. $(13,323) $ 14,828 $(13,802) $ 22,357 $ 16,268 Pro forma net loss available to ========= ========= ========= ======== ======== common stockholders (2) ........ $ 565 $ (7,063) Pro forma basic and diluted ========= ========= loss per share (2).............. $ ========= ========= Shares used for computing pro forma basic and diluted loss per share (2).............. OTHER FINANCIAL DATA: Adjusted EBITDA (3)(4)............ $ 46,510 $ 37,206 $ 73,526 $ 64,445 $ 51,966 Adjusted EBITDA margin (5)........ 22.9% 21.0% 20.7% 20.1% 18.5% Laboratory EBITDA ................ $ 23,743 $ 20,679 $ 38,827 $ 32,273 $ 24,215 Laboratory EBITDA margin (5) ..... 34.7% 34.1% 32.5% 31.2% 26.9% Animal hospital EBITDA............ $ 27,500 $ 21,068 $ 42,985 $ 37,237 $ 31,975 Animal hospital EBITDA margin (5). 20.1% 17.7% 17.9% 17.1% 16.7% Net cash provided by operating activities...................... $ 32,605 $ 26,487 $ 60,054 $ 38,467 $27,123 Capital expenditures ............. 6,979 9,799 22,555 21,803 11,678 OPERATING DATA: Laboratory internal revenue growth (6)...................... 12.0% 13.1% 13.5% 10.9% 14.8% Animal hospital same-facility revenue growth (7).............. 5.5% 7.4% 7.0% 2.6% 5.8% AS OF JUNE 30, 2001 ------------------- AS BALANCE SHEET DATA: ACTUAL ADJUSTED(2) ------ ----------- Cash and cash equivalents......... $19,166 Total assets...................... 489,729 Total debt ....................... 368,087 Total redeemable preferred stock . 164,842 Total stockholders' equity (deficit)....................... (95,390)
Page 7 ---------------- (1) Includes other revenue of $1.0 million and $425,000 for the six months ended June 30, 2001 and 2000, and of $925,000, $5.1 million and $5.1 million for the years ended December 31, 2000, 1999 and 1998. Total revenue is net of intercompany eliminations of $3.8 million and $3.1 million for the six months ended June 30, 2001 and 2000, and of $6.2 million, $5.8 million and $5.8 million for the years ended December 31, 2000, 1999 and 1998. (2) The pro forma data and the balance sheet data as adjusted are presented as if this offering and the application of the net proceeds occurred at the beginning of the periods presented for the pro forma data and at June 30, 2001 for the balance sheet data as adjusted. (3) EBITDA is operating income (loss) before depreciation and amortization. Adjusted EBITDA is EBITDA adjusted to exclude management fees, recapitalization costs, Year 2000 remediation expense and other non-cash operating items. EBITDA and Adjusted EBITDA are not measures of financial performance under generally accepted accounting principles, or GAAP. Although EBITDA and Adjusted EBITDA should not be considered in isolation or as a substitute for net income, cash flows from operating activities and other income or cash flow statement data prepared in accordance with GAAP, or as a measure of profitability or liquidity, we understand that EBITDA and Adjusted EBITDA are widely used by financial analysts as a measure of financial performance. Our calculation of EBITDA and Adjusted EBITDA may not be comparable to similarly titled measures reported by other companies. The calculation of EBITDA and Adjusted EBITDA are shown below (dollars in thousands):
SIX MONTHS ENDED JUNE 30, YEAR ENDED DECEMBER 31, ------------------------- -------------------------------- 2001 2000 2000 1999 1998 -------- -------- -------- -------- -------- Operating income................$ 23,362 $ 28,599 $ 19,205 $ 47,016 $ 38,834 Depreciation and amortization... 12,689 8,607 18,878 16,463 13,132 -------- -------- -------- -------- -------- EBITDA 36,051 37,206 38,083 63,479 51,966 Management fees (a) ............ 1,240 -- 620 -- -- Recapitalization costs.......... -- -- 34,823 -- -- Year 2000 remediation expense... -- -- -- 2,839 -- Other non-cash operating items (b)........................... 9,219 -- -- (1,873) -- -------- -------- -------- -------- -------- Adjusted EBITDA.............$ 46,510 $ 37,206 $ 73,526 $64,445 $51,966 ======== ======== ======== ======== ========
(a) Management fees are paid pursuant to our management services agreement and are included in selling, general and administrative expense in our statements of operations. (b) Other non-cash operating items include a write-down and loss on sale of assets of $8.8 million and stock-based compensation expense of $382,000 for the six months ended June 30, 2001; and a reversal of restructuring charges of $1.9 million for the year ended December 31, 1999. Numbers may not add due to rounding. Page 8 (4) Adjusted EBITDA is the sum of laboratory EBITDA, animal hospital EBITDA and other revenue, less corporate selling, general and administrative expense, excluding management fees, as shown below (dollars in thousands):
SIX MONTHS ENDED JUNE 30, YEAR ENDED DECEMBER 31, ------------------------- -------------------------------- 2001 2000 2000 1999 1998 -------- -------- -------- -------- -------- Laboratory EBITDA $ 23,743 $ 20,679 $ 38,827 $ 32,273 $ 24,215 Animal hospital EBITDA 27,500 21,068 42,985 37,237 31,975 Other revenue 1,000 425 925 5,100 5,100 Corporate selling, general and administrative (6,973) (4,966) (9,831) (10,165) (9,324) Management fees 1,240 -- 620 -- -- -------- -------- -------- -------- -------- Adjusted EBITDA.............$ 46,510 $ 37,206 $ 73,526 $ 64,445 $ 51,966 ======== ======== ======== ======== ========
(5) Adjusted EBITDA margin is calculated by dividing Adjusted EBITDA by total revenue. Laboratory EBITDA margin is calculated by dividing laboratory EBITDA by laboratory revenue. Animal hospital EBITDA margin is calculated by dividing animal hospital EBITDA by animal hospital revenue. (6) Laboratory internal revenue growth is calculated using laboratory revenue as reported, adjusted to exclude estimated laboratory revenue of acquired laboratories for the 12 months subsequent to the respective acquisition dates for those laboratories that we did not own for the entire periods presented. We have estimated our laboratory revenue of acquired laboratories for the 12 months subsequent to the respective acquisition dates based on pre-acquisition historical laboratory revenue information provided to us by the seller. We then increase that amount by our laboratory internal revenue growth rate for the fiscal year prior to acquisition to determine our estimated laboratory revenue of acquired laboratories. To determine our laboratory internal revenue growth rate for the applicable period, we compare our laboratory revenue net of estimated laboratory revenue of acquired laboratories to our laboratory revenue as reported for the prior comparable period. We believe this fairly presents our laboratory internal revenue growth for the periods presented, although our calculation may not be comparable to similarly titled measures reported by other companies. (7) Animal hospital same-facility revenue growth is calculated using the combined revenue of the animal hospitals we owned and managed for the entire periods presented. Page 9 RISK FACTORS THE VALUE OF AN INVESTMENT IN VCA WILL BE SUBJECT TO SIGNIFICANT RISKS INHERENT IN OUR BUSINESS. YOU SHOULD CAREFULLY CONSIDER THE RISKS AND UNCERTAINTIES DESCRIBED BELOW AND OTHER INFORMATION INCLUDED IN THIS PROSPECTUS BEFORE PURCHASING OUR COMMON STOCK. IF ANY OF THE EVENTS DESCRIBED BELOW OCCUR, OUR BUSINESS AND FINANCIAL RESULTS COULD BE ADVERSELY AFFECTED IN A MATERIAL WAY. THIS COULD CAUSE THE TRADING PRICE OF OUR COMMON STOCK TO DECLINE, PERHAPS SIGNIFICANTLY. RISKS RELATED TO OUR BUSINESS WE MAY BE UNABLE TO SUCCESSFULLY EXECUTE OUR GROWTH STRATEGY AND, AS A RESULT, OUR BUSINESS MAY BE HARMED. Our success depends in part on our ability to build on our position as a leading animal health care services company through a balanced program of internal growth initiatives and selective acquisitions of established animal hospitals and laboratories. If we cannot implement or are not successful in executing these initiatives, our results of operations will be adversely affected. Our internal growth rate may decline and could become negative. Our laboratory internal revenue growth has fluctuated between 10.9% and 14.8% for each fiscal year since 1998. Similarly, our animal hospital same-facility revenue growth has fluctuated between 2.6% and 7.0% over the same periods. Even if we are successful implementing our growth strategy, we may not achieve the economies of scale that we have experienced in the past or that we anticipate. Our internal growth may continue to fluctuate and may be below our historical rates. Any reductions in the rate of our internal growth may cause our revenues and margins to decrease. Our historical growth rates and margins are not necessarily indicative of future results. Laboratory internal revenue growth is calculated using laboratory revenue as reported, adjusted to exclude laboratory revenue of acquired laboratories estimated for the 12 months subsequent to the respective acquisition dates. We estimate our laboratory revenue of acquired laboratories for the 12 months subsequent to the respective acquisition dates based on pre-acquisition historical laboratory revenue information provided to us by the seller increased by our laboratory internal revenue growth rate for the year prior to acquisition. To determine our laboratory internal revenue growth rate, we compare our laboratory revenue net of laboratory revenue of acquired laboratories to our laboratory revenue as reported for the prior comparable period. We calculate our animal hospital same-facility revenue growth using the combined revenue of the animal hospitals we owned and managed for the entire periods presented. These calculations involve a number of assumptions, and our internal growth may not be calculated in the same manner as those of comparable companies. OUR BUSINESS AND RESULTS OF OPERATIONS MAY BE ADVERSELY AFFECTED IF WE ARE UNABLE TO MANAGE OUR GROWTH EFFECTIVELY. Since January 1, 1996, we have experienced rapid growth and expansion. Our failure to manage our growth effectively may increase our costs of operations and hinder our ability to execute our business strategy. Our rapid growth has placed, and will continue to place, a significant strain on our management and operational systems and resources. If our business grows, we will need to improve and enhance our overall financial and managerial controls, reporting systems and procedures, and expand, train and manage our workforce. We will also need to increase the capacity of our current systems to meet additional demands. DIFFICULTIES WITH THE INTEGRATION OF NEW ACQUISITIONS MAY IMPOSE SUBSTANTIAL COSTS AND DELAYS AND CAUSE OTHER PROBLEMS FOR US. Acquisitions involve a number of risks relating to our ability to integrate an acquired business into our existing operations. The process of integrating the operations of an acquired business, including its personnel, could cause interruptions to our business. Some of the risks we face include: o negative effects on our operating results; o impairments of goodwill and other intangible assets; o dependence on retention, hiring and training of key personnel, including specialists; Page 10 o amortization of intangible assets; and o contingent and latent risks associated with the past operations of, and other unanticipated problems arising in, an acquired business. The process of integration may require a disproportionate amount of the time and attention of our management, which may distract management's attention from its day-to-day responsibilities. In addition, any interruption or deterioration in service resulting from an acquisition may result in a customer's decision to stop using us. For these reasons, we may not realize the anticipated benefits of an acquisition, either at all or in a timely manner. If that happens and we incur significant costs, it could have a material adverse impact on our business. A PROLONGED ECONOMIC DOWNTURN COULD MATERIALLY ADVERSELY AFFECT OUR BUSINESS. Our business may be materially adversely affected by prolonged, negative trends in the general economy that reduce consumer spending. Our business depends on the ability and willingness of animal owners to pay for our services. This dependence could make us more vulnerable to any reduction in consumer confidence or disposable income than companies in other industries that are less reliant on consumer spending, such as the human health care industry, in which a large portion of payments are made by insurance programs. OUR SUBSTANTIAL AMOUNT OF DEBT COULD ADVERSELY AFFECT OUR ABILITY TO RUN OUR BUSINESS. We have, and will continue to have, a substantial amount of debt. At June 30, 2001, our debt consisted primarily of o $247.4 million of outstanding borrowings under our credit facility. We have an additional $50 million of available credit under our credit facility; o $119.1 million of outstanding senior notes and senior subordinated notes; and o $1.6 million of other debt. Our substantial amount of debt, including senior and secured debt, as well as the guarantees of our subsidiaries and the security interests in our assets, could impair our ability to operate our business effectively and may limit our ability to take advantage of business opportunities. For example, our indentures and credit facility: o limit our ability to borrow additional funds or to obtain other financing in the future for working capital, capital expenditures, acquisitions, investments and general corporate purposes; o require us to dedicate a substantial portion of our cash flow from operations to pay down our indebtedness, thereby reducing the funds available to use for working capital, capital expenditures, acquisitions and general corporate purposes; o limit our ability to dispose of our assets, create liens on our assets or to extend credit; o make us more vulnerable to economic downturns and reduce our flexibility in responding to changing business and economic conditions; o limit our flexibility in planning for, or reacting to, changes in our business or industry; o place us at a competitive disadvantage to our competitors with less debt; and o restrict our ability to pay dividends, repurchase or redeem our capital stock or debt, or merge or consolidate with another entity. Page 11 The terms of our indentures and credit facility allow us, under specified conditions, to incur further indebtedness, which would heighten the foregoing risks. If compliance with our debt obligations materially hinders our ability to operate our business and adapt to changing industry conditions, we may lose market share, our revenue may decline and our operating results may suffer. WE REQUIRE A SIGNIFICANT AMOUNT OF CASH TO SERVICE OUR DEBT AND EXPAND OUR BUSINESS AS PLANNED. Our ability to make payments on our debt, and to fund acquisitions, will depend on our ability to generate cash in the future. Insufficient cash flow could place us at risk of default under our debt agreements or could prevent us from expanding our business as planned. Our ability to generate cash is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Our business may not generate sufficient cash flow from operations, our strategy to increase operating efficiencies may not be realized and future borrowings may not be available to us under our credit facility in an amount sufficient to enable us to service our debt or to fund our other liquidity needs. In order to meet our debt obligations, we may need to refinance all or a portion of our debt. We may not be able to refinance any of our debt, on commercially reasonable terms or at all. OUR FAILURE TO SATISFY COVENANTS IN OUR DEBT INSTRUMENTS WILL CAUSE A DEFAULT UNDER THOSE INSTRUMENTS. In addition to imposing restrictions on our business and operations, our debt instruments include a number of covenants relating to financial ratios and tests. Our ability to comply with these covenants may be affected by events beyond our control, including prevailing economic, financial and industry conditions. The breach of any of these covenants would result in a default under these instruments. An event of default would permit our lenders to declare all amounts borrowed from them to be due and payable, together with accrued and unpaid interest. Moreover, these lenders would have the option to terminate any obligation to make further extensions of credit under these instruments. If we are unable to repay debt to our senior lenders, these lenders could proceed against our assets. DUE TO THE FIXED COST NATURE OF OUR BUSINESS, FLUCTUATIONS IN OUR REVENUE COULD ADVERSELY AFFECT OUR OPERATING INCOME. A significant percentage of our expenses, particularly rent and personnel costs, are fixed costs and are based in part on expectations of revenue. We may be unable to reduce spending in a timely manner to compensate for any significant fluctuations in our revenue. Accordingly, shortfalls in revenues may adversely affect our operating income. THE SIGNIFICANT COMPETITION IN THE ANIMAL HEALTH CARE SERVICES INDUSTRY COULD CAUSE US TO REDUCE PRICES OR LOSE MARKET SHARE. The animal health care services industry is highly competitive. To compete successfully, we may be required to reduce prices, increase our operating costs or take other measures that could have an adverse effect on our financial condition, results of operations, margins and cash flow. If we are unable to compete successfully, we may lose market share. There are many clinical laboratory companies that provide a broad range of laboratory testing services in the same markets we service. Our largest competitor for outsourced laboratory testing services is Idexx Laboratories, Inc. Also, Idexx and several other national companies provide on-site diagnostic equipment that allows veterinarians to perform their own laboratory tests. Our primary competitors for our animal hospitals in most markets are individual practitioners or small, regional, multi-clinic practices. Also, regional pet care companies and some national companies, including operators of super-stores, are developing multi-regional networks of animal hospitals in markets in which we operate. WE MAY EXPERIENCE DIFFICULTIES HIRING SKILLED VETERINARIANS DUE TO PERIODIC SHORTAGES WHICH COULD DISRUPT OUR BUSINESS. Page 12 Skilled veterinarians are in shortage from time to time in particular regional markets in which we operate animal hospitals. During these shortages, we may be unable to hire enough qualified veterinarians to adequately staff our animal hospitals in these regions, in which event we may lose market share and our revenues and profitability may decline. IF WE FAIL TO COMPLY WITH GOVERNMENTAL REGULATIONS APPLICABLE TO OUR BUSINESS, VARIOUS GOVERNMENTAL AGENCIES MAY IMPOSE FINES, INSTITUTE LITIGATION OR PRECLUDE US FROM OPERATING IN CERTAIN STATES. The laws of many states prohibit business corporations from providing, or holding themselves out as providers of, veterinary medical care. These laws vary from state to state and are enforced by the courts and by regulatory authorities with broad discretion. We operate 53 animal hospitals in 11 states with these laws, including 21 in New York. We may experience difficulty in expanding our operations into other states with similar laws. Given varying and uncertain interpretations of the veterinary laws of each state, we may not be in compliance with restrictions on the corporate practice of veterinary medicine in all states. A determination that we are in violation of applicable restrictions on the practice of veterinary medicine in any state in which we operate could have a material adverse effect on us, particularly if we were unable to restructure our operations to comply with the requirements of that state. For example, we currently are a party to a lawsuit in the State of Ohio in which that State has 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. In response, we have restructured our operations in the State of Ohio in a manner that we believe conforms to the state law and the court's order. The Attorney General of the State of Ohio has informed us that it disagrees with our position that we are in compliance with the court's order. We are currently in discussions with the Attorney General's office in the State of Ohio in an attempt to resolve this matter. We may not be able to reach a settlement, in which case we would be required to discontinue our operations in the state. Our five animal hospitals in the State of Ohio have a book value of $6.2 million. If we were required to discontinue our operations in the State of Ohio, we may not be able to dispose of the hospital assets for their book value. The animal hospitals located in the State of Ohio generated EBITDA, revenue and operating income of $754,000, $2.2 million and $513,000, respectively, in the twelve months ended December 31, 2000 and $404,000, $1.2 million and $274,000, respectively, in the six months ended June 30, 2001. 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 veterinary doctors practicing in our clinics are required to maintain valid state licenses to practice. ANY FAILURE IN OUR INFORMATION TECHNOLOGY SYSTEMS COULD SIGNIFICANTLY INCREASE TESTING TURN-AROUND TIME, REDUCE OUR PRODUCTION CAPACITY AND OTHERWISE DISRUPT OUR OPERATIONS. Our laboratory operations depend, in part, on the continued and uninterrupted performance of our information technology systems. Our growth has necessitated continued expansion and upgrade of our information technology infrastructure. Sustained system failures or interruption in one or more of our laboratory operations could disrupt our ability to process laboratory requisitions, perform testing, provide test results in a timely manner and/or bill the appropriate party. We could lose customers and revenue as a result of a system failure. Our computer systems are vulnerable to damage or interruption from a variety of sources, including telecommunications failures, electricity brownouts or blackouts, malicious human acts and natural disasters. Moreover, despite network security measures, some of our servers are potentially vulnerable to physical or electronic break-ins, computer viruses and similar disruptive problems. Despite the precautions we have taken, unanticipated problems affecting our systems could cause interruptions in our information technology systems. Our insurance policies may not adequately compensate us for any losses that may occur due to any failures in our systems. Page 13 THE LOSS OF MR. ROBERT L. ANTIN, OUR CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER, COULD MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS. We are dependent upon the management and leadership of our Chairman, President and Chief Executive Officer, Robert L. Antin. We have an employment contract with Mr. Antin which may be terminated at the option of Mr. Antin. Mr. Antin is a party to a non-competition agreement that expires on September 20, 2003. We do not maintain any key man life insurance coverage for Mr. Antin. The loss of Mr. Antin could materially adversely affect our business. RISKS ASSOCIATED WITH THIS OFFERING CONCENTRATION OF OWNERSHIP AMONG OUR EXISTING EXECUTIVE OFFICERS, DIRECTORS AND PRINCIPAL STOCKHOLDERS MAY PREVENT NEW INVESTORS FROM INFLUENCING SIGNIFICANT CORPORATE DECISIONS. Upon completion of this offering, our executive officers, directors and principal stockholders will beneficially own, in the aggregate, approximately ___% of our outstanding common stock. As a result, these stockholders will be able to exercise control over all matters requiring stockholder approval, including the election of directors, amendment of our certificate of incorporation and approval of significant corporate transactions and will have significant control over our management and policies. The directors elected by these stockholders will be able to make decisions affecting our capital structure, including decisions to issue additional capital stock, implement stock repurchase programs and incur indebtedness. This control may have the effect of deterring hostile takeovers, delaying or preventing changes in control or changes in management, or limiting the ability of our other stockholders to approve transactions that they may deem to be in their best interests. FUTURE SALES OF SHARES OF OUR COMMON STOCK IN THE PUBLIC MARKET MAY DEPRESS OUR STOCK PRICE AND MAKE IT DIFFICULT FOR YOU TO RECOVER THE FULL VALUE OF YOUR INVESTMENT IN OUR SHARES. If our existing stockholders sell substantial amounts of our common stock in the public market following this offering or if there is a perception that these sales may occur, the market price of our common stock could decline. Based on shares outstanding as of August 31, 2001, upon completion of this offering we will have outstanding approximately ___ shares of common stock. Of these shares, only the shares of common stock sold in this offering will be freely tradable, without restriction, in the public market. After the lockup agreements pertaining to this offering expire 180 days from the date of this prospectus unless waived, an additional 18,218,205 shares will be eligible for sale in the public market at various times, subject to volume limitations under Rule 144 of the Securities Act of 1933. See "Shares Eligible for Future Sale" for more information regarding shares of our common stock that may be sold by existing stockholders after the closing of this offering. BECAUSE OUR COMMON STOCK IS NOT CURRENTLY TRADED ON A PUBLIC MARKET, THE INITIAL PUBLIC OFFERING PRICE MAY NOT BE INDICATIVE OF THE MARKET PRICE OF OUR COMMON STOCK AFTER THIS OFFERING. YOU MAY BE UNABLE TO RESELL YOUR SHARES AT OR ABOVE THE INITIAL PUBLIC OFFERING PRICE. There is currently no public market for our common stock. An active public market may not develop for our common stock following this offering. If a market does develop, the market price of our common stock may be less than the public offering price. The public offering price will be determined by negotiations between us and the representatives of the underwriters and will not necessarily be indicative of the market price of the common stock after the offering. The prices at which the common stock will trade after the offering will be determined by the marketplace and may be influenced by many factors, including: o the information included in this prospectus and otherwise available to the representatives; o the history and the prospects of the industry in which we compete; o the ability of our management; o our past and present operations; Page 14 o our prospects for future earnings; o the recent market prices of, and the demand for, publicly traded common stock of generally comparable companies; o market conditions for initial public offerings; and o the general condition of the securities markets at the time of this offering. THE PRICE OF OUR COMMON STOCK MAY BE VOLATILE. Following this offering, the price at which our common stock will trade may be volatile. The stock market has from time to time experienced significant price and volume fluctuations that have affected the market prices of securities. These fluctuations often have been unrelated or disproportionate to the operating performance of publicly traded companies. In the past, following periods of volatility in the market price of a particular company's securities, securities class-action litigation has often been brought against that company. We may become involved in this type of litigation in the future. Litigation of this type is often expensive to defend and may divert management's attention and resources from the operation of our business. TERRORISM AND THE UNCERTAINTY OF WAR MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATING RESULTS. Terrorist attacks, such as the attacks that occurred in New York and Washington, D.C. on September 11, 2001, the response by the United States on October 7, 2001 and other acts of violence or war may affect the market on which our common stock will trade, the markets in which we operate, our operations and profitability and your investment. Further terrorist attacks against the United States or United States businesses may occur. The potential near-term and long-term effect these attacks may have for our customers, the market for our common stock, the markets for our services and the U.S. economy are uncertain. The consequences of any terrorist attacks, or any armed conflicts which may result, are unpredictable, and we may not be able to foresee events that could have an adverse effect on our markets, our business or your investment. OUR STOCK PRICE MAY BE ADVERSELY AFFECTED BECAUSE OUR RESULTS OF OPERATIONS MAY FLUCTUATE SIGNIFICANTLY FROM QUARTER TO QUARTER. Our operating results may fluctuate significantly in the future. If our quarterly revenue and operating results fall below the expectations of securities analysts and investors, the market price of our common stock could fall substantially. We believe that quarter to quarter or annual comparisons of our operating results are not a good indication of our future performance. Historically, when you eliminate the effect of acquisitions, we have experienced higher revenue in the second and third quarters than in the first and fourth quarters. The demand for our veterinary services is higher during 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. Also, use of veterinary services may be affected by levels of infestation of fleas, heartworms and ticks, and the number of daylight hours. A substantial portion of our costs are fixed and do not vary with the level of demand for our services. Therefore, net income for the second and third quarters at individual animal hospitals and veterinary diagnostic laboratories generally is higher than in the first and fourth quarters. Operating results also may vary depending on a number of factors, many of which are outside our control, including: o demand for our tests; o changes in our pricing policies or those of our competitors; o the hiring and retention of key personnel; o wage and cost pressures; Page 15 o changes in fuel prices or electrical rates; o costs related to acquisitions of technologies or businesses; and o seasonal and general economic factors. YOU WILL INCUR IMMEDIATE AND SUBSTANTIAL DILUTION AS A RESULT OF THIS OFFERING. The initial public offering price is substantially higher than the book value per share of the common stock. As a result, purchasers in this offering will experience immediate and substantial dilution of $_______ per share in the tangible book value of the common stock from the initial public offering price. TAKEOVER DEFENSE PROVISIONS MAY ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK. Various provisions of Delaware corporation law and of our corporate governance documents may inhibit changes in control not approved by our board of directors and may have the effect of depriving you of an opportunity to receive a premium over the prevailing market price of our common stock in the event of an attempted hostile takeover. In addition, the existence of these provisions may adversely affect the market price of our common stock. These provisions include: o a classified board of directors; o a prohibition on stockholder action through written consents; o a requirement that special meetings of stockholders be called only by our the board of directors; o advance notice requirements for stockholder proposals and nominations; and o availability of "blank check" preferred stock. Page 16 CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS Some of the statements under "Prospectus Summary," "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business," and elsewhere in this prospectus are forward-looking statements. We generally identify forward-looking statements in this prospectus using words like "believe," "intend," "expect," "estimate," "may," "should," "plan," "project," "contemplate," "anticipate," "predict," or similar expressions. These statements involve known and unknown risks, uncertainties, and other factors, including those described in this "Risk Factors" section, that may cause our or our industry's actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by these forward-looking statements. Except as required by applicable law, including the securities laws of the United States, and the rules and regulations of the SEC, we do not plan to publicly update or revise any forward-looking statements after we distribute this prospectus, whether as a result of any new information, future events or otherwise. Page 17 USE OF PROCEEDS We expect to receive approximately $195.0 million in net proceeds from the sale of shares of our common stock in this offering based on the sale of [____] million shares at an assumed initial public offering price of [$____] per share, the midpoint of the offering range set forth on the cover page of this prospectus. If the underwriters exercise their over-allotment option in full, we expect our net proceeds to be approximately $224.3 million. We intend to use the net proceeds from this offering to: o repay approximately $35.0 million of the outstanding principal amount of our 15.5% senior notes due 2010 at a redemption price of 110% of the principal amount, for an aggregate of $38.5 million, plus accrued and unpaid interest; o redeem in full, all outstanding shares of our 14% series A redeemable preferred stock having an aggregate liquidation preference of $83.4 million, plus accrued and unpaid dividends; and o redeem in full, all outstanding shares of our 12% series B redeemable preferred stock having an aggregate liquidation preference of $81.4 million, plus accrued and unpaid dividends. If the underwriters do not exercise their over-allotment option, we intend to use our cash on hand to fully fund these uses. If the underwriters exercise their over-allotment option, any additional net proceeds will be used to repay up to an additional $6.0 million of the outstanding principal amount of our 15.5% senior notes due 2010 at a redemption price of 110% of the principal amount, for an aggregate of $6.6 million, plus accrued and unpaid interest and up to $7.0 million of the outstanding principal amount of our 13.5% senior subordinated notes due 2010 at a redemption price of 110% of the principal amount, for an aggregate of $7.7 million, plus accrued and unpaid interest. Pending application of the net proceeds as described above, we intend to invest the net proceeds in short-term investment grade securities. DIVIDEND POLICY 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 indentures governing our outstanding senior and 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. The terms of our series A and series B redeemable preferred stock require us to pay dividends whether or not declared by our board of directors, out of funds legally available. Dividends on the series A and series B redeemable preferred stock accrue at the rates of 14% and 12% per annum of the liquidation preference. Dividends are payable in cash on a quarterly basis. If dividends are not paid when due, the amount payable is added to the liquidation preference. At June 30, 2001, dividends earned but not paid were $8.5 million and $7.1 million for the series A and series B redeemable preferred stock, respectively. Page 18 DILUTION At June 30, 2001, we had net tangible book value of $_____ million, or $_____ per share. Net tangible book value per share is equal to our total tangible assets less our total liabilities, divided by the total number of shares of our common stock outstanding. After giving effect to the sale of _________ shares of our common stock at an assumed initial public offering price of $_____ per share, the mid-point of the offering range set forth on the cover of this prospectus, and after deducting the underwriting discount and estimated offering expenses, our as adjusted net tangible book value at June 30, 2001 would have been $_______ million or $____ per share. This represents an immediate increase in net tangible book value of $_____ per share to existing stockholders and an immediate dilution of $_____ per share to new investors purchasing shares of our common stock in this offering. The following table illustrates the per share dilution to the new investors. Assumed initial public offering price $ Net tangible book value per share at June 30, 2001 $ Increase per share attributable to this offering --------- As adjusted net tangible book value per share after this offering --------- Dilution per share to new investors in this offering $ ========= The following table summarizes on an as adjusted basis, as of _______, 2001, the total number of shares of our common stock, the total cash consideration paid and the average price per share paid by the existing stockholders and by the new investors in this offering before deducting the underwriting discount and estimated offering expenses:
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE -------------------- -------------------- PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE -------- -------- -------- --------- ---------- Existing stockholders........... New investors................... ---------- -------- ---------- --------- Total........................ ========== ======== ========== =========
The foregoing discussion and table assume no exercise of any stock options or warrants outstanding as of June 30, 2001. As of June 30, 2001, there were options or warrants outstanding to purchase a total of 2,475,660 shares of our common stock and 2,000,000 shares reserved for issuance pursuant to future grants of options under our 1996 Stock Incentive Plan and our 2001 Stock Incentive Plan. To the extent that any of these shares are issued, there will be further dilution to new investors. See "Capitalization," "Management" and Note 10 to our Consolidated Financial Statements. Page 19 CAPITALIZATION The following table sets forth our capitalization and cash and cash equivalents as of June 30, 2001: o on an actual basis; and o as adjusted to give effect to the sale of [____] shares of our common stock at an assumed initial public offering price of [$___] per share, which is the mid-point in the offering range set forth on the cover page of this prospectus, and the intended application of the net proceeds.
AS OF JUNE 30, 2001 ---------------------------- ACTUAL AS ADJUSTED ---------- ------------ (dollars in millions) Cash and cash equivalents $ 19.2 $ 10.9 ========== ============ Total debt, including current portion: Credit facility...................... Revolving credit facility (1)...... $ -- $ -- Term loan A facility............... 49.3 49.3 Term loan B facility............... 198.1 198.1 Senior subordinated notes............ 20.0 20.0 Senior notes......................... 112.4 77.4 Other debt........................... 1.6 1.6 Unamortized discount................. (13.3) (9.9) ---------- ----------- Total debt......................... 368.1 336.5 ---------- ----------- Series A redeemable preferred stock, $.01 par value; 3,000,000 shares authorized, 2,998,408 shares issued and outstanding, actual; no shares issued and outstanding, as adjusted.. 83.4 -- Series B redeemable preferred stock, $.01 par value; 3,000,000 shares authorized, 2,970,822 shares issued and outstanding, actual; no shares issued and outstanding, as adjusted........................... 81.4 -- Stockholders' equity: Common stock, $.01 par value; 24,000,000 shares authorized, 17,524,000 shares issued and outstanding, actual; 75,000,000 shares authorized and _______ shares issued and outstanding, as adjusted.. 0.2 Additional paid-in capital........... 19.4 Notes receivable from stockholders... (0.5) (0.5) Accumulated deficit.................. (113.4) (117.8) Accumulated comprehensive loss....... (1.1) (1.1) ---------- ------------ Total stockholders' equity (deficit): ........................ (95.4) ---------- ------------ Total capitalization............... $ 437.5 $ ========== ============ ------------------------ (1) The revolving credit facility provides for additional borrowings of up to $50.0 million. (2) Share information is based on the number of shares outstanding as of June 30, 2001; and o excludes 1,325,670 shares of common stock issuable upon exercise of outstanding options under our stock incentive plans, at a weighted average exercise price of $0.58 per share; o excludes 1,149,990 shares of common stock issuable upon exercise of outstanding warrants, at a weighted average exercise price of $0.0007 per share; o excludes 2,000,000 shares available for future issuance under our stock incentive plans; and o assumes no exercise of the underwriters' over-allotment option.
Page 20 SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA The selected historical consolidated financial data as of and for the years ended December 31, 2000, 1999, 1998, 1997 and 1996 have been derived from our audited financial statements. The financial statements were audited by Arthur Andersen LLP. The selected historical consolidated financial data as of and for the six months ended June 30, 2001 and 2000 have been derived from our unaudited interim financial statements and include, in the opinion of management, all adjustments necessary for a fair presentation of our financial position and operating results for those periods and as of those dates. Our results for interim periods are not necessarily indicative of our results for a full year's operations. 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, 2000 and 1999 and for each of the three years in the period ended December 31, 2000 and our unaudited, consolidated financial statements as of and for the six months ended June 30, 2001 and for the six months ended June 30, 2000 are included in this prospectus.
SIX MONTHS ENDED ENDED JUNE 30, YEAR ENDED DECEMBER 31, -------------------- ----------------------------------------------------- 2001 2000 2000 1999 1998 1997 1996 --------- --------- --------- --------- -------- --------- ---------- (dollars in thousands, except per share amounts) STATEMENTS OF OPERATIONS DATA: Laboratory revenue..... $ 68,384 $ 60,726 $119,300 $103,282 $89,896 $ 68,997 $ 56,774 Animal hospital revenue ............. 137,134 119,267 240,624 217,988 191,888 165,848 120,110 Other revenue (1)...... 1,000 425 925 5,100 5,100 5,764 8,674 Intercompany........... (3,789) (3,133) (6,162) (5,810) (5,845) (4,696) (4,130) --------- --------- --------- --------- -------- --------- ---------- Total revenue.......... 202,729 177,285 354,687 320,560 281,039 235,913 181,428 Direct costs........... 141,644 126,517 254,787 232,493 209,380 178,630 138,854 --------- --------- --------- --------- -------- --------- ---------- 61,085 50,768 99,900 88,067 71,659 57,283 42,574 Selling, general and administrative....... 15,815 13,562 26,994 23,622 19,693 17,676 19,735 Depreciation and amortization......... 12,689 8,607 18,878 16,463 13,132 11,199 7,496 Recapitalization costs. -- -- 34,823 -- -- -- -- Year 2000 remediation expense.............. -- -- -- 2,839 -- -- -- Restructuring and merger costs......... -- -- -- -- -- -- 5,690 Other non-cash operating items...... 9,219 -- -- (1,873) -- -- 12,424 --------- --------- --------- --------- -------- --------- ---------- Operating income 23,362 28,599 19,205 47,016 38,834 28,408 (2,771) (loss)............... Net interest expense... 22,070 4,700 19,892 9,449 8,832 7,411 3,325 Other (income) expense. 299 (3,200) 1,800 -- -- -- -- --------- --------- --------- --------- -------- --------- ---------- Income (loss) before minority interest, provision for income taxes and extraordinary item.. 1,063 27,099 (2,487) 37,567 30,002 20,997 (6,096) Minority interest in income of subsidiaries......... 700 515 1,066 850 780 424 6,577 Provision for income taxes................ 3,466 11,756 2,199 14,360 12,954 9,347 1,959 Extraordinary loss on early extinguishment of debt (net of taxes)............... -- -- 2,659 -- -- -- -- Increase in carrying amount of redeemable preferred stock...... 10,220 -- 5,391 -- -- -- -- --------- --------- --------- --------- -------- --------- ---------- Net income (loss) available to common stockholders........ $(13,323) $ 14,828 $(13,802) $ 22,357 $16,268 $ 11,226 $ (14,632) ========= ========= ========= ========= ======== ========= ========== Basic earnings (loss) $ (0.76) $ 0.05 $ (0.06) $ 0.07 $ 0.05 $ 0.04 $ (0.06) per share............ Diluted earnings (loss) per share............ $ (0.76) $ 0.04 $ (0.06) $ 0.07 $ 0.05 $ 0.04 $ (0.06) Shares used for computing basic earnings (loss) per share................ 17,524 318,390 234,055 315,945 305,250 294,390 239,130 Shares used for computing diluted earnings (loss) per share................ 17,524 365,325 234,055 329,775 329,100 315,195 239,130 Page 21 OTHER FINANCIAL DATA: EBITDA (2)(3) $ 46,510 $ 37,206 $ 73,526 $ 64,445 $51,966 $ 39,607 $ 22,839 EBITDA margin (4)...... 22.9% 21.0% 20.7% 20.1% 18.5% 16.8% 12.6% Laboratory EBITDA ..... $ 23,743 $ 20,679 $ 38,827 $ 32,273 $24,215 $ 20,142 $ 16,565 Laboratory margin (4).. 34.7% 34.1% 32.5% 31.2% 26.9% 29.2% 29.2% Animal hospital EBITDA .............. $ 27,500 $ 21,068 $ 42,985 $ 37,237 $ 31,975 $ 23,243 $ 15,794 Animal hospital margin (4)........... 20.1% 17.7% 17.9% 17.1% 16.7% 14.0% 13.1% Net cash provided by operating activities .......... $ 32,605 $ 26,487 $ 60,054 $ 38,467 $ 27,123 $ 22,674 $ 1,603 Capital expenditures... 6,979 9,799 22,555 21,803 11,678 7,241 6,962 BALANCE SHEET DATA (AT PERIOD END): Cash and cash equivalents.......... $ 19,166 $ 1,099 $ 10,519 $ 10,620 $ 8,977 $ 19,882 $ 29,621 Net working capital.... (276) 3,391 4,734 9,605 6,694 (4,454) (10,221) Total assets........... 489,729 446,889 483,070 426,500 393,960 386,089 354,009 Total debt ............ 368,087 156,507 362,749 161,535 159,787 173,875 148,822 Total redeemable 164,842 -- 154,622 -- -- -- -- preferred stock ..... Total stockholders' (95,390) 247,692 (81,865) 231,229 202,685 180,851 167,350 equity (deficit)..... ------------------------ (1) Other revenue includes consulting fees of $1.0 million and $425,000 for the six months ended June 30, 2001 and 2000; and of $925,000, $5.1 million, $5.1 million and $4.7 million for the years ended December 31, 2000, 1999, 1998 and 1997. For the years ended December 31, 1997 and 1996 other revenue also includes revenue from our pet product joint venture; we transferred the control of the joint venture to our joint venture partner in February 1997. (2) EBITDA is operating income (loss) before depreciation and amortization. Adjusted EBITDA represents EBITDA adjusted to exclude management fees, recapitalization costs, Year 2000 remediation expense and other non-cash operating items. EBITDA and Adjusted EBITDA are not measures of financial performance under generally accepted accounting principles, or GAAP. Although EBITDA and Adjusted EBITDA should not 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 understand that EBITDA and Adjusted EBITDA are widely used by financial analysts as a measure of financial performance. Our calculation of EBITDA and Adjusted EBITDA may not be comparable to similarly titled measures reported by other companies.
The calculation of EBITDA and Adjusted EBITDA is shown below (dollars in thousands):
SIX MONTHS ENDED JUNE 30 YEAR ENDED DECEMBER 31, -------------------- ---------------------------------------------------- 2001 2000 2000 1999 1998 1997 1996 --------- --------- --------- --------- -------- --------- ---------- Operating income (loss) .............. $ 23,362 $ 28,599 $ 19,205 $ 47,016 $ 38,834 $ 28,408 $ (2,771) Depreciation and amortization......... 12,689 8,607 18,878 16,463 13,132 11,199 7,496 -------- -------- -------- -------- -------- -------- --------- EBITDA............. 36,051 37,206 38,083 63,479 51,966 39,607 4,725 Management fees (a).... 1,240 -- 620 -- -- -- -- Recapitalization costs................ -- -- 34,823 -- -- -- -- Year 2000 remediation expense.............. -- -- -- 2,839 -- -- -- Restructuring and merger costs......... -- -- -- -- -- -- 5,690 Other non-cash operating items (b).. 9,219 -- -- (1,873) -- -- 12,424 -------- -------- -------- -------- -------- -------- --------- Adjusted EBIDA....... $ 46,510 $ 37,206 $ 73,526 $ 64,445 $ 51,966 $ 39,607 $ 22,839 ======== ======== ======== ======== ======== ======== =========
(a) Management fees are paid pursuant to our management services agreement and are included in selling, general and administrative expense in our statements of operations. (b) Other non-cash operating items include a write-down and loss on sale of assets of $8.8 million and stock-based compensation expense of $382,000 for the six months ended June 30, 2001; reversal of restructuring charges of $1.9 million for the year ended December 31, 1999; reversal of restructuring charges of $2.1 million and restructuring charges of $2.1 million for the year ended December 31, 1997; and restructuring charges of $2.9 million and a write-down of assets of $9.5 million for the year ended December 31, 1996. Numbers may not add due to rounding. Page 22 (3) Adjusted EBITDA is the sum of laboratory EBITDA, animal hospital EBITDA and other revenue, less corporate selling, general and administrative expense, excluding management fees. For the years ended December 31, 1997 and 1996, Adjusted EBITDA also included EBITDA of our pet products joint venture of $168,000 and a loss of $1.1 million. The calculation of Adjusted EBITDA is shown below (dollars in thousands).
SIX MONTHS ENDED JUNE 30 YEAR ENDED DECEMBER 31, -------------------- ---------------------------------------------------- 2001 2000 2000 1999 1998 1997 1996 --------- --------- --------- --------- -------- --------- --------- Laboratory EBITDA...............$ 23,743 $ 20,679 $ 38,827 $ 32,273 $ 24,215 $ 20,142 $ 16,565 Animal hospital EBITDA.......... 27,500 21,068 42,985 37,237 31,975 23,243 15,794 Other revenue................... 1,000 425 925 5,100 5,100 4,700 -- Corporate, selling and administrative expense........ (6,973) (4,966) (9,831) (10,165) (9,324) (8,646) (8,386) Management fees................. 1,240 -- 620 -- -- -- -- Pet products joint venture EBITDA........................ -- -- -- -- -- 168 (1,134) --------- --------- --------- --------- -------- --------- --------- Adjusted EBITDA.............$ 46,510 $ 37,206 $ 73,526 $ 64,445 $ 51,966 $ 39,607 $ 22,839
(4) Adjusted EBITDA margin is calculated by dividing Adjusted EBITDA by total revenue. Laboratory EBITDA margin is calculated by dividing laboratory EBITDA by laboratory revenue. Animal hospital EBITDA margin is calculated by dividing animal hospital EBITDA by animal hospital revenue. Page 23 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS YOU SHOULD READ THE FOLLOWING DISCUSSION AND ANALYSIS OF OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS TOGETHER WITH OUR CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES INCLUDED ELSEWHERE IN THIS PROSPECTUS. SOME OF THE INFORMATION CONTAINED IN THIS DISCUSSION AND ANALYSIS OR SET FORTH ELSEWHERE IN THIS PROSPECTUS, INCLUDING INFORMATION WITH RESPECT TO OUR PLANS AND STRATEGIES FOR OUR BUSINESS, INCLUDES FORWARD-LOOKING STATEMENTS THAT INVOLVE RISK AND UNCERTAINTIES. YOU SHOULD REVIEW THE "RISK FACTORS" SECTION OF THIS PROSPECTUS FOR A DISCUSSION OF IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THE RESULTS DESCRIBED IN OR IMPLIED BY THE FORWARD-LOOKING STATEMENTS CONTAINED HEREIN. OVERVIEW We are a leading animal health care services company and operate the largest networks of veterinary diagnostic laboratories and free-standing, full-service animal hospitals in the United States. Our network of veterinary diagnostic laboratories provides sophisticated testing and consulting services used by veterinarians in the detection, diagnosis, evaluation, monitoring, treatment and prevention of diseases and other conditions affecting animals. Our animal hospitals offer a full range of general medical and surgical services for companion animals. We treat diseases and injuries, offer pharmaceutical products and perform a variety of pet wellness programs, including routine vaccinations, health examinations, diagnostic testing, spaying, neutering and dental care. Our company was formed in 1986 by Robert Antin, Arthur Antin and Neil Tauber, who have served since our inception as our Chief Executive Officer, Chief Operating Officer and Senior Vice President of Development, respectively. During the 1990s, we established a premier position in the veterinary diagnostic laboratory and animal hospital markets through both internal growth and acquisitions. By 1997, we achieved a critical mass, building a laboratory network of 12 laboratories servicing animal hospitals in all 50 states and completing acquisitions for a total of 160 animal hospitals. At August 31, 2001, our laboratory network consisted of 15 laboratories serving all 50 states and our animal hospital network consisted of 214 animal hospitals in 33 states. We are focusing primarily on generating internal growth to increase revenue and profitability. In order to augment internal growth, we may selectively acquire laboratories and intend to acquire approximately 15-25 animal hospitals per year, depending upon the attractiveness of candidates and the strategic fit with our existing operations. The following table summarizes our growth in facilities for the periods presented:
Six Months Ended Year Ended June 30 December 31, ------------------ --------------------------- 2001 2000 2000 1999 1998 -------- -------- -------- -------- ------- Laboratories: Beginning of period 15 13 13 12 12 Acquisitions & new facilities -- 2 3 3 1 Relocated into other labs operated by us -- (1) (1) (2) (1) -------- -------- -------- -------- ------- End of period 15 14 15 13 12 ======== ======== ======== ======== ======= Animal hospitals: Beginning of period 209 194 194 168 160 Acquisitions 13 9 24 39 11 Relocated into hospitals operated by us (8) (3) (8) (11) (1) Sold or closed (3) -- (1) (2) (2) -------- -------- -------- -------- ------- End of period 211 200 209 194 168 ======== ======== ======== ======== ======= Owned at end of period 160 150 157 149 145 Managed at end of period 51 50 52 45 23
We were a publicly traded company from 1991 until September 2000, when we completed a recapitalization with an entity controlled by Leonard Green & Partners. The recapitalization was completed in a financial market which we believed did not adequately value companies of our size and type because the market's focus and attention was on technology and internet based companies. Our subsequent performance and the changing market dynamics support the determination by our Board of Directors to re-enter the public sector. The recapitalization was financed by: Page 24 o the contribution of $155.0 million by a group of investors led by Leonard Green & Partners, o borrowings of $250.0 million under a $300.0 million credit facility, o the issuance of an aggregate of $100.0 million of senior notes, and o the issuance of an aggregate of $20.0 million of senior subordinated notes. BASIS OF REPORTING GENERAL We report our operations in three segments: laboratory, animal hospital and corporate. REVENUE RECOGNITION Revenue is recognized only after the following criteria are met: o there exists adequate evidence of the transaction, o delivery of goods has occurred or services have been rendered, and o the price is not contingent on future activity and collectibility is reasonably assured. LABORATORY REVENUE A portion of laboratory revenue is intercompany revenue that was generated by providing laboratory services to our animal hospitals. Laboratory internal revenue growth is calculated using laboratory revenue as reported, adjusted to exclude laboratory revenue of acquired laboratories estimated for the 12 months subsequent to the respective acquisition dates. We estimate our laboratory revenue of acquired laboratories for the 12 months subsequent to the respective acquisition dates based on pre-acquisition historical laboratory revenue information provided to us by the seller increased by our laboratory internal revenue growth rate for the fiscal year prior to acquisition. To determine our laboratory internal revenue growth rate, we compare our laboratory revenue net of laboratory revenue of acquired laboratories to our laboratory revenue as reported for the prior comparable period. We believe this fairly presents our laboratory internal revenue growth for the periods presented, although our calculation may not be comparable to similarly titled measures reported by other companies. ANIMAL HOSPITAL REVENUE Animal hospital revenue is comprised of revenue of the animal hospitals that we own and the management fees of animal hospitals that we manage. Certain states prohibit business corporations from providing or holding themselves out as providers of veterinary medical care. In these states, we enter into arrangements with a veterinary medical group that provides all veterinary medical care, although we manage the administrative functions associated with the operation of the animal hospitals. In return for our services, the veterinary medical group pays us a management fee. We do not consolidate the operations of animal hospitals that we manage. However, for purposes of calculating same-facility revenue growth in our animal hospitals, we use the combined revenue of animal hospitals owned and managed for the entire periods presented. OTHER REVENUE Other revenue is comprised of consulting fees from Heinz Pet Products relating to the marketing of its proprietary pet food. Page 25 DIRECT COSTS Laboratory direct costs are comprised of all costs of laboratory services, including salaries of veterinarians, technicians and other non-administrative, laboratory-based personnel, facilities rent, occupancy costs and supply costs. Animal hospital direct costs are comprised of all costs of services and products at the hospitals, including salaries of veterinarians, technicians and all other hospital-based personnel employed by the hospitals we own, facilities rent, occupancy costs, supply costs and costs of goods sold associated with the retail sales of pet food and pet supplies. SELLING, GENERAL AND ADMINISTRATIVE Our selling, general and administrative expense is divided between our laboratory, animal hospital and corporate segments. Laboratory selling, general and administrative expense consists primarily of sales and administrative personnel and selling, marketing and promotional expense. Animal hospital selling, general and administrative expense consists primarily of field management and administrative personnel, recruiting and marketing expense. Corporate selling, general and administrative expense consists of administrative expense at our headquarters, including the salaries of corporate officers, professional expense, rent and occupancy costs. EBITDA EBITDA is operating income (loss) before depreciation and amortization. Adjusted EBITDA represents EBITDA adjusted to exclude management fees paid pursuant to our management services agreement, recapitalization costs, Year 2000 remediation expense and other non-cash operating items. Corporate EBITDA is comprised of other revenue less corporate selling, general and administrative expense. EBITDA and Adjusted EBITDA are not measures of financial performance under generally accepted accounting principles, or GAAP. Although EBITDA and Adjusted EBITDA should not 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 understand that EBITDA and Adjusted EBITDA are widely used by financial analysts as a measure of financial performance. Our calculation of EBITDA and Adjusted EBITDA may not be comparable to similarly titled measures reported by other companies. RESULTS OF OPERATIONS The following table sets forth components of our statements of operations data expressed as a percentage of revenue for the indicated periods:
Six Months Ended June 30, Year Ended December 31, ------------------------- -------------------------------- 2001 2000 2000 1999 1998 -------- -------- -------- -------- -------- Revenue: Laboratory 33.7% 34.3% 33.6% 32.2% 32.0% Animal hospital 67.6 67.3 67.8 68.0 68.3 Other 0.5 0.2 0.3 1.6 1.8 Intercompany (1.8) (1.8) (1.7) (1.8) (2.1) -------- -------- -------- -------- -------- Total revenue 100.0 100.0 100.0 100.0 100.0 Direct costs 69.9 71.4 71.8 72.5 74.5 -------- -------- -------- -------- -------- 30.1 28.6 28.2 27.5 25.5 Selling, general and administrative 7.8 7.6 7.6 7.4 7.0 Depreciation and amortization 6.2 4.9 5.4 5.1 4.7 Recapitalization costs -- -- 9.8 -- -- Year 2000 remediation expense -- -- -- 0.9 -- Other non-cash operating items 4.6 -- -- (0.6) -- -------- -------- -------- -------- -------- Operating income 11.5 16.1 5.4 14.7 13.8 Interest expense, net 10.9 2.6 5.6 2.9 3.1 Other (income) expense 0.0 (1.8) 0.5 -- -- Minority interest 0.4 0.3 0.3 0.3 0.3 Income tax provision 1.7 6.6 0.6 4.5 4.6 Extraordinary loss on early extinguishment of debt -- -- 0.8 -- -- -------- -------- -------- -------- -------- Net income (loss) (1.5)% 8.4% (2.4)% 7.0% 5.8% ======== ======== ======== ======== ========
Page 26 SIX MONTHS ENDED JUNE 30, 2001 AND 2000 REVENUE The following table summarizes our revenue for the six months ended June 30, 2001 and 2000 (dollars in thousands, unaudited):
Percentage 2001 2000 Change ----------- ---------- ---------- Laboratory $ 68,384 $ 60,726 12.6% Animal hospital 137,134 119,267 15.0% Other 1,000 425 Intercompany (3,789) (3,133) ----------- ---------- Total revenue $ 202,729 $ 177,285 14.4% =========== ==========
LABORATORY REVENUE Laboratory revenue increased $7.7 million, or 12.6%, for the six months ended June 30, 2001 compared to the six months ended June 30, 2000. The increase primarily was due to internal growth of 12.0%, which resulted from an increase in the overall number of tests and requisitions and an increase in the average revenue per requisition. These increases primarily were due to the continued emphasis on selling our pet health and wellness programs and the implementation of a price increase for most tests in February 2001. ANIMAL HOSPITAL REVENUE The following table summarizes our animal hospital revenue as reported and the combined revenue of animal hospitals that we owned and managed had we consolidated the operating results of the animal hospitals we manage into our operating results for the six months ended June 30, 2001 and 2000 (dollars in thousands, unaudited):
Percentage 2001 2000 Change ----------- ---------- ---------- Animal hospital revenue as reported $ 137,134 $ 119,267 15.0% Less: Management fees paid to us by veterinary medical groups (18,961) (15,318) Add: Revenue of animal hospitals managed 34,999 29,268 ----------- ---------- Combined revenue of animal hospitals owned and managed $ 153,172 $ 133,217 15.0% =========== ===========
Animal hospital revenue as reported increased $17.9 million, or 15.0%, for the six months ended June 30, 2001 compared to the six months ended June 30, 2000. The increase in animal hospital revenue as reported during this period resulted primarily from the net addition of 11 animal hospitals that we owned or managed subsequent to June 30, 2000. The increase also was due to same-facility revenue growth of 5.5% for the six months ended June 30, 2001. Same-facility revenue growth primarily was due to an increase in the average amount spent per visit and revenue generated by customers referred from our relocated animal hospitals. OTHER REVENUE Other revenue increased $575,000 for the six months ended June 30, 2001 compared to the six months ended June 30, 2000. Our consulting agreement with Heinz Pet Products expired February 1, 2000. Under this agreement, we had received monthly consulting fees of $425,000. We entered into a new agreement with Heinz Pet Products effective October 1, 2000, which provides for monthly consulting fees of $167,000 over a term of 24 months. Consequently, for the six months ended June 30, 2001, other revenue includes consulting fees for six months as compared to one month for the period ended June 30, 2000. Page 27 DIRECT COSTS The following table summarizes our direct costs and our direct costs as a percentage of applicable revenue for the six months ended June 30, 2001 and 2000 (dollars in thousands, unaudited):
2001 2000 ------------------ ------------------ % of % of Percentage $ Revenue $ Revenue Change ---------- ------- ---------- ------- ----------- Laboratory $ 40,356 59.0% $ 36,063 59.4% 11.9% Animal hospital 105,077 76.6% 93,587 78.5% 12.3% ---------- ---------- 145,433 129,650 12.2% Other -- -- Intercompany (3,789) (3,133) 20.9% ---------- ---------- Total direct costs $ 141,644 69.9% $ 126,517 71.4% 12.0% ========== ==========
LABORATORY DIRECT COSTS Laboratory direct costs increased $4.3 million, or 11.9%, for the six months ended June 30, 2001 compared to the six months ended June 30, 2000. Laboratory direct costs as a percentage of laboratory revenue decreased to 59.0% for the six months ended June 30, 2001 from 59.4% for the six months ended June 30, 2000. The decrease in laboratory direct costs as a percentage of laboratory revenue during this period primarily was attributable to the increase in laboratory revenue combined with the operating leverage associated with the laboratory business, as a majority of the costs associated with the laboratory business are relatively fixed and the remaining costs do not increase proportionately with an increase in volume of tests. ANIMAL HOSPITAL DIRECT COSTS The following table summarizes our animal hospital direct costs as reported and the combined direct costs of animal hospitals that we owned and managed had we consolidated the operating results of the animal hospitals we manage into our operating results for the six months ended June 30, 2001 and 2000 (dollars in thousands, unaudited):
% of % of Combined Combined Percentage 2001 Revenue 2000 Revenue Change --------- -------- -------- -------- ---------- Animal hospital direct costs as reported $105,077 76.6% $93,587 78.5% 12.3% Add: Direct costs of animal hospitals managed 34,999 29,268 Less: Management fees charged by us to veterinary medical groups (18,961) (15,318) Combined direct costs of animal hospitals owned and managed $121,115 79.1% $107,537 80.7% 12.6% ========= =========
Animal hospital direct costs increased $11.5 million, or 12.3%, for the six months ended June 30, 2001 compared to the six months ended June 30, 2000. Animal hospital direct costs as a percentage of animal hospital revenue decreased to 76.6% for the six months ended June 30, 2001 from 78.5% for the six months ended June 30, 2000. The decrease in animal hospital direct costs as a percentage of animal hospital revenue during this period primarily was attributable to the increase in animal hospital revenue combined with the operating leverage Page 28 associated with the animal hospital business, as most of the costs associated with this business do not increase proportionately with increases in the volume of services rendered. SELLING, GENERAL AND ADMINISTRATIVE The following table summarizes our selling, general and administrative expense and our selling, general and administrative expense as a percentage of applicable revenue for the six months ended June 30, 2001 and 2000 (dollars in thousands, unaudited):
2001 2000 ------------------ ------------------ % of % of Percentage $ Revenue $ Revenue Change --------- ------- -------- ------- ---------- Laboratory $ 4,285 6.3% $ 3,984 6.6% 7.6% Animal hospital 4,557 3.3% 4,612 3.9% (1.2)% Corporate 6,973 3.4% 4,966 2.8% 40.4% ---------- -------- Total selling, general and administrative $ 15,815 7.8% $ 13,562 7.6% 16.6% ========== =========
LABORATORY SELLING, GENERAL AND ADMINISTRATIVE Laboratory selling, general and administrative expense increased $301,000, or 7.6%, for the six months ended June 30, 2001 compared to the six months ended June 30, 2000. The increase primarily was due to an increase in commission payments to sales representatives, which was caused by an increase in sales. Laboratory selling, general and administrative expense as a percentage of laboratory revenue was 6.3% for the six months ended June 30, 2001, compared to 6.6% for the six months ended June 30, 2000. ANIMAL HOSPITAL SELLING, GENERAL AND ADMINISTRATIVE Animal hospital selling, general and administrative expense decreased $55,000, or 1.2%, for the six months ended June 30, 2001 compared to the six months ended June 30, 2000. The decrease in animal hospital selling, general and administrative expense primarily was due to a decrease in travel and related expenses. Animal hospital selling, general and administrative expense as a percentage of animal hospital revenue was 3.3% for the six months ended June 30, 2001 compared to 3.9% for the six months ended June 30, 2000. The decrease in animal hospital selling, general and administrative expense as a percentage of animal hospital revenue primarily was due to operating efficiencies associated with our infrastructure. CORPORATE SELLING, GENERAL AND ADMINISTRATIVE Corporate selling, general and administrative expense increased $2.0 million, or 40.4%, for the six months ended June 30, 2001 compared to the six months ended June 30, 2000. Corporate selling, general and administrative expense as a percentage of total revenue was 3.4% for the six months ended June 30, 2001 compared to 2.8% for the six months ended June 30, 2000. The increase in corporate selling, general and administrative expense primarily was the result of management fees of $1.2 million for the six months ended June 30, 2001 paid pursuant to our management services agreement, dated as of September 20, 2000. For a description of the management services agreement, see "Related Party Transactions - Management Services Agreement." Excluding the management fees, corporate selling, general and administrative expense increased 15.4% for the six months ended June 30, 2001 compared to the comparable prior period and represented 2.8% of total revenue for the six months ended June 30, 2001. Page 29 ADJUSTED EBITDA The following table summarizes our Adjusted EBITDA and our Adjusted EBITDA as a percentage of applicable revenue for the six months ended June 30, 2001 and 2000 (dollars in thousands, unaudited):
2001 2000 ------------------ ------------------ % of % of Percentage $ Revenue $ Revenue Change -------- ------- -------- ------- ----------- Laboratory $23,743 34.7% $20,679 34.1% 14.8% Animal hospital 27,500 20.1% 21,068 17.7% 30.5% Corporate (4,733) (4,541) -------- -------- Total Adjusted EBITDA $46,510 22.9% $37,206 21.0% 25.0% ======== ========
DEPRECIATION AND AMORTIZATION Depreciation and amortization expense increased $4.1 million, or 47.4%, for the six months ended June 30, 2001 compared to the six months ended June 30, 2000. The increase in depreciation and amortization expense primarily was due to the amortization over a three-year period of $15.6 million paid to our executives pursuant to non-competition agreements entered into in September 2000, the purchase of property and equipment and the acquisition of animal hospitals. OTHER NON-CASH OPERATING ITEMS Other non-cash operating items for the six months ended June 30, 2001 consisted of an $8.8 million write-down and loss on sale of assets and $382,000 of stock-based compensation expense. The write-down of assets was attributable to the relocation of five of our animal hospitals into existing animal hospitals we operated, the determination that goodwill was impaired at one of our existing animal hospitals and the write-down of real property available for sale to fair market value. The stock-based compensation expense resulted from the effect of the increase in the fair market value of our common stock on our stock options with variable accounting treatment during the six months ended June 30, 2001. NET INTEREST EXPENSE Net interest expense increased $17.4 million, or 369.6%, to $22.1 million for the six months ended June 30, 2001 from $4.7 million for the six months ended June 30, 2000. The increase in net interest expense primarily was due to debt we incurred in connection with our recapitalization. OTHER (INCOME) EXPENSE Other expense was $229,000 for the six months ended June 30, 2001 and consisted of a non-cash loss on a hedging instrument, pertaining to the changes in the time value of our collar agreement. Other income was $3.2 million for the six months ended June 30, 2000 and consisted of the gain on sale of our investment in Veterinary Pet Insurance, Inc. INCOME TAXES Provision for income taxes was $3.5 million and $11.8 million for the six months ended June 30, 2001 and 2000. The effective income tax rate for the six months ended June 30, 2001 was higher than the statutory rate primarily due to the non-deductibility for income tax purposes of the amortization of a portion of goodwill, the write-down of assets and the stock-based compensation expense. Page 30 MINORITY INTEREST Minority interest in income of our consolidated subsidiaries was $700,000 and $515,000 for the six months ended June 30, 2001 and 2000, respectively. Minority interest in income represents our partners' proportionate share of net income generated by our subsidiaries that we do not wholly own. INCREASE IN CARRYING AMOUNT OF REDEEMABLE PREFERRED STOCK The holders of our series A preferred stock and our series B preferred stock are entitled to receive dividends at a rate of 14% and 12%, respectively. We are not required to pay these dividends in cash. The dividends that are not paid in cash compound quarterly. The dividends earned in the six months ended June 30, 2001 have been added to the principal balance of the preferred stock. YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 REVENUE The following table summarizes our revenue for the years ended December 31, 2000, 1999 and 1998 (dollars in thousands):
Percentage Change 2000 1999 1998 2000 1999 ---------- ---------- ---------- -------- ------- Laboratory $ 119,300 $ 103,282 $ 89,896 15.5% 14.9% Animal hospital 240,624 217,988 191,888 10.4% 13.6% Other 925 5,100 5,100 Intercompany (6,162) (5,810) (5,845) ---------- ---------- ---------- Total revenue $ 354,687 $ 320,560 $ 281,039 10.6% 14.1% ========== ========== ==========
LABORATORY REVENUE Laboratory revenue increased $16.0 million, or 15.5%, for the year ended December 31, 2000 compared to the year ended December 31, 1999, which increased $13.4 million, or 14.9%, compared to the year ended December 31, 1998. The increase in laboratory revenue for the year ended December 31, 2000 compared to the comparable prior period primarily was due to internal growth of 13.5%. This internal laboratory revenue growth resulted primarily from an increase in the overall number of tests and requisitions and an increase in the average revenue per requisition. These increases primarily were due to the development and sale of new programs, the implementation of a price increase for most tests in February 2000 and the continued growth of our Test Express business. The increase in laboratory revenue for the year ended December 31, 1999 compared to the comparable prior period primarily was due to internal growth of 10.9%. This internal laboratory revenue growth resulted primarily from an increase in the overall number of tests due in part to the development of our Test Express business. ANIMAL HOSPITAL REVENUE The following table summarizes our animal hospital revenue as reported and the combined revenue of animal hospitals that we owned and managed had we consolidated the operating results of the animal hospitals we manage into our operating results for the years ended December 31, 2000, 1999 and 1998 (dollars in thousands): Page 31
Percentage Change ----------------- 2000 1999 1998 2000 1999 ---------- ---------- ---------- -------- ------- Animal hospital revenue $ 240,624 $ 217,988 $ 191,888 10.4% 13.6% as reported Less: Management fees paid to us by veterinary medical groups (31,133) (30,202) (19,325) Add: Revenue of animal hospitals managed 60,380 42,829 24,914 ---------- ---------- ---------- Combined revenue of animal hospitals owned and managed $ 269,871 $ 230,615 $ 197,477 17.0% 16.8% ========== ========== ==========
Animal hospital revenue increased $22.6 million, or 10.4%, for the year ended December 31, 2000 compared to the year ended December 31, 1999, which increased $26.1 million, or 13.6%, compared to the year ended December 31, 1998. The increase in animal hospital revenue for the year ended December 31, 2000 as compared to the comparable prior period resulted primarily from the net addition of 15 animal hospitals that we owned or managed subsequent to December 31, 1999. Similarly, the increase for the year ended December 31, 1999 as compared to the comparable prior period resulted primarily from the net addition of 26 animal hospitals that we owned or managed subsequent to December 31, 1998. The increase in animal hospital revenue for the year ended December 31, 2000 also was due to same-facility revenue growth of 7.0%, and the increase in animal hospital revenue for the year ended December 31, 1999 also was due to same-facility revenue growth of 2.6%. Same-facility revenue growth in both years primarily was due to increases in the average amount spent per visit and revenue generated by customers referred from our relocated animal hospitals. OTHER REVENUE Other revenue decreased $4.2 million for the year ended December 31, 2000 compared to each of the years ended December 31, 1999 and 1998. Our consulting agreement with Heinz Pet Products expired February 1, 2000. Under this agreement we had received monthly consulting fees of $425,000. We entered into a new agreement with Heinz Pet Products effective October 1, 2000 which provides for monthly consulting fees of $167,000 over a term of 24 months. Consequently, for the year ended December 31, 2000, other revenue includes consulting fees for an aggregate of four months as compared to the entire periods in each of the years ended December 31, 1999 and 1998. DIRECT COSTS The following table summarizes our direct costs and our direct costs as a percentage of applicable revenue for the years ended December 31, 2000, 1999 and 1998 (dollars in thousands):
2000 1999 1998 Percentage Change ------------------ ---------------- ----------------- ------------------ % of % of % of $ Revenue $ Revenue $ Revenue 2000 1999 -------- ------- -------- ------- -------- ------- ------- ------- Laboratory $ 72,559 60.8% $ 64,234 62.2% $ 60,206 67.0% 13.0% 6.7% Animal hospital 188,390 78.3% 174,069 79.9% 155,019 80.8% 8.2% 12.3% -------- --------- --------- 260,949 238,303 215,225 9.5% 10.7% Other -- -- -- Intercompany (6,162) (5,810) (5,845) 6.1% (0.6)% -------- --------- --------- Total direct costs $254,787 71.8% $232,493 72.5% $209,380 74.5% 9.6% 11.0% ========= ========= =========
LABORATORY DIRECT COSTS Laboratory direct costs increased $8.3 million, or 13.0%, for the year ended December 31, 2000 compared to the year ended December 31, 1999, which increased $4.0 million, or 6.7%, compared to the year ended December 31, 1998. Laboratory direct costs as a percentage of laboratory revenue decreased to 60.8% for the year ended December 31, 2000 from 62.2% for the year ended December 31, 1999, which decreased from 67.0% for the year ended December 31, 1998. The decreases in laboratory direct costs as a percentage of laboratory revenue during these periods primarily were attributable to increases in laboratory revenue combined with operating leverage associated with our laboratory business. Page 32 ANIMAL HOSPITAL DIRECT COSTS The following table summarizes our animal hospital direct costs as reported and the combined direct costs of animal hospitals owned and managed had we consolidated the operating results of the animal hospitals we manage into our operating results for the years ended December 31, 2000, 1999 and 1998 (dollars in thousands):
% of % of % of Percentage Combined Combined Combined Change 2000 Revenue 1999 Revenue 1998 Revenue 2000 1999 --------- -------- --------- -------- --------- -------- ------ ------ Animal hospital direct costs as reported.............. $ 188,390 78.3% $ 174,069 79.9% $ 155,019 80.8% 8.2% 12.3% Add: Direct costs of animal hospitals managed....... 60,380 42,829 24,914 Less: Management fees charged by us to veterinary medical groups................. (31,133) (30,202) (19,325) ---------- ---------- ---------- Combined direct costs of animal hospitals owned and managed........................ $ 217,637 80.6% $ 186,696 81.0% $ 160,608 81.3% 16.6% 16.2% ========== ========== ==========
Animal hospital direct costs increased $14.3 million, or 8.2%, for the year ended December 31, 2000 compared to the year ended December 31, 1999, which increased $19.1 million, or 12.3%, compared to the year ended December 31, 1998. Animal hospital direct costs as a percentage of animal hospital revenue decreased to 78.3% for the year ended December 31, 2000 from 79.9% for the year ended December 31, 1999, which decreased from 80.8% for the year ended December 31, 1998. The decreases in animal hospital direct costs as a percentage of animal hospital revenue during these periods primarily were due to a reduction in some of our obligations to the animal hospitals we manage which reduced our costs, together with a corresponding reduction in our management fees. These decreases also were attributable to the increase in revenue combined with the operating leverage associated with the animal hospital business, as most of the costs associated with this business do not increase proportionately with increases in the volume of services rendered. Page 33 SELLING, GENERAL AND ADMINISTRATIVE The following table summarizes our selling, general and our administrative expense and expense as a percentage of applicable revenue for the years ended December 31, 2000, 1999 and 1998 (dollars in thousands):
2000 1999 1998 Percentage Change ------------------ ------------------- ------------------ ----------------- % of % of % of $ Revenue $ Revenue $ Revenue 2000 1999 --------- ------- --------- ------- -------- ------- ------- ------- Laboratory $ 7,914 6.6% $ 6,775 6.6% $ 5,475 6.1% 16.8% 23.7% Animal hospital 9,249 3.8% 6,682 3.1% 4,894 2.6% 38.4% 36.5% Corporate 9,831 2.8% 10,165 3.2% 9,324 3.3% (3.3)% 9.0% Total selling, general and administrative $ 26,994 7.6% $ 23,622 7.4% $ 19,693 7.0% 14.3% 20.0% ========== ========== ========
LABORATORY SELLING, GENERAL AND ADMINISTRATIVE Laboratory selling, general and administrative expense for the year ended December 31, 2000 increased $1.1 million, or 16.8%, compared to the year ended December 31, 1999, which increased $1.3 million, or 23.7%, compared to the year ended December 31, 1998. The increase in laboratory selling, general and administrative expense for the year ended December 31, 2000 compared to the comparable prior period primarily was due to an increase in commission payments to sales representatives, which was caused by an increase in sales, and salaries attributable to new sales representatives. The increase in laboratory selling, general and administrative expense for the year ended December 31, 1999 compared to the comparable prior period primarily was due to centralizing certain administrative functions that previously were handled by and charged as a direct cost to the individual laboratories. ANIMAL HOSPITAL SELLING, GENERAL AND ADMINISTRATIVE Animal hospital selling, general and administrative expense for the year ended December 31, 2000 increased $2.6 million, or 38.4%, compared to the year ended December 31, 1999, which increased $1.8 million, or 36.5%, compared to the year ended December 31, 1998. The increases in animal hospital selling, general and administrative expense for the years ended December 31, 2000 and 1999 primarily were attributable to salaries associated with new personnel hired in connection with the expansion of our management and administrative infrastructure to support the additional number of animal hospitals we owned and managed. The increases in animal hospital selling, general and administrative expense as a percentage of animal hospital revenue in the years ended December 31, 2000 and 1999 primarily were due to increases in the expense associated with our management and administrative infrastructure without a proportionate increase in animal hospital revenue. CORPORATE SELLING, GENERAL AND ADMINISTRATIVE Corporate selling, general and administrative expense for the year ended December 31, 2000 decreased $334,000, or 3.3%, compared to the year ended December 31, 1999, which increased $841,000, or 9.0%, compared to the year ended December 31, 1998. The decrease in corporate selling, general and administrative expense for the year ended December 31, 2000 compared to the comparable prior period primarily due to efficiencies realized in our information systems, accounting and finance departments that resulted from our systems upgrade. The increase in corporate selling, general and administrative expense for the year ended December 31, 1999 compared to the comparable prior period primarily was due to the expansion of our information systems and accounting departments. Page 34 ADJUSTED EBITDA The following table summarizes our Adjusted EBITDA and our Adjusted EBITDA as a percentage of applicable revenue of the years ended December 31, 2000, 1999 and 1998 (dollars in thousands):
2000 1999 1998 Percentage Change ---------------- ---------------- ---------------- ----------------------- % of % of % of $ Revenue $ Revenue $ Revenue 2000 1999 -------- ------- -------- ------- -------- ------- --------- ----------- Laboratory $38,827 32.5% $32,273 31.2% $24,215 26.9% 20.3% 33.3% Animal hospital 42,985 17.9% 37,237 17.1% 31,975 16.7% 15.4% 16.5% Corporate (8,286) (5,065) (4,224) --------- --------- --------- Total Adjusted EBITDA $73,526 20.7% $64,445 20.1% $51,966 18.5% 14.1% 24.0% ========= ========= =========
DEPRECIATION AND AMORTIZATION Depreciation and amortization expense increased $2.4 million, or 14.7%, for the year ended December 31, 2000 compared to the year ended December 31, 1999, which increased $3.3 million, or 25.4%, compared to the year ended December 31, 1998. The increases in depreciation and amortization expense primarily were due to the amortization over a three-year period of $15.6 million paid to our executives pursuant to non-competition agreements entered into in September 2000, the purchase of property and equipment and the acquisition of animal hospitals and diagnostic laboratories. RECAPITALIZATION COSTS We incurred $34.8 million of recapitalization costs for the year ended December 31, 2000 pertaining to our recapitalization in September 2000. These costs consisted of $24.1 million associated with the buy-out of stock options held by employees, $1.2 million paid to our employees for services rendered in connection with our recapitalization, $7.6 million of professional fees and $1.9 million of other expenses. OTHER NON-CASH OPERATING ITEMS Other non-cash operating items for the year ended December 31, 1999 consisted of a $1.9 million reversal of restructuring charges pertaining to our 1996 and 1997 restructuring plans. NET INTEREST EXPENSE Net interest expense increased $10.4 million, or 110.5% to $19.9 million for the year ended December 31, 2000 from $9.4 million for the year ended December 31, 1999, which represented an increase of $617,000, or 7.0%, from $8.8 million for the year ended December 31, 1998. The increase in net interest expense in 2000 primarily was due to debt we incurred in connection with the recapitalization. OTHER (INCOME) EXPENSE Other (income) expense was $1.8 million for the year ended December 31, 2000, consisting of a $3.2 million gain on sale of our investment in Veterinary Pet Insurance, Inc. and a $5.0 million loss resulting from the write-down of our investment in Zoasis.com, Inc. INCOME TAXES Provision for income taxes was $2.2 million, $14.4 million and $13.0 million for the years ended December 31, 2000, 1999 and 1998. Our effective income tax rate for each year was higher than the statutory rate primarily due to the non-deductibility for income tax purposes of the amortization of a portion of goodwill. In 2000, our effective income tax rate also was impacted by the change in valuation allowance associated with our recapitalization and our write-down of the Zoasis investment. As a result of a favorable change in the U.S. tax Page 35 regulations with respect to limitations on the use of net operating loss carryforwards, we recorded a deferred tax benefit of $2.1 million in 1999. MINORITY INTEREST Minority interest in income of the consolidated subsidiaries was $1.1 million, $850,000 and $780,000 for the years ended December 31, 2000, 1999 and 1998, respectively. Minority interest in income represents our partners' proportionate share of net income generated by our subsidiaries that we do not wholly own. INCREASE IN CARRYING AMOUNT OF REDEEMABLE PREFERRED STOCK The holders of our series A preferred stock and our series B preferred stock are entitled to receive dividends at a rate of 14% and 12%, respectively. We are not required to pay these dividends in cash. The dividends that are not paid in cash compound quarterly. The dividends earned from September 20, 2000 through December 31, 2000 were added to the principal balance of the preferred stock. QUARTERLY RESULTS The following tables set forth selected unaudited quarterly results for the ten quarters commencing January 1, 1999 and ending June 30, 2001. The quarterly financial data as of each period presented below have been derived from our unaudited consolidated financial statements for those periods. Results for these periods are not necessarily indicative of results for the full year. The quarterly financial data should be read in conjunction with this Management's Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements and related notes included elsewhere in this prospectus.
2001 Quarter Ended, 2000 Quarter Ended, 1999 Quarter Ended, ------------------- ----------------------------------------- ----------------------------------------- June 30 March 31 Dec. 31 Sept. 30 June 30 March 31 Dec. 31 Sept. 30 June 30 March 31 -------- --------- -------- --------- --------- --------- --------- --------- -------- --------- (dollars in thousands, except per share amounts, unaudited) Revenue: Laboratory $ 35,707 $ 32,677 $ 28,469 $ 30,105 $ 31,921 $ 28,805 $ 24,846 $ 25,591 $ 27,276 $ 25,569 Animal hospital 72,780 64,354 57,908 63,449 63,472 55,795 52,228 58,150 59,159 48,451 Other 500 500 500 -- -- 425 1,275 1,275 1,275 1,275 Intercompany (1,938) (1,851) (1,471) (1,558) (1,459) (1,674) (1,381) (1,426) (1,546) (1,457) -------- --------- -------- --------- --------- --------- --------- --------- -------- --------- Total revenue 107,049 95,680 85,406 91,996 93,934 83,351 76,968 83,590 86,164 73,838 Direct costs 72,747 68,897 63,511 64,759 65,368 61,149 57,114 60,006 60,460 54,913 Adjusted EBITDA 27,186 19,324 15,986 20,334 21,980 15,226 13,794 17,663 19,949 13,039 Operating income (loss) 11,055 12,307 9,765 (19,159) 17,524 11,075 10,512 12,414 14,915 9,175 Net income (loss) (3,158) 55 944 (24,183) 8,436 6,392 4,305 7,462 6,890 3,700 Diluted EPS $ (0.48) $ (0.28) $ (0.22) $ (0.09) $ 0.02 $ 0.02 $ 0.01 $ 0.02 $ 0.02 0.01
2001 Quarter Ended, 2000 Quarter Ended, 1999 Quarter Ended, ------------------- ----------------------------------------- ----------------------------------------- June 30 March 31 Dec. 31 Sept. 30 June 30 March 31 Dec. 31 Sept. 30 June 30 March 31 -------- --------- -------- --------- --------- --------- --------- --------- -------- --------- (dollars in thousands, except per share amounts, unaudited) Revenue: Laboratory 33.3% 34.1% 33.3% 32.7% 34.0% 34.6% 32.2% 30.6% 31.6% 34.7% Animal hospital 68.0% 67.3% 67.8% 69.0% 67.6% 66.9% 67.9% 69.6% 68.7% 65.6% Other 0.5% 0.5% 0.6% -- -- 0.5% 1.7% 1.5% 1.5% 1.7% Intercompany (1.8)% (1.9)% (1.7)% (1.7)% (1.6)% (2.0)% (1.8)% (1.7)% (1.8)% (2.0)% -------- --------- -------- --------- --------- --------- --------- --------- -------- --------- Total revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Direct costs 68.0% 72.0% 74.4% 70.4% 69.6% 73.4% 74.2% 71.8% 70.2% 74.4% Adjusted EBITDA 25.4% 20.2% 18.7% 22.1% 23.4% 18.3% 17.9% 21.1% 23.2% 17.7% Operating income (loss) 10.3% 12.9% 11.4% (20.8)% 18.7% 13.3% 13.7% 14.9% 17.3% 12.4% Net income (loss) (3.0)% 0.1% 1.1% (26.3)% 9.0% 7.7% 5.6% 8.9% 8.0% 5.0%
Although not readily detectable because of the impact of acquisitions, our operations are subject to seasonal fluctuation. In particular, our revenue historically has been greater in the second and third quarters than in the first and fourth quarters. The demand for our veterinary services are significantly higher during 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, heartworms and Page 36 ticks and the number of daylight hours. A substantial portion of our costs are fixed and do not vary with the level of demand. Consequently, our EBITDA, Adjusted EBITDA and operating income, as well as our EBITDA, Adjusted EBITDA and operating margins, generally have been higher for the second and third quarters than that experienced in the first and fourth quarters. LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operations for the six months ended June 30, 2001 and 2000 was $32.6 million and $26.5 million, and for the years ended December 31, 2000, 1999 and 1998 was $60.1 million, $38.5 million and $27.1 million. The increases are primarily attributable to increases in revenue and operating margins. Net cash used by investing activities for the six months ended June 30, 2001 was $20.1 million, and for the years ended December 31, 2000, 1999 and 1998 was $47.7 million, $13.7 million and $19.5 million. In the six months ended June 30, 2001, and in the years ended December 31, 2000, 1999 and 1998, we used cash of $7.0 million, $22.6 million, $21.8 million and $11.7 million for property and equipment additions. In these same periods, we used $13.5 million to acquire 13 animal hospitals, $18.2 million to acquire 24 animal hospitals and one laboratory, $16.1 million to acquire 39 animal hospitals and two laboratories and $17.1 million to acquire 11 animal hospitals and one laboratory. In the six months ended June 30, 2001, we did not purchase any properties in connection with our acquisitions and in the years ended December 31, 2000, 1999 and 1998, we used $1.8 million, $4.2 million and $4.3 million to purchase real estate in connection with our acquisitions. In connection with the recapitalization transaction, we received $149.2 million from the issuance of preferred stock, $14.4 million from the issuance of common stock, $1.1 million from the issuance of stock warrants and $356.7 million from the issuance of long-term debt. These proceeds were primarily used to repay long-term obligations in the amount of $172.9 million, to repurchase common stock in the amount of $314.5 million and to make non-competition payments in the aggregate amount of $15.6 million to four of our executive officers including: Robert L. Antin, our Chief Executive Officer, President and founder; Arthur J. Antin, our Chief Operating Officer, Senior Vice President and founder; and Neil Tauber, our Senior Vice President of Development and founder; and Tomas W. Fuller, our Chief Financial Officer. For a description of these non-competition agreements, see "Related Party Transactions - Non-Competition Agreements." For the year ended December 31, 1999 and 1998, cash used in financing activities was $23.1 million and $18.6 million in each year primarily for repayment of long term debt. At June 30, 2001, we had cash and cash equivalents of $19.2 million and indebtedness of $368.1 million. The aggregate maturities of principal of our debt obligations for 2001 is $5.8 million. We intend to continue our growth through the selective acquisition of animal hospitals primarily for cash. We anticipate acquiring additional animal hospitals in 2001. As of June 30, 2001, under our credit facility, we may spend $11.0 million for additional acquisitions in 2001. In the second half of 2001, we will pay approximately $822,000 related to acquisition costs on completed acquisitions and we expect to spend approximately $12.0 million for additions to property and equipment. We continue to examine acquisition opportunities in the laboratory field, which may impose additional cash requirements. We review the financial performance of our animal hospitals each year in conjunction with our annual budgeting process, or if there occur unfavorable events in regard to a particular facility. The review process involves an assessment of both financial performance and relevant operational factors including, but not limited to, staffing, capacity and local economy. The cash costs we typically incur to sell or close are not significant. However, we may incur non-cash operating costs consisting primarily of the write-down of some of our assets, including real estate, leasehold improvements and covenants not to compete, to fair market value. We believe we will be able to fund our future cash requirements for operations primarily from operating cash flows, cash on hand and, if needed, borrowings under the $50.0 million revolving credit facility, which we have not yet utilized as of June 30, 2001. We believe these sources of funds will be sufficient to continue our operations and planned capital expenditures and satisfy our scheduled principal and interest payments under debt and capital lease obligations for at least the next 12 months. However, a significant portion of our cash requirements will be determined by the pace and size of our acquisitions. Page 37 DESCRIPTION OF INDEBTEDNESS CREDIT FACILITY We, through our wholly owned subsidiary, have a $300.0 million credit facility, dated as of September 20, 2000, with the lenders party thereto, Goldman Sachs Credit Partners, L.P., as syndication agent, and Wells Fargo Bank, N.A., as administrative agent. STRUCTURE. The credit facility consists of a $50.0 million revolving facility, a $50.0 million term loan A facility and a $200.0 million term loan B facility. Under the revolving facility, up to $50.0 million may be used in connection with letters of credit, and the lesser of (1) $5.0 million, or (2) the aggregate unused amount of the revolving facility then in effect may be borrowed under a "swing line" facility on same-day notice to the lenders. As of the date of this prospectus, we have no borrowings under the revolving facility. MATURITY. We are required to repay the amounts borrowed under the term loan A facility in quarterly installments. Quarterly payments equal $250,000 per quarter in year one, $1.5 million per quarter in year two, $1.75 million per quarter in year three, $2 million per quarter in year four, $2.75 million per quarter in year five and $4.25 million per quarter in year six. The term loan A facility matures on September 20, 2006. We are required to repay the amounts borrowed under the term loan B facility in quarterly installments. Quarterly payments equal $625,000 per quarter in years one through six and $23.125 million per quarter in years seven and eight. The term loan B facility matures on September 20, 2008. The entire outstanding principal amount under the revolving facility is due on September 20, 2006. Mandatory prepayments under the term loan facilities are applied pro rata to each required quarterly payment, subject to a lender's ability to waive a term loan B facility payment and have it applied to other facilities. The term facilities and the revolving facility may be voluntarily prepaid in whole or in part without premium or penalty. Since September 20, 2000, quarterly payments have reduced the outstanding principal amount under the credit facility to $49.3 million for the term loan A facility and $198.1 million for the term loan B facility. GUARANTEES AND SECURITY. Our obligations under the credit facility are guaranteed by us and our wholly owned, consolidated subsidiaries. The borrowings under the credit facility and the subsidiary guarantees are secured by substantially all of our consolidated assets. In addition, borrowings under the credit facility are secured by a pledge of substantially all of the capital stock, or similar equity interests, of our wholly owned, consolidated subsidiaries. INTEREST RATE. In general, borrowings under the credit facility bear interest based, at our option, on either: o the base rate (as defined below) plus a margin ranging from 1.00% to 2.25% per annum for the term loan A facility and the revolving facility and a margin of 2.75% per annum for the term loan B facility; or o the adjusted eurodollar rate (as defined below) plus a margin ranging from 2.00% to 3.25% per annum for the term loan A facility and the revolving facility and a margin of 3.75% per annum for the term loan B facility. 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%. COVENANTS. The credit facility contains financial covenants that require us to satisfy, on a consolidated basis, specified quarterly financial tests, including: Page 38 o a minimum consolidated interest expense coverage ratio; o a minimum fixed charge coverage ratio; o a maximum consolidated senior leverage ratio; and o a maximum consolidated total leverage ratio. The credit facility also contains a number of other customary covenants that, among other things, restrict our ability to: o dispose of assets; o incur additional debt; o prepay other debt, subject to specified exceptions, or amend specified debt instruments; o pay dividends; o create liens on assets; o make investments, loans or advances; o make acquisitions; o engage in mergers or consolidations; o change the business conducted by us; o engage in sale and leaseback transactions; o purchase shares of the outstanding common stock of our wholly owned subsidiary; o make capital expenditures or engage in transactions with affiliates; and o otherwise undertake various corporate activities. EVENTS OF DEFAULT. The credit facility also contains customary events of default, including defaults based on: o nonpayment of principal, interest or fees when due, subject to specified grace periods; o cross-defaults to other debt; o breach of specified covenants; o material inaccuracy of representations and warranties; o specified other defaults under other credit documents; Page 39 o events of bankruptcy and insolvency; o material judgments; o dissolution and liquidation; o specified occurrences relating to subordinated debt; o change in control; and o invalidity of any guaranty or security interest. CHANGE OF CONTROL. The change of control provision makes it an event of default, and permits the acceleration of the credit facility debt, in the event that: o specified persons, including Leonard Green & Partners, its affiliated co-investors and management investors, collectively cease to own at least 51% of the voting interests in our capital stock; o another person or group has acquired 35% or more of the voting interests in our capital stock or shall have obtained the power to elect a majority of our board of directors; o Leonard Green & Partners and its affiliated co-investors cease to own voting interests in our capital stock greater than any other person or group; o we cease to beneficially own and control 100% of the capital stock of our wholly owned subsidiary; o the majority of the seats on our board of directors cease to be occupied by persons who either were members of our board of directors as of September 20, 2000 or were nominated for election by our board of directors, a majority of whom were directors on September 20, 2000 or whose election or nomination was previously approved by a majority of such directors; or o a change of control occurs under our senior notes or the notes offered pursuant to the exchange offer. SENIOR SUBORDINATED NOTES On September 20, 2000, we, through our wholly owned subsidiary, issued $20.0 million principal amount of senior subordinated notes due 2010 pursuant to an indenture of the same date with Chase Manhattan Bank and Trust Company, National Association, as trustee. INTEREST RATE. Interest on the senior subordinated notes is payable in cash, semi-annually in arrears, commencing March 31, 2001, at the rate of 13.5% per annum; provided, however, that if we fail timely to meet specific obligations to holders of the senior subordinated notes, interest on the senior subordinated notes may increase by up to 1% per annum. GUARANTEE. The senior subordinated notes are general unsecured and subordinated obligations, and are guaranteed by our wholly owned, consolidated subsidiaries, that mature on September 20, 2010. REDEMPTION. The senior subordinated notes are redeemable at our option, in whole or in part, but each prepayment must relate to an aggregate principal amount of senior subordinated notes of at least $5.0 million, at any time on or after September 20, 2003, initially at 106.75% of their principal amount at maturity and declining in Page 40 annual increments to 101.35% of such principal amount on and after September 20, 2009, in each case plus accrued interest. Additionally, up to 35% of the senior subordinated notes are redeemable at our option but each prepayment must relate to an aggregate principal amount of senior subordinated notes of at least $5.0 million, at any time prior to September 20, 2002 from the proceeds of an equity offering of our common stock at a price of 110% of the principal amount plus accrued interest. If the underwriters exercise their over-allotment option, we intend to use a portion of the net proceeds, to the extent available, to repurchase up to $7.0 million of the outstanding principal amount of the senior subordinated notes. COVENANTS. The indenture contains a number of covenants, including a provision regarding a change of control. The provision defines a change of control event as o the sale, lease, transfer, conveyance or other disposition of substantially all of our assets and our subsidiaries to a person other than specified persons affiliated with Leonard Green & Partners, specified equity investors and management investors; o the adoption of a plan relating to our liquidation or dissolution or the liquidation or dissolution of our wholly owned subsidiary; o the consummation of any transaction as result of which, o prior to the senior subordinated notes being registered or exchanged for registered notes, o specified persons, including Leonard Green & Partners, its affiliated co-investors and management investors, collectively cease to own at least 51% of the voting interests in our capital stock, or o Leonard Green & Partners and its affiliates cease to own voting interests of at least 25% in our capital stock, o we cease to own directly 100% of the outstanding equity of our wholly owned subsidiary or o any person or group other than specified persons affiliated with Leonard Green & Partners, specified equity investors and management investors have acquired beneficial ownership of 35% or more of the aggregate voting interest attributable to all of our outstanding capital stock; or o the first day on which a majority of our board of directors were not directors on September 20, 2000 or whose election or nomination was previously approved by a majority of such directors. In the event of a change of control event, or in the event of specified dispositions of assets by us or our subsidiaries, the proceeds of which are neither used to repay the senior credit facility, the senior subordinated notes or to acquire long term assets, our wholly owned subsidiary is required to offer to repurchase the senior subordinated notes at a purchase price equal to 101% (in the case of a specified change of control) or 100% (in the case of a specified disposition of assets) of the principal amount thereof, in each case plus accrued interest. The indenture governing the senior subordinated notes also contains covenants that restrict the ability of our wholly owned subsidiary and our other indirect wholly owned subsidiaries to: o incur additional debt; Page 41 o incur specified liens on our assets; o pay dividends on stock or repurchase stock; o make investments; o engage in specified transactions with affiliates; o create or permit to exist specified dividend or payment restrictions affecting subsidiaries; o sell assets; o engage in specified sale/lease-back transactions; o sell all or substantially all of their assets or merge with or into other companies; and o engage in business activities unrelated to activities engaged in at the original date of issuance of the senior subordinated notes. EVENTS OF DEFAULT. The indenture governing the senior subordinated notes also provides for various defaults, including o failure to pay interest on the senior subordinated notes when due (after a specified grace period); o failure to pay any principal on the senior subordinated notes when the same becomes due at maturity; o upon redemption or otherwise, failure to observe or perform any other covenant or agreement in the indenture governing the senior subordinated notes where such failure continues for thirty (30) days after actual knowledge thereof by a senior officer; and o failure to pay at final maturity or other default leading to actual acceleration with respect to other indebtedness having an aggregate principal amount of $7.5 million or more. SENIOR NOTES On September 20, 2000, we issued $100.0 million principal amount of senior notes due 2010 pursuant to an indenture of the same date with Chase Manhattan Bank and Trust Company, National Association, as trustee. INTEREST RATE. Interest on the senior notes is payable semi-annually in arrears, commencing March 31, 2001, at the rate of 15.5% per annum; provided that on any semi-annual interest payment date prior to September 20, 2005, we have the option to pay all or any portion of the interest payable on said date by issuing additional senior notes in a principal amount equal to the interest we elect not to pay in cash on such date; and further provided, however, that if we fail timely to meet specified obligations to holders of the senior notes as set forth in an exchange and registration rights agreement dated as of September 20, 2000, interest on the senior notes may increase by up to 1% per annum. GUARANTEE. The senior notes are general unsecured and unsubordinated obligations that mature on September 20, 2010. REDEMPTION. The senior notes are redeemable at our option, in whole or in part, but each prepayment must relate to an aggregate principal amount of senior notes of at least $5.0 million, at any time on or after September 20, Page 42 2003, initially at 107.5% of their principal amount at maturity and declining in annual increments to 101.55% of such principal amount on and after September 20, 2009, in each case plus accrued interest. Additionally, up to 35% of the senior notes are redeemable at our option but each prepayment must relate to an aggregate principal amount of senior notes of at least $5.0 million, at any time prior to September 20, 2002 from the proceeds of an equity offering of our common stock at a price of 110% of the principal amount plus accrued interest. We intend to use $35.0 million of the net proceeds of this offering to reduce the outstanding principal amount of the senior notes to $65.0 million, and, if the underwriters exercise their over-allotment option, any additional net proceeds will be used to repay up to an additional $6.0 million of the principal amount. The senior notes are also subject to partial mandatory redemption, without premium, on any interest payment date occurring after September 20, 2005, in an aggregate amount equal to the difference, if any, between o the aggregate amount which would be includable in the holders' gross income for federal income tax purposes with respect to the senior notes before such interest payment date, and o the sum of the following: o the aggregate amount of interest paid in cash under the senior notes before such interest payment date, and o the product of the issue price of all of the senior notes (as determined under United States Treasury Regulations Sections 1.1273-2(a)) multiplied by 17.25%. Any such partial mandatory redemption has been expressly subordinated in time and right of payment by the holders of the senior notes to the prior payment in full of all obligations under the credit facility, as it may be supplemented, replaced, restructured, refinanced or otherwise modified from time to time. COVENANTS. The indenture contains a number of covenants, including a provision regarding a change of control. The provision defines a change of control event as o the sale, lease, transfer, conveyance or other disposition of substantially all of our assets and our subsidiaries to a person other than persons affiliated with Leonard Green & Partners, specified equity investors and management investors; o the adoption of a plan relating to our liquidation or dissolution or the liquidation or dissolution of our wholly owned subsidiary; o the consummation of any transaction as result of which, o prior to the senior notes being registered or exchanged for registered notes, o persons, including Leonard Green & Partners, its affiliated co-investors and management investors, collectively cease to own at least 51% of the voting interests in our capital stock, or o Leonard Green & Partners and its affiliates cease to own voting interests of at least 25% in our capital stock, o we cease to own directly 100% of the outstanding equity of our wholly owned subsidiary or Page 43 o any person or group other than persons affiliated with Leonard Green & Partners, specified equity investors and management investors have acquired beneficial ownership of 35% or more of the aggregate voting interest attributable to all our outstanding capital stock; or o the first day on which a majority of our board of directors were not directors on September 20, 2000 or whose election or nomination was previously approved by a majority of such directors. In the event of a change of control event, or in the event of specified dispositions of the assets by us or ours subsidiaries, the proceeds of which are neither used to repay the credit facility, the senior notes or to acquire long term assets, we are required to offer to repurchase the senior notes at a purchase price equal to 101% (in the case of a specified change of control) or 100% (in the case of a specified disposition of assets) of the principal amount thereof, in each case plus accrued interest. The indenture governing the senior notes also contains covenants that restrict the ability of us and our subsidiaries to: o incur additional debt; o incur specified liens on our assets; o pay dividends on stock or repurchase stock; o make investments; o engage in specified transactions with affiliates; o create or permit to exist specified dividend or payment restrictions affecting subsidiaries; o sell assets; o engage in specified sale/lease-back transactions; o sell all or substantially all of their assets or merge with or into other companies; and o engage in business activities unrelated to activities engaged in at the original date of issuance of the senior notes. EVENTS OF DEFAULT. The indenture governing the senior notes also provides for various defaults, including o failure to pay interest on the senior notes when due after a specified grace period; o failure to pay any principal on the senior notes when the same becomes due at maturity, upon redemption or otherwise; o failure to observe or perform any other covenant or agreement in the indenture governing the senior notes where such failure continues for thirty (30) days after actual knowledge thereof by a senior officer; and o failure to pay at final maturity or other default leading to actual acceleration with respect to other indebtedness having an aggregate principal amount of $7.5 million or more. Page 44 NEW ACCOUNTING PRONOUNCEMENTS DERIVATIVES Effective January 1, 2001, we adopted Statement of Financial Accounting Standards, or SFAS, No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value with offsets to other comprehensive income or earnings, depending on the type of derivative and/or the underlying cause for the change in fair value. OUR COLLAR AGREEMENT On November 13, 2000, we entered into a no-fee interest rate collar agreement with Wells Fargo Bank, N.A. effective November 15, 2000 and expiring November 15, 2002. Our collar agreement is based on LIBOR, pays out monthly, resets monthly and has a cap and floor notional amount of $62.5 million, with a cap rate of 7.5% and floor rate of 5.9%. Under SFAS 133, the actual cash paid by us as a result of LIBOR rates being below the floor of our collar agreement are recorded as a component of earnings. As of June 30, 2001, we have paid $253,000 because of LIBOR rates being below the floor of 5.9%. These payments were all made for the six months ended June 30, 2001 and are included in interest expense. Our collar agreement is considered a cash flow hedge. Because LIBOR rates at June 30, 2001 were below the floor rate in the collar agreement of 5.9% and are projected to remain below the floor rate through the term of the collar agreement, the fair value of our collar agreement is a net liability to us of $1.4 million at June 30, 2001. It is recorded in our balance sheet as part of other accrued liabilities. GOODWILL AND OTHER INTANGIBLE ASSETS In July 2001, the Financial Accounting Standards Board, or FASB, issued SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS, which changes the way companies account for intangible assets and goodwill associated with business combinations. The principal changes of SFAS 142 are as follows: o All goodwill amortization will cease effective January 1, 2002. For the six months ended June 30, 2001, we recorded $4.5 million of goodwill amortization. o All of the goodwill on our balance sheet at June 30, 2001 will continue to be amortized through the remaining months of 2001, in accordance with their current amortization schedules. o All goodwill acquired in acquisitions after June 30, 2001 will not be subject to amortization in 2001 or in the future. o All goodwill will be reviewed annually, or as circumstances warrant, using the fair-value-based goodwill impairment tests discussed in SFAS 142. As of June 30, 2001, our goodwill balance was $311.8 million. Any impairment recognized associated with the adoption of SFAS 142 will be accounted for as a cumulative effect of change in accounting principle. We have not yet determined what the impact of SFAS 142 will be on our financial statements. In July, 2001, the FASB issued SFAS 141, BUSINESS COMBINATIONS, which requires all business combinations initiated after June 30, 2001, to be accounted for using the purchase method of accounting. We do not expect the adoption of SFAS 141 to have a material impact on our financial statements or our operations. Page 45 RESTRUCTURING AND ASSET WRITE-DOWN During 1996, we adopted and implemented a restructuring plan and recorded a restructuring charge of $5.7 million and an asset write-down charge of $9.5 million. The major components of the 1996 restructuring plan included: o the termination of leases, the write-down of intangibles, property and equipment, and employee terminations in connection with the closure, sale or consolidation of 12 animal hospitals; o the termination of contracts and leases, the write-down of certain property and equipment, and the termination of employees in connection with the restructuring of our laboratory operations; and o contract terminations and write-down of assets in connection with the migration to common communications and computer systems. Collectively, the 12 hospitals had aggregate revenue of $6.8 million and net operating loss of $350,000 for the year ended December 31, 1996. The restructuring of our laboratory operations consisted primarily of: o plans to relocate our facility in Indiana to Chicago; o the downsizing of our Arizona laboratory operations; o the standardization of laboratory and testing methods throughout all of our laboratories, resulting in the write-down of equipment that will no longer be utilized; and o the shutdown of a laboratory facility in the Midwest. During 1999, pursuant to the 1996 restructuring plan, we incurred the following: o Cash expenditures of $345,000 for lease and other contractual obligations. o Non-cash asset write-downs of $157,000, primarily pertaining to hospitals previously closed and our shutdown of certain computer systems. o We recognized a $321,000 favorable settlement related to a laboratory operations' contract that was terminated as part of the 1996 restructuring plan. o During the fourth quarter of 1999, we were released from our contractual obligation pertaining to certain facility leases for hospitals that were sold in 1997. In addition, we reached a favorable settlement on contractual obligations pertaining to our migration to common communications and computer systems, a component of the 1996 restructuring plan. As a result of these two favorable outcomes, we reversed $889,000 of restructuring charges. During 1998, we took the following actions pursuant to the 1996 restructuring plan: o We closed one animal hospital. o We shut down certain computer hardware and software, as part of our migration to common computer systems. o We decided that two hospitals would continue to be operated instead of closed as was originally outlined in the 1996 restructuring plan. The hospitals' local markets improved since the 1996 restructuring plan was determined, causing our management to revise its plan. Page 46 o We terminated our attempt to sell one hospital because it has been unable to negotiate a fair sales price based on the hospital's operating results. Reserves of $593,000 related to the three hospitals we ultimately retained, were utilized to offset increases in the expected cost to extinguish lease commitments and contract obligations that were part of the 1996 restructuring plan. As of December 31, 1999, all phases of the 1996 restructuring plan were complete and no restructuring reserves remained on our balance sheet. During 1997, we reviewed the financial performance of our hospitals. As a result of this review, an additional 12 hospitals were determined not to meet our performance standards. Accordingly, we adopted phase two of our restructuring plan resulting in restructuring and asset write-down charges of $2.1 million. The major components of the 1997 restructuring plan consisted of the termination of leases, amounting to $1.2 million, and the write-down of intangibles, property and equipment, amounting to $876,000, in connection with the closure or sale of 12 animal hospitals. Collectively, the 12 hospitals had aggregate revenue of $5.4 million and net operating income of $176,000 for the year ended December 31, 1997. For the six months ended June 30, 2001 and the year ended December 31, 2000, we incurred $34,000 and $190,000, of expenditures for lease and other contractual obligations resulting from the 1997 restructuring plan. During 1999, the actions taken pursuant to the 1997 restructuring plan were as follows: o We sold one hospital resulting in cash expenditures of $2,000 and non-cash asset write-downs of $64,000. o We closed three hospitals resulting in cash expenditures of $4,000 and non-cash asset write-downs of $53,000. o We incurred cash expenditures of $71,000 for lease and other contractual obligations. o We recorded an additional $28,000 non-cash asset write-down pertaining to a hospital previously closed. o During the fourth quarter of 1999, we reached favorable settlements from the sale and/or closure of the hospitals noted in the first two bullet points above. As a result we reversed $663,000 of restructuring charges. During 1998, we closed three animal hospitals pursuant to the 1997 restructuring plan, resulting in the write-off of $299,000 of property and equipment and cash expenditures of $81,000 for lease obligations and closing costs. Also during 1998, we determined that five of the animal hospitals that were to be sold as part of the 1997 restructuring plan would be kept due to their improved performance. At June 30, 2001 and December 31, 2000, $118,000 and $153,000, respectively, of the restructuring reserves from the 1997 restructuring plan remain on our balance sheet, consisting primarily of lease and other contractual obligations. All significant phases of the 1997 restructuring plan were complete as of December 31, 1999, although certain lease obligations will continue through 2005. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our market risk exposure is confined to interest rate exposure of our debt obligations that bear interest based on floating rates. Our revolving line of credit and certain other debt obligations are subject to variable rate interest which could be adversely affected by an increase in interest rates. As of June 30, 2001, we had borrowings of $247.4 million under a $300.0 million credit facility. Interest on amounts borrowed under the credit facility is subject to adjustment based on certain levels of financial performance. For LIBOR borrowings, the applicable Page 47 margin added to LIBOR can range from 2.00% to 3.25% for Term A and revolving loans. For every one-half percent rise in interest rates on our variable rate obligations held at June 30, 2001, interest expense would increase by approximately $1.2 million for the twelve months ended June 30, 2002. We will repay a portion of our existing indebtedness with the proceeds from this offering. We invest our cash in money market securities, which are subject to minimal credit and market risk. In addition, our operations are solely in the United States and accordingly we do not have any exposure to foreign currency rate fluctuations. INFLATION Historically, our operations have not been materially affected by inflation. We cannot assure you that our operations will not be affected by inflation in the future. Page 48 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 veterinarian diagnostic laboratories provides sophisticated testing and consulting services to the veterinarian comparable to that provided by the human diagnostic laboratory to the physician. Veterinarians use these services 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 15,000 animal hospitals, a customer base over twice the size of our next largest competitor. 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 750 veterinarians supporting our 214 animal hospitals had over 3 million patient visits in 2000. INDUSTRY OVERVIEW The U.S. population of companion animals has reached approximately 188 million, including about 141 million dogs and cats. The most recent industry data show that over $11 billion was spent on animal health care services in 1996, with an annual growth rate of over 9.5% from 1991 through 1996 for spending on dogs and cats. The ownership of pets is widespread, with over 62% 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." We believe the pet population and the number of pet-owning households should continue to grow, given that the number of households with children under 18 was projected to increase and then remain relatively stable between 1995 and 2010 and the number of empty-nest households was projected to increase. 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 healthcare 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 70% 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 payors 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-payors 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 the service. For example, over 95% of our animal hospital services are paid for in cash or by credit card at that time. In addition, over the past three fiscal years, our bad debt expense has averaged about 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, heartworms and ticks and the number of daylight hours. Page 49 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 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, we believe that veterinarians prefer to use laboratories that specialize in the veterinary market and that 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: o the increased focus on wellness and monitoring programs in veterinary medicine, which is increasing the overall number of tests being performed; o 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; o continued technological developments in veterinary medicine, which are increasing the breadth of tests offered; and o 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, recommendation of friends, reasonable fees, convenient hours 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: Page 50 o the purchasing, marketing and administrative cost advantages that can be realized by a large, multiple location, multi-practitioner veterinary provider; o the cost of financing equipment purchases and upgrading technology necessary for a successful practice; o the desire of veterinarians to focus on practicing veterinary medicine, rather than spending large portions of their time at work on performing the administrative tasks necessary to operate an animal hospital; o 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 o the appeal to many veterinarians of the benefits and work scheduling flexibility that are not typically available to a sole practitioner or single site provider. COMPETITIVE STRENGTHS We believe that we are well-positioned for profitable growth due to the following competitive strengths: o MARKET LEADER. We are the market leader in each of the business segments in which we operate. We maintain the only veterinary diagnostic laboratory network serving all 50 states, which is supported by the largest group of consulting veterinary specialists in the industry. Our network of animal hospitals and veterinarians is the largest in the United States. We believe that it would be difficult, time consuming and expensive for new entrants or existing competitors to assemble a comparable nationwide laboratory or animal hospital network. It would be particularly difficult to replicate our team of specialists, transportation network, management and systems infrastructure, size of our veterinarian group and our customer relationships. o COMPELLING BUSINESS MODEL. We believe our business model enables us to generate consistent growth and increasing cash flows. The fixed cost nature of our business allows us to generate strong margins, particularly on incremental revenues. In each quarter since 1998, we have generated positive laboratory internal revenue growth. The growth in our laboratory revenue, combined with greater utilization of our infrastructure, has enabled us to improve our laboratory EBITDA margin from 26.9% in 1998 to 33.0% for the twelve months ended June 30, 2001, and our laboratory operating margin from 22.4% to 29.4% over the same period. In each quarter since 1998, we have generated positive animal hospital same-facility revenue growth. Due to the operating leverage associated with our animal hospital business, the increase in animal hospital revenue has enabled us to improve our animal hospital EBITDA margin from 16.7% in 1998 to 19.1% for the twelve months ended June 30, 2001, and our animal hospital operating margin from 12.2% to 13.9% over the same period. These high margins, combined with our modest working capital needs and low maintenance capital expenditures, provide cash that we can use for acquisitions or to reduce indebtedness. o LEADING TEAM OF SPECIALISTS. We believe our laboratories are a valuable diagnostic resource for veterinarians. Due to the trend towards offering specialized services in veterinary medicine, our network of 85 specialists, which includes veterinarians, chemists and other scientists with expertise in fields such as pathology, internal medicine, oncology, cardiology, dermatology, neurology and endocrinology, provides us with a significant competitive advantage. These specialists are available to consult with our laboratory customers, providing a compelling reason for them to use our laboratories rather than those of our competitors, most of whom offer no comparable service. Our team of specialists represents the largest interactive source for readily available diagnostic advice in the veterinary industry and interact with animal health care professionals over 90,000 times a year. o HIGH QUALITY SERVICE PROVIDER. We believe that we have built a reputation as a trusted animal health brand among veterinarians and pet owners alike. In our laboratories, we maintain rigorous quality Page 51 assurance programs to ensure the accuracy of reported results. We calibrate our laboratory equipment several times daily, test specimens of known concentration or reactivity to assure accuracy and use only qualified personnel to perform testing. Further, our specialists review all test results outside of the range of established norms. As a result of these measures, we believe our diagnostic accuracy rate is over 99%. In our animal hospitals, we provide continuing education programs, promote the sharing of professional knowledge and expertise and have developed and implemented a program of best practices to promote quality medical care. o SHARED EXPERTISE AMONG VETERINARIANS. We believe our group of animal hospitals and veterinarians provide us with a competitive advantage through our collective expertise and experience. Our veterinarians consult with other veterinarians in our network to share information regarding the practice of veterinary medicine, which continues to expand our collective knowledge. We maintain an internal continuing education program for our veterinarians and have an established infrastructure for the dissemination of information on new developments in diagnostic testing, procedures and treatment programs. We believe the accumulation of veterinary medical knowledge and experience among our veterinarian group enables us to offer new services more rapidly than our competitors, offer our services at a higher level of quality and remain the leading source of veterinary information for interested companies such as pharmaceutical and pet food companies. 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 of our strategy include: o 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 customer 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. For example, in 2000, we implemented a senior wellness program. This program bundles tests and animal hospital services, seeking to promote recurring visits and to increase the average amount spent per visit. o 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 revenues 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. We estimate that in most cases, we realize a gross margin between 60% and 75% on these incremental tests. o UTILIZING ENTERPRISE - WIDE SYSTEMS TO IMPROVE OPERATING EFFICIENCIES. We recently completed the migration of all animal hospital operations to an enterprise-wide management information system. We believe that this common system will enable 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 service, increase volume and implement targeted marketing programs. o PURSUE 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 on the attractiveness of the candidates and the strategic fit Page 52 with our existing operations, we intend to acquire approximately 15 to 25 animals hospitals per year primarily using internally generated cash. DIAGNOSTIC LABORATORIES We operate the only full-service, veterinary diagnostic laboratory network serving all 50 states. We have a client base over two times that of our largest competitor. In 2000, we performed approximately 19.8 million tests and handled roughly 6.4 million requisitions in our state-of-the-art, automated diagnostic laboratories. Our laboratory network services a diverse customer base of over 15,000 animal hospitals, and non-affiliated animal hospitals generated approximately 95% of our laboratory revenue in 2000. SERVICES. Our diagnostic spectrum includes over 300 different tests in the areas of chemistry, pathology, serotology, endocrinology, hematology, and microbiology, as well as tests specific to particular diseases. The average revenue per requisition is approximately $18. 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 treatment programs. 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%. Page 53 LABORATORY NETWORK [GRAPHIC OMITTED] Our 15 laboratories enable us to service the entire United States. Our laboratory network includes: o two primary hubs that are open 24 hours per day and offer a full testing menu, including our most complex tests, o four secondary hubs that service large metropolitan areas, are open 24 hours per day and offer a wide testing menu, generally exclusive of our most complex tests; and o nine STAT laboratories that service other locations with demand sufficient to warrant nearby laboratory facilities and are open during daytime hours. We connect our laboratories to our customers with the industry's largest transportation network, which picks up an average of 20,000 to 25,000 samples daily through an extensive network of drivers and independent couriers. For the six months ended June 30, 2001, we derived approximately 65.2% 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 Memphis laboratory, the proximity of which to the Federal Express primary sorting facility permits speedy and cost efficient testing. Page 54 SALES, MARKETING AND CUSTOMER SERVICE. We employ 40 full-time sales and field service representatives who market laboratory services and maintain relationships with existing customers. The sales force is commissioned-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 90 customer service representatives who respond to customer inquiries, provide test results and, when appropriate, introduce the customer to other services offered by the laboratory. Given the high margins we enjoy on many of our incremental tests, our sales force is compensated primarily on its success in maximizing the amount of business from existing customers as well as adding new customers. PERSONNEL. We employ a staff of approximately 1,025 full-time-equivalent employees in our laboratory network. We employ on average 310 employees at each of our primary laboratories. At a typical secondary laboratory, we employ on average 93 employees and at our typical STAT laboratory we employ on average 18 employees. 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 August 31, 2001, we operated 214 animal hospitals in 33 states that were supported by over 750 veterinarians. Our nationwide network of free-standing, full-service animal hospitals has facilities located in the following states: California 45 Connecticut 3 New York* 21 New Mexico 3 Florida 17 Minnesota* 2 Illinois 17 North Carolina* 2 Michigan 12 Utah 2 Pennsylvania 11 Alabama* 1 Maryland 9 Arizona 1 New Jersey* 9 Georgia 1 Texas* 9 Hawaii 1 Indiana 7 Louisiana* 1 Massachusetts 7 Missouri 1 Virginia 6 Nebraska* 1 Nevada 5 South Carolina 1 Ohio* 5 Washington* 1 Alaska 4 West Virginia* 1 Delaware 4 Wisconsin 1 Colorado 3 * States where we manage animal hospitals owned by veterinary medical groups. We seek to provide quality medical 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: o is located in a 4,000 to 6,000 square foot, free-standing facility in an attractive location; o has annual revenue between $1.0 million and $2.0 million; o is supported by three to five veterinarians; and o has an operating history of over ten years. Page 55 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 pharmacological 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 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. 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. By undertaking prudent acquisitions, we are able to grow our hospital business without diluting the local market for veterinary services. As of August 31, 2001 we had identified and were in negotiations to acquire four animal hospitals. PERSONNEL. Our animal hospitals generally employ a staff of between 10 to 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 highly qualified veterinarians and technicians and are committed to supporting continuing education for our professional staff. We operate post-graduate teaching programs for veterinarians at seven of our facilities, which train approximately 40 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 an animal hospital. In these circumstances, the veterinarian purchases an equity position in our animal hospital and is our partner in its operation. As of August 31, 2001 we operated 26 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. MARKETING. Our marketing efforts are primarily directed towards 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 visits 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. Page 56 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 August 31, 2001, we operated 53 animal hospitals in 11 states with these types of ownership restrictions. In these states, instead of owning an animal hospital, 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: o availability of all facilities and equipment; o day-to-day financial and administrative supervision and management; o maintenance of patient records; o recruitment of veterinarians and animal hospital staff; o marketing; and o malpractice and general insurance. As compensation for these services, we receive management fees, which are included in animal hospital revenue. SYSTEMS We maintain a nationwide management information system to support our veterinary laboratories. In 2000, we completed the migration of our animal hospital operations onto an enterprise-wide management information network. All of our financial and customer records and laboratory results are stored in computer databases, most of which may be accessed by our management. Substantially all of our animal hospitals utilize consistent patient accounting/point-of-sale software, and we are able to track the performance of hospitals on a per service, per veterinarian basis. 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. We expect that this operational visibility will lead to increases in laboratory, veterinarian and hospital productivity. We are continuing to upgrade and integrate our management information systems. The upgrade of the laboratory system will enable us to communicate diagnostic test results to veterinarian customers online and via electronic mail, a service that we believe will provide additional tools for veterinarians in their practice and will help to solidify our relationship with these clients. The upgrade of the animal hospital system will allow us to track performance data on a per customer basis. We expect this upgrade and integration to cost approximately $250,000 and to be substantially complete in early 2002. 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, recommendation of friends, reasonable fees, quality of care and convenient hours. Our primary competitors for our animal hospitals in most markets are individual practitioners or small, regional multi-clinic practices. In addition, some national companies Page 57 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. Our client base is twice that of our primary competitor in the laboratory business. In addition to competing with dedicated veterinary laboratories, we face competition from several providers of on-site diagnostic equipment that allow 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. We operate 53 hospitals in 11 states with these laws, including 21 in New York. 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 veterinary doctors 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 August 31, 2001, we had approximately 3,500 full-time-equivalent employees, including approximately 620 licensed veterinarians. None of our employees is a party to a collective bargaining agreement with the exception of our courier drivers in the State of New York. These employees are subject to a collective bargaining agreement expiring on July 10, 2003 with the Teamsters Local Union 813. We believe our employee relations to be good. PROPERTIES Our corporate headquarters and principal executive offices are located in West Los Angeles, California, in approximately 30,000 square feet of leased space. We maintain leased and owned facilities at 226 other locations that house our animal hospitals and laboratories. We own 62 facilities and the remainder are leased. We believe that our real property facilities are adequate for our current needs. 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. In response, we have restructured our operations in the State of Ohio in a manner that we believe conforms to the state law and the court's order. The Page 58 Attorney General of the State of Ohio has informed us that it disagrees with our position that we are in compliance with the court's order. In June 2001, we appeared at a status conference before the trial court at which time the court directed the parties to meet together to attempt to settle this matter. Consistent with the trial court's directive, we currently are engaged in discussions with the Attorney General's office in the State of Ohio in an attempt to resolve this matter. An additional status conference was scheduled to occur in August 2001 to report to the court with regard to the terms of a settlement or, alternatively, that the parties cannot reach agreement, in which case we will be subject to further court proceedings to review our restructured operations under the Ohio statute. This status conference was postponed and a new date has not been set. Our five animal hospitals in the State of Ohio have a book value of $6.2 million. If we were required to discontinue our operations in the State of Ohio, we may not be able to dispose of the hospital assets for their book value. The animal hospitals located in the State of Ohio generated EBITDA, revenue and operating income of $754,000, $2.2 million and $513,000, respectively, in the twelve months ended December 31, 2000 and $404,000, $1.2 million and $274,000, respectively, in the six months ended June 30, 2001. We are a party to various other legal proceedings that arise in the ordinary course of our business. Although we cannot determine the ultimate disposition of these proceedings, we do not believe that adverse determinations in any or all of these proceedings would have a material adverse effect upon our financial condition, liquidity or results of operations. Page 59 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The following persons are our directors and executive officers:
DIRECTORS AGE PRESENT POSITION ---------------- ----- ------------------------------------------- Robert L. Antin 51 Chief Executive Officer, President and Chairman of our Board of Directors Arthur J. Antin 54 Chief Operating Officer, Senior Vice President, Secretary and Director Neil Tauber 50 Senior Vice President of Development Tomas W. Fuller 43 Chief Financial Officer, Vice President and Assistant Secretary Dawn R. Olsen 42 Vice President, Controller John M. Baumer 33 Director John G. Danhakl 45 Director Melina Higgins 34 Director Peter J. Nolan 43 Director
Our executive officers are appointed by and serve at the discretion of our board of directors. Robert L. Antin and Arthur J. Antin are brothers. There are no other family relationships between any of our directors and/or any executive officers. ROBERT L. ANTIN, one of our founders, has served as our Chief Executive Officer, President and Chairman since our inception in 1986. From September 1983 until our founding, Mr. Antin was President, Chief Executive Officer, a director and co-founder of AlternaCare Corp., a publicly held company that owned, operated and developed freestanding out-patient surgical centers. From July 1978 until September 1983, Mr. Antin was employed as an officer by American Medical International, Inc., an owner and operator of health care facilities. While at American Medical International, Inc., Mr. Antin initially served as Director of Marketing of Professional Hospital Services, then as Director of New Business Development responsible for non-hospital related acquisitions and development, and then as a Vice President of American Medical International, Inc. and President of AMI Ambulatory Center, Inc., a subsidiary of American Medical International, Inc. operating a chain of ambulatory care centers. Mr. Antin received his MBA with a certification in hospital and health administration from Cornell University. ARTHUR J. ANTIN, one of our founders, has served as our Chief Operating Officer, Senior Vice President, Secretary and a director since our inception. From October 1983 to September 1986, Mr. Antin served as Director of Marketing/Investor Relations of AlternaCare Corp. At AlternaCare Corp., Mr. Antin developed and implemented marketing strategies for a network of outpatient surgical centers. Mr. Antin received an MA in Community Health from New York University. NEIL TAUBER, one of our founders, has served as our Senior Vice President of Development since our inception. From 1984 to 1986, Mr. Tauber served as the Director of Corporate Development at AlternaCare. At AlternaCare, Mr. Tauber was responsible for the acquisition of new businesses and syndication to hospitals and physician groups. From 1981 to 1984, Mr. Tauber served as Chief Operating Officer of MDM Services, a wholly owned subsidiary of Mediq, a publicly held health care company, where he was responsible for operating and developing a network of retail dental centers and industrial medical clinics. Mr. Tauber holds an MBA from Wagner College. TOMAS W. FULLER joined us in January 1988 and served as our Vice President and Controller until November 1990 when he became Chief Financial Officer. From 1980 to 1987, Mr. Fuller worked at Arthur Andersen LLP, the last two years of which he served as audit Manager. Mr. Fuller received his BA in business/economics from the University of California at Los Angeles. Page 60 DAWN R. OLSEN joined us in January 1997 as Vice President, Controller. From April 1996 to December 1996, Ms. Olsen worked as an independent consultant at the Rand Corporation. From November 1993 to March 1996, Ms. Olsen served as Senior Vice President, Controller of Optel, Inc., a privately held telecommunications company. From 1987 to 1993, Ms. Olsen served as Assistant Controller and later as Vice President, Controller of Qintex Entertainment, Inc., a publicly held television film distribution and production company. From 1981 to 1987, Ms. Olsen worked at Arthur Andersen LLP, the last year of which she served as audit manager. Ms. Olsen is a certified public accountant and received her BS in business/accounting from California State University, Northridge. JOHN M. BAUMER has served as a director since September 2000. Mr. Baumer is a partner in Leonard Green & Partners, where he has been employed since May 1999. Prior to joining Leonard Green & Partners, he served as a Vice President in the Corporate Finance Division of Donaldson, Lufkin & Jenrette Securities Corporation, or DLJ in Los Angeles. Prior to joining DLJ in 1995, Mr. Baumer worked at Fidelity Investments and Arthur Andersen. Mr. Baumer currently serves on the boards of directors of Intercontinental Art, Inc. and Petco Animal Supplies, Inc. Mr. Baumer is a 1990 graduate of the University of Notre Dame. He received his MBA from the Wharton School at the University of Pennsylvania. JOHN G. DANHAKL has served as a director since September 2000. Mr. Danhakl is a partner of Leonard Green & Partners. Prior to becoming a partner at Leonard Green & Partners in 1995, Mr. Danhakl was a Managing Director at DLJ and had been with DLJ since 1990. Prior to joining DLJ, Mr. Danhakl was a Vice President at Drexel Burnham Lambert from 1985 to 1990. Mr. Danhakl presently serves on the boards of directors of The Arden Group, Inc., Big 5 Holdings Corp., Communications & Power Industries, Inc., TwinLab Corporation, Diamond Triumph Auto Glass, Inc., Liberty Group Publishing, Inc., Leslie's Poolmart, Inc. and Petco Animal Supplies, Inc., and on the board of managers of AsianMedia Group LLC. Mr. Danhakl is a graduate of the University of California at Berkeley. He received his MBA from the Harvard Business School. MELINA HIGGINS has served as a director since September 2000. Ms. Higgins is Chief Financial Officer of GS Mezzanine Partners II, L.P. and GS Mezzanine II Offshore, L.P., leveraged mezzanine funds managed by Goldman, Sachs & Co. Ms. Higgins has been with Goldman Sachs for ten years and has been working with Goldman Sachs mezzanine funds since their inception in 1996. Ms. Higgins presently serves as a director on the boards of directors of the following companies in which GS Mezzanine Partners has invested: Kranson Industries, Inc. and Western Nonwovens Inc. Ms. Higgins holds an MBA from Harvard Business School and a BA from Colgate University. PETER J. NOLAN has served as a director since September 2000. Mr. Nolan became a partner of Leonard Green & Partners in April 1997. Mr. Nolan previously served as Managing Director and Co-Head of DLJ's Los Angeles Investment Banking Division since 1990. Prior to that, Mr. Nolan had been a Vice President in corporate finance at Drexel Burnham Lambert since 1986. Prior to that, Mr. Nolan was a First Vice President at Prudential Securities, Inc. where he had worked from 1982 to 1986, after working as an Associate at Manufacturers Hanover Trust. He presently serves on the boards of directors of M2 Automotive, Liberty Group Publishing, Inc., Contractors Source, Inc. and White Cap Industries, Inc. and on the board of managers of AsianMedia Group LLC. Mr. Nolan is a graduate of Cornell University with a BS in Agricultural Economics and Finance. He received his MBA from Cornell University. BOARD OF DIRECTORS AND COMMITTEES Upon the closing of this offering, we will have authorized six directors. In accordance with the terms of our certificate of incorporation, the terms of office of our board of directors will be divided into three classes. As a result, a portion of our board of directors will be elected each year. The division of the three classes and their respective election dates are as follows: o the class I directors' term will expire at the annual meeting of stockholders to be held in 2002; o the class II directors' term will expire at the annual meeting of stockholders to be held in 2003; and Page 61 At each annual meeting of stockholders after the initial classification, the successors to directors whose terms will then expire will be elected to serve from the time of election and qualification until the third annual meeting following election. In addition, our bylaws provide that the authorized number of directors may be changed by an amendment to the bylaws duly adopted by the board of directors or by the stockholders, or by a duly adopted amendment to our certificate of incorporation. Any additional directorships resulting from an increase in the number of directors will be distributed among the three classes so that, as nearly as possible, each class will consist of one-third of the total number of directors. Our board of directors intends to create an audit committee and a compensation committee. We expect that our audit committee will be comprised of three independent directors whom it will appoint and will be charged with the following responsibilities: o recommending the engagement of our independent public accountants; o reviewing the scope of the audit to be conducted by the independent public accountants; o meeting periodically with the independent public accountants and our Chief Financial Officer to review matters relating to our financial statements, our accounting principles and our system of internal accounting controls; and o reporting its recommendations as to the approval of our financial statements to the board of directors. We anticipate that the compensation committee will be composed of at least two independent directors. The compensation committee will be responsible for considering and making recommendations to the board of directors regarding executive compensation and will be responsible for administering our stock option and executive incentive compensation plans. DIRECTOR COMPENSATION Our directors are not entitled to any compensation for serving as a director. Directors may be reimbursed for the actual reasonable costs incurred in connection with attendance at board meetings. Upon the closing of this offering, our directors who are not also our employees will receive $1,000 for each meeting of the board of directors that they attend plus reimbursement of all out-of-pocket expenses incurred in attending such meeting. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION None of our executive officers or directors presently serves, or in the past has served, on the compensation committee of any other company with which we conduct business, nor do we expect any member of our compensation committee to serve, or in the past to have served, on the compensation committee of a company with which we conduct business. EXECUTIVE COMPENSATION The following table sets forth certain information with respect to compensation awarded to, earned by or paid to each person who served as our Chief Executive Officer or was one of our four other most highly compensated executive officers during the fiscal year ended December 31, 2000. We refer to these officers as our named executive officers. Page 62
SUMMARY COMPENSATION TABLE Long Term Compensation; Awards; Securities Underlying OPTIONS/SARS OTHER ANNUAL ------------- ALL OTHER NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION (#) (2) COMPENSATION -------------------------------- ------ -------- ---------- ------------ ------------- ------------ Robert L. Antin (1) 2000 $364,000 -- $ 23,766 (6) 15,000 $7,014,300(3) Chairman of the Board, 1999 358,077 $327,600 (4) -- -- 21,390 President and 1998 350,000 315,000 (5) -- -- 16,750 Chief Executive Officer Arthur J. Antin (1) 2000 260,000 -- 25,428 (6) 32,845 4,545,225(3) Chief Operating Officer, 1999 255,769 208,000 (4) -- -- 22,885 Senior Vice President and 1998 250,000 200,000 (5) -- -- 18,510 Secretary Neil Tauber (1) 2000 197,000 -- 21,631 (6) 30,000 2,859,319(3) Senior Vice President of 1999 194,385 138,320 (4) -- -- 19,467 Development 1998 190,000 70,989 (5) -- -- 14,250 Tomas W. Fuller (1) 2000 187,200 -- 18,145 (6) 20,000 2,867,436(3) Chief Financial Officer, Vice 1999 184,154 131,040 (4) -- -- 16,330 President and Assistant 1998 180,000 121,406 (5) -- -- 9,750 Secretary 2000 141,000 35,000 -- 42,995 -- Dawn R. Olsen 1999 130,808 9,770 (4) -- -- -- Vice President and 1998 125,000 13,300 (5) -- 15,500 -- Controller -------------- (1) For a description of the employment agreement between us and officer, see below. (2) All numbers reflect the number of shares of our common stock subject to options granted during the fiscal year. (3) Consists of amounts paid to these officers in connection with the recapitalization which includes amounts paid under then existing employment agreements and in consideration of executing non-competition agreements. (4) Reflects the fair market value on January 20, 2000 of restricted stock bonus awards granted in January 2000 for services rendered during the fiscal year ended December 31, 1999. (5) Reflects the fair market value on February 12, 1999 of restricted stock bonus awards granted in February 1999 for services rendered during the fiscal year ended December 31 ,1998. (6) Represents amounts paid as automobile allowance.
Page 63 OPTION/SAR GRANTS IN THE LAST FISCAL YEAR The following table sets forth certain information regarding the grant of stock options to purchase shares of our common stock made during the fiscal year ended December 31, 2000 to our named executive officers.
Individual Grants --------------------------------------------------------------------------------------- Potential Realizable Value Number of at Assumed Rate of Stock Securities Percent of Total Price Appreciation for Underlying Options Granted to Exercise or Option Term (1) Option/SARs Employees in Base Price Expiration ------------------------- Name Granted (#) Fiscal Year (2) ($/SH) (3) Date 5% 10% ------------------- ------------- ------------------ ----------- ---------- ---------- ---------- Robert L. Antin 15,000(4) 1.1% $1.00 9/20/10 $ 9,433 $ 23,906 Arthur J. Antin 32,845(4) 2.5% 1.00 9/20/10 20,656 52,346 Neil Tauber 30,000(4) 2.3% 1.00 9/20/10 18,867 47,812 Tomas W. Fuller 20,000(4) 1.5% 1.00 9/20/10 12,578 31,875 Dawn R. Olsen 23,000(5) 1.7% 1.00 9/20/10 14,465 36,656 19,995(6) 1.5% 0.20 9/20/10 28,571 47,863 --------------- (1) The potential realizable value is based on the assumption that our common stock appreciates at the annual rate shown (compounded annually) from the date of grant until the expiration of the option term. These amounts are calculated pursuant to applicable requirements of the Commission and do not represent a forecast of the future appreciation of our common stock. (2) Options covering an aggregate of 1,325,670 shares were granted to eligible persons under our stock incentive plan during the fiscal year ended December 31, 2000. (3) The exercise price and tax withholding obligations related to exercise may be paid by delivery of already owned shares, subject to specified conditions. (4) Options vest in 24 equal monthly installments commencing on October 1, 2001. (5) Options vest in 30 equal monthly installments commencing on July 1, 2002. (6) Options vested on September 20, 2000.
Page 64 OPTION EXERCISES IN LAST FISCAL YEAR AND YEAR-END OPTION VALUES The following table sets forth, for each of our named executive officers, certain information regarding the exercise of stock options to purchase shares of our common stock during the fiscal year ended December 31, 2000, the number of shares of common stock underlying stock options held at fiscal year end and the value of options held at fiscal year end.
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED UNEXERCISED OPTIONS/SARS AT IN-THE-MONEY OPTIONS/SARS AT SHARES FISCAL YEAR END (#) FISCAL YEAR END ($)(1) ACQUIRED UPON VALUE ----------------------------- ------------------------------- NAME EXERCISE (#) REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ------------------ -------------- ----------- ----------- ------------- ----------- --------------- Robert L. Antin 1,205,000 $5,794,375 -- 15,000 -- -- Arthur J. Antin 678,500 3,714,042 -- 32,845 -- -- Neil Tauber 525,000 2,685,775 -- 30,000 -- -- Tomas W. Fuller 460,667 2,364,071 -- 20,000 -- -- Dawn R. Olsen 30,500 90,813 19,995 23,000 15,996 -- -------------- (1) There was no public trading market for our common stock as of December 31, 2000. Accordingly, these values have been calculated based on our board of directors' determination of the fair market value of the underlying shares as of December 31, 2000 of $1.00 per share, less the applicable exercise price per share, multiplied by the number of underlying shares.
1996 STOCK INCENTIVE PLAN On November 7, 1995, we adopted, and on July 19, 1996, our stockholders approved, the 1996 Stock Incentive Plan. On August 6, 2001, we adopted and our stockholders approved an amendment to the 1996 plan. The 1996 plan is intended to secure for us the benefits arising from stock ownership by selected key employees as our board of directors may from time to time determine. The following are the material terms of the 1996 plan: o SHARES SUBJECT TO PLAN. 1,325,670 shares of our common stock have been reserved for issuance under the 1996 plan. Unexercised options that are subsequently reacquired by us may be available for reissuance under the 1996 plan. The number of shares reserved for issuance is generally subject to equitable adjustment upon the occurrence of any stock dividend or other distribution, recapitalization, stock split, reorganization, merger, consolidation, combination, repurchase, or share exchange, or other similar corporate transaction or event. o ADMINISTRATION. The 1996 plan is administered by our board of directors. Upon the closing of this offering, the 1996 plan will be administered by the compensation committee as designated by our board of directors. Each member of the committee is a "nonemployee director" (within the meaning of Rule 16b-3 promulgated under Section 16 of the Securities Exchange Act of 1934) and an "outside director" (within the meaning of Section 162(m) of the Internal Revenue Code). The committee has authority to construe and interpret the 1996 plan and any awards made thereunder, to grant and determine the terms of awards and to make any necessary rules and regulations for the administration of the 1996 plan. o ELIGIBILITY. Options may be granted to our directors, officers, employees and consultants and those of our subsidiaries. The 1996 plan limits to 500,000 the number of shares that can be granted to any employee in any calendar year. o TYPE OF AWARDS. Upon the closing of this offering, the 1996 plan will permit the compensation committee to grant stock options. The 1996 plan provides for grants of both incentive stock options, also known as ISOs, within the meaning of Section 422 of the Internal Revenue Code, and non-qualified stock options that do not qualify as ISOs. Page 65 o AMENDMENT AND TERMINATION. The 1996 plan may be amended by the board of directors, at any time, subject to stockholder approval where necessary, to satisfy federal tax or other applicable laws or stock exchange requirements. The 1996 plan will terminate no later than July 19, 2006. o EXERCISABILITY, VESTING OF STOCK OPTIONS AND PRICE. The stock options will vest at the times and upon the conditions that the committee may determine, and the price at which shares subject to any stock options may be purchased will be reflected in each particular stock option agreement. 2001 STOCK INCENTIVE PLAN On August 6, 2001, we adopted, and our stockholders approved, the 2001 Stock Incentive Plan. The 2001 plan is intended to secure for us the benefits arising from stock ownership by selected key employees as our board of directors may from time to time determine. The following are the material terms of the 2001 plan: o SHARES SUBJECT TO PLAN. 2,000,000 shares of our common stock have been reserved for issuance under the 2001 plan. Unexercised options that are subsequently reacquired by us may be available for reissuance under the 2001 plan. The number of shares reserved for issuance is generally subject to equitable adjustment upon the occurrence of any stock dividend or other distribution, recapitalization, stock split, reorganization, merger, consolidation, combination, repurchase, or share exchange, or other similar corporate transaction or event. o ADMINISTRATION. The 2001 plan is administered by our board of directors. Upon the closing of this offering, the 2001 plan will be administered by the compensation committee as designated by our board of directors. Each member of the committee is a "nonemployee director" (within the meaning of Rule 16b-3 promulgated under Section 16 of the Securities Exchange Act of 1934) and an "outside director" (within the meaning of Section 162(m) of the Internal Revenue Code). The committee has authority to construe and interpret the 2001 plan and any awards made thereunder, to grant and determine the terms of awards and to make any necessary rules and regulations for the administration of the 2001 plan. o ELIGIBILITY. Options may be granted to our directors, officers, employees and consultants and our subsidiaries. The 2001 plan limits to 500,000 the number of shares that can be granted to any employee in any calendar year. o TYPE OF AWARDS. Upon the closing of this offering, the 2001 plan will permit the compensation committee to grant stock options. The 2001 plan provides for grants of both ISOs and non-qualified stock options that do not qualify as ISOs. o AMENDMENT AND TERMINATION. The 2001 plan may be amended by the board of directors, at any time, subject to stockholder approval where necessary, to satisfy federal tax or other applicable laws or stock exchange requirements. The 2001 plan will terminate no later than August 5, 2011. o EXERCISABILITY, VESTING OF STOCK OPTIONS AND PRICE. The stock options will vest at the times and upon the conditions that the committee may determine, and the price at which shares subject to the stock option may be purchased will be reflected in each particular stock option agreement. EMPLOYMENT AGREEMENTS We have employment agreements with Robert L. Antin, Arthur J. Antin, Neil Tauber and Tomas W. Fuller. ROBERT L. ANTIN. Mr. Antin's employment agreement, dated as of September 20, 2000, provides for Mr. Antin to serve as our Chairman of Board, Chief Executive Officer and President for a term equal to the longer of: (x) five years, and (y) three years from any given date, such that there shall always be a minimum of at least three years remaining under his employment agreement. The employment agreement provides for Mr. Antin to receive an annual base salary and additional compensation of $500,000, subject to annual increase based on the Consumer Page 66 Price Index for Los Angeles County, and to participate in a bonus plan based on annual performance standards to be established by the board of directors. If Mr. Antin's employment is terminated due to his death or disability, the employment agreement provides that we will pay Mr. Antin or his estate, as applicable, his remaining base salary during the remaining scheduled term of the employment agreement, reduced by any amounts paid under any life insurance policy or long-term disability insurance policy, as applicable, maintained by us for the benefit of Mr. Antin, accelerated vesting of options and the continuation of specified benefits. If Mr. Antin terminates the employment agreement for cause, if we terminate the employment agreement without cause or in the event of a change of control, in which event the employment of Mr. Antin terminates automatically, we will pay Mr. Antin his remaining base salary during the remaining scheduled term of the employment agreement and an amount based on his past bonuses, accelerate the vesting of his options and continue to provide specified benefits. In these circumstances, Mr. Antin may exercise his options during the remainder of their term. Mr. Antin may terminate his employment with us at any time, in which event he is entitled to receive all accrued and unpaid salary and other compensation and all accrued and unused vacation and sick pay. If any of the payments due Mr. Antin upon termination qualify as "excess parachute payments" under the Internal Revenue Code, Mr. Antin also is entitled to an additional payment to cover the tax consequences associated with excess parachute payments. ARTHUR J. ANTIN. Mr. Antin's employment agreement, dated as of September 20, 2000, provides for Mr. Antin to serve as our Chief Operating Officer for a term equal to the longer of: (x) five years, or (y) two years from any given date, such that there shall always be a minimum of at least two years remaining under his employment agreement. The employment agreement provides for Mr. Antin to receive an annual base salary and additional compensation of $400,000, subject to annual increase based on the Consumer Price Index for Los Angeles County, and to participate in a bonus plan based on annual performance standards to be established by the board of directors. If Mr. Antin's employment is terminated due to his death or disability, the employment agreement provides that we will pay Mr. Antin or his estate, as applicable, his remaining base salary during the remaining scheduled term of the employment agreement (reduced by any amounts paid under any life insurance policy or long-term disability insurance policy, as applicable, maintained by us for the benefit of Mr. Antin), accelerated vesting of options and the continuation of benefits. If Mr. Antin terminates the employment agreement for cause, if we terminate the employment agreement without cause or in the event of a change of control, in which event the employment of Mr. Antin terminates automatically, we will pay Mr. Antin his remaining base salary during the remaining scheduled term of the employment agreement and an amount based on his past bonuses, accelerate the vesting of his options and continue specified benefits. In these circumstances, Mr. Antin may exercise his options during the remainder of their term. Mr. Antin may terminate his employment with us at any time in which event he is entitled to receive all accrued and unpaid salary and other compensation and all accrued and unused vacation and sick pay. If any of the payments due Mr. Antin upon termination qualify as "excess parachute payments" under the Internal Revenue Code, Mr. Antin also is entitled to an additional payment to cover the tax consequences associated with excess parachute payments. NEIL TAUBER. Mr. Tauber's employment agreement, dated as of September 20, 2000, provides for Mr. Tauber to serve as our Senior Vice President for a term of three years. The employment agreement provides for Mr. Tauber to receive an annual base salary and additional compensation of $248,000, subject to annual increase based on the Consumer Price Index for Los Angeles County, and to participate in a bonus plan based on annual performance standards to be established by the board of directors. If Mr. Tauber's employment is terminated due to his death or disability, the employment agreement provides that we will pay Mr. Tauber or his estate, as applicable, the amount he would have earned as base salary Page 67 during the 12 months following the termination date (reduced by any amounts paid under any life insurance policy or long-term disability insurance policy, as applicable, maintained by us for the benefit of Mr. Tauber), accelerate the vesting of his options and the continue specified benefits for the 12 months following the termination date. In these circumstances, Mr. Tauber may exercise his options during the remainder of their term. If Mr. Tauber terminates the employment agreement for cause, if we terminate the employment agreement without cause or in the event of a change of control, in which event the employment of Mr. Tauber terminates automatically, we will pay Mr. Tauber the amount he would have earned as base salary during the 12 months following the termination date (or a lesser amount if Mr. Tauber is terminated by us without cause and he had not completed 15 consecutive months of service), an amount based on his past bonuses, accelerated vesting of options and the continuation of specified benefits for the 12 months following the termination date. Mr. Tauber may terminate his employment with us at any time in which event he is entitled to receive all accrued and unpaid salary and other compensation and all accrued and unused vacation and sick pay. If any of the payments due Mr. Tauber upon termination qualify as "excess parachute payments" under the Internal Revenue Code, Mr. Tauber also is entitled to an additional payment to cover the tax consequences associated with excess parachute payments. TOMAS W. FULLER. Mr. Fuller's employment agreement, dated as of September 20, 2000, provides for Mr. Fuller to serve as our Chief Financial Officer for a term of three years. The employment agreement provides for Mr. Fuller to receive an annual base salary and additional compensation of not less than $235,000, subject to annual increase based on the Consumer Price Index for Los Angeles County, and to participate in a bonus plan based on annual performance standards to be established by the board of directors. If Mr. Fuller's employment is terminated due to his death or disability, the employment agreement provides that we will pay Mr. Fuller or his estate, as applicable, the amount he would have earned as base salary during the 12 months following the termination date (reduced by any amounts paid under any life insurance policy or long-term disability insurance policy, as applicable, maintained by us for the benefit of Mr. Fuller), accelerated vesting of options and the continuation of specified benefits for the 12 months following the termination date. If Mr. Fuller terminates the employment agreement for cause, if we terminate the employment agreement without cause or in the event of a change of control, in which event the employment of Mr. Fuller terminates automatically, we will pay Mr. Fuller the amount he would have earned as base salary during the 12 months following the termination date and an amount based on his past bonuses, accelerate the vesting of his options and continue specified benefits for the 12 months following the termination date. In these circumstances, Mr. Fuller may exercise his options during the remainder of their term. Mr. Fuller may terminate his employment with us at any time in which event he is entitled to receive all accrued and unpaid salary and other compensation and all accrued and unused vacation and sick pay. If any of the payments due Mr. Fuller upon termination qualify as "excess parachute payments" under the Internal Revenue Code, Mr. Fuller also is entitled to an additional payment to cover the tax consequences associated with excess parachute payments. In the event of a change of control and at our request, each of Messrs. Robert L. Antin, Arthur J. Antin, Neil Tauber and Tomas W. Fuller is obligated to continue to serve under his employment agreement for a period of up to 180 days following the termination date at his then current base salary. Page 68 PRINCIPAL STOCKHOLDERS The following table sets forth information regarding beneficial ownership of our common stock as of August 31, 2001 by: o each of our directors; o each of our named executive officers; o all of our directors and executive officers as a group; and o all other stockholders known by us to beneficially own more than 5% of our outstanding common stock. Beneficial ownership is determined in accordance with the rules of the SEC. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, shares of common stock subject to options held by that person that are currently exercisable or exercisable within 60 days of the date as of which this information is provided, and not subject to repurchase as of that date, are deemed outstanding. These shares, however, are not deemed outstanding for the purposes of computing the percentage ownership of any other person. Except as indicated in the notes to this table, and except pursuant to applicable community property laws, each stockholder named in the table has sole voting and investment power with respect to the shares shown as beneficially owned by them. Percentage ownership is based on 18,216,210 shares of common stock outstanding on August 31, 2001 and _________ shares of common stock outstanding after completion of this offering. This table assumes no exercise of the underwriters' over-allotment option. Unless otherwise indicated, the address for each of the stockholders listed below is c/o VCA Antech, Inc., 12401 West Olympic Boulevard, Los Angeles, California 90064.
Number of Shares of Common Stock Beneficially Percent of Common Name and Address of Beneficial Owner Owned Stock Outstanding -------------------------------------------------------- ------------- -------------------- Before After Offering Offering -------- -------- Green Equity Investors III, L.P. (1).................... 9,221,042 50.6% Leonard Green & Partners, L.P. entities (2)(3).......... 3,263,460 17.9 VCA Co-Investment Fund I, LLC (1)....................... 1,851,615 10.2 Robert L. Antin (4)..................................... 1,807,005 9.9 Arthur J. Antin (5)..................................... 401,375 2.2 Tomas W. Fuller (6)..................................... 200,843 1.1 Neil Tauber (7)......................................... 51,245 * Dawn R. Olsen (8)....................................... 23,062 * John M. Baumer (9)...................................... 14,336,117 78.7 John G. Danhakl (9)..................................... 14,336,117 78.7 Melina Higgins.......................................... 0 * Peter J. Nolan (9)...................................... 14,336,117 78.7 All directors and executive officers as a group (9 persons) (10)........................................ 16,819,646 92.3% ------------------- * Indicates less than one percent (1) Green Equity Investors III, L.P. and VCA Co-Investment Fund I, LLC are managed by Leonard Green & Partners, L.P. Page 69 (2) The address of Leonard Green & Partners, L.P. is 11111 Santa Monica Boulevard, Suite 2000, Los Angeles, California 90025. (3) Includes: (a) 833,220 shares of common stock held by VCA Co-Investment Fund II, LLC, (b) 833,220 shares of common stock held by VCA Co-Investment Fund III, LLC, (c) 462,900 shares of common stock held by VCA Co-Investment Fund IV, LLC, (d) 462,900 shares of common stock held by VCA Co-Investment Fund V, LLC, (e) 185,175 shares of common stock held by VCA Co-Investment Fund VI, LLC, (f) 462,900 shares of common stock held by VCA Co-Investment Fund VII, LLC, and (g) 23,145 shares of common stock held by VCA Co-Investment Fund VIII, LLC. Each VCA Co-Investment Fund LLC is managed by Leonard Green & Partners, L.P. (4) Includes: (a) 250,000 shares held by family trusts established for the benefit of Mr. Antin's family; (b) 60,000 shares held by Mr. Robert Antin's minor children; and (c) 625 shares of common stock reserved for issuance upon exercise of stock options that are or will be exercisable on or before October 31, 2001. (5) Includes 1,369 shares of common stock reserved for issuance upon exercise of stock options which are or will become exercisable on or before October 31, 2001. (6) Includes 833 shares of common stock reserved for issuance upon exercise of stock options which are or will become exercisable on or before October 31, 2001. (7) Includes 1,250 shares of common stock reserved for issuance upon exercise of stock options which are or will become exercisable on or before October 31, 2001. (8) Includes 3,067 shares of common stock reserved for issuance upon exercise of stock options which are or will become exercisable on or before October 31, 2001. (9) Each of John M. Baumer, John G. Danhakl and Peter J. Nolan is a partner of Leonard Green & Partners, L.P. As such, Messrs. Baumer, Danhakl and Nolan may be deemed to have shared voting and investment power with respect to all shares held by Leonard Green & Partners, L.P. These individuals disclaim beneficial ownership of the securities held by Leonard Green & Partners, L.P., except to the extent of their respective pecuniary interests therein. (10) Includes: (a) 2,476,385 shares of common stock; and (b) 7,144 shares of common stock reserved for issuance upon exercise of options and are or will be exercisable on or before October 31, 2001.
Page 70 RELATED PARTY TRANSACTIONS RECAPITALIZATION TRANSACTION On September 20, 2000, we completed a 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 canceled and converted into the right to receive $1.00. The recapitalization was financed by: o the contribution of $155.0 million by a group of investors led by Leonard Green & Partners; o our issuance of an aggregate of $20.0 million of senior subordinated notes; o borrowings of $250.0 million under our $300.0 million credit facility; and o our issuance of an aggregate of $100.0 million of senior notes. Upon the completion of the recapitalization, Robert L. Antin, Arthur J. Antin, Neil Tauber, Tom Fuller, other stockholders and a group of investors led by Leonard Green & Partners acquired 17,524,337 shares of common stock at a purchase price of $1.00 per share. Goldman Sachs Credit Partners L.P. is a lender under our credit facility. GS Mezzanine Partners II, L.P. and GS Mezzanine II Offshore, L.P., affiliates of Goldman, Sachs & Co., purchased portions of our securities for an aggregate purchase price of $85.0 million. Melina Higgins, one of our directors, is the Chief Financial Officer of GS Mezzanine Partners II, L.P. and GS Mezzanine II Offshore, L.P. The following partners of Leonard Green & Partners also serve on our board of directors: John M. Baumer, John G. Danhakl and Peter J. Nolan. STOCKHOLDERS AGREEMENT On September 20, 2000, we entered into a stockholders agreement with each of our 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. Upon the closing of an initial public offering of our shares of common stock, o Call rights will expire on one-half of Robert Antin's shares that initially were subject to the stockholders agreement. Of the remaining shares, call rights will expire ratably over a six month period commencing on the closing date as though the initial public offering had occurred on October 1, 2001; o Call rights will expire 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 amount remaining, call rights will expire on one-half of those shares six months following the closing date, and on the remaining one-half one year following the closing date, in each event as though the initial public offering had occurred on October 1, 2001; and o Call rights will expire on one-half of the other employee's shares that initially were subject to the stockholders agreement. Of the remaining shares, call rights will expire ratably over an 18-month period commencing on the closing date as though the initial public offering had occurred on October 1, 2001. The stockholders agreement also provided for the discharge of $579,514 and $108,486 of indebtedness owing to us from Robert L. Antin and Arthur J. Antin, respectively, including interest accrued thereon. This indebtedness was incurred on January 22, 1987 in the form of promissory notes with principal amounts of $459,399 for Mr. Robert L. Antin and $86,000 for Mr. Arthur J. Antin as payment for the exercise price of stock options. Page 71 Each note was subject to interest at the midterm applicable federal rate. This indebtedness was forgiven January 3, 2001. MANAGEMENT SERVICES AGREEMENT On September 20, 2000, we entered into a 10-year management services agreement with Leonard Green & Partners. The agreement provides that Leonard Green & Partners will provide general investment-banking services, management, consulting and financial planning services and transaction-related financial advisory and investment banking services to us and our subsidiaries. We paid a one-time structuring fee of $7.5 million to Leonard Green & Partners in September 2000 under the agreement. Leonard Green & Partners receives an annual fee of $2.5 million as compensation for the general services and normal and customary fees for transaction-related services. If the group of investors led by Leonard Green & Partners invests any additional capital pursuant to the agreement, this annual fee will increase by 1.6% of the amount of the additional investment. We also agreed to indemnify Leonard Green & Partners and the other investors for any losses and liabilities arising out of the agreement. In 2000 and the six months ended June 30, 2001, we paid management fees in an aggregate amount of $620,000 and $1.2 million. NON-COMPETITION AGREEMENTS On September 20, 2000, Robert L. Antin, Arthur J. Antin, Neil Tauber and Tomas W. Fuller each entered into non-competition agreements with us for a term of three years. Generally, the non-competition agreements restrict these individuals from: o owning, operating, managing or controlling or in any way being connected with a veterinary medical or laboratory practice within certain geographical areas; o disclosing our confidential information; and o soliciting or diverting away our customers and employees. In consideration for the execution of the non-competition agreements, we paid approximately $6.2 million, $4.0 million, $2.7 million and $2.5 million to Robert L. Antin, Arthur J. Antin, Neil Tauber and Tomas W. Fuller, or their affiliates, respectively. INVESTMENT IN ZOASIS During the year ended December 31, 2000, we made a $5.0 million investment in Zoasis.com, Inc., an internet start-up company, majority owned by Robert L. Antin, our Chief Executive Officer and Chairman of the Board. During the six months ended June 30, 2001, we incurred $300,000 of marketing expense for services provided by Zoasis. During the year ended December 31, 2000, we incurred $81,000 of marketing expense for services provided by Zoasis. 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. INVESTMENT IN VET'S CHOICE AND THE WISDOM GROUP, L.P. In September 2000, we sold our entire equity interest in Vet's Choice, which had zero cost basis, to Heinz Pet Products. We received $500,000 in the sale. At the time of the sale, one of our directors, Mr. John A. Heil, served as president of an affiliate of Heinz Pet Products. In connection with the sale, Heinz Pet Products also paid us $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 our executive management had a 30.5% ownership interest in the Wisdom Group, L.P. as limited partners and a subsidiary of ours owned a 1% ownership interest as the general partner. The Wisdom Group, L.P. was dissolved in November 2000 upon redemption of all of the partnership interests. The nature of the business of 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. Page 72 We believe, based on our reasonable judgement, but without further investigation, that the terms of each of the foregoing transactions or arrangements between us on one hand and our affiliates, officers, directors or stockholders which were parties to the transactions on the other hand, were, on an overall basis, at least as favorable to us as could then have been obtained from unrelated parties. RECEIPT OF PROCEEDS FROM THIS OFFERING Affiliates of Leonard Green & Partners own 2,826,000 shares of our 14% series A senior redeemable exchangeable cumulative preferred stock and 2,800,000 shares of our 12% series B junior redeemable cumulative preferred stock. Affiliates of Goldman, Sachs & Co. own 122,123 shares of our 14% series A senior redeemable exchangeable cumulative preferred stock and 121,000 shares of our 12% series B junior redeemable cumulative preferred stock and, as of June 30, 2001, held approximately $76.7 million aggregate principal amount of our senior notes and approximately $14.2 million aggregate principal amount of our senior subordinated notes. We intend to use a portion of the net proceeds from this offering to repay $35.0 million aggregate principal amount of the senior notes on a pro rata basis and redeem all of the shares of the preferred stock. In addition, if the underwriters exercise their over-allotment option, we will use a portion of the additional net proceeds to repay up to an additional $6.0 million aggregate principal amount of our senior notes and up to $7.0 million aggregate principal amount of our senior subordinated notes, in each case on a pro rata basis. See "Use of Proceeds." Page 73 DESCRIPTION OF CAPITAL STOCK This prospectus contains a summary of the material terms of our capital stock. The following description of our capital stock is subject to, and qualified in its entirety by, our certificate of incorporation and bylaws, which are included as exhibits to the registration statement of which this prospectus forms a part, and by the provisions of applicable Delaware law. Following this offering, our authorized capital stock will consist of 75,000,000 shares of common stock, par value $.001 per share, and 5,000,000 shares of preferred stock, par value $.001 per share. As of the date of this prospectus, 18,216,210 shares of our common stock are outstanding and held of record by approximately 70 recordholders and 5,969,230 shares of our preferred stock are outstanding. COMMON STOCK VOTING RIGHTS. The holders of common stock are entitled to one vote per share on all matters submitted to a vote of our stockholders. The common stock does not have cumulative voting rights. DIVIDENDS. Subject to preferences that may be applicable to any preferred stock outstanding at the time, the holders of outstanding shares of common stock are entitled to receive ratably any dividends out of assets legally available therefor as our board of directors may from time to time determine. For a description of our dividend policy, please refer to the information in this prospectus under the heading "Dividend Policy." LIQUIDATION AND DISSOLUTION. Upon our liquidation, dissolution or winding up, holders of our common stock are entitled to share ratably in all assets remaining after payment of all liabilities and the liquidation preference of any then outstanding shares of preferred stock. NO PREEMPTIVE OR SIMILAR RIGHTS. Holders of our common stock have no right preemptive or conversion rights or other subscription rights. There are no redemption or sinking fund provisions applicable to the common stock. Holders of shares of the common stock are not required to make additional capital contributions. All outstanding shares of common stock are fully paid and nonassessable. PREFERRED STOCK As of August 31, 2001, we have outstanding the following shares of preferred stock: o 2,998,408 shares of 14% series A redeemable exchangeable cumulative preferred stock, having an aggregate liquidation preference of $85.4 million, plus accrued and unpaid dividends; and o 2,970,822 shares of 12% series B junior redeemable cumulative preferred stock, having an aggregate liquidation preference of $83.0 million, plus accrued and unpaid dividends. We intend to redeem all of our outstanding shares of series A and series B preferred stock with a portion of the net proceeds from this offering. Following this offering, our certificate of incorporation will provide that our board of directors will have the authority, without further action by the stockholders, to issue up to 5.0 million shares of preferred stock in one or more series. Our board of directors will be able to fix the rights, preferences, privileges and restrictions of the preferred stock, including dividend rights, conversion rights, voting rights, terms of redemption, liquidation preferences, sinking fund terms and the number of shares constituting any series or the designation of this series. The issuance of preferred stock could adversely affect the voting power of holders of common stock, and the likelihood that holders of preferred stock will receive dividend payments and payments upon liquidation may have the effect of delaying, deferring or preventing a change in control of us, which could depress the market price of our common stock. Page 74 WARRANTS As of August 31, 2001, warrants to purchase 1,149,990 shares of common stock were outstanding. The warrants are exercisable at any time with an exercise price of $0.0007 per share and have no expiration date. REGISTRATION RIGHTS Upon completion of this offering, under our stockholders agreement, the holders of 18,216,210 shares of common stock and warrants to purchase 1,149,990 shares of common stock, or their transferees, will be entitled to register these shares under the Securities Act. Under the stockholders agreement, holders may demand that we file a registration statement under the Securities Act covering some or all of the holder's registrable securities. The stockholder agreement limits the number of demand registrations that we are required to make on behalf of the holders. In an underwritten offering, the managing underwriter has the right, subject to specified conditions, to limit the number of registrable securities. In addition, holders have "piggyback" registration rights. If we propose to register any of our equity securities under the Securities Act other than pursuant to demand registration right noted above or specified excluded registrations, holders may require us to include all or a portion of their registrable securities in the registration and in any related underwriting. In an underwritten offering, the managing underwriter, if any, has the right, subject to specified conditions, to limit the number of registrable securities. In general, we will bear all fees, costs and expenses of registrations, other than underwriting discounts and commissions. ANTI-TAKEOVER PROVISIONS OF DELAWARE LAW We are subject to Section 203 of the Delaware General Corporation Law. Section 203 provides that specified persons who, together with affiliates and associates, own, or within three years did own, 15% or more of the outstanding voting stock of a corporation cannot engage in specified business combinations with the corporation for a period of three years after the date on which the person became an interested stockholder, unless: o prior to the date, our board of directors approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder; o upon consummation of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of our voting stock of the corporation outstanding at the time the transaction commenced, excluding those shares owned by persons who are directors and also officers, and employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or o on or subsequent to the date, the business combination is approved by the board of directors and authorized at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least two-thirds of the outstanding voting stock that is not owned by the interested stockholder. Section 203 defines "business combination" to include: o any merger or consolidation involving the corporation and the interested stockholder; o any sale, transfer, pledge or other disposition involving the interested stockholder of 10% or more of the assets of the corporation; Page 75 o subject to exceptions, any transaction that results in the issuance or transfer by the corporation of any stock of the corporation to the interested stockholder; or o the receipt by the interested stockholder of the benefit of any loans, advances, guarantees, pledges or other financial benefits provided by or through the corporation. ANTI-TAKEOVER PROVISIONS OF OUR CHARTER On the closing of this offering, our bylaws will provide that candidates for director may be nominated only by the board of directors or by a stockholder who gives written notice to us no later than 90 days prior nor earlier than 120 days prior to the first anniversary of the last annual meeting of stockholders. The board of directors may consist of one or more members to be determined from time to time by the board of directors. The board of directors currently consists of six members divided into three different classes. As a result, only one class of directors will be elected at each annual meeting of our stockholders, with the other classes continuing for the remainder of their respective terms. Between stockholder meetings, the board of directors may appoint new directors to fill vacancies or newly created directorships. On the closing of this offering, our certificate of incorporation will require that any action required or permitted to be taken by our stockholders must be effected at a duly called annual or special meeting of stockholders and may not be effected by a consent in writing. Our certificate of incorporation also will provide that the authorized number of directors may be changed only by resolution of the board of directors. Delaware law and these charter provisions may have the effect of deterring hostile takeovers or delaying changes in control of our management, which could depress the market price of our common stock. INDEMNIFICATION OF DIRECTORS AND OFFICERS AND LIMITATION OF LIABILITY Our certificate of incorporation and bylaws allow us to eliminate the personal liability of our directors and to indemnify directors and officers to the fullest extent permitted by the Delaware General Corporation law. We also intend to enter into indemnity agreements with each of our directors and officers, which provide for mandatory indemnity of an officer or director made party to a "proceeding" by reason of the fact that he or she is or was a director of ours, if he or she acted in good faith and in a manner he or she reasonably believed to be in or not opposed to our best interests. These agreements also obligate us to advance expenses to a director provided that he or she will repay advanced expenses in the event he or she is not entitled to indemnification. Directors are also entitled to partial indemnification, and indemnification for expenses incurred as a result of acting at our request as a director, officer or agent of an employee benefit plan or other partnership, corporation, joint venture, trust or other enterprise owned or controlled by us. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to our directors, officers and controlling persons pursuant to the above statutory provisions or otherwise, we have been advised that in the opinion of the Securities and Exchange Commission that indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for our common stock is U.S. Stock Transfer Corporation. LISTING We will apply to have our common stock approved for quotation on The Nasdaq Stock Market's National Market under the symbol "____." Page 76 SHARES ELIGIBLE FOR FUTURE SALE Prior to our September 2000 recapitalization, our common stock was listed on The Nasdaq Stock Market's National Market. In connection with the recapitalization, we terminated our listing, and there is currently no public market for our common stock. We can make no prediction as to the effect, if any, that market sales of shares of common stock or the availability of shares of common stock for sale will have on the market price prevailing time to time. The sale of substantial amounts of common stock in the public market could adversely affect the prevailing market price of the common stock and our ability to raise equity capital in the future. SALE OF RESTRICTED SECURITIES Upon completion of this offering, we will have outstanding an aggregate of _______ shares of common stock, assuming no exercise of the underwriters' over-allotment option and no exercise of outstanding options and warrants to purchase common stock. Of these shares, all of the shares sold in this offering will be freely tradable without restriction or further registration under the Securities Act, unless these shares are purchased by affiliates. The remaining _________ shares of common stock held by existing stockholders are restricted securities. Restricted securities may be sold in the public market only if registered or if they qualify for an exemption from registration described below under Rules 144, 144(k) or 701 under the Securities Act. As a result of the contractual restrictions described below and the provisions of Rules 144, 144(k) and 701, the restricted shares will be available for sale in the public market as follows: o __________ shares will be eligible for immediate sale on the date of this prospectus; o __________ shares will be eligible for sale 90 days from the date of this prospectus; o __________ shares will be eligible for sale upon the expiration of the lock-up agreements, described below, 180 days after the date of this prospectus; o __________ shares will be eligible for sale upon the exercise of vested options or warrants 180 days after the date of this prospectus; and o __________ shares will be eligible for sale at various times more than 180 days after the date of this prospectus. LOCK-UP AGREEMENTS Our directors and officers and all of our security holders have signed lock-up agreements under which they agreed not to sell, dispose of, loan, pledge or grant any rights to any shares 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 Corporation for a period of 180 days after the date of this prospectus. Credit Suisse First Boston Corporation may choose to release some of these shares from these restrictions before the expiration of the 180-day period at any time without notice. Credit Suisse First Boston Corporation has no current intention to release any shares subject to lock-up agreements. In considering a request to release any shares, Credit Suisse First Boston Corporation would consider, among other factors, the particular circumstances surrounding the request, including, but not limited to, the number of shares requested to be released, the possible impact on the market for our common stock and the reasons for the request. RULE 144 In general, under Rule 144 as currently in effect, commencing 90 days after the date of this prospectus, a person who has beneficially owned shares of our common stock for at least one year, including a person who is an affiliate, is entitled to sell within any three-month period a number of shares that does not exceed the greater of: Page 77 o 1% of the number of shares of our common stock then outstanding; or o the average weekly trading volume of our common stock on The Nasdaq Stock Market's National Market during the four calendar weeks preceding the filing of a notice on Form 144 with respect to the sale, subject to restrictions specified in Rule 144. Sales under Rule 144 are also subject to manner of sale provisions and notice requirements and to the availability of current public information about us. Under Rule 144(k), a person who has not been one of our affiliates at any time during the three months preceding a sale, and who has beneficially owned the shares proposed to be sold for at least two years, is entitled to sell these shares without regard to the volume, manner of sale or other limitations contained in Rule 144. These shares are subject to the lock-up agreements and will be available for sale in the open market beginning 180 days after the date of this prospectus. RULE 701 In general, under Rule 701 of the Securities Act, any of our employees, consultants or advisors who purchase shares from us in connection with a compensatory stock plan or contract is eligible to resell the shares 90 days after the effective date of this offering in reliance on Rule 144, but without compliance with various restrictions, including the holding period, contained in Rule 144 so long as they are not an affiliate of ours. If they are an affiliate, they are eligible to resell the shares 90 days after the effective date of this offering in reliance on Rule 144 but without compliance with the holding period contained in Rule 144. These shares are subject to the lock-up agreements and will be available for sale in the open market beginning 180 days after the date of this prospectus. STOCK OPTIONS Immediately after this offering, we intend to file a registration statement under the Securities Act covering the shares of common stock reserved for issuance under our 1996 Stock Incentive Plan and our 2001 Stock Incentive Plan, including 1,325,670 shares of common stock underlying outstanding options. These registration statements are expected to be filed and become effective as soon as practicable after the closing of this offering. Accordingly, shares registered under the registration statements will, subject to any vesting provisions and Rule 144 volume limitations applicable to affiliates, be available for sale in the open market beginning 180 days after the date of this prospectus. REGISTRATION RIGHTS Some of our existing stockholders are parties to a stockholders agreement with us that provides for registration rights to cause us to register under the Securities Act all or part of the shares of our common stock. Registration of the sale of these shares of our common stock would permit their sale into the market immediately. If our existing stockholders sell a large number of shares, the market price of our common stock could decline. These holders of registration rights are subject to lock-up periods of 180 days following the date of this prospectus. Please refer to the information in the prospectus under the heading "Description of Capital Stock - Registration Rights" for a more detailed discussion of these registration rights. Page 78 UNDERWRITING Under the terms and subject to the conditions contained in an underwriting agreement dated ___________, 2001, we have agreed to sell to the underwriters named below, for whom Credit Suisse First Boston Corporation, Goldman, Sachs & Co., Banc of America Securities LLC, Tucker Anthony Incorporated, and Wells Fargo Van Kasper, LLC are acting as representatives, the following respective numbers of shares of common stock: Number UNDERWRITER of Shares ----------- ----------- Credit Suisse First Boston Corporation.......................... Goldman, Sachs & Co............................................. Banc of America Securities LLC.................................. Tucker Anthony Incorporated..................................... Wells Fargo Van Kasper, LLC..................................... ----------- Total................................................... =========== The underwriting agreement provides that the underwriters are obligated to purchase all the shares of common stock in the offering if any are purchased, other than those shares covered by the over-allotment option described below. The underwriting agreement also provides that if an underwriter defaults, the purchase commitments of non-defaulting underwriters may be increased or the offering may be terminated. We have granted to the underwriters a 30-day option to purchase on a pro rata basis up to ___________ additional shares at the initial public offering price less the underwriting discounts and commissions. The option may be exercised only to cover any over-allotments of common stock. The underwriters propose to offer the shares of common stock initially at the public offering price on the cover page of this prospectus and to selling group members at that price less a concession of $ _____ per share. The underwriters and selling group members may allow a discount of $ _____ per share on sales to other broker/dealers. After the initial public offering, the representatives may change the public offering price and concession and discount to broker/dealers. The following table summarizes the compensation and estimated expenses we will pay:
PER SHARE TOTAL ----------------------------- ------------------------------ Without With Without With OVER-ALLOTMENT OVER-ALLOTMENT OVER-ALLOTMENT OVER-ALLOTMENT -------------- -------------- -------------- -------------- Underwriting Discounts and Commissions paid by us........ $ $ $ $ Expenses payable by us........ $ $ $ $
The underwriters do not intend to confirm sales to any accounts over which they exercise discretionary authority. The offering is being conducted in accordance with the applicable provisions of Rule 2720 of the National Association of Securities Dealers, Inc. Conduct Rules because affiliates of Goldman, Sachs & Co., one of the underwriters, own more than 10% of our subordinated debt. Rule 2720 requires that the initial public offering price of the shares of common stock not be higher than that recommended by a "qualified independent underwriter" meeting specified standards. Accordingly, Credit Suisse First Boston Corporation is assuming the responsibilities of Page 79 acting as the qualified independent underwriter in pricing the offering and conducting the due diligence. The initial public offering price of the shares of common stock will be no higher than the price recommended by Credit Suisse First Boston Corporation. We have agreed that we will not offer, sell, contract to sell, pledge or otherwise dispose of, directly or indirectly, or file with the Securities and Exchange Commission a registration statement under the Securities Act relating to, any shares of our common stock or securities convertible into or exchangeable or exercisable for any shares of our common stock, or publicly disclose the intention to make any offer, sale, pledge, disposition or filing, without the prior written consent of Credit Suisse First Boston Corporation for a period of 180 days after the date of this prospectus. Our officers and directors and the holders of all of our common stock have agreed that they will not offer, sell, contract to sell, pledge or otherwise dispose of, directly or indirectly, any shares of common stock or securities convertible into or exchangeable or exercisable for any shares of our common stock, enter into a transaction that would have the same effect, or enter into any swap, hedge or other arrangement that transfers, in whole or in part, any of the economic consequences of ownership of our common stock, whether any of these transactions are to be settled by delivery of our common stock or other securities, in cash or otherwise, or publicly disclose the intention to make any offer, sale, pledge or disposition, or to enter into any transaction, swap, hedge or other arrangement, without, in each case, the prior written consent of Credit Suisse First Boston Corporation for a period of 180 days after the date of this prospectus. The underwriters have reserved for sale at the initial public offering price up to _______ shares of the common stock for employees and other persons associated with us who express an interest in purchasing common stock in the offering. No shares have been reserved by the underwriters for purchase by our directors. The number of shares available for sale to the general public in the offering will be reduced to the extent these persons purchase the reserved shares. Any reserved shares not so purchased will be offered by the underwriters to the general public on the same terms as the other shares. Any reserved shares purchased by these persons will not be subject to the lock-up described in the previous paragraph but will be restricted to the extent required by the Conduct Rules of the National Association of Securities Dealers, Inc. from sale, transfer, assignment, pledge or hypothecation for a period of three months following the date of this prospectus. We have agreed to indemnify the underwriters against liabilities under the Securities Act, or contribute to payments that the underwriters may be required to make in that respect. We will apply to have our common stock approved for quotation on The Nasdaq Stock Market's National Market. As of August 31, 2001, GS Mezzanine Partners II, L.P. and GS Mezzanine II Offshore, L.P., affiliates of Goldman, Sachs & Co., held an aggregate of 122,123 shares of Series A preferred stock and 121,000 shares of Series B junior preferred stock; an aggregate principal amount of $76.7 million of our senior notes; and an aggregate principal amount of $14.2 million of our senior subordinated notes, and warrants to purchase 814,575 shares of our common stock at an exercise price of $0.0007 per share. Melina Higgins, one of our directors, is the Chief Financial Officer of GS Mezzanine Partners II, L.P. and GS Mezzanine II Offshore, L.P. Some of the representatives or their affiliates have provided investment banking and advisory services for us from time to time for which they have received customary fees and reimbursements of expenses and may in the future provide additional services. In connection with our recapitalization, an affiliate of Goldman, Sachs & Co. acted as sole lead arranger and sole syndication agent for our $300.0 million credit facility and received customary fees in connection therewith. In addition, Credit Suisse First Boston Corporation provided advisory services in connection with our recapitalization and received customary fees for those services. Page 80 Prior to this offering, there has been no public trading market for the common stock. The initial public offering price for the common stock will be determined by negotiation between us and the representatives. The principal factors to be considered in determining the initial public offering price include: o the information included in this prospectus and otherwise available to the representatives; o the history and the prospects of the industry in which we compete; o the ability of our management; o our past and present operations; o our prospects for future earnings; o the recent market prices of, and the demand for, publicly traded common stock of generally comparable companies; o market conditions for initial public offerings; and o the general condition of the securities markets at the time of this offering. We cannot assure you that the initial public offering price will correspond to the price at which our common stock will trade in the public market subsequent to the offering or that an active trading market for our common stock will develop and continue after the offering. In connection with the offering, the underwriters may engage in stabilizing transactions, over-allotment transactions, syndicate covering transactions and penalty bids in accordance with Regulation M under the Securities Exchange Act of 1934. o Stabilizing transactions permit bids to purchase the underlying security so long as the stabilizing bids do not exceed a specified maximum. o Over-allotment involves sales by the underwriters of shares in excess of the number of shares the underwriters are obligated to purchase, which creates a syndicate short position. The short position may be either a covered short position or a naked short position. In a covered short position, the number of shares over-allotted by the underwriters is not greater than the number of shares that they may purchase in the over-allotment option. In a naked short position, the number of shares involved is greater than the number of shares in the over-allotment option. The underwriters may close out any short position by either exercising their over-allotment option and/or purchasing shares in the open market. o Syndicate covering transactions involve purchases of the common stock in the open market after the distribution has been completed in order to cover syndicate short positions. In determining the source of shares to close out the short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase shares through the over-allotment option. If the underwriters sell more shares than could be covered by the over-allotment option, a naked short position, the position can only be closed out by buying shares in the open market. A naked short position is more likely to be created if the underwriters are concerned that there could be downward pressure on the price of the shares in the open market after pricing that could adversely affect investors who purchase in the offering. o Penalty bids permit the representatives to reclaim a selling concession from a syndicate member when the common stock originally sold by the syndicate member is purchased in a stabilizing or syndicate covering transaction to cover syndicate short positions. Page 81 These stabilizing transactions, syndicate covering transactions and penalty bids may have the effect of raising or maintaining the market price of our common stock or preventing or retarding a decline in the market price of our common stock. As a result the price of our common stock may be higher than the price that might otherwise exist in the open market. These transactions may be effected on The Nasdaq Stock Market's National Market or otherwise and, if commenced, may be discontinued at any time. A prospectus in electronic format may be made available on the web sites maintained by one or more of the underwriters participating in this offering. The representatives may agree to allocate a number of shares to underwriters for sale to their online brokerage account holders. Internet distributions will be allocated by the underwriters that will make internet distributions on the same basis as other allocations. Credit Suisse First Boston Corporation may effect an on-line distribution through its affiliate, CSFBDIRECT Inc., an on-line broker/dealer, as a selling group member. Page 82 NOTICE TO CANADIAN RESIDENTS RESALE RESTRICTIONS The distribution of the common stock in Canada is being made only on a private placement basis exempt from the requirement that we prepare and file a prospectus with the securities regulatory authorities in each province where trades of common stock are made. Any resale of the common stock in Canada must be made under applicable securities laws which will vary depending on the relevant jurisdiction, and which may require resales to be made under available statutory exemptions or under a discretionary exemption granted by the applicable Canadian securities regulatory authority. Purchasers are advised to seek legal advice prior to any resale of the common stock. REPRESENTATIONS OF PURCHASERS By purchasing common stock in Canada and accepting a purchase confirmation a purchaser is representing to us and the dealer from whom the purchase confirmation is received that: o the purchaser is entitled under applicable provincial securities laws to purchase the common stock without the benefit of a prospectus qualified under those securities laws, o where required by law, that the purchaser is purchasing as principal and not as agent, and o the purchaser has reviewed the text above under "Resale Restrictions". RIGHTS OF ACTION (ONTARIO PURCHASERS) The securities being offered are those of a foreign issuer and Ontario purchasers will not receive the contractual right of action prescribed by Ontario securities law. As a result, Ontario purchasers must rely on other remedies that may be available, including common law rights of action for damages or rescission or rights of action under the civil liability provisions of the U.S. federal securities laws. ENFORCEMENT OF LEGAL RIGHTS All of the issuer's directors and officers as well as the experts named herein may be located outside of Canada and, as a result, it may not be possible for Canadian purchasers to effect service of process within Canada upon the issuer or such persons. All or a substantial portion of the assets of the issuer and such persons may be located outside of Canada and, as a result, it may not be possible to satisfy a judgment against the issuer or such persons in Canada or to enforce a judgment obtained in Canadian courts against such issuer or persons outside of Canada. TAXATION AND ELIGIBILITY FOR INVESTMENT Canadian purchasers of common stock should consult their own legal and tax advisors with respect to the tax consequences of an investment in the common stock in their particular circumstances and about the eligibility of the common stock for investment by the purchaser under relevant Canadian legislation. Page 83 LEGAL MATTERS The validity of the common stock offered by this prospectus will be passed upon for us by our legal counsel, Akin, Gump, Strauss, Hauer & Feld, LLP, Los Angeles, California. Various legal matters in connection with this offering will be passed on for the underwriters by Skadden, Arps, Slate, Meagher & Flom, LLP, Los Angeles, California. EXPERTS The audited financial statements and schedules included in this prospectus and elsewhere in the registration statement have been audited by Arthur Andersen LLP, independent public accountants, as indicated in their reports with respect thereto, and are included herein in reliance upon the authority of said firm as experts in giving said reports. WHERE YOU CAN FIND MORE INFORMATION We have filed a registration statement on Form S-1 with the Commission regarding this offering. The registration statement of which this prospectus is a part contains additional relevant information about us and our capital stock and you should refer to the registration statement and its exhibits to read that information. References in this prospectus to any of our contracts or other documents are not necessarily complete, and you should refer to the exhibits attached to the registration statement for copies of the actual contract or document. You may read and copy the registration statement, the related exhibits and the other material we file with the Commission and the Commission's Public Reference Room at 450 Fifth Street, N.W., Washington D.C. 20549. You can also request copies of those documents, upon payment of a duplicating fee, by writing to the Commission. Please call the Commission at 1-800-SEC-0330 for further information on the operation of the public reference rooms. The Commission also maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file with the Commission. The site's address is www.sec.gov. You may also request a copy of these filing, at no cost, by writing or telephoning us as follows: 12401 West Olympic Boulevard, Los Angeles, California 90064-1022, Attention: Chief Financial Officer, or 310-571-6500. As a result of this offering, we will become subject to the information and reporting requirements of the Securities Exchange Act and, in accordance with those requirements, will file periodic reports, proxy statements and other information with the SEC. We intend to furnish our stockholders with annual reports containing financial statements audited by our independent accountants. Page 84 [LOGO] VCA ANTECH, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS ---------------- PAGE Report of Independent Public Accountants....................................F-2 Consolidated Balance Sheets as of December 31, 2000 and 1999................F-3 Consolidated Statements of Operations for the Years Ended December 31, 2000, 1999 and 1998............................................F-4 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2000, 1999 and 1998................................F-5 Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2000, 1999 and 1998................................F-6 Consolidated Statements of Cash Flows for the Years Ended December 31, 2000, 1999 and 1998...............................F-7 Notes to Consolidated Financial Statements..................................F-9 Condensed Consolidated Balance Sheets as of June 30, 2001 and December 31, 2000 (unaudited)..............................................F-31 Condensed Consolidated Statements of Operations for the six months ended June 30, 2001 and 2000 (unaudited)...................................F-32 Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2001 and 2000 (unaudited)...................................F-33 Notes to Condensed Consolidated Financial Statements - June 30, 2001 (unaudited)................................................................F-34 Page F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of VCA Antech, Inc.: We have audited the accompanying consolidated balance sheets of VCA Antech, Inc. (a Delaware corporation) and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders' equity, comprehensive income, and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit 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 financial statements referred to above present fairly, in all material respects, the financial position of VCA Antech, Inc. and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. /s/ Arthur Andersen LLP ARTHUR ANDERSEN LLP Los Angeles, California March 28, 2001 Page F-2
VCA ANTECH, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2000 AND 1999 (IN THOUSANDS, EXCEPT PAR VALUE) Assets 2000 1999 ------------ ---------- Current Assets: Cash and cash equivalents............................................. $ 10,519 $ 10,620 Marketable securities................................................. -- 5,313 Trade accounts receivable, less allowance for uncollectible accounts of $4,110 and $7,162 at December 31, 2000 and 1999, respectively................................................ 15,450 15,276 Inventory............................................................. 5,773 5,455 Prepaid expense and other............................................. 3,424 4,544 Deferred income taxes................................................. 4,655 4,213 Prepaid income taxes.................................................. 9,402 3,986 ----------- ---------- Total current assets............................................... 49,223 49,407 Property and equipment, net............................................... 86,972 70,336 Other Assets: Goodwill, net......................................................... 310,185 291,286 Covenants not to compete, net......................................... 19,549 4,450 Notes receivable, net................................................. 2,178 1,891 Investment in VPI..................................................... -- 5,000 Deferred financing costs, net......................................... 13,373 1,515 Other................................................................. 1,590 2,615 ----------- ---------- $ 483,070 $ 426,500 =========== ========== Liabilities and Stockholders' Equity (Deficit) Current Liabilities: Current portion of long-term obligations................................ $ 5,756 $ 21,901 Accounts payable........................................................ 8,393 8,715 Accrued payroll and related liabilities................................. 8,335 7,258 Accrued recapitalization costs.......................................... 4,014 -- Other accrued liabilities............................................... 13,228 7,896 ----------- ---------- Total current liabilities............................................ 39,726 45,770 Long-term obligations, less current portion................................. 356,993 139,634 Deferred income taxes....................................................... 8,484 6,655 Other liabilities........................................................... 1,500 -- Minority interest........................................................... 3,610 3,212 Series A Redeemable Preferred Stock......................................... 77,875 -- Series B Redeemable Preferred Stock......................................... 76,747 -- Stockholders' Equity (Deficit): Common stock, par value $.01 as of December 31, 2000, 24,000 shares authorized as of December 31, 2000, 17,524 and 325,620 outstanding as of December 31, 2000 and 1999, respectively................................................ 175 3,256 Additional paid-in capital............................................... 18,498 210,492 Retained earnings (accumulated deficit).................................. (100,020) 25,737 Accumulated comprehensive loss - unrealized loss on investment........... -- (361) Notes receivable from stockholders....................................... (518) (654) Less: cost of common stock held in treasury............................. -- (7,241) ----------- ---------- Total stockholders' equity (deficit).................................... (81,865) 231,229 ----------- ---------- $ 483,070 $ 426,500 =========== ==========
The accompanying notes are an integral part of these consolidated balance sheets. Page F-3
VCA ANTECH, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2000 1999 1998 ---------- ---------- ---------- Revenue............................................ $ 354,687 $ 320,560 $ 281,039 Direct costs....................................... 254,787 232,493 209,380 ---------- ---------- ---------- Gross profit..................................... 99,900 88,067 71,659 Selling, general and administrative................ 26,994 23,622 19,693 Depreciation and amortization...................... 18,878 16,463 13,132 Year 2000 remediation expense...................... -- 2,839 -- Reversal of restructuring charges.................. -- (1,873) -- Recapitalization costs............................. 34,823 -- -- ---------- ---------- ---------- Operating income................................. 19,205 47,016 38,834 Interest income.................................... 850 1,194 2,357 Interest expense................................... 20,742 10,643 11,189 Other (income) expense............................. 1,800 -- -- ---------- ---------- ---------- Income (loss) before minority interest, provision for income taxes and extraordinary item.............................. (2,487) 37,567 30,002 Minority interest in income of subsidiaries........ 1,066 850 780 ---------- ---------- ---------- Income (loss) before provision for income taxes and extraordinary item.................... (3,553) 36,717 29,222 Provision for income taxes......................... 2,199 16,462 12,954 Income tax adjustment.............................. -- (2,102) -- ---------- ---------- ---------- Income (loss) before extraordinary item.......... (5,752) 22,357 16,268 Extraordinary loss on early extinguishment of debt (net of income tax benefit of $1,845)....... 2,659 -- -- ---------- ---------- ---------- Net income (loss)................................ $ (8,411) $ 22,357 $ 16,268 ========== ========== ========== Increase in carrying amount of Redeemable Preferred Stock.................................. 5,391 -- -- ---------- ---------- ---------- Net income (loss) available to common stockholders................................ $ (13,802) $ 22,357 $ 16,268 ========== ========== ========== Basic earnings (loss) per common share: Income (loss) before extraordinary item....... $ (0.05) $ 0.07 $ 0.05 Extraordinary loss on early extinguishment of debt..................................... (0.01) -- -- ---------- ---------- ---------- Earnings (loss) per common share.............. $ (0.06) $ 0.07 $ 0.05 ========== ========== ========== Diluted earnings (loss) per common share: Income (loss) before extraordinary item....... $ (0.05) $ 0.07 $ 0.05 Extraordinary loss on early extinguishment of debt..................................... (0.01) -- -- ---------- ---------- ---------- Earnings (loss) per common share.............. $ (0.06) $ 0.07 $ 0.05 ========== ========== ========== Shares used for computing basic earnings (loss) per share................................. 234,055 315,945 305,250 ========== ========== ========== Shares used for computing diluted earnings (loss) per share................................... 234,055 329,775 329,100 ========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. Page F-4
VCA ANTECH, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (IN THOUSANDS) NOTES RECEIV- ACCUMU- ABLE LATED COMMON STOCK ADDITIONAL TREASURY SHARES FROM COMPRE- ------------------- PAID-IN ----------------- STOCK- RETAINED HENSIVE SHARES AMOUNT CAPITAL SHARES AMOUNT HOLDERS (DEFICIT) LOSS TOTAL -------- -------- ---------- ------- -------- ------- --------- -------- -------- Balances, December 31, 1997 304,800 $ 3,048 $ 193,717 (3,405) $(2,480) $(546) $ (12,888) $ -- $180,851 Net income -- -- -- -- -- -- 16,268 -- 16,268 Unrealized loss on investments -- -- -- -- -- -- -- (870) (870) Unrealized loss recognized on investments -- -- -- -- -- -- -- 402 402 Exercise of stock options 2,910 29 2,008 -- -- -- -- -- 2,037 Interest on notes -- -- -- -- -- (71) -- -- (71) Business acquisitions 2,610 26 3,121 -- -- -- -- -- 3,147 Conversion of convertible debt 180 2 83 -- -- -- -- -- 85 Settlement of guaranteed purchase price contingently payable in cash or common stock 315 3 (3) -- -- -- -- -- -- Restricted stock bonus 1,425 14 822 -- -- -- -- -- 836 --------- --------- ---------- -------- --------- ------- ---------- ------- --------- Balances, December 31, 1998 312,240 3,122 199,748 (3,405) (2,480) (617) 3,380 (468) 202,685 Net income -- -- -- -- -- -- 22,357 -- 22,357 Unrealized loss on investments -- -- -- -- -- -- -- (218) (218) Unrealized loss recognized on investments -- -- -- -- -- -- -- 325 325 Exercise of stock options 750 8 527 -- -- -- -- -- 535 Exercise of warrants 45 -- -- -- -- -- -- -- -- Interest on notes -- -- -- -- -- (37) -- -- (37) Business acquisitions 8,820 88 8,740 -- -- -- -- -- 8,828 Conversion of convertible debt 150 2 72 -- -- -- -- -- 74 Restricted stock bonus 3,615 36 1,405 -- -- -- -- -- 1,441 Purchase of treasury shares -- -- -- (5,895) (4,761) -- -- -- (4,761) --------- --------- ---------- -------- --------- ------- ---------- ------- --------- Balances, December 31, 1999 325,620 3,256 210,492 (9,300) (7,241) (654) 25,737 (361) 231,229 Net loss -- -- -- -- -- -- (8,411) -- (8,411) Unrealized loss on investments -- -- -- -- -- -- -- (219) (219) Unrealized loss recognized on investments -- -- -- -- -- -- -- 580 580 Exercise of stock options 1,830 18 905 -- -- -- -- -- 923 Restricted stock bonus 3,060 31 1,071 -- -- -- -- -- 1,102 Interest on notes -- -- -- -- -- (34) -- -- (34) Purchase of treasury shares -- -- -- (7,715) (3,323) -- -- -- (3,323) Retirement of treasury shares (17,015) -- -- 17,015 10,564 -- -- -- 10,564 Issuance of common stock 14,865 149 14,716 -- -- (518) -- -- 14,347 Issuance of warrants -- -- 1,149 -- -- -- -- -- 1,149 Write-off of notes as part of Recapitalization -- -- -- -- -- 688 -- -- 688 Increase in carrying amount of Redeemable Preferred Stock -- -- -- -- -- -- (5,391) -- (5,391) Repurchase and retirement of common stock (310,836) (3,279) (209,835) -- -- -- (111,955) -- (325,069) --------- --------- ---------- -------- --------- ------- ---------- ------- --------- Balances, December 31, 2000 17,524 $ 175 $ 18,498 -- $ -- $(518) $(100,020) $ -- $(81,865) ========= ========= ========== ======== ========= ======= ========== ======= =========
The accompanying notes are an integral part of these consolidated financial statements. Page F-5
VCA ANTECH, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (IN THOUSANDS) 2000 1999 1998 ---------- ---------- ---------- Net income (loss).............................. $ (8,411) $ 22,357 $ 16,268 Other comprehensive income: Unrealized loss on investments............. (219) (218) (870) Recognized loss on investments............. 580 325 402 ---------- ---------- ---------- Other comprehensive income (loss).............. 361 107 (468) ---------- ---------- ---------- Net comprehensive income (loss)................ $ (8,050) $ 22,464 $ 15,800 ========== ========== ========== Accumulated comprehensive loss at beginning of year.......................... $ (361) $ (468) $ -- Other comprehensive income (loss).............. $ 361 $ 107 $ (468) ---------- ---------- ---------- Accumulated comprehensive loss at end of year.. $ -- $ (361) $ (468) ========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. Page F-6
VCA ANTECH, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (IN THOUSANDS) 2000 1999 1998 ---------- ---------- ---------- Cash Flows from Operating Activities: Net income (loss) ........................... $ (8,411) $ 22,357 $ 16,268 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and Amortization........... 18,878 16,463 13,132 Amortization of deferred financing costs and debt discount............... 836 241 431 Provision for uncollectible accounts.... 3,105 2,515 2,898 Extraordinary loss on early extinguishment of debt................ 4,504 -- -- Recapitalization costs.................. 34,823 -- -- Interest paid in kind on senior subordinated notes.................... 4,306 -- -- Gain on sale of investment in VPI....... (3,200) -- -- Loss recognized on investment in Zoasis. 5,000 -- -- Minority interest in income of subsidiaries.......................... 1,066 850 780 Distributions to minority interest partners.............................. (1,400) (926) (627) Increase in accounts receivable......... (3,362) (5,535) (3,749) Increase in inventory................... (167) (347) (242) Increase (decrease) in accounts payable and accrued liabilities....... 5,932 (1,383) (4,872) Decrease (increase) in prepaid income taxes.......................... (5,416) 1,054 594 Decrease (increase) in prepaid expense and other..................... 2,173 (414) (1,061) Increase in deferred income tax asset... (442) (102) (1,043) Increase in deferred income tax liability............................. 1,829 3,694 4,614 --------- --------- --------- Net cash provided by operating activities.... 60,054 38,467 27,123 --------- --------- --------- Cash Flows from Investing Activities: Business acquisitions, net of cash acquired.. (18,183) (16,079) (17,108) Real estate acquired in connection with business acquisitions...................... (1,800) (4,241) (4,270) Property and equipment additions, net........ (22,555) (21,803) (11,678) Investments in marketable securities......... (129,992) (58,258) (44,902) Proceeds from sales or maturities of marketable securities...................... 135,666 86,410 62,447 Payment for covenants not to compete......... (15,630) -- -- Investment in VPI............................ -- -- (4,000) Net proceeds from sale of investment in VPI.. -- -- 8,200 Investment in Zoasis......................... (5,000) -- -- Other........................................ 1,615 295 37 --------- --------- --------- Net cash used in investing activities........ (47,679) (13,676) (19,474) --------- --------- --------- Cash Flows from Financing Activities: Repayment of long-term debt.................. (172,854) (18,922) (20,591) Proceeds from the issuance of long-term debt. 356,670 -- -- Payment of deferred financing costs.......... (13,958) -- -- Proceeds from issuance of common stock under stock option plans................... 923 535 2,037 Proceeds from issuance of preferred stock.... 149,231 -- -- Proceeds from issuance of common stock....... 14,350 -- -- Proceeds from issuance of stock warrants..... 1,149 -- -- Repurchase of common stock................... (314,508) -- -- Purchase of treasury stock................... (3,323) (4,761) -- Payments for recapitalization expense........ (30,156) -- -- --------- --------- --------- Net cash used in financing activities........ (12,476) (23,148) (18,554) --------- --------- --------- Increase (Decrease) in Cash and Cash Equivalents.................................. (101) 1,643 (10,905) Cash and Cash Equivalents at beginning of year...................................... 10,620 8,977 19,882 --------- --------- --------- Cash and Cash Equivalents at end of year....... $ 10,519 $ 10,620 $ 8,977 ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements. Page F-7
VCA ANTECH, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (IN THOUSANDS) 2000 1999 1998 ---------- ---------- ---------- Supplemental Disclosures of Cash Flow Information: Interest paid.............................. $ 15,237 $ 10,517 $ 11,301 Income taxes paid.......................... 4,337 9,603 10,944 Supplemental Schedule of Noncash Investing and Financing Activities: In connection with acquisitions, assets acquired and liabilities assumed were as follows: Fair value of assets acquired............. $ 29,616 $ 53,209 $ 30,740 Less consideration given: Cash paid and acquisition costs......... (18,230) (19,497) (20,255) Cash paid in settlement of assumed liabilities........................... (1,262) (517) (812) Common stock issued..................... -- (8,828) (3,100) ---------- ---------- ---------- Liabilities assumed including notes payable issued.......................... $ 10,124 $ 24,367 $ 6,573 ========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. Page F-8 VCA ANTECH, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 1. THE COMPANY Based in Los Angeles, California, VCA Antech, Inc. ("VCA"), a Delaware corporation, is an animal health care services company with positions in two core businesses, animal hospitals ("Animal Hospitals") and veterinary diagnostic laboratories ("Laboratories"). In 2000, the Company established a new legal structure, comprised of a holding company and an operating company. VCA is the holding company ("Holding Company"). Vicar Operating, Inc. ("Operating Company") is wholly-owned by the Holding Company and owns the capital stock of all of the Company's subsidiaries. Collectively, the Holding Company and the Operating Company are referred to as VCA or the Company. Prior to September 24, 2001, VCA was known as Veterinary Centers of America, Inc. Animal Hospitals offer a full range of general medical and surgical services for companion animals. 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. 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. The Company does not conduct experiments on animals and is not engaged in animal research. At December 31, 2000, the Company owned or operated 209 animal hospitals throughout 30 states, as follows: California 45 Delaware 4 New York (a) 24 Connecticut 3 Florida 18 New Mexico 3 Illinois 15 Colorado 2 Michigan 12 North Carolina (a) 2 Pennsylvania 10 Utah 2 Maryland 9 Alabama (a) 1 Texas (a) 9 Arizona 1 New Jersey (a) 8 Georgia 1 Indiana 7 Hawaii 1 Massachusetts 7 Louisiana (a) 1 Nevada 6 Missouri 1 Virginia 5 Nebraska (a) 1 Ohio (a) 5 South Carolina 1 Alaska 4 West Virginia (a) 1 (a) states where the Company manages animal hospitals under long-term management agreements. Page F-9 At December 31, 2000, the Company operated 15 full-service laboratories. Our 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 nine STAT laboratories that service other locations with demand sufficient to warrant nearby laboratory facilities and are open during daytime hours. PRIMARY HUBS SECONDARY HUBS STAT LABORATORIES ----------------- -------------- ------------------ California 1 Arizona 1 California 1 New York 1 Georgia 1 Colorado 1 Illinois 1 Florida 1 Tennessee 1 Hawaii 1 Michigan 1 Oregon 1 Texas 2 Washington 1 ---- ---- ---- Totals 2 4 9 ==== ==== ==== 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. On September 20, 2000, the Company completed a recapitalization transaction (the "Recapitalization") with certain investors who are affiliated with Leonard Green & Partners, L.P. The Company purchased the majority 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 then issued 14,350,005 new common shares to certain investors in exchange for an 80% controlling interest in the Company. An additional 517,995 shares of common stock were issued to certain members of management. In connection with the Recapitalization, the Company also authorized and issued preferred stock for which it received approximately $149.2 million and entered into various debt agreements through which it received approximately $356.7 million in cash. 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 common stock, which amounted to approximately 20% of the Company's outstanding common stock following the Recapitalization. The Company incurred $34.8 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 $1.9 million of other expenses. Additionally, the Company paid $15.6 million out of these proceeds for covenants not to compete to the following executive officers: Robert L. Antin, Chief Executive Officer; Arthur J. Antin, Chief Operating Officer; Tomas W. Fuller, Chief Financial Officer; and Neil Tauber, Senior Vice President of Development. The payments made for the covenants not to compete are being amortized over a three-year period commencing September 20, 2000. 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, 2000, the Company operated in nine of these states. In these states, instead of owning an Page F-10 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: o availability of all facilities and equipment o day-to-day financial and administrative supervision and management o maintenance of patient records o recruitment of veterinary and hospitals staff o marketing o 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 $31.1 million, $30.2 million and $19.3 million for the years ended December 31, 2000, 1999 and 1998, respectively. b. CASH AND CASH EQUIVALENTS For purposes of the balance sheets and statements of cash flows, the Company considers only highly liquid investments to be cash equivalents. Cash and cash equivalents at December 31 consisted of (in thousands):
2000 1999 ------- ------- Cash............................. $ 3,443 $ 8,160 Money market funds............... 7,076 2,460 ------- ------- $10,519 $10,620 ======= =======
c. MARKETABLE SECURITIES During the year ending December 31, 2000, the Company realized a loss on the sale of an investment of $1.3 million; however, the Company recorded unrealized losses of $727,000 on this investment in years prior to 2000. 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 30 years Leasehold improvements.................. Lesser of lease term or 15 years Furniture and equipment................. 5 to 7 years Property held under capital leases...... 5 to 30 years Page F-11 Property and equipment at December 31, consisted of (in thousands):
2000 1999 --------- ---------- Land.................................... $ 19,788 $ 14,423 Building and improvements............... 33,920 24,615 Leasehold improvements.................. 17,565 13,428 Furniture and equipment................. 43,771 35,206 Equipment held under capital leases..... 1,533 1,552 Construction in progress................ 1,293 4,479 Total fixed assets...................... 117,870 93,703 Less-Accumulated depreciation and amortization............................ (30,898) (23,367) --------- --------- $ 86,972 $ 70,336 ========= =========
Accumulated depreciation on equipment held under capital leases amounted to $1.3 million and $1.2 million at December 31, 2000 and 1999, respectively. 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. Goodwill is amortized on a straight-line basis over the expected period to be benefited, not exceeding 40 years. 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 $35.0 million and $27.2 million at December 31, 2000 and 1999, respectively. 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 $6.6 million and $4.7 million at December 31, 2000 and 1999, 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 and $270,000 as of December 31, 2000 and 1999, respectively. The notes bear interest at rates varying from 7% to 9% per annum. h. DEFERRED 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 commencing on February 1, 1997, for an aggregate fee of $15.3 million payable in semi-annual installments over a five-year period. Consulting and management fees earned under this agreement are included in revenue and amounted to $425,000 for the year ended December 31, 2000, and $5.1 million for each of the years ended December 31, 1999 and 1998, respectively. The agreement expired February 1, 2000. Page F-12 In October 2000, the Company entered into a two-year consulting agreement with HPP for which the Company was paid $5.0 million. Of the $5.0 million received, $4.0 million will be recognized as revenue ratably over the life of the agreement and $1.0 million will be used for certain marketing obligations under the agreement. As of December 31, 2000, $500,000 has been recognized as revenue and deferred revenue of $2.0 million and $1.5 million is recorded in other accrued liabilities and other liabilities, respectively. i. DEFERRED FINANCING COSTS In connection with the issuance of long-term debt in 2000, the Company incurred $13.9 million of deferred financing costs. These costs are shown net of accumulated amortization of $586,000 in the Consolidated Balance Sheet at December 31, 2000. The deferred financing costs are amortized using the effective interest method over the life of the related debt. j. INVESTMENT IN VPI AND ZOASIS During portions of 2000 and 1999, the Company had investments in Veterinary Pet Insurance, Inc. ("VPI") and Zoasis.com, Inc. ("Zoasis"), both of which were accounted for on the cost basis. See Footnote 4, 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 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 are 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. RECENT ACCOUNTING PRONOUNCEMENTS 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 133"). SFAS 133, which as amended is effective beginning in the fiscal year beginning 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. 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 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 is accounted for as a cash flow hedge which will require that the Company report the market value of the Collar Agreement in the balance sheet. Payments made or received as a result of a LIBOR outside of the cap or floor of the Collar Agreement will be accounted for as a component of net income. Page F-13 The Company adopted SFAS 133 effective January 1, 2001; however, had the Company adopted it in the year ending December 31, 2000, it would have reported a liability from interest rate hedging activities at the market rate of $525,000, $411,000 of which would have been recognized in comprehensive income and $114,000 which would have been recognized in other (income) expense. No payments were required under the Collar Agreement during the year ending December 31, 2000. With the exception of the Collar Agreement, management does not intend to enter into derivative contracts in the future and does not expect the implementation of SFAS 133 to have a material impact on its future earnings. n. RECLASSIFICATIONS Certain 1999 and 1998 balances have been reclassified to conform with the 2000 financial statement presentation. o. 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. p. RELATED PARTY TRANSACTIONS 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; the related lease agreements are negotiated as part of the acquisition before the doctor is hired. These arrangements are not contingent upon the current or future employment of the doctors. In June 2000, the Company invested $5.0 million for convertible preferred stock of Zoasis, an internet start-up business, majority-owned by Robert A. Antin, the Company's Chief Executive Officer and a director of the Company. 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. (See Footnote 4, JOINT VENTURES AND INVESTMENTS, for a description of Zoasis and the reason for impairment). Zoasis continues to provide marketing reminder services to the Company. The Company incurred $81,000 during the year ended December 31, 2000 for these marketing reminder services. In September 2000, we sold our entire equity interest in Vet's Choice, which had zero cost basis, to Heinz Pet Products. We received $500,000 in the sale. At the time of the sale, one of our directors, Mr. John A. Heil, served as president of an affiliate of Heinz Pet Products. In connection with the sale, Heinz Pet Products also paid us $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 our executive management had a 30.5% ownership interest in the Wisdom Group, L.P. as limited partners and a subsidiary of ours owned a 1% ownership interest as the general partner. The Wisdom Group, L.P. was dissolved in November 2000 upon redemption of all of the partnership interests. The nature of the business of 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. On September 20, 2000, the Company entered into a ten-year management services agreement with Leonard Green & Partners, L.P. ("Leonard Green") for services relating to investment banking, general consulting and financial planning. The agreement calls for monthly payments of $207,000 and is subject to an increase of 1.6% of any additional capital invested by Green Equity Investors, III, L.P., a Delaware limited partnership, any of its affiliates, or any of its co-investors in the Company. In addition, Leonard Green received one-time fees of approximately $7.6 million in connection with the Company's recapitalization on September 20, 2000. Page F-14 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 $5.6 million, $4.3 million and $3.2 million for the years ended December 31, 2000, 1999 and 1998, respectively. 3. ACQUISITIONS During 2000, the Company purchased 24 animal hospitals and one veterinary diagnostic laboratory, all of which were accounted for as purchases. 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 $29.6 million, consisting of $18.2 million in cash, $11.1 million in debt, and the assumption of liabilities totaling $315,000. The aggregated purchase price was allocated as follows: $2.7 million to tangible assets, $21.6 million to goodwill and $5.3 million to other intangibles. During 1999, the Company purchased 24 animal hospitals and two veterinary diagnostic laboratories all of which were accounted for as purchases. Five of the acquired animal hospitals and both laboratories were merged into existing VCA facilities upon acquisition. Including acquisition costs, VCA paid an aggregate consideration of $24.2 million, consisting of $10.4 million in cash, $12.4 million in debt, 70,712 shares of common stock of the Company with a value of $1.1 million, and the assumption of liabilities totaling $369,000. The aggregated purchase price was allocated as follows: $1.9 million to tangible assets, $18.6 million to goodwill and $3.8 million to other intangibles. In addition, on April 1, 1999, the Company completed the acquisition of AAH Management Corp. ("AAH") for a total consideration (including acquisition costs) of $29.0 million, consisting of 517,585 shares of VCA common stock, with a value at the date of acquisition of $7.8 million, $9.1 million in cash, $1.2 million in notes payable and the assumption of $10.9 million in liabilities. AAH operated 15 animal hospitals located in New York and New Jersey. The acquisition of AAH was accounted for as a purchase. The purchase price has been allocated as follows: $6.3 million to tangible assets, $21.9 million to goodwill, and $725,000 to other intangible assets. During 1998, the Company completed the acquisitions of 11 animal hospitals and one veterinary diagnostic laboratory. In connection with these acquisitions, which were accounted for as purchases, VCA paid an aggregate consideration including acquisition costs of $30.7 million, consisting of $20.2 million in cash, $6.5 million in debt, 171,564 shares of common stock of the Company with a value of $3.1 million, and the assumption of liabilities totaling $903,000. The $30.7 million aggregate purchase price was allocated $6.2 million to tangible assets, $23.4 million to goodwill and $1.2 million to other intangible assets. The pro forma results listed below are unaudited and reflect purchase price accounting adjustments assuming 2000 and 1999 acquisitions occurred at January 1, 1999. 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 amounts) (Unaudited) 2000 1999 ----------- ----------- Revenue................................ $ 369,958 $ 365,391 Net income (loss) available to common stockholders........................... $ (12,587) $ 24,224 Diluted earnings per share............. $ (0.05) (0.07) Shares used for computing diluted earnings per share..................... $ 234,055 $ 329,775
Page F-15 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 three to five 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 multiplier 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 2000 and 1999 consisted entirely of cash approximating $486,000 and $326,000, respectively. Earn-Out Payments in 1998 amounted to approximately $358,000, consisting of $311,000 in cash and 2,394 shares of common stock valued on the date of issuance at $47,000. 4. 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 L. Antin, the Company's Chief Executive Officer and a director of the Company. 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 web sites 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 VPI, 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. 5. LONG-TERM OBLIGATIONS Long-term obligations consisted of the following at December 31 (in thousands):
2000 1999 ------------ ----------- SENIOR TERM A Notes payable of Operating Company, maturing in 2006, secured by assets, variable interest rates (weighted average interest rate at 9.882% during the year ended December 31, 2000, and an interest rate of 9.938% at December 31, 2000)................................................ $ 50,000 $ -- SENIOR TERM B Notes payable of Operating Company, maturing in 2008, secured by assets, variable interest rates (weighted average interest rate at 10.382% during the year ended December 31, 2000, and an interest rate of 10.438% at December 31, 2000)................................................ 200,000 -- SENIOR Notes payable of Operating Company, SUBORDINATED maturing in 2010, unsecured, fixed interest NOTES rate of 13.5%........................................ 20,000 -- HOLDING COMPANY Notes payable of Holding Company, SENIOR NOTES maturing in 2010, unsecured, fixed interest rate of 15.5%........................................ 104,306 -- Page F-16 SECURED SELLER Notes payable and other obligations, NOTES various maturities Through 2014, secured by assets and stock of certain Subsidiaries, various interest rates ranging from 5.3% to 12.0%............................................. 1,328 69,213 MORTGAGE DEBT Notes payable and other obligations, various maturities Through 2008, secured by land and buildings of Certain subsidiaries, various interest rates ranging From 7.0% to 9.0%............. -- 3,212 CONVERTIBLE Notes payable, convertible into VCA common DEBT stock at Prices ranging from $0.47 to $1.00 per share, due Through 2013, secured by stock of certain Subsidiaries at interests rates ranging from 7.0% to 10.0%............................ -- 1,803 UNSECURED DEBT Notes payable, various maturities through 2004, Adjustable interest rates of 6.2% and fixed interest Rates ranging from 7.0% to 12.0%............. 350 2,982 DEBENTURES Convertible subordinated 5.25% debentures, due in 2006, convertible into approximately 36.8 million shares of VCA common stock at $2.29 per share......... -- 84,385 ---------- --------- Total debt obligations................................ 375,984 161,595 Capital lease obligations............................. 110 187 Less - unamortized discount........................... (13,345) (247) ---------- --------- 362,749 161,535 Less - current portion................................ (5,756) (21,901) ---------- --------- $ 356,993 $139,634 ========== =========
Page F-17 The annual aggregate scheduled maturities of debt obligations for the five years subsequent to December 31, 2000 are presented below (in thousands): 2001................................... $ 5,756 2002................................... 8,592 2003................................... 8,960 2004................................... 9,850 2005................................... 17,486 Thereafter............................. 325,340 -------- $375,984 ======== During the year ended December 31, 2000, the Company recorded an extraordinary loss of approximately $4.5 million, before effect of the income tax benefit, primarily as a result of the early redemption of $84.4 million of convertible subordinated 5.25% debentures. The Company entered into a Credit and Guaranty Agreement, dated September 20, 2000, with various lenders for $300.0 million of Senior Secured Credit Facilities (the "Credit Agreement'). The Credit Agreement includes a $50.0 million Revolving Credit Facility and the Senior Term A and B Notes. A first priority lien has been granted on certain of the Company's assets, including a pledge of all the capital stock of the Operating Company's subsidiaries, to secure the borrowings under the Credit Agreement. The Revolving Credit Facility allows the Company to borrow up to an aggregate principal amount of $50.0 million and expires in 2006. As of December 31, 2000, the Company has not utilized the Revolving Credit Facility. The Revolving Credit Facility and the Senior Term A Notes bear interest at an annual rate equal to: (1) thegreater of Wells Fargo Bank's prime lending rate or the Federal funds effective rate plus 0.5% (the "Base Rate"), plus an applicable margin for unpaid principal amounts maintained as base rate loans; or (2) the average British Bankers Association Interest Settlement Rate for deposits ("LIBOR") plus an applicable margin for unpaid principal amounts maintained as eurodollar rate loans. The applicable margin is 3.25% for the first twelve months ending September 20, 2001. Thereafter, applicable margin varies based upon the Company's leverage ratio as defined in the Credit Agreement. The applicable margin varies from 3.25% for a leverage ratio of 3.75 to 1.0 to 2.00% for a leverage ratio of 2.25 to 1.0. The Senior Term B Notes bear interest at an annual rate equal to: (1) the Base Rate plus 2.75% for unpaid principal amounts maintained as base rate loans; or (2) LIBOR plus 3.75% for unpaid principal amounts maintained as eurodollar rate loans. Interest for the Senior Term A and B Notes is payable in cash at the earlier of the maturity of a eurodollar rate loan or on a quarterly basis. Maturities of Senior A Term Notes principal during each of the years 2001 through 2006 are $2.5 million, $6.3 million, $7.2 million, $8.7 million, $12.5 million and $12.8 million, respectively. The principal for the Senior B Term Notes matures at $2.5 million per year for the first six years and $92.5 million per year for 2007 and 2008. The Credit Agreement contains certain financial covenants pertaining to interest coverage, fixed charge coverage and leverage ratios which commence in 2001. In addition, the Credit Agreement has restrictions pertaining to capital expenditures, acquisitions and the payment of dividends on all classes of stock. Page F-18 On September 20, 2000, the Operating Company issued $20.0 million of 13.5% Senior Subordinated Notes, which are subordinated to the borrowings under the Credit Agreement. Interest on the Senior Subordinated Notes is payable in cash on a semi-annual basis. The effective interest rate for these notes is 16.2%. The $20.0 million aggregate principal amount of the Senior Subordinated Notes is due in full in September 2010. In addition, on September 20, 2000, the Holding Company issued $100.0 million of 15.5% Senior Notes (the "Holding Company Senior Notes"). The Holding Company Senior Notes are subordinated to the Operating Company's liabilities. Interest on the Holding Company Senior Notes is payable on a semi-annual basis. At the Company's sole discretion it may issue additional Holding Company Senior Notes in lieu of cash payments for all interest due through March 2005. Thereafter, interest is payable in cash on a semi-annual basis. The effective rate for these notes is 17.3%. A mandatory redemption of principal and accumulated interest paid in kind approximating $80.0 million is due September 2005. The remaining principal is due in full in September 2010. There were no significant differences between the carrying amount and fair values of the Company's long-term debt as of December 31, 2000. 6. 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 $.01 per share, and 2,970,822 shares of Series B Junior Redeemable Cumulative Preferred Stock ("Series B Preferred Stock"), par value $.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 $74.3 million, respectively. The Series A and Series B Preferred Stock earn 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 is the sum of $25.00 per share plus accrued and unpaid dividends less any special dividend paid. Holders of preferred stock are entitled to receive dividends, whether or not declared by the Board of Directors, out of funds legally available. Dividends are payable in cash on a quarterly basis. If dividends are not paid when due, the amount payable is added to the liquidation preference and redemption value. For the year ended December 31, 2000, dividends earned but not paid were $2.9 million and $2.5 million for the Series A and Series B Preferred Stock, respectively. These dividends were recorded as an increase to preferred stock and a corresponding decrease to retained earnings. The Company has the option to redeem both series of preferred stock beginning September 2002. The prepayment premium at September 2002 is 109%, at September 2003 is 106%, and at September 2004 is 103%. Beginning September 2005 and thereafter, the Company has the option to redeem the preferred shares at 100% of the liquidation preference. The Company is required to redeem the preferred shares at 100% of liquidation preference in September 2012 from funds legally available. The Series A Preferred Stock is ranked senior to the Series B Preferred Stock and the Company's common stock. The Company has the option to exchange all the Series A Preferred Stock into 14% Senior Subordinated Debentures due 2012 (the "Exchange Debentures"). The Exchange Debentures are subordinated to the Holding Company Senior Notes. The Series B Preferred Stock is ranked senior to the Company's common stock. Neither series of preferred stock is convertible into common stock or securities convertible into common stock. Prior to the Recapitalization, there were no preferred shares of the Company issued or outstanding. 7. COMMON STOCK 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. Page F-19 During 2000 and prior to the Recapitalization, the Company repurchased 3,315,000 shares of its common stock for $3.3 million. These shares, along with all other treasury shares held prior to 2000, were retired. On September 20, 2000, in connection with the Recapitalization, the Company repurchased and retired a majority of the outstanding common stock of the Company. Certain members of senior management that held 2,656,335 shares before the Recapitalization continued to hold those shares. In 2000, the Company adopted an Amended and Restated Certificate of Incorporation, which authorized the issuance of up to 24,000,000 common shares with a par value of $.01 per common share. The Company had approximately 17,524,000 and 325,620,000 common shares outstanding at December 31, 2000 and 1999, respectively. During 1999, the Company issued 8,820,000 shares of its common stock valued at $8.8 million, the fair market value at the date of commitment, as a portion of the consideration for certain acquisitions. During 1999, the Company repurchased 5,895,000 shares of its common stock for $4.8 million. 8. WARRANTS In connection with the Recapitalization, the Company issued warrants to purchase 1,149,990 shares of the Company's common stock to certain investors. The warrants allow the holders to purchase common shares at a price equal to $0.0007. 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. 9. NOTES RECEIVABLE FROM STOCKHOLDERS Concurrent with the Recapitalization, the Company sold 518,000 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 which was purchased by the stockholders. At December 31, 1999, the Company held two notes receivable with balances totaling $654,000 from certain management stockholders of the Company. These notes arose from transactions whereby the Company loaned funds to the management stockholders to purchase an aggregate of 2,739,990 shares of the Company's common stock. These notes had an interest rate of 6.1% per annum and had a maturity date of January 22, 2001. The receivables are shown in the accompanying 1999 consolidated balance sheet as a reduction of stockholders' equity. In connection with the Recapitalization in September 2000, the Company forgave the indebtedness of these notes. The total principal and interest approximating $688,000 are included in Recapitalization costs. 10. STOCK-BASED COMPENSATION PLANS The Company has granted stock options to various employees. The Company accounts for these plans under APB Opinion 25. In November 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS 123 recommends changes in accounting for employee stock-based compensation plans and requires certain disclosures with respect to these plans. SFAS 123 disclosures have been adopted by the Company effective January 1, 1996. Had compensation cost for these plans been determined consistent with SFAS 123, 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): Page F-20
2000 1999 1998 --------- --------- --------- Net income (loss) available to common stockholders: As reported $(13,802) $ 22,357 $ 16,268 Pro forma (14,178) 19,214 12,040 Diluted earnings (loss) per share: As reported $ (.06) 0.07 0.05 Pro forma (.06) 0.06 0.04
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
2000 1999 1998 -------- -------- ------- Risk free interest rate 6.0% 5.8% 5.0% Dividend yield 0.0% 0.0% 0.0% Expected volatility 0.0% 54.2% 64.5% Weighted fair value average $0.78 $7.97 $9.25 Expected option life (years) 5 7 7
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 will be accounted for as variable awards, and related expense of $555,000 was recorded in the year ended December 31, 2000. As of December 31, 2000, 693,870 such new options are outstanding. These options are fully vested and expire in 2010. In September 2000, the Company issued 631,800 stock options under the 1996 Stock Incentive Plan. These options vest ratably over four years from the date of grant. The exercise price of these options is $1.00 (the fair market value at such date) and they expire in 2010. The table below summarizes the transactions in the Company's stock option plans (in thousands, except per share amounts):
2000 1999 1998 -------- -------- -------- Options outstanding at beginning of year 57,300 57,315 53,760 Exchanged in connection with Recapitalization 694 -- -- Granted 632 2,490 7,275 Exercised (1,815) (750) (2,910) Purchased (54,585) -- -- Canceled (900) (1,755) (810) -------- -------- -------- Options outstanding at end of year (Exercise prices ranging from $0.20 to $1.00 at December 31, 2000) 1,326 57,300 57,315 ======== ======== ======== Exercisable at end of year 694 30,465 25,110 ======== ======== ========
Page F-21 The following table summarizes information about certain options in the stock option plans outstanding as of December 31, 2000 in accordance with SFAS 123:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE --------------------------------------------------------------- --------------------------- WEIGHTED AVG. NUMBER REMAINING WEIGHTED AVG. NUMBER WEIGHTED AVG. EXERCISE PRICE OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE -------------- ----------- ---------------- -------------- ----------- -------------- $ 0.20 694 9.73 $ 0.20 694 $ .20 1.00 632 9.73 1.00 -- 1.00 ----- ----- 1,326 694 ===== =====
11. COMMITMENTS AND CONTINGENCIES A. LEASES 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, 2000, including renewal option periods, are as follows (in thousands): 2001............................................... $ 11,161 2002............................................... 10,825 2003............................................... 10,746 2004............................................... 10,828 2005............................................... 10,626 Thereafter......................................... 112,065 ---------- $ 166,251 ========== Rent expense totaled $11.7 million, $10.4 million and $9.1 million for the years ended December 31, 2000, 1999 and 1998, respectively. Rental income totaled $259,000, $310,000 and $203,000 for the years ended December 31, 2000, 1999 and 1998, 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 two 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 is attained in the future, but not exceeded, the Company will be obligated to make cash payments of approximately $1.1 million over the next two years. Page F-22 C. OFFICERS' COMPENSATION Four members of the Company's executive management have employment agreements with the Company that aggregate to $1.4 million per year. These members include the Chief Executive Officer, Chief Operating Officer, Senior Vice President and Chief Financial Officer. The agreements allow for upward adjustments to annual salary based on the Consumer Price Index for Los Angeles County. The agreements also call for a maximum of $900,000 to be paid as annual bonuses based on EBITDA targets. Lastly, the agreements call for aggregate severance payments under different scenarios with the maximum amount approximating $8.0 million. D. MANAGEMENT SERVICES On September 20, 2000, the Company entered into a ten-year management services agreement with Leonard Green & Partners, L.P. for services relating to investment banking, general consulting and financial planning. The agreement calls for monthly payments of $207,000 and is subject to an increase of 1.6% of any additional capital invested by Green Equity Investors III, L.P., a Delaware limited partnership, any of its affiliates, or any of its co-investors in the Company. In addition, Leonard Green received one-time fees of approximately $7.6 million in connection with the Company's recapitalization on September 20, 2000. E. STATE LAWS The laws of many states prohibit business corporations from providing, or holding themselves out as providers of, veterinary medical care. These laws vary from state to state and are enforced by the courts and by regulatory authorities with broad discretion. While the Company seeks to structure its operations to comply with the corporate practice of veterinary medicine laws of each state in which it operates, there can be no assurance that, given varying and uncertain interpretations of such laws, the Company would be found to 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 restriction on the practice of veterinary medicine in any state in which it operates could have a material adverse effect on the Company, if the Company were unable to restructure its operations to comply with the requirements of such state. For example, the Company is currently a party to a lawsuit in the State of Ohio in which the State has alleged that the Company's management of a licensed veterinary medical group 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 the Company from operating in the State of Ohio in a manner that is in violation of the state statute. In response, the Company has restructured its operations in the State of Ohio in a manner that it believes conforms to the state law and the court's order. The Attorney General of the State of Ohio has informed the Company that it disagrees with the Company's position and that it does not believe that the Company is in compliance with the court's order. The Company is currently in discussions with the Attorney General's office in the State of Ohio in an attempt to resolve this matter. The Company may not be able to reach a settlement, in which case we would be required to discontinue our operations in the state. The Company's five animal hospitals in the State of Ohio have a book value of $6.2 million. If the Company is required to discontinue its operations in the State of Ohio, it may not be able to dispose of the hospital assets for their book value. The animal hospitals located in the State of Ohio generated revenue and operating income of $2.2 million and $513,000, respectively, in 2000. 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. Page F-23 12. CALCULATION OF PER SHARE AMOUNTS A reconciliation of the income and shares used in the computations of the basic and diluted earnings (loss) per share ("EPS") for each of the three years in the period ended December 31, 2000 follows (amounts shown in thousands, except per share amounts):
2000 1999 1998 --------- --------- --------- Income (loss) before extraordinary item $ (5,752) $ 22,357 $ 16,268 Increase in carrying amount of Redeemable Preferred Stock (5,391) -- -- --------- --------- --------- Income (loss) from continuing operations Available to Common stockholders (Basic and Diluted) $(11,143) 22,357 16,268 ========= ========= ========= Weighted average common shares outstanding: Basic 234,055 315,945 305,250 Effect of dilutive common shares stock options -- 13,830 23,850 --------- --------- --------- Diluted 234,055 329,775 329,100 --------- --------- --------- Earnings per share (before extraordinary items) Basic $ (0.05) 0.07 0.05 Diluted $ (0.05) 0.07 0.05
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 in connection with the Recapitalization, 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 consideration for these shares, the management shareholders signed promissory notes which become due in 2007 and accrue interest at the rate of 6.22% per year, compounded annually. At December 31, 2000, warrants to purchase an aggregate of 1,149,990 common shares and 1,325,675 stock options were outstanding but were not included in the computation of Diluted EPS because conversion would have an antidilutive effect on Diluted EPS. The $84.4 million of 5.25% convertible debentures which were convertible into 36,849,345 shares of common stock were outstanding at both December 31, 1999 and 1998, but were not included in the computation of Diluted EPS, because conversion would have an antidilutive effect on Diluted EPS. These convertible debentures were retired in 2000. 13. INCOME TAXES The provision for income taxes is comprised of the following for the three years ended December 31, (in thousands):
2000 1999 1998 --------- --------- -------- Federal: Current............................ $ (889) $ 10,161 $ 8,064 Deferred........................... 1,219 515 2,080 -------- --------- --------- 330 10,676 10,144 -------- --------- --------- State: Current............................ (142) 2,850 2,157 Deferred .......................... 166 834 653 -------- --------- --------- 24 3,684 2,810 -------- --------- --------- $ 354 $ 14,360 $ 12,954 ======== ========= =========
Page F-24 The consolidated statement of operations for the year ended December 31, 2000 includes a provision for income taxes of $2.2 million and a benefit for income taxes of $1.8 million associated with the early extinguishment of debt; the net provision is approximately $354,000 as reflected in the table above. The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards 109, "Accounting for Income Taxes" ("SFAS 109"). SFAS 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):
2000 1999 --------- --------- Current deferred tax assets (liabilities): Accounts receivable......................... $ 1,273 $ 2,782 State taxes................................. (903) (457) Other liabilities and reserves.............. 3,696 2,347 Start-up costs.............................. 66 66 Restructuring charges....................... -- 815 Other assets................................ (294) (299) Inventory................................... 817 817 Valuation allowance......................... -- (1,858) --------- --------- Total current deferred tax asset, net................................ $ 4,655 $ 4,213 ========= ========== 2000 1999 --------- --------- Non-current deferred tax (liabilities) assets: Net operating loss carryforwards............ $ 6,460 $ 5,704 Write-down of assets........................ 1,377 1,433 Start-up costs.............................. 302 300 Other assets................................ 3,537 445 Intangible assets........................... (11,934) (9,204) Property and equipment...................... (1,720) (1,267) Unrealized loss on investments.............. 2,555 355 Valuation allowance......................... (9,061) (4,421) --------- --------- Total non-current deferred tax liability, net............................ $ (8,484) $ (6,655) ========= ==========
Under the Tax Reform Act of 1986, the utilization of 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 the Pets' Rx, Pet Practice and AAH 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 acquisition related expenditures where the realization of this deduction is uncertain at this time. At December 31, 2000, the Company has Federal net operating loss ("NOL") carryforwards of approximately $20.3 million, comprised principally of NOL carryforwards acquired in the Pets' Rx, Pet Practice and AAH mergers. Also included in this amount is the loss generated in the current year which can be utilized with no cumulative ownership change limitations in future years. These NOL carryforwards expire at various dates through 2015. Page F-25 On October 25, 1999, the FASB's Emerging Issues Task Force ("EITF") reached consensus in Issue 99-15, "Accounting for Decreases in Deferred Tax Asset Valuation Allowances Established in a Purchase Business Combination as a Result of a Change in Tax Regulation" ("Issue No. 99-15"). Issue No. 99-15 is the EITF's response to the Internal Revenue Services's June 25, 1999 ruling, as stated in Treasury Regulation 1.1502-21, reducing the requirements for using certain net operating loss carryovers and carrybacks ("NOLs"). As a result, the Company recorded a deferred tax benefit during the year ended December 31, 1999 equal to $2.1 million. As a result of a loss of $5.0 million recognized by the Company on its investment in Zoasis, the valuation allowance is increased since it is more likely than not that the carrying amount of the asset will not be recognized due to the character of the loss. A reconciliation of the provision for income taxes to the amount computed at the Federal statutory rate for the three years ended December 31, is as follows:
2000 1999 1998 ------ ------ ------ Federal income tax at statutory rate.......... (35)% 35% 35% Effect of amortization of goodwill............ 18 4 3 State taxes, net of federal benefit........... (2) 7 6 Tax exempt income............................. (1) (1) (1) Change in valuation allowance associated with the Recapitalization, and the write-off of investments.................... 24 (6) -- Other......................................... -- -- 1 ------ ------ ------ 4% 39% 44% ====== ====== ======
14. 401(K) PLAN 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 for annual matching contributions by the Company at the discretion of the Company's board of directors. In 2000, 1999 and 1998, the Company provided a total matching contribution approximating $715,000, $353,000 and $942,000, respectively. 15. LINES OF BUSINESS During the three years ending December 31, 2000, the Company had three reportable segments: Animal Hospital, Laboratory 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 inter-company sales and purchases are accounted for as if they were transactions with independent third parties at current market prices. Page F-26 The following is a summary of certain financial data for each of the three segments (in thousands):
INTER- COMPANY ANIMAL SALES HOSPITAL LABORATORY CORPORATE ELIMINATIONS TOTAL ----------- ---------- --------- ------------ ---------- 2000 Revenue........................... $ 240,624 $ 119,300 $ 925 $ (6,162) $ 354,687 Operating income (loss)........... 30,818 34,355 (45,968) -- 19,205 Recapitalization costs............ -- -- 34,823 -- (34,823) Depreciation/amortization expense. 12,167 4,472 2,239 -- 18,878 Identifiable assets............... 312,473 109,453 61,144 -- 483,070 Capital expenditures.............. 18,751 2,194 1,610 -- 22,555 1999 Revenue........................... $ 217,988 $ 103,282 $ 5,100 $ (5,810) $ 320,560 Operating income (loss)........... 26,765 28,039 (7,788) -- 47,016 Year 2000 remediation costs....... -- -- 2,839 -- 2,839 Reversal of restructuring charges. -- -- 1,873 -- 1,873 Depreciation/amortization expense. 10,472 4,234 1,757 -- 16,463 Identifiable assets............... 280,742 105,224 40,534 -- 426,500 Capital expenditures.............. 15,970 1,997 3,836 -- 21,803 1998 Revenue........................... $ 191,888 $ 89,896 $ 5,100 $ (5,845) $ 281,039 Operating income (loss)........... 23,487 20,141 (4,794) -- 38,834 Depreciation/amortization expense. 8,488 4,074 570 -- 13,132 Identifiable assets............... 226,182 106,217 60,484 -- 392,883 Capital expenditures.............. 7,450 3,813 415 -- 11,678
Corporate operating loss includes salaries, general and administrative expense for the executive, finance, accounting, human resources, marketing, purchasing and regional operational management functions that support the Animal Hospital and Laboratory 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):
2000 1999 1998 --------- ---------- ---------- Total segment operating income after Eliminations................. $ 19,205 $ 47,016 $ 38,834 Interest income...................... 850 1,194 2,357 Interest expense..................... (20,742) (10,643) (11,189) Minority interest.................... (1,066) (850) (780) Gain on sale of VPI.................. 3,200 -- -- Loss on investment in Zoasis......... (5,000) -- -- --------- --------- --------- Income (loss) before provision for income taxes and extraordinary items................ (3,553) $ 36,717 $ 29,222 ========= ========= =========
16. RESTRUCTURING AND ASSET WRITE-DOWN During 1996, the Company adopted and implemented a restructuring plan (the "1996 Plan") and recorded a restructuring charge of $5.7 million and an asset write-down charge of $9.5 million. The major components of the 1996 Plan included: o the termination of leases, the write-down of intangibles, property and equipment, and employee terminations in connection with the closure, sale or consolidation of 12 animal hospitals; Page F-27 o the termination of contracts and leases, the write-down of certain property and equipment, and the termination of employees in connection with the restructuring of the Company's laboratory operations; and o contract terminations and write-down of assets in connection with the migration to common communications and computer systems. Collectively, the 12 hospitals had aggregate revenue of $6.8 million and net operating loss of $350,000 for the year ended December 31, 1996. The restructuring of the Company's laboratory operations consisted primarily of: o plans to relocate the Company's facility in Indiana to Chicago; o the downsizing of its Arizona laboratory operations; o the standardization of laboratory and testing methods throughout all of the Company's laboratories, resulting in the write-down of equipment that will no longer be utilized; and o the shutdown of a laboratory facility in the Midwest. During 1999, pursuant to the 1996 Plan, the Company incurred the following: o Cash expenditures for $345,000 for lease and other contractual obligations. o Non-cash asset write-downs of $157,000, primarily pertaining to hospitals previously closed and the shutdown of certain computer systems. o The Company recognized a $321,000 favorable settlement related to a laboratory operations' contract that was terminated as part of the 1996 restructuring plan. o During the fourth quarter of 1999, the Company was released from its contractual obligation pertaining to certain facility leases for hospitals that were sold in 1997. In addition, the Company reached a favorable settlement on contractual obligations pertaining to its migration to common communications and computer systems, a component of the 1996 Plan. As a result of these two favorable outcomes, the Company reversed $889,000 of restructuring charges. During 1998, the Company took the following actions pursuant to the 1996 Plan: o The Company closed one animal hospital. o The Company shutdown certain computer hardware and software, as part of our migration to common computer systems. o The Company decided that two hospitals would continue to be operated instead of closed as was originally outlined in the 1996 restructuring plan. The hospitals' local markets improved since the 1996 Plan was determined, causing the Company's management to revise its plan. o The Company terminated its attempt to sell one hospital because it has been unable to negotiate a fair sales price based on the hospital's operating results Reserves of $593,000 related to the three hospitals were ultimately retained, were utilized to offset increases in the expected cost to extinguish lease commitments and contract obligations that were part of the 1996 Plan. As of December 31, 1999, all phases of the 1996 Plan were complete and no restructuring reserves remained on the Company's balance sheet. Page F-28 During 1997, the Company reviewed the financial performance of its hospitals. As a result of this review, an additional 12 hospitals were determined not to meet the Company's performance standards. Accordingly, the Company adopted phase two of its restructuring plan (the "1997 Plan") resulting in restructuring and asset write-down charges of $2.1 million. The major components of the 1997 Plan consisted of the termination of leases, amounting to $1.2 million, and the write-down of intangibles, property and equipment, amounting to $876,000, in connection with the closure or sale of 12 animal hospitals. Collectively, the 12 hospitals had aggregate revenue of $5.4 million and net operating income of $176,000 for the year ended December 31, 1997. During the year ended December 31, 2000, the Company incurred $190,000 of expenditures for lease and other contractual obligations. During 1999, the actions taken pursuant to the 1997 Plan were as follows: o The Company sold one hospital resulting in cash expenditures of $2,000 and non-cash asset write-downs of $64,000. o The Company closed three hospitals resulting in cash expenditures of $4,000 and non-cash asset write-downs of $53,000. o The Company incurred cash expenditures of $71,000 for lease and other contractual obligations. o The Company recorded an additional $28,000 non-cash asset write-down pertaining to a hospital previously closed. o During the fourth quarter of 1999, the Company reached favorable settlements from the sale and/or closure of the hospitals noted in the first two bulleted points above. As a result the Company reversed $663,000 of restructuring charges. During 1998, the Company closed three animal hospitals pursuant to the 1997 Plan, resulting in the write-off of $299,000 of property and equipment and cash expenditures of $81,000 for lease obligations and closing costs. Also during 1998, we determined that five of the animal hospitals that were to be sold as a part of the 1997 Plan would be kept due to their improved performance. At December 31, 2000, $153,000 of the restructuring reserves from the 1997 Plan remain on our balance sheet, consisting primarily of lease and other contractual obligations. All significant phases of the 1997 Plan were complete as of December 31, 1999, although certain lease obligations will continue though 2005. Page F-29 The following tables summarize the activity in the Company's restructuring reserves (in thousands):
THE 1996 PLAN Cash Non-Cash CHARGES CHARGES TOTAL --------- --------- ---------- Balance, December 31, 1997............... $ 2,635 $ 377 $ 3,012 Cash expenditures for lease and other contractual obligations........ (989) -- (989) Non-cash net assets write-downs ....... -- (632) (632) Reclassifications ..................... (255) 255 -- --------- --------- ---------- Balance, December 31, 1998............... 1,391 -- 1,391 Cash expenditures for lease and other contractual obligations........ (345) -- (345) Non-cash net asset write-downs ........ -- (157) (157) Reclassifications ..................... (157) 157 -- Reversal of restructuring reserves..... (889) -- (889) --------- --------- ---------- Balance, December 31, 1999............... $ -- $ -- $ -- ========= ========= ========== THE 1997 PLAN Cash Non-Cash CHARGES CHARGES TOTAL --------- --------- ---------- Balance, December 31, 1997............... $ 842 $ 766 $ 1,608 Cash expenditures for lease and other contractual obligations........ (81) -- (81) Non-cash net assets write-downs ....... -- (299) (299) Reclassifications...................... 105 (105) -- --------- --------- ---------- Balance, December 31, 1998............... 866 362 1,228 Cash expenditures for lease and other contractual obligations........ (77) -- (77) Non-cash net asset write-downs ........ -- (145) (145) Reversal of restructuring reserves..... (446) (217) (663) --------- --------- ---------- Balance, December 31, 1999............... 343 -- 343 Cash expenditures for lease and other contractual obligations........ (190) -- (190) --------- --------- ---------- Balance, December 31, 2000............... $ 153 -- 153 ========= ========= ==========
17. SUBSEQUENT EVENTS From January 1, 2001 through March 28, 2001, the Company has acquired nine animal hospitals, of which two were merged upon acquisition into existing VCA facilities, for an aggregate consideration (including acquisition costs) of $11.9 million, consisting of $10.3 million in cash, $1.5 million in debt and the assumption of liabilities totaling $80,000. In addition, on January 30, 2001, the Company opened a diagnostics imaging center that performs CT scans and MRI's. The total cost of forming the center was $800,000, consisting of equipment and leasehold improvements. Page F-30
VCA ANTECH, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2001 AND DECEMBER 31, 2000 (IN THOUSANDS) (UNAUDITED) Assets December June 30, 31, 2001 2000 ---------- --------- Current assets: Cash and equivalents ............................... $ 19,166 $ 10,519 Trade accounts receivable, less allowance for uncollectible accounts of $5,003 and $4,110 at June 30, 2001 and December 31, 2000, respectively..................................... 17,623 15,450 Inventory, prepaid expense and other ............... 7,922 9,197 Deferred income taxes .............................. 4,565 4,655 Prepaid income taxes ............................... 7,496 9,402 ---------- --------- Total current assets ........................... 56,772 49,223 Property and equipment, net ........................... 87,889 86,972 Goodwill, net ......................................... 311,833 310,185 Covenants not to compete, net ......................... 16,857 19,549 Notes receivable, net ................................. 2,642 2,178 Deferred financing costs, net ......................... 12,319 13,373 Other.................................................. 1,417 1,590 ---------- --------- $ 489,729 $ 483,070 ========== ========= Liabilities and Stockholders' Equity Current liabilities: Current portion of long-term obligations ........... $ 7,731 $ 5,756 Accounts payable ................................... 9,310 8,393 Accrued payroll and related liabilities ............ 10,111 8,335 Other accrued liabilities .......................... 18,461 17,242 ---------- --------- Total current liabilities ...................... 45,613 39,726 Long-term obligations, less current portion ........... 360,356 356,993 Deferred income taxes ................................. 9,155 8,484 Minority interest ..................................... 4,653 3,610 Other liabilities ..................................... 500 1,500 Series A Redeemable Preferred Stock, at redemption value................................................ 83,422 77,875 Series B Redeemable Preferred Stock, at redemption value................................................ 81,420 76,747 Stockholders' equity (deficit): Common stock ....................................... 175 175 Additional paid-in capital ......................... 18,498 19,435 Notes receivable from stockholders ................. (518) (518) Accumulated deficit................................. (113,343) (100,020) Accumulated comprehensive loss ..................... (1,139) -- ---------- --------- Total stockholders' deficit..................... (95,390) (81,865) ---------- --------- $ 489,729 $ 483,070 ---------- ---------
The accompanying notes are an integral part of these condensed consolidated balance sheets. Page F-31
VCA ANTECH, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2001 AND 2000 (UNAUDITED) (IN THOUSANDS) Six Months Ended June 30, 2001 2000 ----------- ----------- Revenue........................................ $ 202,729 $ 177,285 Direct costs................................... 141,644 126,517 ----------- ----------- 61,085 50,768 Selling, general and administrative............ 15,815 13,562 Depreciation and amortization.................. 12,689 8,607 Write-down and loss on sale of assets.......... 8,837 -- Stock-based compensation....................... 382 -- ----------- ----------- Operating income............................. 23,362 28,599 Net interest expense........................... 22,070 4,700 Other (income) expense......................... 229 (3,200) ----------- ----------- Income before minority interest and provision for income taxes............ 1,063 27,099 Minority interest in income of subsidiaries................................. 700 515 ----------- ----------- Income before provision for income taxes 363 26,584 Provision for income taxes .................... 3,466 11,756 ----------- ----------- Net income (loss)......................... $ (3,103) $ 14,828 =========== =========== Increase in carrying amount of redeemable preferred stock.............................. 10,220 -- ----------- ----------- Net income (loss) available to common stockholders................................... $ (13,323) $ 14,828 =========== =========== Basic earnings (loss) per common share.... $ (0.76) 0.05 =========== =========== Diluted earnings (loss) per common share.. $ (0.76) 0.04 =========== =========== Shares used for computing basic earnings per share................................... 17,524 318,390 =========== =========== Shares used for computing diluted earnings per share.......................... 17,524 365,325 =========== ===========
The accompanying notes are an integral part of these condensed consolidated financial statements. Page F-32
VCA ANTECH, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 2001 AND 2000 (UNAUDITED) (IN THOUSANDS) 2001 2000 --------- --------- Cash flows from operating activities: Net income (loss) ....................................................... $ (3,103) $ 14,828 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization ...................................... 12,689 8,607 Amortization of debt discount and deferred financing costs ...... 1,101 184 Interest paid in kind on senior notes ........................... 8,066 -- Loss on write-down and sale of assets ........................... 8,837 -- Gain on sale of investment in VPI .................................. -- (3,200) Minority interest in income of subsidiaries ........................ 700 516 Distributions to minority interest partners ........................ (606) (697) Stock-based compensation ........................................ 382 -- Provision for uncollectible accounts ............................... 1,363 1,666 Increase in accounts receivable, net ............................... (3,437) (6,137) Decrease (increase) in inventory, prepaid expense and other assets . 1,350 (1,494) Decrease in prepaid income taxes ................................... 1,906 9,650 Increase in accounts payable and accrued liabilities ............... 3,596 2,564 Changes in deferred revenue ..................................... (1,000) -- Changes in deferred taxes ....................................... 761 -- --------- --------- Net cash provided by operating activities ....................... 32,605 26,487 --------- --------- Cash flows from investing activities: Property and equipment additions ................................... (6,979) (9,799) Business acquisitions, net of cash acquired ........................ (13,539) (5,590) Proceeds from sales of marketable securities, net .................. -- (83,276) Investments in marketable securities, net ......................... -- 71,442 Proceeds from sale of real estate................................ 370 -- Net proceeds from sale of investment in VPI ........................ -- 8,200 Investment in Zoasis ............................................... -- (5,000) Other .............................................................. 57 85 --------- --------- Net cash used in investing activities ........................... (20,091) (23,938) --------- --------- Cash flows from financing activities: Repayment of long-term obligations ................................. (2,779) (12,360) Net payments related to recapitalization......................... (1,088) -- Proceeds from exercise of stock options ............................ -- 290 --------- --------- Net cash used in financing activities ........................... (3,867) (12,070) --------- --------- Increase (decrease) in cash and equivalents ................................ 8,647 (9,521) Cash and equivalents at beginning of period ................................ 10,519 10,620 --------- --------- Cash and equivalents at end of period ...................................... $ 19,166 $ 1,099 ========= =========
The accompanying notes are an integral part of these condensed consolidated financial statements. Page F-33 VCA ANTECH, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2001 (UNAUDITED) (1) GENERAL The accompanying unaudited condensed consolidated financial statements of VCA Antech, Inc. and subsidiaries (the "Company" or "VCA") have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and in accordance with the rules and regulations of the United States Securities and Exchange Commission (the "SEC"). Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements as permitted under applicable rules and regulations. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. The results of operations for the six months ended June 30, 2001 are not necessarily indicative of the results to be expected for the full year. For further information, refer to the Company's 2000 consolidated financial statements and footnotes thereto included in the Company's S-1 Registration Statement filed on August 9, 2001 with the SEC. Prior to September 24, 2001, VCA was known as Veterinary Centers of America, Inc. (2) ACQUISITIONS During the second quarter of 2001, the Company purchased four animal hospitals, two of which were merged into existing VCA facilities, for an aggregate consideration (including acquisition costs) of $2.7 million, consisting of $2.4 million in cash, $320,000 in debt and the assumption of liabilities totaling $30,000. The $2.7 million aggregate purchase price was allocated as follows: $82,000 to tangible assets, $2.0 million to goodwill and $609,000 to other intangible assets. During the first quarter of 2001, the Company purchased nine animal hospitals, two of which were merged into existing VCA facilities for an aggregate consideration (including acquisition costs) of $11.9 million, consisting of $10.4 million in cash, $1.4 million in debt and the assumption of liabilities totaling $80,000. The $11.9 million aggregate purchase price was allocated as follows: $827,000 to tangible assets, $9.5 million to goodwill and $1.6 million to other intangible assets. (3) WRITE-DOWN AND LOSS ON SALE OF ASSETS The Company periodically evaluates whether events, circumstances or net losses at the entity level have occurred that indicate the remaining estimated useful life of goodwill may warrant revision or that the remaining balance may not be recoverable. As a result of such analysis, the Company recorded a write-down of goodwill at one animal hospital in the amount of approximately $800,000 during 2001. Also during 2001, five animal hospitals were closed because their operating performance was unsatisfactory. The book value of the related goodwill and certain other assets that were determined to be unrecoverable of approximately $6.0 million was written off during 2001. During the six months ended June 30, 2001, the Company determined to sell three properties whose fair value was less than their respective book value. In 2001, the Company sold substantially all the assets of one animal hospital and a portion of real estate related to another animal hospital. Both sales were completed during the six months ended June 30, 2001 for aggregate cash proceeds of $370,000. In connection with these asset sales, the Company recorded a pre-tax loss of $870,000. As a result of the items discussed above, a non-cash charge to operations in the amount of approximately $8.8 million was recorded in 2001. Page F-34 (4) CALCULATION OF PER SHARE AMOUNTS Below is a reconciliation of the income (loss) and shares used in the computations of the basic and diluted earnings (loss) per share ("EPS") (amounts in thousands, except per share amounts):
Six Months Ended June 30, 2001 2000 --------- --------- Net income (loss) ......................... $ (3,103) $ 14,828 Increase in carrying amount of redeemable preferred stock ................ (10,220) -- Impact on conversion of debentures......... -- 1,376 --------- --------- Net income (loss) available to common shareholders (basic and diluted)......... $(13,323) $ 16,204 ========= ========= Weighted average common shares outstanding: Basic ................................ 17,524 318,390 Effect of dilutive common shares: Stock options.................... -- 10,080 Converted debentures............. -- 36,855 --------- --------- Diluted............................... 17,524 365,325 ========= ========= Earnings (loss) per share: Basic ................................ $ (0.76) $ 0.05 ========= ========= Diluted .............................. $ (0.76) $ 0.04 ========= =========
(5) COMPREHENSIVE INCOME (LOSS) Below is a calculation of comprehensive income (loss) (in thousands):
Six Months Ended June 30, 2001 2000 --------- --------- Net income (loss) .......................... $ (3,103) $ 14,828 Decrease in the intrinsic value of the collar agreement ........................... (1,139) -- Decrease in unrealized loss on investment.................................. -- 261 --------- --------- Net comprehensive income (loss)............. $ (4,242) $ 15,089 ========= =========
No income tax benefit related to the unrealized loss on investment was recognized due to the potential tax treatment of investment losses. See Footnote 8 "Derivatives", for additional information. Page F-35 (6) LINES OF BUSINESS During the six months ended June 30, 2001 and 2000, the Company had three reportable segments: Animal Hospital, Laboratory 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 as detailed in the Company's 2000 Financial Statements included in the Company's S-1 filing. 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 inter-company sales and purchases are accounted for as if they were transactions with independent third parties at current market prices. Below is a summary of certain financial data for each of the three segments (in thousands):
ANIMAL INTER-COMPANY HOSPITAL LABORATORY CORPORATE ELIMINATIONS TOTAL ---------- ---------- --------- -------------- ---------- SIX MONTHS ENDED JUNE 30, 2001 Revenue............................ $ 137,134 $ 68,384 $ 1,000 $ (3,789) $ 202,729 Operating income (loss)............ 20,358 21,439 (9,216) -- 32,581 Depreciation/amortization expense.. 7,142 2,304 3,243 -- 12,689 Capital expenditures............... 4,578 878 1,523 -- 6,979 SIX MONTHS ENDED JUNE 30, 2000 Revenue............................ $ 119,267 $ 60,726 $ 425 $ (3,133) $ 177,285 Operating income (loss)............ 15,119 18,472 (4,992) -- 28,599 Depreciation/amortization expense.. 5,949 2,207 451 -- 8,607 Capital expenditures............... 7,750 980 1,069 -- 9,799 AT JUNE 30, 2001 Identifiable assets................ 317,192 112,080 60,457 -- 489,729 AT JUNE 30, 2000 Identifiable assets................ 291,758 112,361 42,770 -- 446,889 AT DECEMBER 31, 2000 Identifiable assets................ 312,473 109,453 61,144 -- 483,070
Page F-36 Below is a reconciliation between total segment operating income after eliminations and consolidated income (loss) before provision for income taxes as reported on the condensed consolidated statements of operations (in thousands):
Six Months Ended June 30, 2001 2000 --------- --------- Total segment operating income after eliminations.............................. $ 32,581 $ 28,599 Write-down of assets .................. 8,837 -- Stock-based compensation .............. 382 -- --------- --------- Total reported operating income .......... 23,362 28,599 Net interest expense................... 22,070 4,700 Other (income) expense ................ 229 (3,200) Minority interest...................... 700 515 --------- --------- Income (loss) before provision for income taxes.......................... 363 26,584 ========= =========
(7) OTHER (INCOME) EXPENSE The components of other (income) expense are as follows: o LOSS ON HEDGING INSTRUMENT - For the six months ended June 30, 2001, the Company incurred non-cash charges of $229,000 for changes in the time value of a collar agreement. See Footnote 8, "Derivatives", for additional information. o GAIN ON SALE OF VPI - 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 for the six months ended June 30, 2000. (8) DERIVATIVES Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES ("SFAS 133"). SFAS 133 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"). All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value with offsets to other comprehensive income or earnings, depending on the type of derivative and/or the underlying cause for the change in fair value. 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 LIBOR, pays out monthly, resets monthly and has a cap and floor notional amount of $62.5 million, with a cap rate of 7.5% and floor rate of 5.9%. The actual cash paid by the Company as a result of LIBOR rates being below the floor of the collar agreement are recorded as a component of earnings. As of June 30, 2001, the Company has paid $253,000 because of LIBOR rates being below the floor of 5.9%. These payments were all made during the six months ended June 30, 2001 and are included in interest expense. Page F-37 The Company's objective for entering into the collar agreement is to minimize the interest rate risks related to our variable rate debt. The collar agreement is considered a cash flow hedge. Because LIBOR rates at June 30, 2001 were below the floor rate in the collar agreement of 5.9% and are projected to remain below the floor rate through the term of the collar agreement, the fair value of the collar agreement is a net liability to the Company of $1.4 million at June 30, 2001. It is recorded in the Company balance sheet as part of other liabilities. The valuation of the collar agreement is the sum of the following: o Non-cash charges for the changes in the time value of the collar agreement were recorded as a component of other income and expense of $229,000 for the six months ending June 30, 2001. The cumulative effect of changes in the value of the collar agreement prior to adoption of SFAS 133 was immaterial. o A non-cash charge for the changes in the intrinsic value of the collar agreement resulting in a cumulative net charge of $1.1 million to other comprehensive income as of June 30, 2001. (9) STOCK-BASED COMPENSATION In connection with the Recapitalization, employee option holders were allowed to exchange their stock options for new stock options with the same intrinsic value. The stock option exchange offer resulted in variable accounting treatment for the new stock options. The Company engaged an appraisal firm to determine the fair value of its common stock as of June 30, 2001. The appraisal firm determined that the fair value of the Company's common stock was $1.55 per share, an increase from the $1.00 per share fair value at the time of the Recapitalization. The effect of the increase in the fair market value of the common stock on these stock options resulted in a charge of $382,000 in the six months ended June 30, 2001. The Company expects to offer loans to the employee new stock option holders to encourage exercise of the new stock options in July 2001. The variable accounting treatment will cease once the stock options are exercised. (10) ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS, which changes the way companies account for intangible assets and goodwill associated with business combinations. The principal changes of SFAS No. 142 are as follows: o All goodwill amortization will cease effective January 1, 2002. For the six months ended June 30,2001, the Company recorded $4.5 million of goodwill amortization. o All of the goodwill on the Company's balance sheet at June 30, 2001 will continue to be amortized through the remaining months of 2001, under their current amortization schedules. o All goodwill acquired in acquisitions after June 30, 2001 will not be subject to amortization in 2001 or in the future. o All goodwill will be reviewed annually, or as circumstances warrant, using the fair-value-based goodwill impairment tests discussed in SFAS No. 142. As of June 30, 2001, our goodwill balance was $311.8 million. Any impairment recognized associated with the adoption of SFAS No. 142 will be accounted for as a cumulative effect of change in accounting principal. All other intangible assets typically included in goodwill will be valued independently and amortized over their useful lives. For the Company these intangibles may include: Page F-38 o the value of names and addresses associated with customer lists, o the value of repeat sales in non-contractual customer relationships, and o the value of established business names. The impact of SFAS No. 142 on the Company's financial statements has not yet been determined. In July, 2001, the FASB issued SFAS No. 141, BUSINESS COMBINATIONS, which requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting. The Company does not expect the impact of SFAS No. 141 to have a material impact on its financials statements or its operations. (11) RECLASSIFICATIONS Certain 2000 balances have been reclassified to conform to the 2001 financial statement presentation. (12) COMMITMENTS AND CONTINGENCIES 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. While the Company seeks to structure its operations to comply with the corporate practice of veterinary medicine laws of each state in which it operates, there can be no assurance that, given varying and uncertain interpretations of such laws, the Company would be found to 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 restriction on the practice of veterinary medicine in any state in which it operates could have a material adverse effect on the Company, if the Company were unable to restructure its operations to comply with the requirements of such state. For example, the Company is currently a party to a lawsuit in the State of Ohio in which the State has alleged that the Company's management of a licensed veterinary medical group 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 the Company from operating in the State of Ohio in a manner that is in violation of the state statute. In response, the Company has restructured its operations in the State of Ohio in a manner that it believes conforms to the state law and the court's order. The Attorney General of the State of Ohio has informed the Company that it disagrees with the Company's position and that it does not believe that the Company is in compliance with the court's order. The Company is currently in discussions with the Attorney General's office in the State of Ohio in an attempt to resolve this matter. The Company may not be able to reach a settlement, in which case we would be required to discontinue our operations in the State. The Company's five animal hospitals in the State of Ohio have a book value of $6.2 million. If the Company is required to discontinue its operations in the State of Ohio, it may not be able to dispose of the hospital assets for their book value. The animal hospitals located in the State of Ohio generated revenue and operating income of $1.2 million and $274,000, respectively, in 2001. Page F-39 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The following table itemizes the expenses incurred by the Registrant in connection with the issuance and distribution of the Securities being registered, other than underwriting discounts. All the amounts shown are estimates except the Securities and Exchange Commission registration fee and the NASD filing fee. Registration fee--Securities and Exchange Commission............ $ 60,375 Filing fee - National Association of Securities Dealers, Inc.... 24,650 Listing fee - The Nasdaq National Market........................ 95,000 Accounting fees and expenses.................................... 150,000 Legal fees and expenses (other than blue sky)................... 250,000 Blue sky fees and expenses, including legal fees................ 10,000 Printing; stock certificates.................................... 200,000 Transfer agent and registrar fees............................... 15,000 Miscellaneous................................................... 50,000 ------------ Total........................................................... $ 855,025 ============ ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS. Subsection (a) of Section 145 of the General Corporation Law of the State of Delaware, the "DGCL," empowers a corporation to indemnify any person who by reason of the fact that he is or was a director, officer, employee or agent of the corporation, or is or was serving at or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees) judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. Subsection (b) of Section 145 empowers a corporation to indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that he acted in any of the capacities set forth above, against expenses (including attorneys' fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted under similar standards, except that no indemnification may be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Court of Chancery or the court in which action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or such other court shall deem proper. Section 145 further provides that to the extent that a director or officer of a corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in subsections (a) and (b) of Section 145, or in the defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith; that indemnification provided by, or granted pursuant to, Section 145 shall not be deemed exclusive of any other rights to which those seeking indemnification may be entitled; and empowers the corporation to purchase and maintain insurance on Page 1 behalf of any person who is or was a director or officer of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or against another corporation, partnership, joint venture, trust or other enterprise, against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such whether or not the corporation would have the power to indemnify him against such liabilities under Section 145. As permitted by Delaware law, our amended and restated certificate of incorporation, which is filed as Exhibit 3.1, provides that no director of ours will be personally liable to us or our stockholders for monetary damages for breach of fiduciary duty as a director, except for the following: o for liability for any breach of duty of loyalty to us or to our stockholders; o for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law; o for unlawful payment of dividends or unlawful stock repurchases or redemptions under Section 174 of the Delaware General Corporation Law; or o for any transaction from which the director derived an improper personal benefit. Our amended and restated certificate of incorporation further provides that we must indemnify our directors and executive officers and may indemnify our other officers and employees and agents to the fullest extent permitted by Delaware law. We believe that indemnification under our amended and restated certificate of incorporation covers negligence and gross negligence on the part of indemnified parties. Our by-laws, which is filed as Exhibit 3.2, provides us with the authority to indemnify our directors, officers and agents to the full extent allowed by Delaware law. We intend to enter into indemnification agreements, the form of which is filed as Exhibit 10.13, with each of our directors and officers. These agreements, among other things, will require us to indemnify each director and officer for certain expenses including attorneys' fees, judgments, fines and settlement amounts incurred by any such person in any action or proceeding, including any action by or in our right, arising out of the person's services as our director or officer, any subsidiary of ours or any other company or enterprise to which the person provides services at our request. The underwriting agreement will provide for indemnification by our underwriters, our directors, our officers who sign the registration statement, and our controlling persons for some liabilities, including liabilities arising under the Securities Act. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES. In January 2000, we granted to Robert L. Antin, Arthur J. Antin, Neil Tauber, Tomas W. Fuller, Dawn Olsen and other employees restricted stock bonus awards to purchase an aggregate of 319,043 shares of common stock. These stock bonus awards have all been exercised. These shares were issued in reliance on the exemption from registration provided by Section 4(2) of the Securities Act. In February 1999 and January 1998, we granted to Robert L. Antin, Arthur J. Antin, Neil Tauber, Tomas W. Fuller, Dawn Olsen and other employees restricted stock bonus awards to purchase an aggregate of 79,916 shares of common stock. These stock bonus awards have all been exercised. These shares were issued in reliance on the exemption from registration provided by Section 4(2) of the Securities Act. As part of our recapitalization, on September 20, 2000 we made the following sales of unregistered securities: o Issued and sold 17,524,335 shares of our common stock at a per share purchase price of $1.00 for an aggregate purchase price of $17,524,335 to the following: Robert L. Antin, 1,906,380 shares; Arthur J. Antin, 400,005 shares; Neil Tauber, 49,995 shares; Tomas W. Fuller, 200,010 shares; certain entities Page 2 controlled by Leonard Green & Partners, 14,336,117 shares; and certain of our employees, some of whom are accredited and some of whom are unaccredited, 631,828 shares. These securities were issued in reliance on the exemption from registration provided by Regulation D, Rule 506, of the Securities Act. o Issued and sold 2,998,408 shares of 14% Series A Senior Redeemable Exchangeable Cumulative Preferred Stock at a per share purchase price of $25.00 for an aggregate purchase price of approximately $75,000,000 to the following: Green Equity Investors III, L.P. and affiliated investment funds, 2,826,000 shares; GS Mezzanine Partners II, L.P. and affiliated investment funds, 122,123 shares; TCW Leveraged Income Trust, L.P. and affiliated investment funds, 35,918 shares; and The Northwestern Mutual Life Insurance Company, 14,367 shares. These securities were issued in reliance on the exemption from registration provided by Regulation D, Rule 506, of the Securities Act. o Issued and sold 2,970,822 shares of 12% Series B Junior Redeemable Cumulative Preferred Stock at a per share purchase price of $25.00 for an aggregate purchase price of approximately $74,300,000 to the following: Green Equity Investors III, L.P. and affiliated investment funds, 2,800,000 shares; GS Mezzanine Partners II, L.P. and affiliated investment funds, 121,000 shares; TCW Leveraged Income Trust, L.P. and affiliated investment funds, 35,588 shares; and The Northwestern Mutual Life Insurance Company, 14,234 shares. These securities were issued in reliance on the exemption from registration provided by Regulation D, Rule 506, of the Securities Act. o Sold $100.0 million in Senior Notes due 2010 pursuant to an indenture of the same date with Chase Manhattan Bank and Trust Company, National Association, as trustee, to the following: GS Mezzanine Partners II, L.P. and affiliated investment funds, $70,834,000; TCW Leveraged Income Trust, L.P. and affiliated funds, $20,833,000; and The Northwestern Mutual Life Insurance Company, $8,333,000. In connection with the sale of the Senior Notes, VCA Antech issued warrants to purchase up to 1,149,990 shares of common stock to the following investors: GS Mezzanine Partners II, L.P. and affiliated investment funds, 814,575 warrants; TCW Leveraged Income Trust, L.P. and affiliated funds, 239,580 warrants; and The Northwestern Mutual Life Insurance Company, 95,835 warrants. The warrants allow the holders to purchase the common shares at a price of $0.0007 on or before the closing of an initial public offering of our common stock. These securities were issued in reliance on the exemption from registration provided by Regulation D, Rule 506, of the Securities Act. o Sold $20.0 million in Senior Subordinated Notes due 2010 pursuant to an indenture of the same date with Chase Manhattan Bank and Trust Company, National Association, as trustee, to the following: GS Mezzanine Partners II, L.P. and affiliated investment funds, $14,166,000; TCW Leveraged Income Trust, L.P. and affiliated funds, $4,167,000; and The Northwestern Mutual Life Insurance Company, $1,667,000. These securities were issued in reliance on the exemption from registration provided by Section 4(2) of the Securities Act. Page 3 ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (A) EXHIBIT NUMBER EXHIBIT DESCRIPTION -------- ------------------- 1.1 Form of Underwriting Agreement.* 3.1 Form of Amended and Restated Certificate of Incorporation of Registrant.** 3.2 Form of Amended and Restated Bylaws of Registrant.** 4.1 Stockholders Agreement by and among Registrant, Green Equity Investors III, L.P., Co-Investment Funds and Stockholders.** 4.2 Amendment No. 1 to Stockholders Agreement by and among Registrant, Green Equity Investors III, L.P., GS Mezzanine Partners II. L.P. and Robert L. Antin.* 4.3 Indenture Agreement, dated as of September 20, 2000, by and between Registrant and Chase Manhattan Bank and Trust Company, National Association.** 4.4 Indenture Agreement, dated as of September 20, 2000, by and among Vicar Operating, Inc., Chase Manhattan Bank and Trust Company, National Association, with Registrant and its subsidiaries as Guarantors.** 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.** 5.1 Opinion of Akin, Gump, Strauss, Hauer & Feld, LLP, regarding validity of securities.* 10.1 Employment Agreement by and between Registrant and Robert L. Antin.* 10.2 Employment Agreement by and between Registrant and Arthur J. Antin.* 10.3 Employment Agreement by and between Registrant and Tomas W. Fuller.* 10.4 Employment Agreement by and between Registrant and Neil Tauber.* 10.5 Non-Compete Agreement, dated as of September 20, 2000, by and between Registrant and Robert L. Antin.** 10.6 Non-Compete Agreement, dated as of September 20, 2000, by and between Registrant and Arthur J. Antin.** 10.7 Non-Compete Agreement, dated as of September 20, 2000, by and between Registrant and Tomas W. Fuller.** 10.8 Non-Compete Agreement, dated as of September 20, 2000, by and between Registrant and Neil Tauber.** 10.9 Amended and Restated 1996 Stock Incentive Plan.* 10.10 2001 Stock Incentive Plan.* 10.11 Corporate Headquarters Lease, dated as of August 1, 1999, by and between Registrant and Werner Wolfen, Michael Duritz, Nancy Bruch, Dorothy A. Duritz, Harvey Rosenberg and Judy Rosenberg (Landlords). 10.12 Management Services Agreement, dated as of September 20, 2000, by and among Registrant, Vicar Operating, Inc. and Leonard Green and Partners, L.P.** 10.13 Form of Indemnification Agreement.** 10.14 Amended and Restated Agreement and Plan of Merger, dated as of August 11, 2000, by and among Registrant, Vicar Operating, Inc. and Vicar Recap, Inc.** 21.1 List of Subsidiaries of Registrant.** 23.1 Consent of Arthur Andersen LLP. 23.2 Consent of Akin, Gump, Strauss, Hauer & Feld, LLP (Set forth in Exhibit 5.1).* 24.1 Power of Attorney.** ----------------------------------- * To be filed by amendment. ** Previously filed. (B) Financial Statement Schedules: - Report of Independent Public Accountants - Schedule II - Valuation and Qualifying Accounts Page 4 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Stockholders of VCA Antech, Inc.: We have audited in accordance with auditing standards generally accepted in the United States, the consolidated financial statements of VCA Antech, Inc. and subsidiaries included in this registration statement and have issued our report thereon dated March 28, 2001. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedule II - Valuation and Qualifying Accounts is the responsibility of the company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. /s/ Arthur Andersen LLP ARTHUR ANDERSEN LLP Los Angeles, California March 28, 2001 Page 5
SCHEDULE II VCA ANTECH, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (IN THOUSANDS) BALANCE CHARGED AT TO COSTS BALANCE BEGINNING AND AT END OF PERIOD EXPENSES WRITE-OFFS OTHER (1) OF PERIOD --------- -------- ---------- --------- --------- Year ended December 31, 2000 Allowance for uncollectible accounts (2)...................... $ 7,432 $ 3,105 $ (6,771) $ 407 $ 4,173 Year ended December 31, 1999 Allowance for uncollectible accounts (2)...................... $ 6,532 $ 2,515 $ (2,252) $ 637 $ 7,432 Year ended December 31, 1998 Allowance for uncollectible accounts (2)...................... $ 5,128 $ 2,898 $ (1,831) $ 337 $ 6,532 (1) "Other" changes in the allowance for uncollectible accounts include allowances acquired with animal hospitals and laboratories acquisitions. (2) Balance includes allowance for trade accounts receivable and notes receivable.
Page 6 ITEM 17. UNDERTAKINGS. (a) The undersigned Registrant hereby undertakes to provide to the underwriter at the closing specified in the underwriting agreements, certificates in such denominations and registered in such names as required by the underwriter to permit prompt delivery to each purchaser. (b) Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers, and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer of controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by a controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. (c) The undersigned registrant hereby undertakes that: (1) For the purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the Offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. Page 7 SIGNATURES Pursuant to the requirements of the Securities Act, the Registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-1 and has duly caused this Amendment No. 1 to the Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Los Angeles, State of California, on October 15, 2001. By: /S/ TOMAS W. FULLER ---------------------------------- Tomas W. Fuller Its: Chief Financial Officer, Principal Accounting Officer, Vice President and Assistant Secretary Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates stated.
SIGNATURE TITLE DATE * --------------------------- Chairman of the Board, President and Robert L. Antin Chief Executive Officer October 15, 2001 --------------------------- Director, Chief Operating Officer, Senior Arthur J. Antin Vice President and Secretary October 15, 2001 /S/ TOMAS W. FULLER Chief Financial Officer, Principal --------------------------- Accounting Officer, Vice President and Tomas W. Fuller Assistant Secretary October 15, 2001 * --------------------------- John. M. Baumer Director October 15, 2001 * --------------------------- John G. Danhakl Director October 15, 2001 --------------------------- Melina Higgins Director October 15, 2001 * --------------------------- Peter J. Nolan Director October 15, 2001 * BY: /S/ TOMAS W. FULLER ----------------------- Attorney-in-Fact Director October 15, 2001
Page 8 LIST OF EXHIBITS EXHIBIT NUMBER EXHIBIT DESCRIPTION 1.1 Form of Underwriting Agreement.* 3.1 Form of Amended and Restated Certificate of Incorporation of Registrant.** 3.2 Form of Amended and Restated Bylaws of Registrant.** 4.1 Stockholders Agreement by and among Registrant, Green Equity Investors III, L.P., Co- Investment Funds and Stockholders.** 4.2 Amendment No. 1 to Stockholders Agreement by and among Registrant, Green Equity Investors III, L.P., GS Mezzanine Partners II. L.P. and Robert L. Antin.* 4.3 Indenture Agreement, dated as of September 20, 2000, by and between Registrant and Chase Manhattan Bank and Trust Company, National Association.** 4.4 Indenture Agreement, dated as of September 20, 2000, by and among Vicar Operating, Inc., Chase Manhattan Bank and Trust Company, National Association, with Registrant and its subsidiaries as Guarantors.** 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.** 5.1 Opinion of Akin, Gump, Strauss, Hauer & Feld, LLP, regarding validity of securities.* 10.1 Employment Agreement by and between Registrant and Robert L. Antin.* 10.2 Employment Agreement by and between Registrant and Arthur J. Antin.* 10.3 Employment Agreement by and between Registrant and Tomas W. Fuller.* 10.4 Employment Agreement by and between Registrant and Neil Tauber.* 10.5 Non-Compete Agreement, dated as of September 20, 2000, by and between Registrant and Robert L. Antin.** 10.6 Non-Compete Agreement, dated as of September 20, 2000, by and between Registrant and Arthur J. Antin.** 10.7 Non-Compete Agreement, dated as of September 20, 2000, by and between Registrant and Tomas W. Fuller.** 10.8 Non-Compete Agreement, dated as of September 20, 2000, by and between Registrant and Neil Tauber.** 10.9 Amended and Restated 1996 Stock Incentive Plan.* 10.10 2001 Stock Incentive Plan.* 10.11 Corporate Headquarters Lease, dated as of August 1, 1999, by and between Registrant and Werner Wolfen, Michael Duritz, Nancy Bruch, Dorothy A. Duritz, Harvey Rosenberg and Judy Rosenberg (Landlords). 10.12 Management Services Agreement, dated as of September 20, 2000, by and among Registrant, Vicar Operating, Inc. and Leonard Green and Partners, L.P.** 10.13 Form of Indemnification Agreement.** 10.14 Amended and Restated Agreement and Plan of Merger, dated as of August 11, 2000, by and among Registrant, Vicar Operating, Inc. and Vicar Recap, Inc.** 21.1 List of Subsidiaries of Registrant.** 23.1 Consent of Arthur Andersen LLP. 23.2 Consent of Akin, Gump, Strauss, Hauer & Feld, LLP (Set forth in Exhibit 5.1).* 24.1 Power of Attorney.** ------------------------------ * To be filed by amendment. ** Previously filed. Page 9 EX-10 3 ex-10_11.txt EXHIBIT 10.11 EXHIBIT 10.11 AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION STANDARD INDUSTRIAL/COMMERCIAL SINGLE-TENANT LEASE - NET (DO NOT USE THIS FORM FOR MULTI-TENANT BUILDINGS) 1. BASIC PROVISIONS ("BASIC PROVISIONS") 1.1 PARTIES: This Lease ("LEASE"), dated for reference purposes only January 1, 1999 is made by and between WERNER WOLFEN, TRUSTEE OF THE LOUIS GLASIER 1974 REVOCABLE TRUST, MICHAEL DUNITZ, NANCY BRUCH, DOROTHY A. DUNITZ, HARVEY ROSENBERG, AND JUDY ROSENBERG ("LESSOR") and VETERINARY CENTERS OF AMERICA, INC, a Delaware corporation ("LESSEE"), (collectively the "PARTIES," or individually a "PARTY"). 1.2 PREMISES: That certain real property, including all improvements therein or to be provided by Lessor under the terms of this Lease, and commonly known as 12401 West Olympic Blvd., Los Angeles (APN 4259-019-009) located in the County of Los Angeles, State of California and generally described as (describe briefly the nature of the property and, if applicable, the "PROJECT", if the property is located within Project) the three (3) buildings which contain approximately 30,782 square feet of space, subject to measurement as provided in Paragraph 48, together with the presently existing parking lot, all of which constitute the Premises ("PREMISES"). (See also Paragraph 2.) 1.3 EARLY POSSESSION: The provisions regarding Early Possession are not applicable to this Lease. ("EARLY POSSESSION DATE"). 1.4 BASE RENT: $ SEE PARAGRAPH 50 per month ("BASE RENT"), payable on the first (1st) day of each month commencing on the-Rent Commencement Date (as defined in Para. 49.3) (See also Paragraph 4) |X|If this box is checked, there are provisions in this Lease for the Base Rent to be adjusted. 1.5 BASE RENT PAID UPON EXECUTION: $ SEE PARAGRAPH 60 as Base Rent for the period of the fifth month after the Rent Commencement Date. 1.6 SECURITY DEPOSIT: $ zero ($0.00) ("SECURITY DEPOSIT"). (See also Paragraph 4.) 1.7 AGREED USE: General offices and uses related to general offices but for no other use or purpose. (See also Paragraph 5.) 1.8 INSURING PARTY. Lessor is the "INSURING PARTY" unless otherwise stated herein. (See also Paragraph 7.) 1.9 REAL ESTATE BROKERS: (See also Paragraph 14) (a) REPRESENTATION: The following real estate brokers (collectively, the "BROKERS") and brokerage relationships exist in this transaction (check applicable boxes): |X| Madison Partners (through Mitch Stokes) represents Lessor exclusively ("LESSOR'S BROKER"); Page 1 |X| Lee & Assoc. Commercial R.E. Services (through Richard B. Abbitt and Duncan Lemmon) represents Lessee exclusively ("LESSEE'S BROKER"); or |_| ("DUAL AGENCY") represents both Lessor and LESSEE. (b) PAYMENT TO BROKERS: Upon execution and delivery of this Lease by both Parties, Lessor shall pay to the Broker the fee agreed to in their separate written agreement. 1.10 ADDENDA AND EXHIBITS. Attached hereto is an Addendum or Addenda consisting of Paragraphs 48 through 83 and Exhibits A, B, C & D all of which constitute a part of this Lease. 2. PREMISES. 2.1 LETTING. Lessor hereby leases to Lessee, and Lessee hereby leases from Lessor, the Premises, for the term, at the rental, and upon all of the terms, covenants and conditions set forth in this Lease. 2.2 CONDITION. Lessor shall deliver the Premises to Lessee broom clean and free of debris on the Commencement Date ("START DATE"), and, so long as the required service contracts described in Paragraph 6.1(b) below are obtained by Lessee within thirty (30) days following the Start Date, warrants that the existing electrical, plumbing, fire sprinkler, lighting, heating, ventilating and air conditioning systems ("HVAC"), loading doors, if any, and all other such elements in the Premises, other than those constructed by Lessee, shall be in good operating condition on said date and that the structural elements of the roof, bearing walls and foundation of any buildings on the Premises (the "BUILDING") shall be free of material defects. If a non-compliance with said warranty exists as of the Start Date, Lessor shall, as Lessor's sole obligation with respect to such matter, except as otherwise provided in this Lease, promptly receipt of written notice from Lessee setting forth with specificity the nature and extent of such non-compliance, rectify same at Lessor's expense. If, after the Start Date, Lessee does not give Lessor written notice of any non-compliance with this warranty within: (i) eighteen (18) months as to the surface of the roof and the structural portions of the roof, foundations and bearing walls, (ii) twelve (12) months as to the HVAC systems (iii) ninety (90) days as to the remaining systems and other elements of the Building, correction of such non-compliance shall be the obligation of Lessee at Lessee's sole cost and expense. 2.3 COMPLIANCE. Lessor warrants that the improvements on the Premises comply with all applicable laws, covenants or restrictions of record, building codes, regulations and ordinances ("APPLICABLE REQUIREMENTS") in effect on the Start Date. Said warranty does not apply to the use to which Lessee will put the Premises or to any Alterations or Utility Installations (as defined in Paragraph 6.3(a)) made or to be made by Lessee. NOTE: Lessee is responsible for determining whether or not the zoning is appropriate for Lessee's intended use, and acknowledges that past uses of the Premises may no longer be allowed. If the Premises do not comply with said warranty, Lessor shall, except as otherwise provided, promptly after receipt of written notice from Lessee setting forth with specificity the nature and extent of such non-compliance, rectify the same at Lessor's expense. If Lessee does not give Lessor written notice of a non-compliance with this warranty within six (6) months following the Start Date, Page 2 correction of that non-compliance shall be the obligation of Lessee at Lessee's sole cost and expense. If the Applicable Requirements are hereafter changed (as opposed to being in existence at the Start Date, which is addressed in Paragraph 5.2(e) below) so as to require during the term of this Lease the construction of an addition to or an alteration of the Building, the remediation of any Hazardous Substance, or the reinforcement or other physical modification of the Building ("CAPITAL EXPENDITURE"), Lessor and Lessee shall allocate the cost of such work as follows: (a) Subject to Paragraph 2.3(c) below, if such Capital Expenditures are required as a result of the specific and unique use of the Premises by Lessee as compared with uses by tenants in general, Lessee shall be fully responsible for the cost thereof, provided, however that if such Capital Expenditure is required during the last two (2) years of this Lease and the cost thereof exceeds six (6) months' Base Rent, Lessee may instead terminate this Lease unless Lessor notifies Lessee, in writing, within ten (10) days after receipt of Lessee's termination notice that Lessor has elected to pay the difference between the actual cost thereof and the amount equal to six (6) months' Base Rent. If Lessee elects termination, Lessee shall immediately cease the use of the Premises which requires such Capital Expenditure and deliver to Lessor written notice specifying a termination date at least ninety (90) days thereafter. Such termination date shall, however, in no event be earlier than the last day that Lessee could legally utilize the Premises without commencing such Capital Expenditure. (b) If such Capital Expenditure is not the result of the specific and unique use of the Premises by Lessee (such as, governmentally mandated seismic modifications), then Lessor and Lessee shall allocate the obligation to pay for such costs pursuant to the provisions of Paragraph 6.1 (c); provided, however, that if such Capital Expenditure is required during the last two years of this Lease or if Lessor reasonably determines that it is not economically feasible to pay its share thereof, Lessor shall have the option to terminate this Lease upon ninety (90) days prior written notice to Lessee unless Lessee notifies Lessor, in writing, within ten (10) days after receipt of Lessor's termination notice that Lessee will pay for such Capital Expenditure. If Lessor does not elect to terminate, and fails to tender its share of any such Capital Expenditure, Lessee may advance such funds and deduct same, with Interest, from Rent until Lessor's share of such costs have been fully paid. If Lessee is unable to finance Lessor's share, or if the balance of the Rent due and payable for the remainder of this Lease is not sufficient to fully reimburse Lessee on an offset basis, Lessee shall have the right to terminate this Lease upon thirty (30) days written notice to Lessor. (c) Notwithstanding the above, the provisions concerning Capital Expenditures are intended to apply only to non-voluntary, unexpected, and new Applicable Requirements. If the Capital Expenditures are instead triggered by Lessee as a result of an actual or proposed change in use, change in intensity of use, or modification to the Premises then, and in that event, Lessee shall be fully responsible for the cost thereof, and Lessee shall not have any right to terminate this Lease. 2.4 ACKNOWLEDGEMENTS. Lessee acknowledges that: (a) it has been advised by Lessor and/or Brokers to satisfy itself with respect to the condition of the Premises (including but not limited to the electrical, HVAC and fire sprinkler systems, security, environmental aspects, and compliance with Applicable Requirements), and their suitability for Lessee's intended use, (b) Lessee has made such investigation as it deems necessary with reference to such matters and Page 3 assumes all responsibility therefor as the same relate to its occupancy of the Premises, and (c) neither Lessor, Lessor's agents, nor any Broker has made any oral or written representations or warranties with respect to said matters other than as set forth in this Lease. In addition, Lessor acknowledges that: (a) Broker has made no representations, premises or warranties concerning Lessee's ability to honor the Lease or suitability to occupy the Premises, and (b) it is Lessor's sole responsibility to investigate the financial capability and/or suitability of all proposed tenants. 2.5 LESSEE AS PRIOR OWNER/OCCUPANT. The warranties made by Lessor in Paragraph 2 shall be of no force or effect if immediately prior to the Start Date Lessee was the owner or occupant of the Premises. In such event, Lessee shall be responsible for any necessary corrective work. 3. TERM. 3.1 TERM. The Commencement Date, Expiration Date and Original Term of this Lease are as specified in Paragraph 49. 3.2 LESSEE COMPLIANCE. Lessor shall not be required to tender possession of the Premises to Lessee until Lessee complies with its obligation to provide evidence of insurance (Paragraph 7.5). Pending delivery of such evidence, Lessee shall be required to perform all of its obligations under this Lease from and after the Start Date, including the payment of Rent, notwithstanding Lessor's election to withhold possession pending receipt of such evidence of insurance. Further, if Lessee is required to perform any other conditions prior to or concurrent with the Start Date, the Start Date shall occur but Lessor may elect to withhold possession until such conditions are satisfied. 4. RENT. 4.1 RENT DEFINED. All monetary obligations of Lessee to Lessor under the terms of this Lease (except for the Security Deposit) are deemed to be rent ("RENT"). 4.2 PAYMENT. Lessee shall cause payment of Rent to be received by Lessor in lawful money of the United States, without offset or deduction (except as specifically permitted in this Lease), on or before the day on which it is due. Rent for any period during the term hereof which is for less than one (1) full calendar month shall be prorated based upon the actual number of days of said month. Payment of Rent shall be made to Lessor at its address stated herein or to such other persons or place as Lessor may from time to time designate in writing. Acceptance of a payment which is less than the amount then due shall not be a waiver of Lessor's rights to the balance of such Rent, regardless of Lessor's endorsement of any check so stating. 5. USE. 5.1 USE. Lessee shall use and occupy the Premises only for the Agreed Use, and for no other purpose. Lessee shall not use or permit the use of the Premises in a manner that is unlawful, creates damage, waste or a nuisance, or that disturbs owners and/or occupants of, or causes damage to neighboring properties. Lessor shall not unreasonably withhold or delay its consent to any written request for a modification of the Agreed Use, so long as the same will not impair the structural integrity of the improvements on the Premises or the mechanical or Page 4 electrical systems therein, is not significantly more burdensome to the Premises. If Lessor elects to withhold consent, Lessor shall within five (5) business days after such request give written notification of same, which notice shall include an explanation of Lessors objections to the change in use. 5.2 HAZARDOUS SUBSTANCES. (a) REPORTABLE USES REQUIRE CONSENT. The term "HAZARDOUS SUBSTANCE" as used in this Lease shall mean any product, substance, or waste whose presence, use, manufacture, disposal, transportation, or release, either by itself or in combination with other materials expected to be on the Premises, is either: (i) potentially injurious to the public health, safety or welfare, the environment or the Premises, (ii) regulated or monitored by any governmental authority, or (iii) a basis for potential liability of Lessor to any governmental agency or third party under any applicable statute or common law theory. Hazardous Substances shall include, but not be limited to, hydrocarbons, petroleum, gasoline, and/or crude oil or any products, by-products or fractions thereof. Lessee shall not engage in any activity in or on the Premises which constitutes a Reportable Use of Hazardous Substances without the express prior written consent of Lessor and timely compliance (at Lessee's expense) with all Applicable Requirements. "REPORTABLE USE" shall mean (i) the installation or use of any above or below ground storage tank, (ii) the generation, possession, storage, use, transportation, or disposal of a Hazardous Substance that requires a permit from, or with respect to which a report, notice, registration or business plan is required to be filed with, any governmental authority, and/or (iii) the presence at the Premises of a Hazardous Substance with respect to which any Applicable Requirements requires that a notice be given to persons entering or occupying the Premises or neighboring properties. Notwithstanding the foregoing, Lessee may use any ordinary and customary materials reasonably required to be used in the normal course of the Agreed Use, so long as such use is in compliance with all Applicable Requirements, is not a Reportable Use, and does not expose the Premises or neighboring property to any meaningful risk of contamination or damage or expose Lessor to any liability therefor. In addition, Lessor may condition its consent to any Reportable Use upon receiving such additional assurances as Lessor reasonably deems necessary to protect itself, the public, the Premises and/or the environment against damage, contamination, injury and/or liability, including, but not limited to, the installation (and removal on or before Lease expiration or termination) of protective modifications (such as concrete encasements) and/or increasing the Security Deposit. (b) DUTY TO INFORM LESSOR. If Lessee knows, or has reasonable cause to believe, that a Hazardous Substance has come to be located in, on, under or about the Premises, other than as previously consented to by Lessor, Lessee shall immediately give written notice of such fact to Lessor, and provide Lessor with a copy of any report, notice, claim or other documentation which it has concerning the presence of such Hazardous Substance. See Addendum Paragraph 81.1.1 (c) LESSEE REMEDIATION. Lessee shall not cause or permit any Hazardous Substance to be spilled or released in, on, under, or about the Premises (including through the plumbing or sanitary sewer system) and shall promptly, at Lessee's expense, take all investigatory and/or remedial action reasonably recommended, whether or not formally ordered or required, for the cleanup of any contamination of, and for the maintenance, security and/or Page 5 monitoring of the Premises or neighboring properties, that was caused or materially contributed to by Lessee, or pertaining to or involving any Hazardous Substance brought onto the Premises during the term of this Lease, by or for Lessee, or any third party. (d) LESSEE INDEMNIFICATION. Lessee shall indemnify, defend and hold Lessor, its agents, employees, lenders and ground lessor, if any, harmless from and against any and all loss of rents and/or damages, liabilities, judgments, claims, expenses, penalties, and attorneys' and consultants' fees arising out of or involving any Hazardous Substance brought onto the Premises by or for Lessee, or any third party (provided, however, that Lessee shall have no liability under this Lease with respect to underground migration of any Hazardous Substance under the Premises from adjacent properties). Lessee's obligations shall include, but not be limited to, the effects of any contamination or injury to person, property or the environment created or suffered by Lessee, and the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Lease. NO TERMINATION, CANCELLATION OR RELEASE AGREEMENT ENTERED INTO BY LESSOR AND LESSEE SHALL RELEASE LESSEE FROM ITS OBLIGATIONS UNDER THIS LEASE WITH RESPECT TO HAZARDOUS SUBSTANCES, UNLESS SPECIFICALLY SO AGREED BY LESSOR IN WRITING AT THE TIME OF SUCH AGREEMENT. (e) LESSOR INDEMNIFICATION. Lessor and its successors and assigns shall indemnify, defend, reimburse and hold Lessee, its employees and lenders, harmless from and against any and all environmental damages, including the cost of remediation, which existed as a result of Hazardous Substances on the Premises prior to the Start Date or which are caused by the gross negligence or willful misconduct of Lessor, its agents or employees. Lessor's obligations, as and when required by the Applicable Requirements, shall include, but not be limited to, the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Lease. (f) INVESTIGATIONS AND REMEDIATIONS. Lessor shall retain the responsibility and pay for any investigations or remediation measures required by governmental entities having jurisdiction with respect to the existence of Hazardous Substances on the Premises prior to the Start Date, unless such remediation measure is required as a result of Lessee's use (including "Alterations", as defined in paragraph 6.3(a) below) of the Premises, in which event Lessee shall be responsible for such payment. Lessee shall cooperate fully in any such activities at the request of Lessor, including allowing Lessor and Lessor's agents to have reasonable access to the Premises at reasonable times in order to carry out Lessor's investigative and remedial responsibilities. (g) (See Addendum 81.2). 5.3 LESSEE'S COMPLIANCE WITH APPLICABLE REQUIREMENTS. Except as otherwise provided in this Lease, Lessee shall, at Lessee's sole expense, fully, diligently and in a timely manner, materially comply with all Applicable Requirements, the requirements of any applicable fire insurance underwriter or rating bureau, and the recommendations of Lessor's engineers and/or consultants which relate in any manner to the Premises, without regard to whether said requirements are now in effect or become effective after the Start Date. Lessee shall, within ten (10) days after receipt of Lessors written request, provide Lessor with copies of all permits and other documents, and other information evidencing Lessee's compliance with any Applicable Page 6 Requirements specified by Lessor, and shall immediately upon receipt, notify Lessor in writing (with copies of any documents involved) of any threatened or actual claim, notice, citation, warning, complaint or report pertaining to or involving the failure of Lessee or the Premises to comply with any Applicable Requirements. 5.4 INSPECTION; COMPLIANCE. Lessor and Lessor's "Lender" (as defined in Paragraph 29 below) and consultants shall have the right to enter into Premises at any time, in the case of an emergency, and otherwise at reasonable times, for the purpose of inspecting the condition of the Premises and for verifying compliance by Lessee with this Lease. The cost of any such inspections shall be paid by Lessor, unless a violation of Applicable Requirements, or a contamination is found to exist or be imminent, or the inspection is requested or ordered by a governmental authority. In such case, Lessee shall upon request reimburse Lessor for the cost of such inspections, so long as such inspection is requested or ordered by a governmental authority. In such cases, Lessee shall upon request reimburse Lessor for the cost of such inspections, so long as such inspection is reasonably related to the violation or contamination. 6. MAINTENANCE; REPAIRS, UTILITY INSTALLATIONS; TRADE FIXTURES AND ALTERATIONS. 6.1 LESSEE'S OBLIGATIONS. (a) IN GENERAL. Subject to the provisions of Paragraph 2.2 (Condition), 2.3 (Compliance), 5.3 (Lessee's Compliance with Applicable Requirements), 6.2 (Lessee's Obligations), 8 (Damage or Destruction), and 13 (Condemnation), Lessee shall, at Lessee's sole expense, keep the Premises, Utility Installations, and Alterations in good order, condition and repair (whether or not the portion of the Premises requiring repairs, or the means of repairing the same, are reasonably or readily accessible to Lessee, and whether or not the need for such repairs occurs as a result of Lessee's use, any prior use, the elements or the age of such portion of the Premises), including, but not limited to, all equipment or facilities, such as plumbing, heating, ventilating, air-conditioning, electrical, lighting facilities, boilers, pressure vessels, fire protection system, fixtures, interior walls, ceilings, floors, windows, doors, plate glass, skylights, landscaping, driveways, parking lots, fences, retaining walls, signs, sidewalks and parkways located in, on, or adjacent to the Premises. Lessee, in keeping the Premises in good order, condition and repair, shall exercise and perform good maintenance practices, specifically including the procurement and maintenance of the service contracts required by Paragraph 6.1(b) below. Lessee's obligations shall include restorations, replacements or renewals when necessary to keep the Premises and all improvements thereon or a part thereof in good order, condition and state of repair. Lessee shall, during the term of this Lease, keep the exterior appearance of the Building in a first-class condition consistent with the exterior appearance of other similar facilities of comparable age and size in the vicinity, including, when necessary, the exterior repainting of the Building. (b) SERVICE CONTRACTS. Lessee shall, at Lessee's sole expense, procure and maintain contracts, with copies to Lessor, in customary form and substance for, and with contractors specializing and experienced in the maintenance of the following equipment and improvements ("Basic Elements" collectively herein) if any, if and when installed on the Premises: (i) HVAC equipment, (ii) boiler, and pressure vessels, (iii) fire extinguishing systems, including fire alarm and/or smoke detection, (iv) landscaping and irrigation systems, (v) roof Page 7 covering and drains, (vi) driveways and parking lots, (vii) clarifiers, (viii) basic utility feed to the perimeter of the Building, and (ix) any other equipment, if reasonably required by Lessor. (c) REPLACEMENT. Subject to Lessee's indemnification of Lessor as set forth in Paragraph 7.7 below, and without relieving Lessee of liability resulting from Lessee's failure to exercise and perform good maintenance practices, if the Basic Elements described in Paragraph 6.1 (b) cannot be repaired other than at a cost which is in excess of 50% of the cost of replacing such Basic Elements, then such Basic Elements shall be replaced by Lessor, and the cost thereof shall be prorated between the Parties and Lessee shall only be obligated to pay, each month during the remainder of the term of this Lease, on the date on which Base Rent is due, an amount equal to the product of multiplying the cost of such replacement by a fraction, the numerator of which is one, and the denominator of which is the number of months of the useful life of such replacement as such useful life is specified pursuant to Federal income tax regulations or guidelines for depreciation thereof (including interest on the unamortized balance as is then commercially reasonable in the judgment of Lessor's accountants), with Lessee reserving the right to prepay its obligation at any time. 6.2 LESSOR'S OBLIGATIONS. Subject to the provisions of Paragraphs 2.2 (Condition), 2.3 (Compliance), 8 (Damage or Destruction) and 13 (Condemnation), it is intended by the Parties hereto that Lessor have no obligation, in any manner whatsoever, to repair and maintain the Premises, or the equipment therein, all of which obligations are intended to be that of the Lessee. It is the intention of the Parties that the terms of this Lease govern the respective obligations of the Parties as to maintenance and repair of the Premises, and they expressly waive the benefit of any statute now or hereafter in effect to the extent it is inconsistent with the terms of this Lease. 6.3 UTILITY INSTALLATIONS; TRADE FIXTURES; ALTERATIONS. (a) DEFINITIONS; CONSENT REQUIRED. The term "UTILITY INSTALLATIONS" refers to all floor and window coverings, air lines, power panels, electrical distribution, security and fire protection systems, communication systems, lighting fixtures, HVAC equipment, plumbing, and fencing in or on the Premises. The term "TRADE FIXTURES" shall mean Lessee's machinery and equipment including telephone, cable, computer, furniture and similar systems and items that can be removed without doing material damage to the Premises. The term "ALTERATIONS" shall mean any modification of the improvements, other than Utility Installations or Trade Fixtures, whether by addition or deletion. "LESSEE OWNED ALTERATIONS AND/OR UTILITY INSTALLATIONS" are defined as Alterations and/or Utility Installations made by Lessee that are not yet owned by Lessor pursuant to Paragraph 6.4(a). Lessee shall not make any Alterations or Utility Installations to the Premises without Lessor's prior written consent. Lessee may, however, make non-structural Utility Installations to the interior of the Premises (excluding the roof) without such consent but upon notice to Lessor, as long as they are not visible from the outside, do not involve puncturing, relocating or removing the roof or any existing walls, and the cumulative cost thereof during this Lease as extended does not exceed $50,000 in the aggregate or $10,000 in any one year. (b) CONSENT. Any Alterations or Utility Installations that Lessee shall desire to make and which require the consent of the Lessor shall be presented to Lessor in written form Page 8 with detailed plans. Consent shall be deemed conditioned upon Lessee's: (i) acquiring all applicable governmental permits, (ii) furnishing Lessor with copies of both the permits and the plans and specifications prior to commencement of the work, and (iii) compliance with all conditions of said permits and other Applicable Requirements in a prompt and expeditious manner. Any Alterations or Utility Installations shall be performed in a workmanlike manner with good and sufficient materials. Lessee shall promptly upon completion furnish Lessor with as-built plans and specifications. For work which costs an amount equal to the greater of one month's Base Rent, or $10,000, Lessor may condition its consent upon Lessee providing a lien and completion bond in an amount equal to one and one-half times the estimated cost of such Alteration or Utility Installation and/or upon Lessee's posting an additional Security Deposit with Lessor. (c) INDEMNIFICATION. Lessee shall pay, when due, all claims for labor or materials furnished or alleged to have been furnished to or for Lessee at or for use on the Premises, which claims are or may be secured by any mechanic's or materialmen's lien against the Premises or any interest therein. Lessee shall give Lessor not less than ten (10) days' notice prior to the commencement of any work in, on or about the Premises, and Lessor shall have the right to post notices of non-responsibility. If Lessee shall contest the validity of any such lien, claim or demand, then Lessee shall, at its sole expense defend and protect itself, Lessor and the Premises against the same and shall pay and satisfy any such adverse judgment that may be rendered thereon before the enforcement thereof. If Lessor shall require, Lessee shall furnish a surety bond in an amount equal to one and one-half times the amount of such contested lien, claim or demand, indemnifying Lessor against liability for the same. If Lessor elects to participate in any such action, Lessee shall pay Lessor's attorneys' fees and costs. 6.4 OWNERSHIP; REMOVAL; SURRENDER; AND RESTORATION. (a) OWNERSHIP. Subject to Lessor's right to require removal or elect ownership as hereinafter provided, all Alterations and Utility Installations made by Lessee shall be the property of Lessee, but considered a part of the Premises. Lessor may, at any time, elect in writing to be the owner of all or any specified part of the Lessee Owned Alterations and Utility Installations. Unless otherwise instructed per Paragraph 6.4(b) hereof, all Lessee Owned Alterations and Utility Installations shall, at the expiration or termination of this Lease, become the property of Lessor and be surrendered by Lessee with the Premises. (b) REMOVAL. By delivery to Lessee of written notice from Lessor not earlier than ninety (90) and not later than thirty (30) days prior to the end of the term of this Lease, Lessor may require that any or all Lessee Owned Alterations or Utility Installations be removed by the expiration or termination of this Lease. Lessor may require the removal at any time of all or any part of any Lessee Owned Alterations or Utility Installations made without the required consent. (c) SURRENDER/RESTORATION. Lessee shall surrender the Premises by the Expiration Date or any earlier termination date, with all of the improvements, parts and surfaces thereof broom clean and free of debris, and in good operating order, condition and state of repair, ordinary wear and tear excepted. "Ordinary wear and tear" shall not include any damage or deterioration that would have been prevented by good maintenance practice. Lessee shall repair Page 9 any damage occasioned by the installation, maintenance or removal of Trade Fixtures, Lessee Owned Alterations and/or Utility Installations, furnishings, and equipment as well as the removal of any storage tank installed by or for Lessee, and the removal, replacement, or remediation of any soil, material or groundwater contaminated by Lessee. Trade Fixtures shall remain the property of Lessee and shall be removed by Lessee. The failure by Lessee to timely vacate the Premises pursuant to this Paragraph 6.4(c) without the express written consent of Lessor shall constitute a holdover under the provisions of Paragraph 25 below. 7. INSURANCE; INDEMNITY. 7.1 PAYMENT FOR INSURANCE. Lessee shall pay for all insurance required under Paragraph 7 except to the extent of the cost attributable to liability insurance carried by Lessor under Paragraph 7.2(b) in excess of $2,000,000 per occurrence. Premiums for policy periods commencing prior to or extending beyond the Lease term shall be prorated to correspond to the Lease term. Payment shall be made by Lessee to Lessor within ten (10) days following receipt of an invoice. 7.2 LIABILITY INSURANCE. (a) CARRIED BY LESSEE. Lessee shall obtain and keep in force a Commercial General Liability Policy of Insurance protecting Lessee and Lessor against claims for bodily injury, personal injury and property damage based upon or arising out of the ownership, use, occupancy or maintenance of the Premises and all areas appurtenant thereto. Such insurance shall be on an occurrence basis providing single limit coverage in an amount not less than $2,000,000 per occurrence with an "ADDITIONAL INSURED-MANAGERS OR LESSORS OF PREMISES ENDORSEMENT" and contain the "AMENDMENT OF THE POLLUTION EXCLUSION ENDORSEMENT" for damage caused by heat, smoke or fumes from a hostile fire. The Policy shall not contain any intra-insured exclusions as between insured persons or organizations, but shall include coverage for liability assumed under this Lease as an "insured contract" for the performance of Lessee's indemnity obligations under this Lease. The limits of said insurance shall not, however, limit the liability of Lessee nor relieve Lessee of any obligation hereunder. All insurance carried by Lessee shall be primary to and not contributory with any similar insurance carried by Lessor, whose insurance shall be considered excess insurance only. (b) CARRIED BY LESSOR. Lessor shall maintain liability insurance as described in Paragraph 7.2(a), in addition to, and not in lieu of, the insurance required to be maintained by Lessee. Lessee shall not be named as an additional insured therein. 7.3 PROPERTY INSURANCE - BUILDING, IMPROVEMENTS AND RENTAL VALUE. (a) BUILDING AND IMPROVEMENTS. The Insuring Party shall obtain and keep in force a policy or policies in the name of Lessor, with loss payable to Lessor, any groundlessor, and to any Lender(s) insuring loss or damage to the Premises. The amount of such insurance shall be equal to the full replacement cost of the Premises, as the same shall exist from time to time, or the amount required by any Lenders, but in no event more than the commercially reasonable and available insurable value thereof. If Lessor is the Insuring Party, however, Lessee Owned Alterations and Utility Installations, Trade Fixtures, and Lessee's personal Page 10 property shall be insured by Lessee under Paragraph 7.4 rather than by Lessor. If the coverage is available and commercially appropriate, such policy or policies shall insure against all risks of direct physical loss or damage, including coverage for debris removal and the enforcement of any Applicable Requirements requiring the upgrading, demolition, reconstruction or replacement of any portion of the Premises as the result of a covered loss. Said policy or policies shall also contain an agreed valuation provision in lieu of any coinsurance clause, waiver of subrogation, and inflation guard protection causing an increase in the annual property insurance coverage amount by a factor of not less than the adjusted U.S. Department of Labor Consumer Price Index for All Urban Consumers for the city nearest to where the Premises are located. If such insurance coverage has a deductible clause, the deductible amount shall not exceed $1,000 per occurrence, and Lessee shall be liable for such deductible amount in the event of an Insured Loss. (b) RENTAL VALUE. The Insuring Party shall obtain and keep in force a policy or policies in the name of Lessor with loss payable to Lessor and any Lender, insuring the loss of the full Rent for eighteen (18) months. Said insurance shall provide that in the event the Lease is terminated by reason of an insured loss, the period of indemnity for such coverage shall be extended beyond the date of the completion of repairs or replacement of the Premises, to provide for one full year's loss of Rent from the date of any such loss. Said insurance shall contain an agreed valuation provision in lieu of any coinsurance clause, and the amount of coverage shall be adjusted annually to reflect the projected Rent otherwise payable by Lessee, for the next twelve (12) month period. Lessee shall be liable for any deductible amount in the event of such loss. (c) ADJACENT PREMISES. Lessee shall pay for any increase in the premiums for the property insurance if said increase is caused by Lessee's acts, omissions, use or occupancy of the Premises. 7.4 LESSEE'S PROPERTY/BUSINESS INTERRUPTION INSURANCE. (a) PROPERTY DAMAGE. Lessee shall obtain and maintain insurance coverage on all of Lessee's personal property, Trade Fixtures, and Lessee Owned Alterations and Utility Installations. Such insurance shall be full replacement cost coverage with a deductible of not to exceed $1,000 per occurrence. The proceeds from any such insurance shall be used by Lessee for the replacement of personal property, Trade Fixtures and Lessee Owned Alterations and Utility Installations. Lessee shall provide Lessor with written evidence that such insurance is in force. (b) BUSINESS INTERRUPTION. Lessee shall obtain and maintain loss of income and extra expense insurance in amounts as will reimburse Lessee for direct or indirect loss of earnings attributable to all perils commonly insured against by prudent lessees in the business of Lessee or attributable to prevention of access to the Premises as a result of such perils. (c) NO REPRESENTATION OF ADEQUATE COVERAGE. Lessor makes no representation that the limits or forms of coverage of insurance specified herein are adequate to cover Lessee's property, business operations or obligations under this Lease. Page 11 7.5 INSURANCE POLICIES. Insurance required herein shall be by companies duly licensed or admitted to transact business in the state where the Premises are located, and maintaining during the policy term a "General Policyholders Rating" of at least B+, V, as set forth in the most current issue of "Best's Insurance Guide", or such other rating as may be required by a Lender. Lessee shall not do or permit to be done anything which invalidates the required insurance policies. Lessee shall, prior to the Start Date, deliver to Lessor certified copies of policies of such insurance or certificates evidencing the existence and amounts of the required insurance. No such policy shall be cancelable or subject to modification except after thirty (30) days prior written notice to Lessor. Lessee shall, at least thirty (30) days prior to the expiration of such policies, furnish Lessor with evidence of renewals or "insurance binders" evidencing renewal thereof, or Lessor may order such insurance and charge the cost thereof to Lessee, which amount shall be payable by Lessee to Lessor upon demand. Such policies shall be for a term of at least one year, or the length of the remaining term of this Lease, whichever is less. If either Party shall fail to procure and maintain the insurance required to be carried by it, the other Party may, but shall not be required to, procure and maintain the same. 7.6 WAIVER OF SUBROGATION. Without affecting any other rights or remedies, Lessee and Lessor each hereby release and relieve the other, and waive their entire right to recover damages against the other, for loss of or damage to its property arising out of or incident to the perils required to be insured against herein. The effect of such releases and waivers is not limited by the amount of insurance carried or required, or by any deductibles applicable hereto. The Parties agree to have their respective property damage insurance carriers waive any right to subrogation that such companies may have against Lessor or Lessee, as the case may be, so long as the insurance is not invalidated thereby. 7.7 INDEMNITY. Except for Lessor's gross negligence or willful misconduct, Lessee shall indemnify, protect, defend and hold harmless the Premises, Lessor and its agents, Lessor's master or ground lessor, partners and Lenders, from and against any and all claims, loss of rents and/or damages, liens, judgments, penalties, attorneys' and consultants' fees, expenses and/or liabilities arising out of, involving, or in connection with, the use and/or occupancy of the Premises by Lessee. If any action or proceeding is brought against Lessor by reason of any of the foregoing matters, Lessee shall upon notice defend the same at Lessee's expense by counsel reasonably satisfactory to Lessor and Lessor shall cooperate with Lessee in such defense. Lessor need not have first paid any such claim in order to be defended or indemnified. See Addendum Paragraph 82. 7.8 EXEMPTION OF LESSOR FROM LIABILITY. Lessor shall not be liable for injury or damage to the person or goods, wares, merchandise or other property of Lessee, Lessee's employees, contractors, invitees, customers, or any other person in or about the Premises, whether such damage or injury is caused by or results from fire, steam, electricity, gas, water or rain, or from the breakage, leakage, obstruction or other defects of pipes, fire sprinklers, wires, appliances, plumbing, HVAC or lighting fixtures, or from any other cause, whether the said injury or damage results from conditions arising upon the Premises or upon other portions of the Building of which the Premises are a part, or from other sources or places. Lessor shall not be liable for any damages arising from any act or neglect of any other tenant of Lessor. Notwithstanding Lessor's negligence or breach of this Lease, Lessor shall under no Page 12 circumstances be liable for injury to Lessee's business or for any loss of income or profit therefrom. 8. DAMAGE OR DESTRUCTION. 8.1 DEFINITIONS. (a) "PREMISES PARTIAL DAMAGE" shall mean damage or destruction to the improvements on the Premises, other than Lessee Owned Alterations and Utility Installations, which can reasonably be repaired in six (6) months or less from the date of the damage or destruction. Lessor shall notify Lessee in writing within thirty (30) days from the date of the damage or destruction as to whether or not the damage is Partial or Total. (b) "PREMISES TOTAL DESTRUCTION" shall mean damage or destruction to the Premises, other than Lessee Owned Alterations and Utility Installations and Trade Fixtures, which cannot reasonably be repaired in six (6) months or less from the date of the damage or destruction, Lessor shall notify Lessee in writing within thirty (30) days from the date of the damage or destruction as to whether or not the damage is Partial or Total. (c) "INSURED LOSS" shall mean damage or destruction to improvements on the Premises, other than Lessee Owned Alterations and Utility Installations and Trade Fixtures, which was caused by an event required to be covered by the insurance described in Paragraph 7.3(a), irrespective of any deductible amounts or coverage limits involved. (d) "REPLACEMENT COST" shall mean the cost to repair or rebuild the improvements owned by Lessor at the time of the occurrence to their condition existing immediately prior thereto, including demolition, debris removal and upgrading required by the operation of Applicable Requirements, and without deduction for depreciation. (e) "HAZARDOUS SUBSTANCE CONDITION" shall mean the occurrence or discovery of a condition involving the presence of, or a contamination by, a Hazardous Substance as defined in Paragraph 5.2(a), in, on, or under the Premises. 8.2 PARTIAL DAMAGE - INSURED LOSS. If a Premises Partial Damage that is an Insured Loss occurs, then Lessor shall, at Lessor's expense, repair such damage (but not Lessee's Trade Fixtures or Lessee Owned Alterations and Utility Installations) as soon as reasonably possible and this Lease shall continue in full force and effect; provided, however, that Lessee shall, at Lessor's election, make the repair of any damage or destruction the total cost to repair of which is $10,000 or less, and, in such event, Lessor shall make any applicable insurance proceeds available to Lessee on a reasonable basis for that purpose. Notwithstanding the foregoing, if the required insurance was not in force or the insurance proceeds are not sufficient to effect such repair, the Insuring Party shall promptly contribute the shortage in proceeds (except as to the deductible which is Lessee's responsibility) as and when required to complete said repairs. In the event, however, such shortage was due to the fact that, by reason of the unique nature of the improvements, full replacement cost insurance coverage was not commercially reasonable and available, Lessor shall have no obligation to pay for the shortage in insurance proceeds or to fully restore the unique aspects of the Premises unless Lessee provides Lessor with the funds to cover same, or adequate assurance thereof, within ten (10) days following receipt of written Page 13 notice of such shortage and request therefor. If Lessor receives said funds or adequate assurance thereof within said ten (10) day period, the party responsible for making the repairs shall complete them as soon as reasonably possible and this Lease shall remain in full force and effect. If such funds or assurance are not received, Lessor may nevertheless elect by written notice to Lessee within ten (10) days thereafter to: (i) make such restoration and repair as is commercially reasonable with Lessor paying any shortage in proceeds, in which case this Lease shall remain in full force and effect, or have this Lease terminate thirty (30) days thereafter. Lessee shall not be entitled to reimbursement of any funds contributed by Lessee to repair any such damage or destruction. Premises Partial Damage due to flood or earthquake shall be subject to Paragraph 8.3, notwithstanding that there may be some insurance coverage, but the net proceeds of any such insurance shall be made available for the repairs if made by either Party. 8.3 PARTIAL DAMAGE - UNINSURED LOSS. If a Premises Partial Damage that is not an Insured Loss occurs, unless caused by a negligent or willful act of Lessee (in which event Lessee shall make the repairs at Lessee's expense), Lessor may either: (i) repair such damage as soon as reasonably possible at Lessor's expense, in which event this Lease shall continue in full force and effect, or (ii) terminate this Lease by giving written notice to Lessee within thirty (30) days after receipt by Lessor of knowledge of the occurrence of such damage. Such termination shall be effective sixty (60) days following the date of such notice. In the event Lessor elects to terminate this Lease, Lessee shall have the right within ten (10) days after receipt of the termination notice to give written notice to Lessor of Lessee's commitment to pay for the repair of such damage without reimbursement from Lessor. Lessee shall provide Lessor with said funds or satisfactory assurance thereof within thirty (30) days after making such commitment. In such event this Lease shall continue in full force and effect, and Lessor shall proceed to make such repairs as soon as reasonably possible after the required funds are available. If Lessee does not make the required commitment, this Lease shall terminate as of the date specified in the termination notice. 8.4 TOTAL DESTRUCTION. Notwithstanding any other provision hereof, if a Premises Total Destruction occurs, this Lease shall terminate sixty (60) days following such Destruction. If the damage or destruction was caused by the gross negligence or willful misconduct of Lessee, Lessor shall have the right to recover Lessor's damages from Lessee, except as provided in Paragraph 7.6. 8.5 DAMAGE NEAR END OF TERM. If at any time during the last six (6) months of this Lease there is damage for which the cost to repair exceeds one (1) month's Base Rent, whether or not an Insured Loss, Lessor may terminate this Lease effective sixty (60) days following the date of occurrence of such damage by giving a written termination notice to Lessee within thirty (30) days after the date of occurrence of such damage. Notwithstanding the foregoing, if Lessee at that time has an exercisable option to extend this Lease or to purchase the Premises, then Lessee may preserve this Lease by, (a) exercising such option and (b) providing Lessor with any shortage in insurance proceeds (or adequate assurance thereof) needed to make the repairs on or before the earlier of (i) the date which is ten (10) days after Lessee's receipt of Lessor's written notice purporting to terminate this Lease, or (ii) the day prior to the date upon which such option expires. If Lessee duly exercises such option during such period and provides Lessor with funds (or adequate assurance thereof) to cover any shortage in insurance proceeds, Lessor shall, at Lessor's commercially reasonable expense, repair such damage as soon as reasonably possible Page 14 and this Lease shall continue in full force and effect. If Lessee fails to exercise such option and provide such funds or assurance during such period, then this Lease shall terminate on the date specified in the termination notice and Lessee's option shall be extinguished. 8.6 ABATEMENT OF RENT; LESSEE'S REMEDIES. (a) ABATEMENT. In the event of Premises Partial Damage or Premises Total Destruction or a Hazardous Substance Condition for which Lessee is not responsible under this Lease, the Rent payable by Lessee for the period commencing on the date such Premises Partial Damage, Premises Total Destruction or Hazardous Substance Condition occurs required for the repair, remediation or restoration of such damage shall be abated in proportion to the degree to which Lessee's use of the Premises is impaired, but not to exceed the proceeds received from the Rental Value insurance. All other obligations of Lessee hereunder shall be performed by Lessee, and Lessor shall have no liability for any such damage, destruction, remediation, repair or restoration except as provided herein. (b) REMEDIES. If Lessor shall be obligated to repair or restore the Premises and does not commence, in a substantial and meaningful way, such repair or restoration within sixty (60) days after such obligation shall accrue, Lessee may, at any time prior to the commencement of such repair or restoration, give written notice to Lessor and to any Lenders of which Lessee has actual notice, of Lessee's election to terminate this Lease on a date not less than sixty (60) days following the giving of such notice. If Lessee gives such notice and such repair or restoration is not commenced within thirty (30) days thereafter, this Lease shall terminate as of the date specified in said notice. If the repair or restoration is commenced within said thirty (30) days, this Lease shall continue in full force and effect. "COMMENCE" shall mean either the unconditional authorization of the preparation of the required plans, or the beginning of the actual work on the Premises, whichever first occurs. 8.7 TERMINATION-ADVANCE PAYMENTS. Upon termination of this Lease pursuant to Paragraph 5.2(g) or Paragraph 8, an equitable adjustment shall be made concerning advance Base Rent and any other advance payments made by Lessee to Lessor. Lessor shall, in addition, return to Lessee so much of Lessee's Security Deposit as has not been, or is not then required to be, used by Lessor. 8.8 WAIVE STATUTES. Lessor and Lessee agree that the terms of this Lease shall govern the effect of any damage to or destruction of the Premises with respect to the termination of this Lease and hereby waive the provisions of any present or future statute to the extent inconsistent herewith. 9. REAL PROPERTY TAXES. 9.1 DEFINITION OF "REAL PROPERTY TAXES": As used herein, the term "REAL PROPERTY TAXES" shall include any form of assessment; real estate, general, special, ordinary or extraordinary, or rental levy or tax (other than inheritance, personal income or estate taxes); improvement bond; and/or license too imposed upon or levied against any legal or equitable interest of Lessor in the Premises, Lessor's right to other income therefrom, and/or Lessor's business of leasing, by any authority having the direct or indirect power to tax and where the Page 15 funds are generated with reference to the Building address and where the proceeds so generated are to be applied by the city, county or other local taxing authority of a jurisdiction within which the Premises are located. The term "REAL PROPERTY TAXES" shall also include any tax, fee, levy, assessment or charge, or any increase therein, imposed by reason of events occurring during the term of this Lease, including but not limited to, a change in the ownership of the Premises. 9.2 (a) PAYMENT OF TAXES. Lessee shall pay Lessor the Real Property Taxes applicable to the Premises during the term of this Lease. All such payments shall be made at lease twenty (20) days prior to any delinquency date. Lessee shall promptly furnish Lessor with satisfactory evidence that such taxes have been paid. If any such taxes shall cover any period of time prior to or after the expiration or termination of this Lease, Lessee's share of such taxes shall be prorated to cover only that portion of the tax bill applicable to the period that this Lease is in effect, and Lessor shall reimburse Lessee for any overpayment. It Lessee shall fail to pay any required Real Property Taxes, Lessor shall have the right to pay the same, and Lessee shall reimburse Lessor therefor upon demand. 9.3 JOINT ASSESSMENT. If the Premises are not separately assessed, Lessee's liability shall be an equitable proportion of the Real Property Taxes for all of the land and improvements included within the tax parcel assessed, such proportion to be conclusively determined by Lessor from the respective valuations assigned in the assessor's work sheets or such other information as may be reasonably available. 9.4 PERSONAL PROPERTY TAXES. Lessee shall pay, prior to delinquency, all taxes assessed against and levied upon Lessee Owned Alterations, Utility Installations, Trade Fixtures, furnishings, equipment and all personal property of Lessee. When possible, Lessee shall cause such property to be assessed and billed separately from the real property of Lessor. If any of Lessee's said personal property shall be assessed with Lessor's real property, Lessee shall pay Lessor the taxes attributable to Lessee's property within ten (10) days after receipt of a written statement. 10. UTILITIES. Lessee shall pay for all water, gas, heat, light, power, telephone, trash disposal and other utilities and services supplied to the Premises, together with any taxes thereon. If any such services are not separately metered to Lessee, Lessee shall pay a reasonable proportion, to be determined by Lessor, of all charges jointly metered. 11. ASSIGNMENT AND SUBLETTING. 11.1 LESSOR'S CONSENT REQUIRED (a) Lessor shall not voluntarily or by operation of law assign, transfer, mortgage or encumber (collectively, "ASSIGN OR ASSIGNMENT") or sublet all or any part of Lessee's interest in this Lease or in the Premises without Lessor's prior written consent. (b) See addendum Paragraph 80.4. Page 16 (c) The involvement of Lessee or its assets in any transaction, or series of transactions (by way of merger, sale, acquisition, financing, transfer, leveraged buy-out or otherwise), whether or not a formal assignment or hypothecation of this Lease or Lessee's assets occurs, which results or will result in a reduction of the Net Worth of Lessee by an amount greater than twenty-five percent (25%) of such Net Worth as it was represented at the time of the execution of this Lease or at the time of the most recent assignment to which Lessor has consented, or as it exists immediately prior to said transaction or transactions constituting such reduction, whichever was or is greater, shall be considered an assignment of this Lease to which Lessor may withhold its consent. "NET WORTH OF LESSEE" shall mean the net worth of Lessee (excluding any guarantors) established under generally accepted accounting principles. (d) An assignment or subletting without consent shall, at Lessor's option, be a Default curable after notice per Paragraph 12.1 (c), or a noncurable Breach without the necessity of any notice and grace period. If Lessor elects to treat such unapproved assignment or subletting as a noncurable Breach, Lessor may either: (i) terminate this Lease, or (ii) upon thirty (30) days written notice, increase the monthly Base Rent to one hundred ten percent (110%) of the Base Rent then in effect. Further, in the event of such Breach and rental adjustment, (i) the purchase price of any option to purchase the Premises hold by Lessee shall be subject to similar adjustment to one hundred ten percent (110%) of the price previously in effect, and (ii) all fixed and non-fixed rental adjustments scheduled during the remainder of the Lease term shall be increased to One Hundred Ten Percent (110%) of the scheduled adjusted rent. (e) Lessee's remedy for any breach of Paragraph 11.1 by Lessor shall be limited to compensatory damages and/or injunctive relief. 11.2 TERMS AND CONDITIONS APPLICABLE TO ASSIGNMENT AND SUBLETTING. (a) Regardless of Lessor's consent, any assignment or subletting shall not: (i) be effective without the express written assumption by such assignee or sublessee of the obligations of Lessee under this Lease, (ii) release Lessee of any obligations hereunder, or (iii) alter the primary liability of Lessee for the payment of Rent or for the performance of any other obligations to be performed by Lessee. (b) Lessor may accept Rent or performance of Lessee's obligations from any person other than Lessee pending approval or disapproval of an assignment. Neither a delay in the approval or disapproval of such assignment nor the acceptance of Rent or performance shall constitute a waiver or estoppel of Lessor's right to exercise its remedies for Lessee's Default or Breach. (c) Lessor's consent to any assignment or subletting shall not constitute a consent to any subsequent assignment or subletting. (d) In the event of any Default or Breach by Lessee, Lessor may proceed directly against Lessee, any Guarantors or anyone else responsible for the performance of Lessee's obligations under this Lease, including any assignee or sublessee, without first exhausting Lessor's remedies against any other person or entity responsible therefore to Lessor, or any security held by Lessor. Page 17 (e) Each request for consent to an assignment or subletting shall be in writing, accompanied by information relevant to Lessor's determination as to the financial and operational responsibility and appropriateness of the proposed assignee or sublessee, including but not limited to the intended use and/or required modification of the Premises, if any, together with a fee of $1,000 as consideration for Lessor's considering and processing said request. Lessee agrees to provide Lessor with such other or additional information and/or documentation as may be reasonably requested. (f) Any assignee of, or Sublessee under, this Lease shall, by reason of accepting such assignment or entering into such sublease, be deemed to have assumed and agreed to conform and comply with each and every term, covenant, condition and obligation herein to be observed or performed by Lessee during the term of said assignment or sublease, other than such obligations as are contrary to or inconsistent with provisions of an assignment or sublease to which Lessor has specifically consented to in writing. 11.3 ADDITIONAL TERMS AND CONDITIONS APPLICABLE TO SUBLETTING. The following terms and conditions shall apply to any subletting by Lessee of all or any part of the Premises and shall be deemed included in all subleases under this Lease whether or not expressly incorporated therein: (a) Lessee hereby assigns and transfers to Lessor all of Lessee's interest in all Rent payable on any sublease, and Lessor may collect such Rent and apply same toward Lessee's obligations under this Lease; provided, however, that until a Breach shall occur in the performance of Lessee's obligations, Lessee may collect said Rent. Lessor shall not, by reason of the foregoing or any assignment of such sublease, nor by reason of the collection of Rent, be deemed liable to the sublessee for any failure of Lessee to perform and comply with any of Lessee's obligations to such sublessee. Lessee hereby irrevocably authorizes and directs any such sublessee, upon receipt of a written notice from Lessor stating that a Breach exists in the performance of Lessee's obligations under this Lease, to pay to Lessor all Rent due and to become due under the sublease. Sublessee shall rely upon any such notice from Lessor and shall pay all Rents to Lessor without any obligation or right to inquire as to whether such Breach exists, notwithstanding any claim from Lessee to the contrary. (b) In the event of a Breach by Lessee, Lessor may, at its option, require sublessee to attorn to Lessor, in which event Lessor shall undertake the obligations of the sublessor Lessor such sublease from the time of the exercise of said option to the expiration of such sublease; provided, however, Lessor shall not be liable for any prepaid rents or security deposit paid by such sublessee to such sublessor or for any prior Defaults or Breaches of such sublessor. (c) Any matter requiring the consent of the sublessor under a sublease shall also require the consent of Lessor. (d) No sublessee shall further assign or sublet all or any part of the Premises without Lessor's prior written consent. Page 18 (e) Lessor shall deliver a copy of any notice of Default or Breach by Lessee to the sublessee, who shall have the right to cure the Default of Lessee within the grace period, if any, specified in such notice. The sublessee shall have a right of reimbursement and offset from and against Lessee for any such Defaults cured by the sublessee. 12. DEFAULT; BREACH; REMEDIES. 12.1 DEFAULT; BREACH. A "DEFAULT" is defined as a failure by the Lessee to comply with or perform any of the terms, covenants, conditions or rules under this Lease. A "BREACH" is defined as the occurrence of one or more of the following Defaults, and the failure of Lessee to cure such Default within any applicable grace period: (a) The abandonment of the Premises; or the vacating of the Premises without providing a commercially reasonable level of security, or where the coverage of the property insurance described in Paragraph 7.3 is jeopardized as a result thereof, or without providing reasonable assurances to minimize potential vandalism. (b) The failure of Lessee to make any payment of Rent or any Security Deposit required to be made by Lessee hereunder, whether to Lessor or to a third party, when due, to provide reasonable evidence of insurance or surety bond, or to fulfill any obligation under this Lease which endangers or threatens life or property, where such failure continues for a period of three (3) business days following written notice to Lessee. (c) The failure by Lessee to provide (i) reasonable written evidence of compliance with Applicable Requirements, (ii) the service contracts, (iii) the rescission of an unauthorized assignment or subletting, (iv) a Tenancy Statement, (v) a requested subordination, (vi) evidence concerning any guaranty and/or Guarantor, (vii) any document requested under Paragraph 40 (easements), or (viii) any other documentation or information which Lessor may reasonably require of Lessee under the terms of this Lease, where any such failure continues for a period of ten (10) days following written notice to Lessee. (d) A Default by Lessee as to the terms, covenants, conditions or provisions of this Lease, or of the rules adopted under Paragraph 38 hereof, other than those described in subparagraphs 12.1 (a), (b) or (c), above, where such Default continues for a period of thirty (30) days after written notice; provided, however, that if the nature of Lessee's Default is such that more than thirty (30) days are reasonably required for its cure, then it shall not be deemed to be a Breach if Lessee commences such cure within said thirty (30) day period and thereafter diligently prosecutes such cure to completion. (e) The occurrence of any of the following events: (i) the making of any general arrangement or assignment for the benefit of creditors; (ii) becoming a "DEBTOR" as defined in 11 U.S.C. ss. 101 or any successor statute thereto (unless, in the case of a petition filed against Lessee, the same is dismissed within sixty (60) days); (iii) the appointment of a trustee or receiver to take possession of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease, where possession is not restored to Lessee within thirty (30) days; or (iv) the attachment, execution or other judicial seizure of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease, where such seizure is not discharged Page 19 within thirty (30) days; provided, however, in the event that any provision of this subparagraph (e) is contrary to any applicable law, such provision shall be of no force or effect, and not affect the validity of the remaining provisions. (f) The discovery that any financial statement of Lessee or of any Guarantor given to Lessor was materially false. (g) If the performance of Lessee's obligations under this Lease is guaranteed: (i) the death of a Guarantor, (ii) the termination of a Guarantor's liability with respect to this Lease other than in accordance with the terms of such guaranty, (iii) a Guarantor's becoming insolvent or the subject of a bankruptcy filing, (iv) a Guarantor's refusal to honor the guaranty, or (v) a Guarantor's breach of its guaranty obligation on an anticipatory basis, and Lessee's failure, within sixty (60) days following written notice of any such event, to provide written alternative assurance or security, which, when coupled with the then existing resources of Lessee, equals or exceeds the combined financial resources of Lessee and the Guarantors that existed at the time of execution of this Lease. 12.2 REMEDIES. If Lessee fails to perform any of its affirmative duties or obligations, within ten (10) days after written notice (or in case of an emergency, without notice), Lessor may, at its option, perform such duty or obligation on Lessee's behalf, including but not limited to the obtaining of reasonably required bonds, insurance policies, or governmental licenses, permits or approvals. The costs and expenses of any such performance by Lessor shall be due and payable by Lessee upon receipt of invoice therefor. If any check given to Lessor by Lessee shall not be honored by the bank upon which it is drawn, Lessor, at its option, may require all future payments to be made by Lessee to be by cashier's check. In the event of a Breach, Lessor may, with or without further notice or demand, and without limiting Lessor in the exercise of any right or remedy which Lessor may have by reason of such Breach: (a) Terminate Lessee's right to possession of the Premises by any lawful means, in which case this Lease shall terminate and Lessee shall immediately surrender possession to Lessor. In such event Lessor shall be entitled to recover from Lessee: (i) the unpaid Rent which had been earned at the time of termination; (ii) the worth at the time of award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that the Lessee proves could have been reasonably avoided; (iii) the worth at the time of award of the amount by which the unpaid rent for the balance of the term after the time of award exceeds the amount of such rental loss that the Lessee proves could be reasonably avoided; and (iv) any other amount necessary to compensate Lessor for all the detriment proximately caused by the Lessee's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom, including but not limited to the cost of recovering possession of the Premises, expenses of reletting, including necessary renovation and alteration of the Premises, reasonable attorneys' fees, and that portion of any leasing commission paid by Lessor in connection with this Lease applicable to the unexpired term of this Lease. The worth at the time of award of the amount referred to in provision (iii) of the immediately preceding sentence shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of the District within which the Premises are located at the time of award plus one percent (1%). Efforts by Lessor to mitigate damages caused by Lessee's Breach of this Lease shall not waive Lessor's right to Page 20 recover damages under Paragraph 11. If termination of this Lease is obtained through the provisional remedy of unlawful detainer, Lessor shall have the right to recover in such proceeding any unpaid Rent and damages as are recoverable therein, or Lessor may reserve the right to recover all or any part thereof in a separate suit. If a notice and grace period required under Paragraph 12.1 was not previously given, a notice to pay rent or quit, or to perform or quit given to Lessee under the unlawful detainer statute shall also constitute the notice required by Paragraph 12.1. In such case, the applicable grace period required by Paragraph 12.1 and the unlawful detainer statute shall run concurrently, and the failure of Lessee to cure the Default within the greater of the two such grace periods shall constitute both an unlawful detainer and a Breach of this Lease entitling Lessor to the remedies provided for in this Lease and/or by said statute. (b) Continue the Lease and Lessee's right to possession and recover the Rent as it becomes due, in which event Lessee may sublet or assign, subject only to reasonable limitations. Acts of maintenance, efforts to relet, and/or the appointment of a receiver to protect the Lessor's interests, shall not constitute a termination of the Lessee's right to possession. (c) Pursue any other remedy now or hereafter available under the laws or judicial decisions of the state wherein the Premises are located. The expiration or termination of this Lease and/or the termination of Lessee's right to possession shall not relieve Lessee from liability under any indemnity provisions of this Lease as to matters occurring or accruing during the term hereof or by reason of Lessee's occupancy of the Premises. 12.3 INDUCEMENT RECAPTURE. Any agreement for free or abated rent or other charges, or for the giving or paying by Lessor to or for Lessee of any cash or other bonus, inducement or consideration for Lessee's entering into this Lease, all of which concessions are hereinafter referred to as "INDUCEMENT PROVISIONS," shall be deemed conditioned upon Lessee's full and faithful performance of all of the terms, covenants and conditions of this Lease. Upon Breach of this Lease by Lessee, any such Inducement Provision shall automatically be deemed deleted from this Lease and of no further force or effect, and any rent, other charge, bonus, inducement or consideration theretofore abated, given or paid by Lessor under such an Inducement Provision shall be immediately due and payable by Lessee to Lessor, notwithstanding any subsequent cure of said Breach by Lessee. The acceptance by Lessor of rent or the cure of the Breach which initiated the operation of this paragraph shall not be deemed a waiver by Lessor of the provisions of this paragraph unless specifically so stated in writing by Lessor at the time of such acceptance. 12.4 LATE CHARGES. Lessee hereby acknowledges that late payment by Lessee of Rent will cause Lessor to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Such costs include, but are not limited to, processing and accounting charges, and late charges which may be imposed upon Lessor by any Lender. Accordingly, if any Rent shall not be received by Lessor within five (5) days after such amount shall be due, then, without any requirement for notice to Lessee, Lessee shall pay to Lessor a one-time late charge equal to three percent (3%) of each such overdue amount. The parties hereby agree that such late charge represents a fair and reasonable estimate of the costs Lessor will incur by reason of such late payment. Acceptance of such late charge by Lessor shall in no event constitute a waiver of Lessee's Default or Breach with respect to such overdue amount, nor prevent the exercise of any of the other rights and remedies granted hereunder. In the event that Page 21 a late charge is payable hereunder, whether or not collected, for three (3) consecutive installments of Base Rent, then notwithstanding any provision of this Lease to the contrary, Base Rent shall, at Lessor's option, become due and payable quarterly in advance. (See Addendum Paragraph 64.3). 12.5 INTEREST. Any monetary payment due Lessor hereunder, other than late charges, not received by Lessor, when due as to scheduled payments (such as Base Rent) or within thirty (30) days following the date on which it was due for non-scheduled payment, shall bear interest from the date when due, as to scheduled payments, or the thirty-first (31st) day after it was due as to non-scheduled payments. The interest ("INTEREST") charged shall be equal to the prime rate reported in the Wall Street Journal as published closest prior to the date when due plus four percent (4%), but shall not exceed the maximum rate allowed by law. Interest is payable in addition to the potential late charge provided for in Paragraph 12.4. 12.6 BREACH BY LESSOR. (a) NOTICE OF BREACH. Lessor shall not be deemed in breach of this Lease unless Lessor fails within a reasonable time to perform an obligation required to be performed by Lessor. For purposes of this Paragraph, a reasonable time shall in no event be less than thirty (30) days after receipt by Lessor, and any Lender whose name and address shall have been furnished Lessee in writing for such purpose, of written notice specifying wherein such obligation of Lessor has not been performed; provided, however, that if the nature of Lessor's obligation is such that more than thirty (30) days are reasonably required for its performance, then Lessor shall not be in breach if performance is commenced within such thirty (30) day period and thereafter diligently pursued to completion. 13. CONDEMNATION. If the Premises or any portion thereof are taken under the power of eminent domain or sold under the threat of the exercise of said power (collectively "CONDEMNATION"), this Lease shall terminate as to the part taken as of the date the condemning authority takes title or possession, whichever first occurs. If more than ten percent (10%) of any building portion of the premises, or more than twenty-five percent (25%) of the land area portion of the premises not occupied by any building, is taken by Condemnation, Lessee may, at Lessee's option, to be exercised in writing within ten (10) days after Lessor shall have given Lessee written notice of such taking (or in the absence of such notice, within ten (10) days after the condemning authority shall have taken possession) terminate this Lease as of the date the condemning authority takes such possession. If Lessee does not terminate this Lease in accordance with the foregoing, this Lease shall remain in full force and effect as to the portion of the Premises remaining, except that the Base Rent shall be reduced in proportion to the reduction in utility of the Premises caused by such Condemnation. Condemnation awards and/or payments shall be the property of Lessor, whether such award shall be made as compensation for diminution in value of the leasehold, the value of the part taken, or for severance damages; provided, however, that Lessee shall be entitled to any compensation for Lessee's relocation expenses, loss of business goodwill and/or Trade Fixtures, without regard to whether or not this Lease is terminated pursuant to the provisions of this Paragraph. All Alterations and Utility Installations made to the Premises by Lessee, for purposes of Condemnation only, shall be considered the property of the Lessee and Lessee shall be entitled to any and all compensation Page 22 which is payable therefor. In the event that this Lease is not terminated by reason of the Condemnation, Lessor shall repair any damage to the Premises caused by such Condemnation. 14. BROKERS' FEE. 14.1 ASSUMPTION OF OBLIGATIONS. Any buyer or transferee of Lessor's interest in this Lease shall be deemed to have assumed Lessor's obligations hereunder. 14.2 REPRESENTATIONS AND INDEMNITIES OF BROKER RELATIONSHIPS. Lessee and Lessor each represent and warrant to the other that it has had no dealings with any person, firm, broker or finder (other than the Brokers, if any) in connection with this Lease, and that no one other than said named Brokers is entitled to any commission or finder's fee in connection herewith. Lessee and Lessor do each hereby agree to indemnify, protect, defend and hold the other harmless from and against liability for compensation or charges which may be claimed by any such unnamed broker, finder or other similar party by reason of any dealings or actions of the indemnifying Party. including any costs, expenses, attorneys' fees reasonably incurred with respect thereto. 15. ESTOPPEL CERTIFICATES. (a) Each Party (as "RESPONDING PARTY") shall within ten (10) days after written notice from the other Party (the "REQUESTING PARTY") execute, acknowledge and deliver to the Requesting Party a statement in writing in form similar to the then most current "ESTOPPEL CERTIFICATE" form published by the American Industrial Real Estate Association, plus such additional information, confirmation and/or statements as may be reasonably requested by the Requesting Party and are reasonably available to the Responding Party. (b) If the Responding Party shall fail to execute or deliver the Estoppel Certificate within such ten day period, the Requesting Party may execute an Estoppel Certificate stating that: (i) the Lease is in full force and effect without modification except as may be represented by the Requesting Party, (ii) there are no uncured defaults in the Requesting Party's performance, and (iii) if Lessor is the Requesting Party, not more than one month's rent has been paid in advance. Prospective purchasers and encumbrancers may rely upon the Requesting Party's Estoppel Certificate, and the Responding Party shall be estopped from denying the truth of the facts contained in said Certificate. (c) If Lessor desires to finance, refinance, or sell the Premises, or any part thereof, Lessee and all Guarantors shall deliver to any potential lender or purchaser designated by Lessor such financial statements as may be reasonably required by such lender or purchaser, including but not limited to Lessee's financial statements for the past three (3) years which financial statements shall be, if the stock in Lessee (or in Lessee's parent or successor corporation) is publicly traded on a national stock exchange, those financial statements which Lessee makes available to the public and to the Securities and Exchange Commission. All such financial statements, shall be received by Lessor and such lender or purchaser in confidence and shall be used only for the purposes herein set forth. 16. DEFINITION OF LESSOR. The term "LESSOR" as used herein shall mean the owner or owners at the time in question of the fee title to the Premises, or, if this is a sublease, of the Lessee's interest in the prior lease. In the event of a transfer of Lessor's title or interest in the Premises or Page 23 this Lease, Lessor shall deliver to the transferee or assignee (in cash or by credit) any unused Security Deposit held by Lessor. Except as provided in Paragraph 14, upon such transfer or assignment and delivery of the Security Deposit, as aforesaid, the prior Lessor shall be relieved of all liability with respect to the obligations and/or covenants under this Lease thereafter to be performed by the Lessor. Subject to the foregoing, the obligations and/or covenants in this Lease to be performed by the Lessor shall be binding only upon the Lessor as hereinabove defined. Notwithstanding the above, and subject to the provisions of Paragraph 19 below, the original Lessor under this Lease, and all subsequent holders of the Lessor's interest in this Lease shall remain liable and responsible with regard to the potential duties and liabilities of Lessor pertaining to Hazardous Substances as outlined in Paragraph 5 above. 17. SEVERABILITY. The invalidity of any provision of this Lease, as determined by a court of competent jurisdiction, shall in no way affect the validity of any other provision hereof. 18. DAYS. Unless otherwise specifically indicated to the contrary, the word "days" as used in this Lease shall mean and refer to calendar days. 19. See Addendum Paragraph 59. 20. TIME OF ESSENCE. Time is of the essence with respect to the performance of all obligations to be performed or observed by the Parties under this Lease. 21. NO PRIOR OR OTHER AGREEMENTS; BROKER DISCLAIMER. This Lease contains all agreements between the Parties with respect to any matter mentioned herein, and no other prior or contemporaneous agreement or understanding shall be effective. Lessor and Lessee each represents and warrants to the Brokers that it has made, and is relying solely upon, its own investigation as to the nature, quality, character and financial responsibility of the other Party to this Lease and as to the nature, quality and character of the Premises. Brokers have no responsibility with respect thereto or with respect to any default or breach hereof by either Party. The liability (including court costs and Attorneys' fees), of any Broker with respect to negotiation, execution, delivery or performance by either Lessor or Lessee under this Lease or any amendment or modification hereto shall be limited to an amount up to the fee received by such Broker pursuant to this Lease; provided, however, that the foregoing limitation on each Broker's liability shall not be applicable to any gross negligence or willful misconduct of such Broker. 22. NOTICES. 22.1 NOTICE REQUIREMENTS. All notices required or permitted by this Lease shall be in writing and may be delivered in person (by hand or by courier) or may be sent by regular, certified or registered mail or U.S. Postal Service Express Mail, with postage prepaid, or by facsimile transmission, and shall be deemed sufficiently given if served in a manner specified in this Paragraph 22. The addresses noted adjacent to a Party's signature on this Lease shall be that Party's address for delivery or mailing of notices. Either Party may by written notice to the other specify a different address for notice, except that upon Lessee's taking possession of the Premises, the Premises shall constitute Lessee's address for notice. A copy of all notices to Page 24 Lessor shall be concurrently transmitted to such party or parties at such addresses as Lessor may from time to time hereafter designate in writing. 22.2 DATE OF NOTICE. Any notice sent by registered or certified mail, return receipt requested, shall be deemed given on the date of delivery shown on the receipt card, or if no delivery date is shown, the postmark thereon. If sent by regular mail the notice shall be deemed given forty-eight (48) hours after the same is addressed as required herein and mailed with postage prepaid. Notices delivered by United States Express Mail or overnight courier that guarantee next day delivery shall be deemed given twenty-four (24) hours after delivery of the same to the Postal Service or courier. Notices transmitted by facsimile transmission or similar means shall be deemed delivered upon telephone confirmation of receipt, provided a copy is also delivered via delivery or mail. If notice is received on a Saturday, Sunday or legal holiday, it shall be deemed received on the next business day. 23. WAIVERS. No waiver by Lessor of the Default or Breach of any term, covenant or condition hereof by Lessee, shall be deemed a waiver of any other term, covenant or condition hereof, or of any subsequent Default or Breach by Lessee of the same or of any other form, covenant or condition hereof. Lessors consent to, or approval of, any act shall not be deemed to render unnecessary the obtaining of Lessor's consent to, or approval of, any subsequent or similar act by Lessee, or be construed as the basis of an estoppel to enforce the provision or provisions of this Lease requiring such consent. The acceptance of Rent by Lessor shall not be a waiver of any Default or Breach by Lessee. Any payment by Lessee may be accepted by Lessor on account of moneys or damages due Lessor, notwithstanding any qualifying statements or conditions made by Lessee in connection therewith, which such statements and/or conditions shall be of no force or effect whatsoever unless specifically agreed to in writing by Lessor at or before the time of deposit of such payment. 24. RECORDING. Either Lessor or Lessee shall, upon request of the other, execute, acknowledge and deliver to the other a short form memorandum of this Lease for recording purposes. The Party requesting recordation shall be responsible for payment of any fees applicable thereto. 25. NO RIGHT TO HOLDOVER. Lessee has no right to retain possession of the Premises or any part thereof beyond the expiration or termination of this Lease. In the event that Lessee holds over, then the Base Rent shall be increased to one hundred fifty percent (150%) of the Base Rent applicable during the month immediately preceding the expiration or termination. Nothing contained herein shall be construed as consent by Lessor to any holding over by Lessee. 26. CUMULATIVE REMEDIES. No remedy or election hereunder shall be deemed exclusive but shall, wherever possible, be cumulative with all other remedies at law or in equity. 27. COVENANTS AND CONDITIONS; CONSTRUCTION OF AGREEMENT. All provisions of this Lease to be observed or performed by Lessee are both covenants and conditions. In construing this Lease, all headings and titles are for the convenience of the parties only and shall not be considered a part of this Lease. Whenever required by the context, the singular shall include the plural and vice versa. This Lease shall not be construed as if prepared by one of the parties, but rather according to its fair meaning as a whole, as if both parties had prepared it. Page 25 28. BINDING EFFECT; CHOICE OF LAW. This Lease shall be binding upon the parties, their personal representatives, successors and assigns and be governed by the laws of the State in which the Premises are located. Any litigation between the Parties hereto concerning this Lease shall be initiated in the county in which the Premises are located. 29. SUBORDINATION; ATTORNMENT; NON-DISTURBANCE. 29.1 SUBORDINATION. This Lease and any Option granted hereby shall be subject and subordinate to any ground lease, mortgage, deed of trust, or other hypothecation or security device (collectively, "SECURITY DEVICE"), now or hereafter placed upon the Premises, to any and all advances made on the security thereof, and to all renewals, modifications, and extensions thereof. Lessee agrees that the holders of any such Security Devices (in this Lease together referred to as "Lessor's Lender") shall have no liability or obligation to perform any of the obligations of Lessor under this Lease. Any Lender may elect to have this Lease and/or any Option granted hereby superior to the lien of its Security Device by giving written notice thereof to Lessee, whereupon this Lease and such Options shall be deemed prior to such Security Device, notwithstanding the relative dates of the documentation or recordation thereof. 29.2 ATTORNMENT. Subject to the non-disturbance provisions of Paragraph 29.3, Lessee agrees to attorn to a Lender or any other party who acquires ownership of the Premises by reason of a foreclosure of a Security Device, and that in the event of such foreclosure, such new owner shall not: (i) be liable for any act or omission of any prior lessor or with respect to events occurring prior to acquisition of ownership; (ii) be subject to any offsets or defenses which Lessee might have against any prior lessor, or (iii) be bound by prepayment of more than one (1) month's rent. 29.3 NON-DISTURBANCE. With respect to Security Devices entered into by Lessor after the execution of this Lease, Lessee's subordination of this Lease shall be subject to receiving a commercially reasonable non-disturbance agreement (a "NON-DISTURBANCE AGREEMENT") from the Lender which Non-Disturbance Agreement provides that Lessee's possession of the Premises, and this Lease, including any options to extend the term hereof, will not be disturbed so long as Lessee is not in Breach hereof and attorns to the record owner of the Premises. Further, within sixty (60) days after the execution of this Lease, Lessor shall use its commercially reasonable efforts to obtain a Non-Disturbance Agreement from the holder of any pre-existing Security Device which is secured by the Premises. In the event that Lessor is unable to provide the Non-Disturbance Agreement within said sixty (60) days, then Lessee may, at Lessee's option, directly contact Lessor's lender and attempt to negotiate for the execution and delivery of a Non-Disturbance Agreement. 29.4 SELF-EXECUTING. The agreements contained in this Paragraph 29 shall be effective without the execution of any further documents; provided, however, that, upon written request from Lessor or a Lender in connection with a sale, financing or refinancing of the Premises, Lessee and Lessor shall execute such further writings as may be reasonably required to separately document any subordination, attornment and/or Non-Disturbance Agreement provided for herein. Page 26 30. ATTORNEYS' FEES. If any Party or Broker brings an action or proceeding involving the Premises to enforce the terms hereof or to declare rights hereunder, the Prevailing Party (as hereafter defined) in any such proceeding, action, or appeal thereon, shall be entitled to reasonable attorneys' fees. Such fees may be awarded in the same suit or recovered in a separate suit, whether or not such action or proceeding is pursued to decision or judgment. The term, "PREVAILING PARTY" shall include, without limitation, a Party or Broker who substantially obtains or defeats the relief sought, as the case may be, whether by compromise, settlement, judgment, or the abandonment by the other Party or Broker of its claim or defense. The attorneys' fees award shall not be computed in accordance with any court fee schedule, but shall be such as to fully reimburse all attorneys' fees reasonably incurred. In addition, Lessor shall be entitled to attorneys' fees, costs and expenses incurred in the preparation and service of notices of Default and consultations in connection therewith, whether or not a legal action is subsequently commenced in connection with such Default or resulting Breach. 31. LESSOR'S ACCESS; SHOWING PREMISES; REPAIRS. Lessor and Lessor's agents shall have the right to enter the Premises at any time, in the case of an emergency, and otherwise at reasonable times for the purpose of showing, the same to prospective purchasers, lenders, or lessees, and making such alterations, repairs, improvements or additions to the Premises as Lessor may deem necessary. All such activities shall be without abatement of rent or liability to Lessee. Lessor may at any time place on the Premises any ordinary "FOR SALE" signs and Lessor may during the last six (6) months of the term hereof place on the Premises any ordinary "FOR LEASE" signs. Lessee may at any time place on or about the Premises any ordinary "FOR SUBLEASE" sign. 32. AUCTIONS. Lessee shall not conduct, nor permit to be conducted, any auction upon the Premises without Lessor's prior written consent. Lessor shall not be obligated to exercise any standard of reasonableness in determining whether to permit an auction. 33. SIGNS. Except for ordinary "FOR SUBLEASE" signs, Lessee shall not place any sign upon the Premises without Lessor's prior written consent. All signs must comply with all Applicable Requirements. 34. TERMINATION; MERGER. Unless specifically stated otherwise in writing by Lessor, the voluntary or other surrender of this Lease by Lessee, the mutual termination or cancellation hereof, or a termination hereof by Lessor for Breach by Lessee, shall automatically terminate any sublease or lessor estate in the Premises; provided, however, that Lessor may elect to continue any one or all existing subtenancies. Lessor's failure within ten (10) days following any such event to elect to the contrary by written notice to the holder of any such lesser interest, shall constitute Lessor's election to have such event constitute the termination of such interest. 35. CONSENTS. Except as otherwise provided herein, wherever in this Lease the consent of a Party is required to an act by or for the other Party, such consent shall not be unreasonably withhold or delayed. Lessor's actual reasonable costs and expenses (including but not limited to architects', attorneys' engineers' and other consultants' fees) incurred in the consideration of, or response to, a request by Lessee for any Lessor consent, including but not limited to consents to an assignment, a subletting or the presence or use of a Hazardous Substance, shall be paid by Lessee upon receipt of an invoice and supporting documentation therefor. Lessor's consent to Page 27 any act, assignment or subletting shall not constitute an acknowledgment that no Default or Breach by Lessee of this Lease exists, nor shall such consent be deemed a waiver of any then existing Default or Breach, except as may be otherwise specifically stated in writing by Lessor at the time of such consent. The failure to specify herein any particular condition to Lessor's consent shall not preclude the imposition by Lessor at the time of consent of such further or other conditions as are then reasonable with reference to the particular matter for which consent is being given. In the event that either Party disagrees with any determination made by the other hereunder and reasonably requests the reasons for such determination, the determining party shall furnish its reasons in writing and in reasonable detail within ten (10) business days following such request. 36. GUARANTOR. 36.1 EXECUTION. The Guarantors, if any, shall each execute a guaranty in the form most recently published by the American Industrial Real Estate Association, and each such Guarantor shall have the same obligations as Lessee under this Lease. 36.2 DEFAULT. It shall constitute a Default of the Lessee if any Guarantor fails or refuses, upon request to provide: (a) evidence of the execution of the guaranty, including the authority of the party signing on Guarantor's behalf to obligate Guarantor, and in the case of a corporate Guarantor, a certified copy of a resolution of its board of directors authorizing the making of such guaranty, (b) current financial statements, (c) a Tenancy Statement, or (d) written confirmation that the guaranty is still in effect. 37. QUIET POSSESSION. Subject to payment by Lessee of the Rent and performance of all of the covenants, conditions and provisions on Lessee's part to be observed and performed under this Lease, Lessee shall have quiet possession and quiet enjoyment of the Premises during the term hereof. 38. OPTIONS. 38.1 DEFINITION. "OPTION" shall mean: (a) the right to extend the term of or renew this Lease or to extend or renew any lease that Lessee has on other property of Lessor; (b) the right of first refusal or first offer to lease either the Premises or other property of Lessor; (c) the right to purchase or the right of first refusal to purchase the Premises or other property of Lessor. 38.2 See Addendum Paragraph 51.5. 38.3 MULTIPLE OPTIONS. In the event that Lessee has any multiple Options to extend or renew this Lease, a later Option cannot be exercised unless the prior Options have been validly exercised. 38.4 EFFECT OF DEFAULT ON OPTIONS. (a) Lessee shall have no right to exercise an Option: (i) during the period commencing with the giving of any notice of Default and continuing until said Default is cured, (ii) during the period of time any Rent is unpaid (without regard to whether notice thereof is given Lessee), (iii) during the time the Lessee is in Breach of this Lease, or (iv) in the event that Page 28 Lessee has been given three (3) or more notices of separate Default, whether or not the Defaults are cured, during the twelve (12) month period immediately preceding the exercise of the Option. (b) The period of time within which an Option may be exercised shall not be extended or enlarged by reason of Lessee's inability to exercise an Option because of the provisions of Paragraph 38.4(a). (c) An Option shall terminate and be of no further force or effect, notwithstanding Lessee's due and timely exercise of the Option, if, after such exercise and prior to the commencement of the extended term, (i) Lessee fails to pay Rent for a period of thirty (30) days after such Rent becomes due (without any necessity of Lessor to give notice thereof), (ii) Lessor gives to Lessee three (3) or more notices of separate Default during any twelve (12) month period, whether or not the Defaults are cured, or (iii) if Lessee commits a Breach of this Lease. 39. SECURITY MEASURES. Lessee hereby acknowledges that the rental payable to Lessor hereunder does not include the cost of guard service or other security measures, and that Lessor shall have no obligation whatsoever to provide same. Lessee assumes all responsibility for the protection of the Premises, Lessee, its agents and invitees and their property from the acts of third parties. 40. RESERVATIONS. Lessor reserves to itself the right, from time to time, to grant, without the consent or joinder of Lessee, such easements, rights and dedications that Lessor deems necessary, and to cause the recordation of parcel maps and restrictions, so long as such easements, rights, dedications, maps and restrictions do not unreasonably interfere with the use of the Premises by Lessee. Lessee agrees to sign any documents reasonably requested by Lessor to effectuate any such easement rights, dedication, map or restrictions. 41. PERFORMANCE UNDER PROTEST. If at any time a dispute shall arise as to any amount or sum of money to be paid by one Party to the other under the provisions hereof, the Party against whom the obligation to pay the money is asserted shall have the right to make payment "under protest" and such payment shall not be regarded as a voluntary payment and there shall survive the right on the part of said Party to institute suit for recovery of such sum. If it shall be adjudged that there was no legal obligation on the part of said Party to pay such sum or any part thereof, said Party shall be entitled to recover such sum or so much thereof as it was not legally required to pay. 42. AUTHORITY. If either Party hereto is a corporation, trust, limited liability company, partnership, or similar entity, each individual executing this Lease on behalf of such entity represents and warrants that he or she is duly authorized to execute and deliver this Lease on its behalf. Each party shall, within thirty (30) days after request, deliver to the other party satisfactory evidence of such authority. 43. CONFLICT. Any conflict between the printed provisions of this Lease and the typewritten or handwritten provisions shall be controlled by the typewritten or handwritten provisions. Page 29 44. OFFER. Preparation of this Lease by either Party or their agent and submission of same to the other Party shall not be deemed an offer to lease to the other Party. This Lease is not intended to be binding until executed and delivered by all Parties hereto. 45. AMENDMENTS. This Lease may be modified only in writing, signed by the Parties in interest at the time of the modification. As long as they do not materially change Lessee's obligations hereunder, Lessee agrees to make such reasonable non-monetary modifications to this Lease as may be reasonably required by a Lender in connection with the obtaining of normal financing or refinancing of the Premises. 46. MULTIPLE PARTIES. If more than one person or entity is named herein as either Lessor or Lessee, such multiple Parties shall have joint and several responsibility to comply with the terms of this Lease. 47. MEDIATION AND ARBITRATION OF DISPUTES. An Addendum requiring the Mediation and/or the Arbitration of all disputes between the Parties and/or Brokers arising out of this Lease |_| IS |_| IS NOT attached to this Lease, but is subject to the Reference Procedure set forth in paragraph 68 of the Addendum. LESSOR AND LESSEE HAVE CAREFULLY READ AND REVIEWED THIS LEASE AND EACH TERM AND PROVISION CONTAINED HEREIN, AND BY THE EXECUTION OF THIS LEASE SHOW THEIR INFORMED AND VOLUNTARY CONSENT THERETO. THE PARTIES HEREBY AGREE THAT, AT THE TIME THIS LEASE IS EXECUTED, THE TERMS OF THIS LEASE ARE COMMERCIALLY REASONABLE AND EFFECTUATE THE INTENT AND PURPOSE OF LESSOR AND LESSEE WITH RESPECT TO THE PREMISES. ------------------------------------------------------------------------------- ATTENTION: NO REPRESENTATION OR RECOMMENDATION IS MADE BY THE AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION OR BY ANY BROKER AS TO THE LEGAL SUFFICIENCY, LEGAL EFFECT, OR TAX CONSEQUENCES OF THIS LEASE OR THE TRANSACTION TO WHICH IT RELATES. THE PARTIES ARE URGED TO: 1. SEEK ADVICE OF COUNSEL AS TO THE LEGAL AND TAX CONSEQUENCES OF THIS LEASE. 2. RETAIN APPROPRIATE CONSULTANTS TO REVIEW AND INVESTIGATE THE CONDITION OF THE PREMISES. SAID INVESTIGATION SHOULD INCLUDE BUT NOT BE LIMITED TO: THE POSSIBLE PRESENCE OF HAZARDOUS SUBSTANCES, THE ZONING OF THE PREMISES, THE STRUCTURAL INTEGRITY, THE CONDITION OF THE ROOF AND OPERATING SYSTEMS, AND THE SUITABILITY OF THE PREMISES FOR LESSEE'S INTENDED USE. WARNING: IF THE PREMISES IS LOCATED IN A STATE OTHER THAN CALIFORNIA, CERTAIN PROVISIONS OF THE LEASE MAY NEED TO BE REVISED TO COMPLY WITH THE LAWS OF THE STATE IN WHICH THE PREMISES IS LOCATED. ------------------------------------------------------------------------------- Page 30 SEE SIGNATURE PAGE ATTACHED HERETO AND INCORPORATED HEREIN BY THIS REFERENCE The parties hereto have executed this Lease at the place and on the dates specified above their respective signatures. NOTE: These forms are often modified to meet changing requirements of law and industry needs. Always write or call to make sure you are utilizing the most current form: AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION, 700 S. Flower Street, Suite 600, Los Angeles, CA 90017. (213) 687-8777. Fax No. (213) 687-8616. Page 31 SIGNATURE PAGE ATTACHED TO AND A PART OF THAT CERTAIN STANDARD INDUSTRIAL/COMMERCIAL SINGLE-TENANT LEASE - NET DATED JANUARY 1, 1999 ("LEASE" HEREIN) BY AND BETWEEN WERNER WOLFEN, TRUSTEE OF THE LOUIS GLASIER 1974 REVOCABLE TRUST, MICHAEL DUNITZ, NANCY BRUCH, DOROTHY A. DUNITZ, HARVEY ROSENBERG, AND JUDY ROSENBERG ("LESSOR" COLLECTIVELY, HEREIN) AND VETERINARY CENTERS OF AMERICA, INC., A DELAWARE CORPORATION ("LESSEE" HEREIN) LESSOR: DATED: February _, 1999. /S/ WERNER WOLFEN Address for Notices to Lessor under ------------------------------------ Paragraph 22.1 of this Lease: WERNER WOLFEN, TRUSTEE OF THE LOUIS GLASIER 1974 REVOCABLE TRUST Werner Wolfen, Esq. 1800 Avenue of the Stars /S/ MICHAEL DUNITZ Suite 900 ------------------------------------ Los Angeles, California 90067 MICHAEL DUNITZ Fax: (310) 203-7199 Phone: (310) 277-1010 /S/ NANCY BRUCH with a copy to: ------------------------------------ NANCY BRUCH Mr. Michael Dunitz 1112 Ocean Drive Manhattan Beach, California 90266 Phone: (310) 376-1112 /S/ DOROTHY DUNITZ ------------------------------------ DOROTHY A. DUNITZ /S/ HARVEY ROSENBERG ------------------------------------ HARVEY ROSENBERG /S/ JUDY ROSENBERG ------------------------------------ JUDY ROSENBERG Page 32 LESSEE: DATED: February _, 1999. VETERINARY CENTERS OF AMERICA, INC., A DELAWARE CORPORATION Address for Notices to Lessee under Paragraph 22.1 of this Lease: BY: /s/ Robert L. Antin Veterinary Centers of America, Inc. Robert L. Antin 12401 West Olympic Boulevard Its President Los Angeles, California 90064-1022 Attn: President BY: /s/Tomas Fuller with a copy to: Tomas Fuller Its Vice President James M. Leonard, Esq. Berger, Kahn, Shafton, Moss, Figler, Simon & Gladstone 4215 Glencoe Avenue 2nd Floor Marina del Rey, California 90292 Page 33 ADDENDUM TO STANDARD INDUSTRIAL/COMMERCIAL SINGLE-TENANT LEASE - NET DATED JANUARY 1, 1999 ("LEASE" HEREIN) BY AND BETWEEN WERNER WOLFEN, TRUSTEE OF THE LOUIS GLASIER 1974 REVOCABLE TRUST, MICHAEL DUNITZ, NANCY BRUCH, DOROTHY A. DUNITZ, HARVEY ROSENBERG, AND JUDY ROSENBERG ("LESSOR" COLLECTIVELY, HEREIN) AND VETERINARY CENTERS OF AMERICA, INC., A DELAWARE CORPORATION ("LESSEE" HEREIN) ------------------------------------------------------------------------------- The Standard Industrial/Commercial Single-Tenant Lease - Net dated January 1, 1999 ("Printed Lease" herein) by and between WERNER WOLFEN, TRUSTEE OF THE LOUIS GLASIER 1974 REVOCABLE TRUST, MICHAEL DUNITZ, NANCY BRUCH, DOROTHY A. DUNITZ, HARVEY ROSENBERG, AND JUDY ROSENBERG ("LESSOR" collectively herein) and VETERINARY CENTERS OF AMERICA, INC., A DELAWARE CORPORATION ("LESSEE" herein) is hereby supplemented and amended by this Addendum to Standard Industrial/Commercial Single-Tenant Lease-Net ("ADDENDUM" herein). To the extent that there is any conflict or inconsistency between the Printed Lease and this Addendum, the terms and provisions of this Addendum shall control. The Printed Lease and the amendments contained in this Addendum are hereafter collectively sometimes referred to in the Printed Lease and in this Addendum as the "LEASE". 48. PREMISES. 48.1 MEASUREMENT OF BUILDING AREA. Lessor and Lessee both agree that the square footage of the area contained within the three (3) buildings comprising part of the Premises stated in PARAGRAPH 1.2 of the Basic Provisions on Page 1 of the Printed Lease ("BUILDING AREA" herein), which is approximately 30,782 square feet, may be adjusted as hereinafter more particularly set forth. No sooner than the date the tenant which is currently in possession of the Premises ("EXISTING TENANT" herein) has vacated, Lessor shall instruct Lessor's architect or space planner to measure the Building Area of the Premises, at Lessor's sole cost and expense. In determining the Building Area, the buildings shall be measured in the field from the exterior face of exterior walls, exterior doors and exterior windows to the opposite exterior face of exterior walls, exterior doors and exterior windows; and, any vertical penetrations (such as, by way of illustration only, columns, air shafts and stairwells) shall not be deducted. Lessor shall give Lessee written notice of said final field measurement, which shall be conclusive as between Lessor and Lessee. If such field measurement indicates that the square footage measurement prepared by the Lessor produces a square footage number in excess of, or lower than, the square footage number set forth in PARAGRAPH 1.2 of this Lease, then any payments due to Lessor from Lessee, or any other amounts in this Lease, based upon the amount of square feet contained in the Building Area of the Premises shall be proportionally, retroactively and prospectively reduced or increased, as appropriate, to reflect the actual number of square feet, as properly measured under said standards. 48.2 PARKING. During the Term of this Lease, Lessee shall have the exclusive right to use the parking lot solely for the purposes of: (a) parking passenger vehicles and delivery vehicles; (b) vehicular and pedestrian ingress to and egress from the parking lot; and, (c) pedestrian ingress to and egress from the buildings which are part of the Premises. The current location of the parking spaces is shown on EXHIBIT "A" which is attached hereto and incorporated herein by this reference. Lessor shall not lease any of the parking spaces on the Premises to any other party during the Term of this Lease. 49. TERM. 49.1 (This subparagraph is intentionally omitted.] 49.2 "COMMENCEMENT DATE". The "COMMENCEMENT DATE" as that term is used in this Lease shall mean the date on which Lessor notifies Lessee in writing that Lessor has substantially completed (as that term is more particularly defined in PARAGRAPH 54.1 of this Lease) "Lessor's Phase One Work" (as that term is more particularly defined in PARAGRAPH 52 of this Lease). 49.3 "RENT COMMENCEMENT DATE". Lessee's obligation to commence paying the Base Rent in the amounts set forth in this Lease shall commence on AUGUST 1, 1999 ("RENT COMMENCEMENT Date" herein). If the Rent Commencement Date occurs on a date which is not the first (1st) day of a month, then on the Rent Commencement Date, Lessee shall pay Lessor an amount equal to: (A) the prorated amount of the Base Rent for such partial month (which shall be prorated based on the actual number of days in such partial month) and the Base Rent for the next following calendar month LESS (B) the prepaid amount of Base Rent under PARAGRAPH 60.1 of this Addendum. 49.4 "EXPIRATION DATE". The "EXPIRATION DATE" as that term is used in this Lease shall mean the date which is fifteen (15) years after the Rent Commencement Date. 49.5 "ORIGINAL TERM". The "ORIGINAL TERM" as that term is used in this Lease shall mean the period commencing on and including the Commencement Date and continuing through and including the Expiration Date. 49.6 COMMENCEMENT DATE MEMORANDUM. Within thirty (30) days after the Commencement Date has occurred, the parties shall execute a memorandum confirming the Commencement Date, Expiration Date, Rent Commencement Date, and any dates for Base Rent adjustments required by PARAGRAPH 50. 49.7 LESSEE'S OPTIONS TO TERMINATE LEASE. 49.7.1 Notwithstanding anything in this Lease to the contrary contained in PARAGRAPHS 49.4 AND 49.5 of this Lease, Lessee shall have five (5) options to terminate this Lease ("TERMINATION OPTION(S)" herein); provided, that in order to duly exercise any of the Termination Options each of the following conditions precedent have been fulfilled: Page 2 (1) Lessee shall give Lessor written notice ("TERMINATION NOTICE" herein) that Lessee exercises each respective Termination Option before the first (1st) day of the respective month after the Rent Commencement Date set forth below ("LAST TERMINATION NOTICE DATE" herein) which termination of the Lease shall be effective as of the respective dates ("TERMINATION DATE" herein) set forth below:
TERMINATION LAST TERMINATION NOTICE DATE TERMINATION DATE TERMINATION OPTION PAYMENT --------------- ---------------------------- ---------------------------- --------------- 1 first day of the 115th month 10th anniversary of the Rent Six (6) Months after the Rent Commencement Commencement Date Date 2 first day of the 127th month 11th anniversary of the Rent Five (5) after the Rent Commencement Commencement Date Months Date 3 first day of the 139th month 12th anniversary of the Rent Four (4) after the Rent Commencement Commencement Date Months Date 4 first day of the 151st month 13th anniversary of the Rent Three (3) after the Rent Commencement Commencement Date Months Date 5 first day of the 163rd month 14th anniversary of the Rent Two (2) Months after the Rent Commencement Commencement Date Date
If the Rent Commencement Date occurs on a date which is not the first (1st) day of a month, then for purposes of this PARAGRAPH 49.7.1 only, the Rent Commencement Date shall be the first (1st) day of the month following the date on which the Rent Commencement Date actually occurred. (2) The Termination Notice shall be deemed validly given only if Lessee concurrently with giving the Termination Notice delivers to Lessor an amount equal to the "Termination Payment" (as that term is hereinafter more particularly defined) in an amount equal to the Base Rent, Real Property Taxes, insurance and any other amounts under the Lease which Lessee is required to pay to Lessor during the number of months after the Termination Date which are set forth in the table above under the heading "TERMINATION PAYMENT", as such amounts may be adjusted or increased during such respective periods, as though this Lease had continued for said respective periods and had not been terminated. If as of the date Lessee delivers to Lessor the Termination Notice the amount of Real Property Taxes for the number of months after the Termination Date which are set forth in the table above under the heading "Termination Payment" are not known, then the portion of the Termination Payment applicable to Real Property Taxes shall consist of the Real Property Taxes based on the most recent Page 3 available tax bill information; and, once the actual Real Property Taxes for said period have been determined, (i) if the portion of the Termination Payment applicable to Real Property Taxes paid by Lessee is less than the actual amount of the Real Property Taxes, then within ten (10) days after the actual amount has been ascertained Lessee shall pay the deficiency, if any, to Lessor; or, (ii) if the portion of the Termination Payment applicable to Real Property Taxes paid by Lessee is more than the actual amount of the Real Property Taxes, then within ten (10) days after the actual amount has been ascertained Lessor shall refund the difference to Lessee. For example, if Lessee duly exercises Termination Option 4 by giving Lessor the Termination Notice prior to the first date of the 151st month after the Rent Commencement Date, such Termination Notice must be accompanied by the Base Rent, Real Property Taxes, insurance and any other amounts under the Lease which Lessee is required to pay to Lessor during the three (3) months after the Termination Date, as such amounts may be adjusted or increased during such three (3) months. (3) During the period from the date Lessee delivers to Lessor the Termination Notice and continuing until the Termination Date, Lessee shall continue to pay Lessor the Base Rent, Real Property Taxes, insurance and any other amounts under the Lease which Lessee is required to pay to Lessor, as though the Termination Option has not been exercised. (4) Lessee shall not have the right to terminate this Lease by exercising the Termination Options during the Option Periods (as such term is defined in PARAGRAPH 51.1 of this Lease). (5) Lessee shall have no right to exercise the Termination Option, notwithstanding any provision in the grant of the Termination Option to the contrary if there has been a Breach under PARAGRAPH 12.1 of this Lease. The period of time within which the Termination Option may be exercised shall not be extended or enlarged by reason of Lessee's inability to exercise an Termination Option because of this PARAGRAPH 49.7.1(5). (6) If Lessee validly exercises the Termination Option but becomes in Breach of this Lease between the date of giving the Termination Notice and the Termination Date, then the Termination Notice shall be deemed null and void ab initio and the Lease shall continue as though the Termination Notice had not been given and Lessee shall not thereafter after the right or option to terminate this Lease pursuant to the Termination Option which Lessee exercised, although Lessee shall have the right to exercise future Termination Options subject to the terms and provisions of this Lease including, without limitation, this PARAGRAPH 49.7.1. 49.7.2 The Termination Options granted to Lessee are personal to the original Lessee named in this Lease and may not be exercised or be assigned voluntarily or involuntarily, by or to any person or entity other than said Lessee; provided, however the Termination Option may be exercised by or assigned to any party to whom the Lease is transferred under PARAGRAPH 11.1(C) of this Lease or to any party to whom the Lease is transferred as part of a Permitted Transfer (as that term is more particularly defined in PARAGRAPH 80.2 of this Lease). The Termination Option herein granted to Lessee is not assignable separate and apart from this Lease. Page 4 49.7.3 If Lessee exercises any Termination Option within the time and in the manner provided herein, Lessee shall vacate the Premises on the Termination Date and all obligations of Lessor and Lessee under this Lease shall terminate except for the obligations under this Lease which exist upon the expiration or earlier termination of this Lease and for obligations accruing or arising before the Termination Date. 49.7.4 Time is of the essence in the exercise of the Termination Options. If Lessee fails to exercise any particular Termination Option within the time and in the manner provided herein, said Termination Option shall expire and be of no further force and effect and Lessee shall not thereafter have the right to terminate the Lease pursuant to the particular Termination Option which expired. 50. BASE RENT. 50.1 AMOUNT OF BASE RENT. During the Original Term of this Lease, Lessee shall pay Base Rent to Lessor during the following periods of time in the following amounts: 50.1.1 During the period commencing on the Commencement Date and continuing until the Rent Commencement Date, Base Rent shall be abated, subject to and as more particularly defined in PARAGRAPH 50.2 of this Lease. 50.1.2 Commencing on the Rent Commencement Date and continuing through and including the eighteenth (18th) month after the Rent Commencement Date the Base Rent per month shall be computed by multiplying the Building Area (determined under PARAGRAPH 48.L) by $1.55. 50.1.3 On the first day of each of the nineteenth (19th), thirty-seventh (37th), fifty-fifth (55th), seventy-third (73rd), ninety-first (91st), one hundred ninth (109th), one hundred twenty-seventh (127th), one hundred forty-fifth (145th) and one hundred fifty-seventh (157th) and one hundred seventy-fifth (175th) months after the Rent Commencement Date, each such date being referred to herein as an "ADJUSTMENT DATE", the Base Rent determined under PARAGRAPH 50.1.2 shall be increased (but not decreased) by multiplying said Base Rent determined under PARAGRAPH 50.1.2 by one hundred three percent (103%) of a fraction, the numerator of which is the Index (as that term is hereinafter more particularly defined in PARAGRAPH 50.1.5) for the month which is two (2) calendar months prior to the Adjustment Date in question and the denominator of which is the Index for the month in which the Rent Commencement Date occurred. The sum so calculated shall constitute the new Base Rent hereunder until the next Adjustment Date; provided, however, in no event whatsoever shall such new Base Rent be less than the "ADJUSTMENT FLOOR" nor more than the "ADJUSTMENT Ceiling" (as those terms are hereinafter more particularly defined). The "ADJUSTMENT FLOOR" shall be equal to the Base Rent payable for the month immediately preceding the date for such rent adjustment plus any cumulative and compounded increases for past adjustments of Base Rent which would have been paid by Lessee but for the application of the Adjustment Ceiling. The "ADJUSTMENT CEILING" shall be the amount per month for the respective months set forth below computed by multiplying the Building Area (determined under PARAGRAPH 48.1) by the respective Monthly Rent Per Foot set forth below, as follows: Page 5 MONTHS AFTER THE RENT COMMENCEMENT DATE MONTHLY RENT PER FOOT --------------------------------------- ---------------------- 1-18, inclusive $1.55 19-36, inclusive $1.60 37-54, inclusive $1.65 55-72, inclusive $1.70 73-90, inclusive $1.75 91-108, inclusive $1.80 109-126, inclusive $1.85 127-144, inclusive $1.95 145-156, inclusive $2.00 157-174, inclusive $2.05 175-180, inclusive $2.10 The months listed above are measured from the Rent Commencement Date. The months listed above are inclusive of the beginning month and the ending month so that, for example, in the listing above of "91-108, inclusive" the Adjustment Ceiling shall be $1.80 per square foot of Building Area during and including the 91st month after the Rent Commencement Date and continuing through and including the 108th month after the Rent Commencement Date. Until the new Base Rent has been calculated, Lessee shall pay the Base Rent Lessee had been paying during the immediately preceding period, and shall immediately pay the deficiency, if any, once the new Base Rent has been determined pursuant to this PARAGRAPH 50.1.3. [EXAMPLE: The following example is inserted for purposes of illustration only: MONTHS 1-18 Assume that the Building Area is 47,712 square feet. Therefore, the Base Rent in months 1 through 18, inclusive, is $47,712. Further, assume that the Index as of the Rent Commencement Date was 100. MONTHS 19-36 Further, assume that the Index in the 17th month after the Rent Commencement Date is 105. The calculation of the Base Rent in months 19 through 36, inclusive, would be as follows: Page 6 $47,712 multiplied by 1.03% multiplied by 105/100 = $51,600.53 Adjustment Floor = $47,712 Adjustment Ceiling = $1.60 multiplied by 30,782 = $49,251.20 Since the Base Rent calculation of $51,600.53 is more than the Adjustment Ceiling, but at least the Adjustment Floor, the final Base Rent would be the Adjustment Ceiling of $49,251.20. MONTHS 37-54 Further, assume that the Index in the 35th month after the Rent Commencement Date is 106. The calculation of the Base Rent in months 37 through 54, inclusive, would be as follows: $47,712 multiplied by 1.03% multiplied by 106/100 = $52,091.96 Adjustment Floor = $47,712 plus $2,349.33 (which is the cumulative difference between the Base Rent calculation in months 19-36 without reference to the Adjustment Ceiling ($51,600.53) and the Adjustment Ceiling in months 19-36 ($49,251.20)) = $50,061.33 Adjustment Ceiling = $1.65 multiplied by 30,782 = $50,790.00 Since the Base Rent calculation of $52,091.96 is more than Adjustment Ceiling, but at least the Adjustment Floor, the final Base Rent would be the Adjustment Ceiling of $50,790.00. End of Example.] 50.1.4 Until the Building Area has been determined under PARAGRAPH 48.1, the Base Rent shall be Forty Seven Thousand Seven Hundred Twelve Dollars ($47,712) per month, which is a Building Area of 30,782 multiplied by $1.55. Said amount shall continue to be paid until the Building Area has been determined under PARAGRAPH 48.1. If the amount of the Building Area determined under PARAGRAPH 48.1 is less than 30,782 square feet, then the Base Rent payable under PARAGRAPH 50.1.2, PARAGRAPH 50.1.3 and this PARAGRAPH 50.1.4 shall be recalculated as provided herein and Lessor shall credit against the next ensuing Rent payments the difference between the amount of Base Rent Lessee paid to Lessor and the amount recalculated under this PARAGRAPH 50.1.4. If the amount of the Building Area determined under PARAGRAPH 48.1 is more than 30,782 square feet, then the Base Rent payable under PARAGRAPH 50.1.2, PARAGRAPH 50.1.3 and this PARAGRAPH 50.1.4 shall be recalculated as provided herein and Lessee shall promptly pay Lessor the difference between the amount recalculated under this PARAGRAPH 50.1.4 and the amount Lessee paid Lessor. The recalculation provided in this PARAGRAPH 50.1.4 shall also pertain to the amount of Base Rent paid upon execution which is referred to in PARAGRAPH 1.5 of the Printed Lease and in PARAGRAPH 60.1 of this Addendum. 50.1.5 The "INDEX" shall be the Consumer Price Index for Urban Wage Earners and Clerical Workers for all items for Los Angeles-Riverside-Orange Co., All Items, published by the United States Department of Labor, Bureau of Labor Statistics, in which the 1982-84 average of 100 points is the base. If the 1982-84 average of 100 points ceases to be used as the base, the Index shall be converted in accordance with conversion factor published by the United Page 7 States Department of Labor, Bureau of Labor Statistics, to the 1982-84 base. If the Index is discontinued or if a substantial change is made in the terms or number of items used to compile the Index, then any similar index which most closely comprehends the impact of cost of living increases on commercial real property rentals published by any branch or department of the United States Government shall be used, and if none is so published, then another non-partisan index evaluating the information theretofore used in compiling the Index, and generally recognized as authoritative on the impact of cost of living increases on commercial real property rentals shall be used and if the parties are unable to agree on the index to be used prior to thirty (30) days before each Adjustment Date as of which the adjustment is being made, then and in such event, the designation of a particular index shall be done by arbitrators appointed and acting under the Rules of the American Arbitration Association and Landlord and Tenant shall each bear one-half (1/2) of the cost thereof. The Base Rent adjusted as herein provided shall thereafter be payable until the next adjustment. Base Rent, both before and after the adjustment as provided herein, is referred to as the "Base Rent". 50.2 RENT ABATEMENT. The parties acknowledge that Lessee is not paying the Base Rent for the period commencing with the Commencement Date and continuing until the Rent Commencement Date ("RENTAL ABATEMENT PERIOD" herein). However, the Lessee is required to pay during the Rental Abatement Period all Real Property Taxes, insurance, utilities and all other additional Rent. The parties acknowledge that the foregoing Rental Abatement Period has been granted to Lessee as additional consideration for entering into this Lease, and for agreeing to pay the Rent and performing the terms and conditions otherwise required under the Lease. Accordingly, in the event of a Default by Lessee which Lessee fails to cure within the times permitted for curing hereunder, Lessee shall be obligated to pay the unamortized portion of Base Rent otherwise abated hereunder during the Rental Abatement Period, with interest as provided in the Lease, from the date such Base Rent would otherwise have been due but for the abatement provided for herein, immediately upon written demand by Lessor. The unamortized portion of the abated Base Rent would be equal to the total amount of the abated Base Rent (which is the amount of One and 55/100 Dollars ($1.55) multiplied by the Building Area multiplied by four (4) months) divided by the number of months in the Original Term of this Lease multiplied by the number of months (or fractions thereof) remaining in the Original Term of this Lease at the time of such Default. The parties hereby agree that Lessee's obligation to repay any abated Base Rent and interest thereon is of the essence of this Lease and Lessee's covenant was a material inducement to Lessor entering into this Lease. 51. OPTIONS TO EXTEND LEASE TERM. 51.1 GRANT OF OPTIONS. Subject to all of the terms and provisions of PARAGRAPH 38 of the Lease, Lessee is hereby granted two (2) consecutive options ("OPTIONS" herein) to extend the term of this Lease, each for a period of five (5) years from the then expiration of the term of this Lease ("OPTION PERIODS" herein), on all of the same terms and conditions contained herein except Base Rent and except for the further grant of any options to renew the term of this Lease; provided that Lessee gives Lessor written notice of Lessee's election to exercise each of the Options, which is actually received by Lessor, at least six (6) months but not more than nine (9) months prior to the then scheduled expiration of the Lease term; and, further provided that Lessee has duly exercised any prior Options within the time and in the manner provided herein before Lessee shall have the right to exercise the Option in question. If Lessee fails to give Page 8 Lessor such written notice within the time and in the manner provided herein, said Option and any then unexercised Options shall expire and be of no further force and effect"; provided, however, that either (a) at least fourteen (14) days prior to the expiration of the time period during which Lessee may exercise an Option, Lessor gave Lessee written notice reminding Lessee of the existence of such Options; or, (b) if Lessor did not give Lessee such reminder notice and Lessee fails to timely exercise the Option in question, Lessor gave Lessee written notice reminding Lessee of the existence of the Option and Lessee failed to exercise same within fourteen (14) days after the giving of such written notice to Lessee. Time is of the essence in the exercise of the Options. If Lessee gives notice to Lessor of its election to exercise an Option within the time and in the manner prescribed herein, the Base Rent payable during such Option Period shall be determined as hereinafter provided. 51.2 RENT DURING OPTION PERIODS. If Lessee duly exercises each Option within the time and in the manner provided herein, the Base Rent during each Option Period (including but not limited to periodic increases of the Base Rent during each Option Period) shall be increased (but not decreased) as of the commencement of each Option Period to the monthly "FAIR MARKET RENT" (as that term is more particularly defined in PARAGRAPH 51.3 below); provided, however that the new Base Rent computed under this PARAGRAPH 51.2 shall not be less than the Base Rent payable during the period immediately preceding such adjustment. 51.3 DETERMINATION OF FAIR MARKET RENT. The "FAIR MARKET RENT" for the Premises as of the beginning of each of the Option Periods (and the periodic increases during each Option Period) shall be determined, as follows: 51.3.1 Lessor shall determine the "FAIR MARKET RENT" (including but not limited to the Fair Market Rent at the beginning of each Option Period and periodic increases thereof during each Option Period) by using its good faith judgment. Lessor shall use its best efforts to provide written notice of such amount within thirty (30) days after Lessee sends notice to Lessor exercising an Option. Lessee shall have thirty (30) days ("LESSEE REVIEW PERIOD" herein) after receipt of Lessor's notice of the new rental within which to accept such rental or to reasonably object thereto in writing. In the event Lessee objects, Lessor and Lessee shall attempt to agree upon such Fair Market Rent, using their best good faith efforts. If Lessor and Lessee fail to reach agreement within fifteen (15) days following Lessee's Review Period ("OUTSIDE AGREEMENT DATE" herein), then each party's determination shall be submitted to arbitration in accordance with PARAGRAPHS 51.3.2 through 51.3.6 below. Failure of Lessee to so object in writing within the Lessee's Review Period shall conclusively be deemed its approval of the Fair Market Rent determined by Lessor. In the event that Lessor fails to timely generate the initial written notice of Lessor's determination of the Fair Market Rent which triggers the negotiation period of this section, then Lessee may commence such negotiations by providing the initial notice, in which event Lessor shall have thirty (30) days ("LESSOR'S REVIEW PERIOD" herein) after receipt of Lessee's notice of the new rental within which to accept such rental. In the event Lessor does not affirmatively in writing consent to Lessee's proposed rental, such proposed rental shall be deemed rejected and Lessor and Lessee shall attempt in good faith to agree upon such Fair Market Rent, using their best good faith efforts. If Lessor and Lessee fail to reach agreement within fifteen (15) days following Lessor's Review Period (which shall be, in such event, the "OUTSIDE AGREEMENT DATE" in lieu of the above definition of such date), then each party shall place in a separate sealed envelope their final proposal as to Fair Market Rent and Page 9 such determination shall be submitted to arbitration in accordance with PARAGRAPHS 51.3.2 through 53.3.6 below. 51.3.2 Lessor and Lessee shall meet with each other within five (5) business days of the Outside Agreement Date and exchange the sealed envelopes and then open such envelopes in each other's presence. If Lessor and Lessee do not mutually agree upon the Fair Market Rent within five (5) business days of the exchange and opening of envelopes, then, within ten (10) business days after exchange and opening of envelopes Lessor and Lessee shall agree upon and jointly appoint a single arbitrator who shall by profession be a real estate broker who shall have been active over the five (5) year period ending on the date of such appointment in the leasing of comparable properties in West Los Angeles, California. Neither Lessor nor Lessee shall consult with such broker as to his or her opinion as to Fair Market Rent prior to the appointment. The determination of the arbitrator shall be limited solely to the issue of whether Lessor's or Lessee's submitted Fair Market Rent for the Premises is the closest to the actual Fair Market Rent for the Premises as determined by the arbitrator taking into account the requirements of this provision regarding same. Such arbitrator may (or at the request of either party, shall) hold such hearings and require such briefs as the arbitrator in his or her sole discretion, determines to be necessary. 51.3.3 The arbitrator shall within thirty (30) days of his or her appointment, reach a decision as to whether the parties shall use Lessor's or Lessee's submitted Fair Market Rent, and shall notify Lessor and Lessee of such determination. 51.3.4 The decision of the arbitrator shall be binding upon Lessor and Lessee, except as provided below. 51.3.5 If Lessor and Lessee fail to agree upon and appoint an arbitrator then, notwithstanding anything to the contrary in PARAGRAPH 68 of this Lease, the appointment of the arbitrator shall be made by the Presiding judge of the Los Angeles County Superior Court, or, if he or she refuses to act, any judge having jurisdiction over the parties. 51.3.6 The cost of arbitration shall be paid by Lessor and Lessee equally. 51.4 "FAIR MARKET RENT" DEFINED. "FAIR MARKET RENT" shall mean the amount equal to the monthly rental rate per rentable square foot that a comparable lessor of a comparable property in the vicinity of the building ("COMPARABLE BUILDING" herein) with comparable vacancy factors would accept in current transactions between non-affiliated parties from new, non-expansion, non-renewal, non-sublease and non-equity lessees of comparable credit worthiness, for comparable space, for a comparable use for a comparable period of time ("COMPARABLE TRANSACTIONS" herein). In any determination of Comparable Transactions appropriate consideration shall be given to the annual rental rates per rentable square foot but not (a) the standard of measurement by which the rentable square foot is measured, (b) the ratio of rentable square feet to usable square feet, (c) the type of escalation clause (e.g., whether increases in additional rent are determined on a net or gross basis, and if gross, whether such increases are determined according to a base year or a base dollar amount expense stop), (d) the extent of Lessee's liability under the Lease, (e) abatement provisions reflecting free rent and/or no rent during the period of construction or subsequent to the commencement date as to the space in question, (f) brokerage commissions, if any, which would be payable by Lessor in Page 10 similar transactions, (g) length of the lease term, (h) size and location of premises being leased, (i) building standard work letter and/or Lessee improvement allowances, if any, and (j) other generally applicable conditions of tenancy for such Comparable Transactions. The term "FAIR MARKET RENT" shall include, but not be limited to, the Fair Market Rent at the beginning of each Option Period but also periodic increases thereof during each Option Period which periodic increases shall be those which are then being used in leases of Comparable Transactions in Comparable Buildings. By way of example only, if the "face rate" for space in a Comparable Building in a Comparable Transaction is $56 per square foot, but in such Comparable Building and Comparable Transaction, the lessee is entitled to six (6) months of free rent, a tenant improvement allowance of $45 per square foot, there is a base year for operating expenses and taxes, there is a 5% brokerage commission, and the tenant pays $5 per square foot for its own tenant improvements, then the Fair Market Rent for purposes of this Lease shall be $56 per square foot. 51.5 OPTIONS PERSONAL TO ORIGINAL LESSEE. PARAGRAPH 38.2 of the Printed Lease is hereby deleted in its entirety and the following is hereby inserted in lieu thereof: "38.2 OPTIONS PERSONAL TO ORIGINAL LESSEE. Each Option granted to Lessee in this Lease is personal to the original Lessee or a Lessee Affiliate (as that term is hereinafter more particularly defined), and cannot be assigned or exercised by anyone other than said original Lessee or a Lessee Affiliate and only while the original Lessee or a Lessee Affiliate is in full possession of the Premises and, if requested by Lessor, with Lessee certifying that Lessee has no intention of thereafter assigning or subletting. As used in this PARAGRAPH 38.2, "LESSEE AFFILIATE" shall mean and include a subsidiary which is wholly owned by the original Lessee. 52. LESSOR'S WORK. 52.1 DESCRIPTION OF LESSOR'S WORK. 52.1.1 LESSOR'S PHASE ONE WORK. After all contingencies to the effectiveness of this Lease have expired or been waived, at Lessor's sole cost and expense, Lessor shall perform only the following Alterations for Lessee ("LESSOR'S PHASE ONE WORK" collectively herein): (A) Lessor shall deliver Buildings A, B and C to Lessee in broom clean condition; and, (B) Lessor shall demolish the non-structural improvements in Buildings A, B and C (including the presently existing men's and women's restrooms in Buildings A, B and C) which improvements are shown on the Demolition Plan which is attached hereto as EXHIBIT "B"; and, (C) Lessor shall perform Lessor's Phase One Work in compliance with all Applicable Requirements including, but not limited to, compliance with fire code requirements and any work necessary for the Lessor's Phase One Work to comply with the Americans with Disabilities Act or any similar Applicable Requirements pertaining to access by handicapped persons, all of which shall be accomplished without regard to Lessee's Work. Page 11 Lessee shall at Lessee's sole cost and expense cause any of Lessee's Work to comply with the Americans With Disabilities Act including but not limited to any compliance with the Americans With Disabilities Act for matters which are not Lessee's Work which are triggered by Lessee's Work. After the Commencement Date, Lessee shall at Lessee's sole cost and expense (except as provided above) cause the Premises and any Alterations and/or Utility Installations done by Lessee and Lessee's Work to comply with the Americans With Disabilities Act; and, (D) Lessor shall provide Lessee with information concerning the condition and specifications of the presently existing electrical system. By signing this Lease, Lessee approves such condition and specifications; and, (E) Provide level floors throughout the Premises using the existing floor as a benchmark; and, (F) Abate asbestos-containing material, if any, or other Hazardous Substances, if any, in the Premises in accordance with Applicable Requirements. Lessor shall have the sole right to determine whether the method employed will be removing or remediating the asbestos, taking into consideration the extent that Lessee's Work will disturb any existing asbestos-containing materials or other Hazardous Substances; and, (G) The presently existing fire sprinkler system shall be delivered in good working order without reference to the use for which Lessee shall use the Premises. Lessor shall raise the sprinkler heads to the interior of the roofline and, if required by Applicable Requirements have such sprinkler heads re-certified by the City of Los Angeles. 52.1.2 LESSOR'S PHASE TWO WORK. After all contingencies to the effectiveness of this Lease have expired or been waived, and after Lessee has delivered Lessor Plans (as defined in PARAGRAPH 53.7 which have been approved by the City of Los Angeles and Lessor, Lessor's sole cost and expense, Lessor shall perform only the following Alterations for Lessee ("LESSOR'S PHASE TWO WORK" collectively herein): (A) Lessor shall provide information to Lessee regarding the condition and specifications of the presently existing HVAC units. By signing this Lease, Lessee approves such condition and specifications. Lessor shall deliver the HVAC units to Lessee in good operating condition as required by and subject to PARAGRAPH 2.2 of this Lease. If new HVAC units are required for Building A, the tonnage shall not exceed 55 tons. Lessor and Lessee shall use the same contractor for performing their respective work in connection with the HVAC system in Building A. Lessor shall provide the HVAC in Building A stubbed to the Premises. Lessee (not Lessor) shall be responsible for distribution of the HVAC within the Building A. Notwithstanding anything to the contrary contained in this Lease, Lessee shall not be responsible for the capital costs of replacing such HVAC units unless the reason for such replacement was that Lessee failed to maintain the HVAC service contracts required by this Lease or failed to perform routine maintenance of such units. Lessee shall keep in force and effect at Lessee's sole cost and expense a service and maintenance contract with respect to the HVAC units; and, Page 12 (B) Re-install or install the windows shown on the Window Plan which is attached hereto as EXHIBIT "C" and incorporated herein by this reference. The Window Plan shall also contain the size and specifications for such windows; and, (C) Remove the presently existing broadcast tower at the rear of the Premises; and, (D) Install a new roof cover on the A Building and B Building. As to the C Building, Lessor shall perform an evaluation of the presently existing condition of the roof. Lessor shall install a new roof cover as part of Lessor's Phase Two Work unless: (a) it is determined that there are at least three (3) years of useful life remaining in the roof of the C Building; and, (b) Lessee is not performing extensive roof modifications to the C Building roof as part of Lessee's Work; and, (E) Lessor shall sandblast the interior and exterior walls and ceilings of Buildings A and B only; however, whether the north exterior side of Building B shall be sandblasted shall be determined by the Parties within the time and in the manner provided in Paragraph 53.1 of this Lease; and, (F) Building to meet City seismic code requirements but only if mandated and required by any earthquake hazard ordinance in effect as of the Commencement Date (but not if required due to Lessee's Work, Lessee Owned Alterations and/or Utility Installations or by the use to which Lessee will put the Premises); and, (G) Install rigid insulation with an R-factor of ________ on the roof of Buildings A and B, which R-factor shall be determined as provided in PARAGRAPH 53.1; and, (H) Clean and fix any operable windows. Lessor shall also replace the existing broken glass in the windows as necessary. 52.2 DESCRIPTIONS OF EXCLUSIONS FROM LESSOR'S WORK. Lessor's Phase One Work and Lessor's Phase Two Work shall specifically not include any items or matters which are not specifically set forth in PARAGRAPH 52.1. Lessor is not obligated to pay for nor to make any improvements, alterations, demolitions, additions or betterments at the inception of the Original Term other than those specifically specified in PARAGRAPH 52.1. 52.3 DELIVERY OF POSSESSION OF PREMISES TO LESSEE. Lessor ordinarily would not deliver possession of the Premises to Lessee until Lessor had substantially completed Lessor's Phase One Work and Lessor's Phase Two Work. However, Lessee has an immediate need to occupy and perform Lessee's Work and to make Lessee Owned Alterations and/or Utility Installations to the Premises. Therefore, the parties recognize that Lessor's Phase Two Work may not be commenced nor substantially completed in the Premises at the time that Lessee is delivered possession of the Premises. 52.4 TIME FOR SUBSTANTIAL COMPLETION. 52.4.1 LESSOR'S PHASE ONE WORK. After all contingencies to the effectiveness of this Lease have expired or been waived, Lessor shall endeavor to substantially complete (as that Page 13 term is defined below) the Lessor's Phase One Work referred to in PARAGRAPHS 52.1.1 no later than APRIL 1, 1999; provided, however, Lessor's obligation is subject to: (a) obtaining a building permit, if one is required; (b) Lessee's cooperation with Lessor in performing Lessor's Phase One Work; (c) Force Majeure Delay (as that term is defined in PARAGRAPH 54.2 of this Lease) ; and, (d) Lessee's Delay (as that term is defined in PARAGRAPH 54.3 of this Lease). In the event that Lessor fails by APRIL 1, 1999 (subject to Force Majeure Delay and to Lessee's Delay) to substantially complete the Lessor's Phase One Work referred to in PARAGRAPH 52.1.1 as it relates to the Premises, (which is not concurrent with a Force Majeure Delay or Lessee Delay), then notwithstanding anything to the contrary contained in this Lease, as Lessee's sole and exclusive remedy, (a) for the first thirty (30) days of such delay, Lessee shall be entitled to abate one (1) day of Base Rent for each one (1) day of such delay; and, (b) after the first thirty (30) days of such delay, Lessee shall be entitled to abate an amount equal to one (1) day of Base Rent plus Five Hundred Dollars ($500) for each one (1) day of such delay In the event Lessor fails by MAY 15, 1999 (subject to Force Majeure Delay and to Lessee's Delay) to substantially complete the Lessor's Phase One Work referred to in PARAGRAPH 52.1.1 as it relates to the Premises (which is not concurrent with a Force Majeure Delay or Lessee Delay), then notwithstanding anything to the contrary contained in this Lease, as Lessee's sole and exclusive remedy, Lessee shall have the right to terminate this Lease by giving Lessor thirty (30) days' prior written notice. If Lessee gives Lessor such termination notice, this Lease shall terminate thirty (30) days after Lessor gives Lessee such termination notice unless within said thirty (30) day period Lessor substantially completes the Lessor's Phase One Work. 52.4.2 LESSOR'S PHASE TWO WORK. After all contingencies to the effectiveness of this Lease have expired or been waived, Lessor shall endeavor to substantially complete (as that term is defined below) the Lessor's Phase Two Work referred to in PARAGRAPHS 52.1.2 no later than sixty (60) days after Lessee has delivered Lessor the Plans (as defined in PARAGRAPH 53.7) which have been approved by the City of Los Angeles and Lessor (and, with respect to Lessor's Work shown on the Window Plan, ninety (90) days after Lessee has delivered Lessor the Plans (as defined in PARAGRAPH 53.7) which have been approved by the City of Los Angeles and Lessor); provided, however, Lessor's obligation is subject to: (a) obtaining a building permit, if one is required; (b) Lessee's cooperation with Lessor in performing Lessor's Phase One Work and Lessor's Phase Two Work; (c) Force Majeure Delay (as that term is defined in PARAGRAPH 54.2 of this Lease); and, (d) Lessee's Delay (as that term is defined in PARAGRAPH 54.3 of this Lease). In the event that within said time periods Lessor fails (subject to Force Majeure Delay and to Lessee's Delay) to substantially complete the Lessor's Phase Two Work referred to in PARAGRAPH 52.1.2 as it relates to the Premises, (which is not concurrent with a Force Majeure Delay or Lessee Delay), then notwithstanding anything to the contrary contained in this Lease, as Lessee's sole and exclusive remedy, (a) for the first thirty (30) days of such delay, Lessee shall be entitled to abate one (1) day of Base Rent for each one (1) day of such delay; and, (b) after the first thirty (30) days of such delay, Lessee shall be entitled to abate an amount equal to one (1) day of Base Rent plus Five Hundred Dollars ($500) for each one (1) day of such delay; provided, however, that such abatements shall run concurrently with any abatement provided under PARAGRAPH 52.4.1. In the event Lessor fails within ninety (90) days after Lessee has delivered Lessor the Plans (as defined in PARAGRAPH 53.7 which have been approved by the City of Los Angeles and Lessor (subject to Force Majeure Delay and to Lessee's Delay) to substantially complete the Lessor's Phase Two Work referred to in PARAGRAPH 52.1.2 as it relates to the Premises (which is not concurrent with a Force Majeure Delay or Lessee Delay), then Page 14 notwithstanding anything to the contrary contained in this Lease, as Lessee's sole and exclusive remedy, Lessee shall have the right to terminate this Lease by giving Lessor thirty (30) days' prior written notice. If Lessee gives Lessor such termination notice, this Lease shall terminate thirty (30) days after Lessor gives Lessee such termination notice unless within said thirty (30) day period Lessor substantially completes the Lessor's Phase Two Work. 52.5 LESSEE'S RIGHT TO ENTER. At all times during the construction of the Lessor's Phase One Work and the Lessor's Phase Two Work, Lessee or an authorized agent of Lessee, may enter upon and inspect the work and the Premises and perform Lessee's Work; provided, that: (a) neither Lessee nor any authorized agent of Lessee shall interfere with Lessor or any subcontractor (of any tier) in the performance of their work; (b) Lessee, or an authorized agent of Lessee, shall enter the Premises at Lessee's sole risk; (c) Lessor shall not be liable for any injury sustained by Lessee or Lessee's representative in, on or about the Premises, except as a result of the gross negligence or willful misconduct of Lessor or of Lessor's contractor's or agents, in which case Lessor shall be liable but only to the extent such injury is not covered by Lessee's insurance required under this Lease or under insurance actually maintained by Lessee; (d) such entry does not delay Lessor in obtaining a final inspection of Lessor's construction work, certificate of occupancy or in substantially completing the Lessor's Phase One Work or the Lessor's Phase Two Work; and, (e) Lessee has first delivered to Lessor copies of certificates of insurance evidencing that Lessee has obtained the insurance coverage required by the Lease. In the event of any conflict in scheduling Lessor's Phase One Work and Lessor's Phase Two Work, on the one hand, or Lessee's Work on the other hand, Lessor's Phase One Work and Lessor's Phase Two Work shall prevail. 52.6 [This paragraph has been intentionally omitted.] 52.7 ALLOWANCES. If any amount in this Lease is stated to be an allowance with Lessor is giving to Lessee ("ALLOWANCE" herein), Lessor shall pay the actual cost of the amount of such Lessee's Work up to and not exceeding an amount equal to the amount of such Allowance; and, Lessee shall bear all costs and expenses in excess of such amount. The Allowances shall be paid within the time and in the manner provided herein, or, at Lessor's sole option, Lessor shall have the right to credit the amount of the Allowance against the next ensuing payments of Base Rent under this Lease. Lessee shall use the Allowance only for the purpose of installing the particular item of Lessee's Work for which the Allowance has been given. Lessor shall reimburse Lessee for the cost of the Lessee's Work when Lessee's Work has been substantially completed within thirty (30) days after a written request therefor from Lessee which request shall be accompanied by: (a) such written evidence substantiating the request as the Lessor shall require; (b) unconditional mechanic's lien releases in the statutory form with respect to all work; (c) a certificate from the Architect that the work represented as being done by the request has in fact been completed; (d) written evidence (which written evidence shall be at no cost to Lessee) from a reputable title insurance company mutually agreeable to Lessor and Lessee that no mechanic's liens have been recorded against the Premises by any contractor or subcontractor that was not in privity of contract with Lessor, which lien Lessee has not bonded against; (e) paid or unpaid invoices evidencing that such work has been finished; (f) a copy of the final certificate of occupancy (or the equivalent thereof) from any governmental authority having jurisdiction of such work; (g) a Notice of Completion as defined in California Civil Code Section 3093 showing that it has been recorded in the Office of the County Recorder of Los Angeles County, California Page 15 and showing the recording information as affixed by said Office, showing completion of Lessee's Work (and said final payment shall not be made until at least thirty (30) days have elapsed since the recordation of said Notice); and, (h) "as built" plans and specifications for the Lessee's Work (prepared by Lessee at its sole cost and expense). Notwithstanding anything to the contrary contained in this PARAGRAPH 52.7, Lessor shall not make any such payments if: (a) Lessee is in Breach under this Lease beyond any grace period provided herein for the rectification thereof; and, (b) there is any notice of violation or cease and desist with respect to the Lessee's Work which has been issued by the City of Los Angeles or any governmental authority having jurisdiction of the Lessee's Work. If Lessee does not draw the entire amount of any Allowance for the purpose of making the Lessee's Work for Lessee's use, then the balance of the Allowance shall be and remain Lessor's sole property. 53. LESSEE'S WORK. 53.1 LESSEE'S WORK. If Lessee desires any Alterations and/or Utility Installations to the Premises ("LESSEE'S WORK" herein), Lessee shall comply with all of the terms and provisions of this Lease including but not limited to PARAGRAPH 6 of this Lease. Lessee shall construct all of such Lessee's Work at Lessee's sole cost and expense, except as hereinafter provided. Lessor hereby agrees to provide Lessee with an Allowance in the total amount of One Hundred Twelve Thousand Six Hundred Eighty Dollars ($112,680.00), subject to PARAGRAPH 52.7, so that Lessee shall perform the following as part of Lessee's Work: 53.1.1 Install new men's and women's restrooms in Buildings A, B and C in compliance with all Applicable Requirements. The restroom fixtures and configuration shall be subject to the mutual approval of Lessor and Lessee; and, 53.1.2 Slurry coat, re-stripe and repair the parking lot area; and, 53.1.3 Install skylights in the front two (2) buildings; and, 53.1.4 Install windows where there are roll-up doors in the C Building as shown on the Window Plan which is attached hereto as EXHIBIT "C", The Window Plan shall also contain the size and specifications for such windows. The amount of the Allowance is based on estimates contained in a letter from Prats/Coffee dated January 18, 1999, a copy of which is attached hereto as EXHIBIT "D". The Parties recognize that said figure is based on estimates which have not been bid out to subcontractors. The only way to determine the exact amount of any particular item is to have it bid out to subcontractors. The successful subcontractor would then sign a contract becoming contractually bound to honor the price for the particular work in question. The Lessee has an immediate need for the Premises because Lessee's existing office lease expires soon. The Parties are using said estimates, rather than figures which have been bid to subcontractors, in order to get this Lease signed in time for work to be done so Lessee may move into the Premises on or about the time its existing office lease expires. Lessee acknowledges that Lessee has had said estimates reviewed by Lessee and by its design professionals, including but not limited to architect, space planner, engineers, and contractors. Lessor shall not be liable to Lessee and the amount of the Allowance shall not be increased if said estimates are not accurate, except as hereinafter provided. After this Lease is Page 16 fully executed and delivered, the Parties to this Lease shall further review the estimates, the Allowance amount, the Lessor's Phase One Work, Lessor's Phase Two Work and Lessee's Work. If the Parties have any different figures which are more reliable than the ones contained in EXHIBIT " D" attached hereto, the Parties shall confer to determine the reliability of the figures. If the Parties mutually determine, in good faith, that the numbers on the estimate should be revised, the Parties shall execute an amendment to this Lease on or before MARCH 10, 1999. If the Parties are unable to resolve any differences concerning said matters, then either Lessor or Lessee shall have the right to terminate this Lease by giving written notice to the other Party on or before MARCH 10, 1999. In the event that neither side terminates this Lease on or before MARCH 10, 1999, then this right to terminate shall expire and this Lease shall remain in full force and effect. The amount of the R-factor for purposes of Paragraph 52.1.2(G), the existing capacity of the existing HVAC units for the B Building and C Building, the definition of "Permitted Transfer" under Paragraph 80.2, and the percentage set forth in Paragraph 80.4 (which is presently 25%) shall all also be determined prior to MARCH 10, 1999 or either of the Parties may terminate the Lease by written notice to the other Party on or before MARCH 10, 1999. 53.2 ARCHITECT. The plans and detailed specifications for the construction of the Lessee's Work ("PLANS" herein) shall be prepared by an architect reasonably acceptable to Lessor ("ARCHITECT" herein). Lessee shall pay Architect at its sole cost and expense. Lessee shall not change the Architect without Lessor's prior written approval, which shall not be unreasonably withheld, delayed or conditioned. 53.3 EXISTING CONDITION OF PREMISES. Lessee acknowledges that it has been given an opportunity to inspect the Premises and finds the Premises in satisfactory condition. Except for the condition in which the Existing Tenant may leave the Premises when the Existing Tenant vacates the Premises, Lessee hereby acknowledges that Lessee is leasing the Premises in their existing "AS IS/WHERE IS" condition; that Lessee has made a full inspection and investigation of the physical condition of the Premises, all casements, rights, rights of way, reservations, covenants, conditions and restrictions with respect to the Premises and all other matters of record and all Applicable Requirements pertaining to the Premises and to Lessee's business; that Lessee is relying entirely upon said inspections and investigations made by Lessee; that Lessee is not relying upon any representations or warranties made by Lessor or Lessor's agents, except as specifically set forth in this Lease; that Lessee is satisfied that the Premises are suitable for Lessee's intended use; that Lessee is satisfied that the existing electrical service to the Premises and electrical system in, on or about the Premises are suitable for Lessee's intended use; that Lessee is satisfied that the existing water service to the Premises and water system in, on or about the Premises are suitable for Lessee's intended use; that Lessee is satisfied that the existing gas service, if any, to the Premises and gas system, if any, in, on or about the Premises are suitable for Lessee's intended use; that no representation or warranty is made regarding the square footage of the Premises nor any other physical attributes of the Premises; that Lessee has determined that the building's fire safety system, if any, is satisfactory for Lessee's intended use and any requirements of the appropriate fire department and Lessee's insurance underwriter; that Lessee is not required to obtain the approval of this Lease by any other person, firm, corporation or governmental agency in order for this Lease to be binding on Lessee; and that the acknowledgments contained in this PARAGRAPH 53.3 are material inducements to Lessor in Page 17 agreeing to lease the Premises to Lessee and that Lessor would not have leased the Premises to Lessee had Lessee not made the acknowledgments contained in this PARAGRAPH 53.3. 53.4 APPROVAL OF PRELIMINARY PLANS. Within thirty (30) days after Lessor and Lessee have executed and delivered this Lease, Lessee shall have prepared by Architect and submit to Lessee the preliminary plans for the construction of Lessee's Work ("PRELIMINARY PLANS" herein). Within five (5) business days of receipt of the Preliminary Plans from Lessee, Lessor and Lessee shall approve such Preliminary Plans or Lessor shall within such period deliver to Lessee written notice specifying with particularity the specific changes required to be made to the Preliminary Plans, which changes Architect shall make as soon as reasonably possible. This procedure shall be repeated until the Preliminary Plans are finally approved by Lessor and Lessee. 53.5 APPROVAL OF FINAL PLANS. Within thirty (30) days after Lessor and Lessee have approved the Preliminary Plans, Lessee shall have prepared and submit to Lessor the final plans for the construction of the Lessee's Work which shall contain all elements consistent with the approved Preliminary Plans, including, without limitation, structural engineering, structural elements, masonry elements, roofing elements, plumbing elements, electrical elements, heating, ventilating and air conditioning elements, office improvement elements, and handicap specifications. Within five (5) days of receipt of the Final Plans, Lessor and Lessee shall approve such Final Plans or Lessor shall within such period deliver to Lessee written notice specifying with particularity the specific changes required to be made to the Final Plans, which changes shall be consistent with the Preliminary Plans, and which changes Architect shall make as soon as reasonably possible. This procedure shall be repeated until the Final Plans are finally approved by Lessor and Lessee. 53.6 OBTAINING PERMITS FROM CITY. Lessee shall submit the Plans to the City of Los Angeles for approval. If the City of Los Angeles requires any Changes to the Plans which are material and substantial ("CITY CHANGES" herein), Lessee shall submit drawings showing such Changes ("CITY CHANGE DRAWINGS" herein) to Lessor for its approval. Within five (5) days of receipt of the City Change Drawings, Lessor and Lessee shall approve such City Change Drawings or Lessor shall within such period deliver to Lessee written notice specifying with particularity the specific Changes required to be made to the City Change Drawings, and which Changes Architect shall make as soon as reasonably possible. This procedure shall be repeated until the City Change Drawings are finally approved by Lessor, Lessee and the City of Los Angeles. After the City Change Drawings are finally approved by Lessor, Lessee and the City of Los Angeles, then at its sole cost and expense, Lessee shall pull a building permit from the City of Los Angeles to construct the Lessee's Work. 53.7 DEFINITION OF PLANS. The Final Plans approved by Lessor, Lessee and by the City of Los Angeles are herein defined as the "PLANS". The term "LESSEE'S WORK" shall mean all improvements shown on the Plans. 53.8 COMMENCEMENT OF CONSTRUCTION. Lessee shall not commence to construct the Lessee's Work unless and until a building permit for the Lessee's Work has been issued by the City of Los Angeles. Lessee shall commence the Lessee's Work diligently after the building permit has been issued. Page 18 53.9 COSTS OF CONSTRUCTION; BIDDING; BUDGET; CONTRACTOR. 53.9.1 COSTS. Lessee shall construct the Lessee's Work in accordance with the Plans consistent with industry custom and practice, at Lessee's sole and entire cost and expense; provided, however, the Allowances may be used in the manner provided herein. 53.9.2 CONTRACTOR. Lessee shall not award the job unless and until Lessee has obtained Lessor's prior written consent to the general contractor ("CONTRACTOR" herein), which consent Lessor shall not unreasonably withhold, delay or condition. The Contractor shall be bondable. The Contractor shall name Lessor as an additional insured on all insurance which Contractor obtains and carries which insurance shall include at least: (a) worker's compensation insurance in the statutory form and amount; (b) comprehensive commercial liability insurance having a liability limit of not less than One Million Dollars ($1,000,000); and, (c) any other insurance normally required by commercial lessors and construction lenders. 53.10 CHANGES; CHANGE ORDERS. Any deviation from the approved Plans for any reason including but not limited to work requested by Lessee which is not shown on the Preliminary Plans, the Final Plans, any work not shown on the Plans which is required by any governmental authority, and any work required due to conditions which are unknown as of the date this Lease is entered is defined as a "CHANGE". In the event that Lessee requests any Changes, Lessee shall obtain Lessor's prior written approval of such Changes if such Changes (a) affect the exterior of the Premises; (b) affect any structural matter of the Premises; (c) affect any matter which the Lessor is required by the Lease to maintain or repair; (d) affect any major building systems including, but not limited to, electrical, plumbing, and HVAC; (e) affect any of the Lessor's Phase One Work or Lessor's Phase Two Work which Lessor is required to do at the inception of the term of this Lease; or, (f) cost individually more than $10,000 or in the aggregate during the term of this Lease more than $50,000. Lessor shall not unreasonably withhold its consent to any such Changes, provided the Changes do not adversely affect the structure, systems, equipment, security system or appearance of the Premises or of the Lessee's Work. The Commencement Date and the Rent Commencement Date shall not be extended by any period of additional construction time resulting from any such Change Order. Lessee shall submit invoices to Lessor showing which Changes have been substantially completed and the amounts applicable to such completed portion. 53.11 SUBSTITUTION OF MATERIALS. Whenever possible and practical, Lessee will utilize, for the construction of the Lessee's Work, the items and materials designated in the Plans. However, whenever Lessee determines in its judgment that it is not practical or efficient to use such materials, Lessee shall have the right, upon receipt of Lessor's consent, which consent shall not be unreasonably withheld, delayed or conditioned, to substitute comparable items and materials. 53.12 SUBSTANTIAL COMPLETION OF LESSEE'S WORK. Subject to Force Majeure Delays, Lessee shall cause the Lessee's Work to be substantially completed no later than AUGUST 1, 1999. Page 19 54. CERTAIN DEFINITIONS. 54.1 SUBSTANTIAL COMPLETION. The term "SUBSTANTIALLY COMPLETE" means that Lessee has completed the Lessee's Work and other work that it is obligated to perform pursuant to this Lease or that Lessor has completed the Lessor's Phase One Work, Lessor's Phase Two Work and other work that it is obligated to perform pursuant to this Lease, as the case may be, and that said work shall be deemed complete, notwithstanding the fact that minor details of construction, mechanical adjustments or decorations which do not materially interfere with Lessee's use of the Premises remain to be performed (items normally referred to as "PUNCH-LIST" items). The Premises shall be deemed substantially complete even though certain portions of the Premises, which do not interfere with Lessee's efficient conduct of its business, have not been fully completed, and even though Lessee's Trade Fixtures, furniture, telephones, telecopiers, photocopy machines, computers and other business machines or equipment have not been installed, the purchase and installation of which shall be Lessee's sole responsibility. With respect to the Lessee's Work, Lessee shall cause the Punch-List items to be corrected as soon as reasonably possible and practical. With respect to the Lessor's Phase One Work and Lessor's Phase Two Work, Lessor shall cause the Punch-List items to be corrected as soon as reasonably possible and practical. 54.2 FORCE MAJEURE DELAY. The term "FORCE MAJEURE DELAY" shall mean any delay which is attributable to any: (1) actual, industry-wide delay or failure to perform affecting all similar works of construction in the Los Angeles area, attributable to any strike, lockout or other labor or industrial disturbance (whether or not on the part of the employees of either party hereto), civil disturbance, future order claiming jurisdiction, act of the public enemy, war, riot, sabotage, blockade, embargo, inability to secure customary materials, supplies or labor through ordinary sources by reason of regulation or order of any government or regulatory body; (2) delay attributable to the failure of Lessee or Lessor to secure building permits and approvals within the same time periods that normally prevailed for obtaining such permits and approvals in February 1999; or (3) delay attributable to lightning, earthquake, fire, storm, hurricane, tornado, flood, washout, explosion, or any other similar industry-wide cause beyond the reasonable control of the party from whom performance is required, or any of its contractors or other representatives. Any prevention, delay or stoppage due to any Force Majeure Delay shall excuse the performance of the party affected for a period of time equal to any such prevention, delay or stoppage (but not the Lessee's obligation to pay Rent pursuant to the Lease). 54.3 LESSEE'S DELAY. The term "LESSEE DELAY" shall mean any delay that Lessor may encounter in the performance of Lessor's obligations under the Lease because of any act or omission of any nature by Lessee or its agents or contractors, including, but not limited to, any: (a) delay attributable to Changes (as that term is defined herein) in or additions requested by Lessee to the Final Plans, or to the Lessee's Work, or to the Lessor's Phase One Work, or to the Lessor's Phase Two Work, including any delay by Lessee in the submission of information required by this Lease or the giving of authorizations or approvals within the time limits set forth in this Lease; (b) delay attributable to the postponement of any of Lessor's Phase One Work or Lessor's Phase Two Work at the request of Lessee; (c) delay attributable to the failure of Lessee to deliver to Lessor the Preliminary Plans, Final Plans and other plans required to be submitted by Lessee pursuant to this Lease; (d) delay attributable to the failure of Lessee to pay, when due, the amounts required by Lessee pursuant to the Lease; and, (e) Lessee's delay in substantially Page 20 completing any of Lessee's Work. Lessee shall pay all costs and expenses incurred by Lessor which result from any Lessee Delay, including, without limitation, any actual and reasonable costs and expenses attributable to increases in the cost of labor or materials. 55. MAINTENANCE; REPAIRS. 55.1 Notwithstanding anything to the contrary contained in PARAGRAPHS 6.1 AND 6.2 of this Lease and except as provided in PARAGRAPHS 55.2, 55.3, AND 56 of this Lease, at its sole cost and expense, Lessor shall maintain in good condition, order, and repair the roof, the exterior walls (but not interior walls) and foundation of the Premises. Lessor shall have the right, but not the obligation, at Lessor's sole cost and expense, to have appropriate professionals inspect the roof, exterior walls and foundation, to insure that same are in good condition, maintenance and repair, which inspections may be conducted no more often than once a year. 55.2 Notwithstanding anything to the contrary contained in PARAGRAPH 55.1, Lessor shall not be required to maintain and repair any damage, deterioration, or injury to any of the items enumerated in PARAGRAPH 55.1 or elsewhere to the extent caused by: (a) the intentional or negligent acts or omissions of Lessee, its agents, contractors, invitees, assignees, sublessees, successors or assigns; (b) any Alterations and/or Utility Installations made by Lessee, its agents, contractors, invitees, assignees, sublessees, successors or assigns; (c) Lessee's Work; (d) the installation or removal of any Trade Fixtures by Lessee, its agents, contractors, invitees, assignees, sublessees, successors or assigns; or, (e) any roof penetrations of the roof structure, roof membrane, or roof cover or any pedestrian traffic on the roof caused by Lessee, its agents, contractors, invitees, assignees, sublessees, successors or assigns. At Lessee's sole cost and expense, Lessee shall repair any damage, deterioration or injury enumerated in this PARAGRAPH 55.2. 55.3 Lessee shall not nail or air hammer any nails or other penetrations into the floor slab or foundation. Notwithstanding the immediately preceding sentence, Lessee shall have the right to nail or air hammer nails and other penetrations into the floor slab or foundation for the purpose of installing Lessee's Trade Fixtures; provided, however, that upon the expiration or sooner termination of this Lease, at Lessee's sole cost and expense, Lessee shall remove such items and shall patch and repair the floor slab or foundation with materials approved by Lessor. 56. ROOF PENETRATIONS. If Lessee's Work, Lessee Owned Alterations and/or Utility Installations require any penetration of the roof structure, roof membrane, or roof cover of the Premises, Lessee shall: (a) at its sole cost and expense make any necessary repairs caused as result of said work utilizing a roofing contractor which contractor is satisfactory to Lessor and Lessee; and, (b) provide a new roof warranty from a bona fide, responsible roofing contractor acceptable to Lessor if any existing roof warranty is voided by such penetrations. Upon the expiration or sooner termination of this Lease, Lessor shall have the right to require Lessee at Lessee's sole cost and expense to remove such roof penetrations and restore the roof to the condition in which it was in upon the commencement of the Original Term hereof, less reasonable wear and tear. Page 21 57. USE. 57.1 Lessee shall have the right to have legal drugs on the Premises if (a) such legal drugs are reasonably related to Lessee's business; and, (b) Lessee complies with all Applicable Requirements pertaining to such drugs. Lessee shall not use nor knowingly permit to be used the Premises or any portion thereof for the warehousing, distribution, or storage of any illegal drugs or other controlled substances. 57.2 Lessee shall indemnify, defend and hold harmless Lessor from any and all costs, claims or liability arising from: (i) the use, possession or sale of any illegal drug or controlled substance by Lessee, its employees, agents, contractors or invitees in, on or about the Premises; and, (ii) the seizure of the Premises by any governmental authority having jurisdiction thereof alleged to be due to any of the reasons in subparagraph (i). Lessee shall defend Lessor against any such cost, claim or liability at Lessees expense with counsel reasonably acceptable to Lessor or, at Lessor's election, Lessee shall reimburse Lessor for any legal fees or costs incurred by Lessor in connection with any such claim or liability. 57.3 Lessee shall not use the Premises nor any portion thereof for any use or purpose which would invalidate any insurance coverage required under this Lease pertaining to the Premises. 58. AMERICANS WITH DISABILITIES ACT. Lessor shall at Lessor's sole cost and expense: (a) cause the Premises to comply with the Americans With Disabilities Act as of the Commencement Date; and, (b) provide access to the Premises in compliance with the Americans With Disabilities Act as of the Commencement Date. Lessee shall at Lessee's sole cost and expense cause any of Lessee's Work to comply with the Americans With Disabilities Act as of the Commencement Date. After the Commencement Date, Lessee shall at Lessee's sole cost and expense cause the Premises and any Alterations and/or Utility Installations done by Lessee and Lessee's Work to comply with the Americans With Disabilities Act. 59. LIMITATION ON LESSOR'S LIABILITY. Subject to the provisions of PARAGRAPH 16 of the Printed Lease, (a) the obligations of Lessor under this Lease shall not constitute personal obligations of Lessor, the individual partners of Lessor or its or their individual partners, tenants-in-common, trustees, directors, officers or shareholders; (b) Lessee shall look to the interest of the Lessor in the Premises but not more than the aggregate amount of One Million Five Hundred Thousand Dollars ($1,500,000), and to no other assets of Lessor, for the satisfaction of any liability of Lessor with respect to this Lease; (c) if Lessor causes a deed of trust or mortgage to be recorded against the Premises, immediately after such recordation Lessor shall have an equity in the property of at least One Million Five Hundred Thousand Dollars ($1,500,000); and, (d) except as provided in this PARAGRAPH 59, Lessee shall not seek recourse against the individual partners of Lessor, or its or their individual partners, tenants-in-common, trustees, directors, officers or shareholders, or any of their personal assets for such satisfaction. Page 22 60. AMOUNT OF RENT PAYABLE AND DOCUMENTS TO BE DELIVERED UPON EXECUTION. Concurrently with the execution and delivery of this Lease, Lessee shall: 60.1 Pay Lessor in the form of a cashier's check the sum of Forty Seven Thousand Seven Hundred Twelve Dollars ($47,712) as the estimated Base Rent for the fifth (5th) month following the Commencement Date, as provided in PARAGRAPH 50.1.4 of this Lease; and, 60.2 Deliver to Lessor the resolution required by PARAGRAPH 42 of the Lease together. 61. PEST CONTROL. Prior to Lessor delivering the Premises to Lessee, at Lessor's sole cost and expense, Lessor shall have a licensed, bonded professional pest and sanitation control service inspect the Premises to evidence that the Premises are free of dry rot, termites and other wood-destroying organisms. Lessee shall, at its own cost and expense, retain a licensed, bonded professional pest and sanitation control service to perform inspections of the Premises not less frequently than once every calendar quarter for the purpose of controlling infestation by insects, rodents, vermin, termites and dry rot and shall promptly cause any corrective or extermination work recommended by such service to be performed. Lessee shall require such service to make a written report and shall promptly deliver such reports to Lessor. If Lessee fails to perform its obligations under this PARAGRAPH 61, Lessor may, but shall not be required to, after five (5) days' written notice to Lessee, cause such inspection to be performed and any necessary corrective or extermination work which is recommended to be done and the cost of such inspections and corrective or extermination work shall be additional rent. 62. GRAFFITI. Notwithstanding anything to the contrary contained in this Lease, Lessee shall, at its expense, remove any future graffiti on the exterior walls, doors and windows of the Premises. 63. LENDER'S REQUIREMENTS. Lessee hereby agrees to make any reasonable revisions to this Lease which may be required in good faith by Lessor's bona fide construction, interim or permanent lender in connection with the financing of the Premises initiated by Lessor, but in no event shall such changes materially interfere with Lessee's use of the Premises or increase the rent or other costs of Lessee's occupancy of the Premises or impose upon Lessee any greater burden or obligation than that which exists under the Lease. 64. RENT PAYMENTS; LATE CHARGES. 64.1 Lessee hereby acknowledges that: (i) Base Rent is due and payable on the first day of each month regardless of the fact that Lessor may not bill Lessee for such payments; and, (ii) late charges and interest charges for failure to timely pay rent and other sums due under this Lease shall be strictly enforced by Lessor. 64.2 If Lessor fails to bill Lessee for any increases in the Base Rent or for any other charges under this Lease, then: (a) Lessee shall pay Lessee within ten (10) days after Lessee is billed for the deficiency; (b) Lessee shall nevertheless continue to be liable for such amounts; (c) Lessor does not waive Lessor's right to collect such amounts in full at any time; and, (d) Lessee waives the statute of limitations (to the fullest extent permitted by Applicable Requirements) as a defense to Lessor's right to collect such amounts. Page 23 64.3 Notwithstanding anything to the contrary contained in PARAGRAPH 12.4 of the Printed Lease, Lessor shall not charge Lessee a late charge the first time that Lessee is late in the payment of rent in each calendar year (which rent shall be late if it is not paid five (5) days after the due date); provided, that as to such first time in any calendar year that such rent is late, Lessee pays such rent within five (5) days after receiving written notice from Lessor that the rent is late. 65. INSURANCE PREMIUMS; ESTIMATED AMOUNTS. In order to insure payment when due and before Lessor is required to pay insurance premiums under PARAGRAPH 7 of the Lease, Lessor reserves the right, at Lessor's option, to estimate the current insurance premiums applicable to the Premises for which Lessee is liable, and to require such current year's such insurance premiums to be paid in advance to Lessor by Lessee, either: (i) in a lump sum amount equal to the premiums due, at least twenty (20) days prior to the applicable due date, or (ii) monthly in advance with the payment of the Base Rent. If Lessor elects to require payment monthly in advance, the monthly payment shall be that equal monthly amount which, over the number of months remaining before the month in which the applicable insurance premiums would become due, would provide a fund large enough to fully discharge before the due date the estimated installment of premiums to be paid. When the actual amount of the applicable premiums are known, the amount of such equal monthly advance payment shall be adjusted as required to provide the fund needed to pay the applicable premiums before they are due to the insurance carrier. If the amounts paid to Lessor by Lessee under the provisions of this PARAGRAPH 65 are insufficient to discharge the obligations of Lessee to pay such insurance premiums as the same become due, Lessee shall pay to Lessor, upon Lessor's demand, such additional sums as are necessary to pay such obligations. All moneys paid to Lessor under this PARAGRAPH 65 may be intermingled with other moneys of Lessor and shall not bear interest. In the event of a Breach by Lessee in the performance of the obligations of Lessee under this Lease, then any balance of funds paid to Lessor under the provisions of this Paragraph may, subject to proration as provided in PARAGRAPH 7.1, at the option of Lessor, be treated as additional Rent. 66. PROPOSITION 65 COMPLIANCE. Lessee shall do everything necessary and proper in order to comply with California Proposition 65 as it relates to its operation in and its occupancy of the Premises. Lessee shall defend, indemnify and hold harmless the Lessor and its real estate manager, in the event that either or both are found liable under Proposition 65 with respect to any act or omission by Lessee, its agents, employees or subcontractors. 67. NO RIGHT TO TERMINATE. In no event shall Lessee have the right to terminate this Lease as a result of Lessor's default or breach; and Lessee's remedies shall be limited to damages and/or injunction. 68. REFERENCE PROCEDURE. 68.1 Each controversy, dispute or claim between the Parties arising out of or relating to this Lease, which controversy, dispute or claim is not settled in writing within thirty (30) days after the date upon which notice is given in accordance with PARAGRAPH 22 herein of a controversy, dispute or claim by a complaining Party to the other Party ("CLAIM DATE" herein) will be settled by a reference proceeding in Los Angeles, California in accordance with the provisions of Sections 638 of the California Code of Civil Procedure, or their successor sections Page 24 ("CCP" herein), which shall constitute the exclusive remedy for the settlement of any controversy, dispute or claim concerning this Lease, including whether such controversy, dispute or claim is subject to the reference proceeding and the parties waive their rights to initiate any legal proceedings against each other in any court or Jurisdiction other than the Superior Court of Los Angeles ("COURT" herein), except as provided in PARAGRAPH 68.5 of this Lease. The referee shall be a retired Judge of the Court selected by mutual agreement of the Parties, and if they cannot so agree within forty-five (45) days after the Claim Date, the referee shall be promptly selected by the Presiding Judge of the Los Angeles Superior Court (or his representative). The referee shall be appointed to sit as a temporary judge, with all of the powers of a temporary Judge, as authorized by Applicable Requirements, and upon selection should take and subscribe to the oath of office as provided for in Rule 244 of the California Rules of Court (or any subsequently enacted Rule). Each Party shall have one peremptory challenge pursuant to CCP 170.6. The referee shall (a) be requested to set the matter for hearing within sixty (60) days after the Claim Date; and, (b) try any and all issues of law or fact and report a statement of decision upon them, if possible, within ninety (90) days of the Claim Date. Any decision rendered by the referee will be final, binding and conclusive and judgment shall be entered pursuant to CCP 644 in any court in the State of California having jurisdiction. Any Party may apply for a reference at any time after thirty (30) days following notice to any other Party of the nature of the controversy, dispute or claim, by filing a petition for a hearing and/or trial. All discovery permitted by this Lease shall be completed no later than fifteen (15) days before the first hearing date established by the referee. The referee may extend such period in the event of a Party's refusal to provide requested discovery for any reason whatsoever, including, without limitation, legal objections raised to such discovery or unavailability of a witness due to absence or illness. No Party shall be entitled to "priority" in conducting discovery. Depositions may be taken by either party upon seven (7) days written notice, and, request for production or inspection of documents shall be responded to within ten (10) days after service. All disputes relating to discovery which cannot be resolved by the Parties shall be submitted to the referee, whose decision shall be final and binding upon the Parties. 68.2 Except as expressly set forth in this Lease, the referee shall determine the manner in which the reference proceeding is conducted including the time and place of all hearings, the order or presentation of evidence, and all other questions that arise with respect to the course of the reference proceeding. All proceedings and hearings conducted before the referee, except for trial, shall be conducted without a court reporter, except that when any Party so requests, a court reporter will be used at any hearing conducted before the referee. The Party making such a request shall have the obligation to arrange for and pay for the court reporter. The costs of the court reporter at the trial shall be borne equally by the Parties. 68.3 The referee shall be required to determine all issues in accordance with existing case law and the statutory laws of the State of California. The rules of evidence applicable to proceedings at law in the State of California will be applicable to the reference proceeding. The referee shall be empowered to enter equitable as well as legal relief, to provide all temporary and/or provisional remedies and to enter equitable orders that will be binding upon the Parties. The referee shall issue a single judgment at the close of the reference proceeding which shall dispose of all of the claims of the Parties that are the subject of the reference. The Parties hereto expressly reserve the right to contest or appeal from the final judgment or any appealable order or appealable judgment entered by the referee. The Parties hereto expressly reserve the right to Page 25 findings of fact, conclusions of law, a written statement of decision, and the right to move for a new trial or a different judgment. 68.4 In the event that the enabling legislation which provides for appointment of a referee is repealed (and no successor statute is enacted), any dispute between the Parties that would otherwise be determined by the reference procedure herein described will be resolved and determined by arbitration. The arbitration will he conducted by a retired Judge of the Los Angeles Superior Court, in accordance with the California Arbitration Act, Sections 1280 through 1294.2 of the CCP as amended from time to time. The limitations with respect to discovery as set forth herein above shall apply to any such arbitration proceeding. 68.5 Notwithstanding anything to the contrary contained in this PARAGRAPH 68, the following matters are excluded from the jurisdiction of the referee: (a) an unlawful detainer action; (b) the filing or enforcement of a mechanic's lien; (c) any matter which is within the jurisdiction of a probate court; and, (d) any action for a restraining order or injunctive relief. 69. NON-DISTURBANCE AND ATTORNMENT AGREEMENT. Lessor represents and warrants that as of the date this Lease is fully executed and delivered there is no deed of trust or mortgage which encumbers the Premises. 70. [This paragraph is intentionally omitted.] 71. CONDITION AND AVAILABILITY OF ELECTRICAL SERVICES. Lessee is executing this Lease with the understanding that existing electrical services may contain amperage and power ratings that are actually different than what is shown on the power panel itself and/or on the marketing brochures. Lessor cannot confirm, guarantee or substantiate that such amperage or power ratings are correct. Lessee agrees to confirm the presence and/or availability of such electrical services with Lessee's electrical contractor and/or with the City of Los Angeles or the Southern California Edison Company (or applicable utilities service company) and hereby releases Lessor from any such electrical service insufficiencies that may exist. 72. REAL PROPERTY TAXES. 72.1 Notwithstanding anything to the contrary contained in the Printed Lease, if during the first ninety (90) months after the Commencement Date there is any increase in the Real Property Taxes applicable to the Premises or the improvements thereon resulting solely from any change in ownership of the Premises or the improvements thereon occurring during the first ninety (90) months after the Commencement Date, then; 72.1.1 During such first ninety (90) months, Lessor (and not Lessee) shall be solely responsible for such increase in the Real Property Taxes; and, 72.1.2 After such first ninety (90) months, Lessee (not Lessor) shall be solely responsible for such increase in Real Property Taxes which resulted from such change in ownership of the Premises or the improvements thereon which occurred during the first ninety (90) months; and, Page 26 72.1.3 If after the first ninety (90) months after the Commencement Date there is any increase in Real Property Taxes applicable to the Premises or the improvements thereon resulting solely from a change in ownership of the Premises or the improvements thereon occurring after such first ninety (90) months, then Lessee (not Lessor) shall pay such increase with respect to one (1) such a change in ownership occurring during each five (5) year period after the expiration of such first ninety (90) months and Lessor shall pay any increases resulting from any further changes in ownership during the same five (5) year period; provided, however, upon the expiration of each such five (5) year period, Lessee shall be responsible for all increases which occurred prior to such expiration. 72.2 Notwithstanding anything to the contrary contained in the Printed Lease, except as provided in PARAGRAPH 72.1, if after the first ninety (90) months after the Commencement Date there is any increase in Real Property Taxes applicable to the Premises or the improvements thereon resulting solely from a change in ownership of the Premises or the improvements thereon occurring after such first ninety (90) months, then Lessee (not Lessor) shall pay such increase with respect to one (1) such a change in ownership occurring during each five (5) year period after the expiration of such first ninety (90) months and Lessor shall pay any increases resulting from any further changes in ownership during the same five (5) year period; provided, however, upon the expiration of each such five (5) year period, Lessee shall be responsible for all increases which occurred prior to such expiration. 73. CHLOROFLUORCARBONS. Lessee acknowledges that the use, maintenance or storage of chlorofluorcarbons (including, but not limited to, freon and other so-called "CFC'S") may hereafter be prohibited or limited by Applicable Requirements. In the event use, maintenance or storage of chlorofluorcarbons is hereafter prohibited or limited: 73.1 After the use or maintenance of chlorofluorcarbons is prohibited or limited, Lessee shall not thereafter allow, cause, suffer or permit chlorofluorcarbons to be either placed, stored, maintained, used or kept within the Premises, except in compliance with all Applicable Requirements. 73.2 Lessee shall forthwith contain or otherwise abate (as required by Applicable Requirements) all chlorofluorcarbons placed in the Premises after the date of the Lease. 73.3 Lessor shall have the right to contain or otherwise abate any chlorofluorcarbons that are: (1) placed in the Premises prior to the date of the Lease, or (2) placed in the Premises after the date of the Lease and as to which Lessee has not promptly complied with its obligations of containment and abatement set forth in PARAGRAPH 73.2. Lessor shall have no obligation to so contain or otherwise abate. Lessor shall be entitled to access to the Premises for the purposes of performing any necessary containment or abatement in accordance with Applicable Requirements and provided that Lessor shall take reasonable steps to minimize interruption of Lessee's business. Furthermore, Lessee shall not be entitled to terminate the Lease or to receive any rent abatement or to hold Lessor liable for any incidental or consequential damages (such as, but not limited to, damages for business interruption) arising by reason of the fact that any chlorofluorcarbons are present in the Premises as of the date of the Lease or thereafter and/or by the reason of the containment or abatement thereof. Page 27 73.4 Promptly upon the expiration or sooner termination of the term of the Lease, Lessee shall remove all chlorofluorcarbons which have been placed in the Premises after the date of the Lease (regardless of whether the use, storage or maintenance of chlorofluorcarbons is prohibited within the Premises at the expiration or sooner termination of the term of the Lease) unless requested not to do so in writing by Lessor. 74. PERMITS. Lessee shall diligently attempt to obtain all licenses, permits, franchises and other authorizations necessary to conduct the business it intends to conduct in the Premises. Lessee warrants and represents that Lessee has satisfied itself that it can obtain all licenses, permits, franchises and other authorizations necessary to conduct the business it intends to conduct in the Premises and is not relying on any representation or warranty made by Lessor or Lessor's agents with respect thereto. Lessor makes no representations or warranties that Lessee will be able to obtain any licenses, permits, franchises or other authorizations necessary or required to conduct the uses permitted herein in the Premises. Lessee at its sole cost and expense shall obtain all licenses, permits, franchises and authorizations. If it is subsequently determined that Lessee cannot obtain such licenses, permits, franchises or other authorizations, Lessee shall not have the right to terminate this Lease or to have an abatement of Rent. 75. PLATE GLASS INSURANCE. Lessee shall procure and maintain, at its expense, throughout the term any extension of this Lease, a policy of plate glass insurance in an amount sufficient to cover the replacement value of all of the plate glass in said Premises. Lessor shall be named as an additional insured in said policy, and Lessee shall deliver to Lessor, immediately upon procurement thereof, a copy of said policy or a certificate evidencing such insurance coverage. 76. WAIVER. No payment by Lessee or receipt by Lessor of a lesser amount than the fixed rent payment herein stipulated shall be deemed to be other than on account of the earliest stipulated rent, nor shall any endorsement or statement on any check or any letter accompanying any check or payment as rent be deemed an accord and satisfaction, and Lessor may accept such check or payment without prejudice to Lessor's right to recover the balance of such rent or pursue any other remedy provided in this Lease. 77. SIGNAGE. 77.1 RIGHT TO INSTALL. Lessee shall have the right to install the Permitted Signs (as that term is hereinafter defined). Except for the Permitted Signs, Lessee shall not have the right to install any other signs without complying with PARAGRAPH 33 of the Lease and this PARAGRAPH 77. 77.2 PERMITTED SIGNS. Lessee shall have the right to install the following signs, in the following numbers, in the following locations ("PERMITTED SIGNS" herein): (a) One (1) exclusive monument sign; (b) One (1) sign on the exterior of the front of the building, which shall be located in front of the Premises; (c) One (1) sign on each of the entrance doors to each of the buildings. Page 28 77.3 INSTALLATION. Lessee shall have the right to install and to maintain the Permitted Signs; provided, however, that (a) Lessee shall pay the cost of fabricating and installing such Permitted Signs; (b) Lessee shall obtain all required permits, consents and approvals from all applicable governmental authorities at Lessee's sole cost and expense; (c) obtaining such permits, consents and approvals is not a contingency to the effectiveness of this Lease; (d) Lessor makes no representations or warranties whether Lessee will be able to obtain any of the foregoing permits, consents or approvals; (e) prior to installation of the sign, Lessee shall submit plans for the Permitted Signs (showing exact locations, dimensions, colors, materials and utilities) to Lessor for Lessor's prior written approval; (f) the Permitted Signs shall be subject to PARAGRAPH 33 of the Lease; and, (g) such Permitted Signs shall comply with all Applicable Requirements. 77.4 REMOVAL. Upon the expiration or sooner termination of this Lease, at Lessee's sole cost and expense, Lessee shall remove such Permitted Signs and restore the Premises to its original condition prior to the installation of such Permitted Signs. 77.5 BILLBOARDS; RESERVATIONS. Lessee shall not have the right to install any billboards on the Premises. Lessor reserves the exclusive right to install and maintain cellular and/or pager antennae in, on or about the Premises which do not materially interfere with Lessee's business operations. As part of Lessor's Phase Two Work, Lessor shall remove the existing broadcast tower at the rear of the Premises. 78. INSURANCE. Notwithstanding anything to the contrary in the Printed Form, Lessor shall have the right, but not the obligation, to require that the insurance required by PARAGRAPH 7.3(A) of the Lease include earthquake and flood insurance, whether required by a Lender. 79. WAIVER OF JURY TRIAL. LESSOR AND LESSEE EACH ACKNOWLEDGES THAT IT IS AWARE OF AND HAS THE ADVICE OF COUNSEL OF ITS CHOICE WITH RESPECT TO ITS RIGHTS TO TRIAL BY JURY, AND EACH PARTY DOES HEREBY EXPRESSLY AND KNOWINGLY WAIVE AND RELEASE ALL SUCH RIGHTS TO TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM BROUGHT BY EITHER PARTY HERETO AGAINST THE OTHER (AND/OR AGAINST ITS OFFICERS, DIRECTORS, EMPLOYEES, AGENTS, OR SUBSIDIARY OR AFFILIATED ENTITIES) ON ANY MATTERS WHATSOEVER ARISING OUT OF OR IN ANY WAY CONNECTED WITH THIS LEASE, LESSEE'S USE OR OCCUPANCY OF THE PREMISES, AND/OR ANY CLAIM OF INJURY OR DAMAGE. 80. ASSIGNMENT AND SUBLETTING. 80.1 TRANSFER CONSIDERATION. If Lessee shall assign this Lease or sublet any portion of the Premises, Lessee shall pay to Lessor as additional Rent as and when received by Lessee the following amounts ("TRANSFER CONSIDERATION" herein): 80.1.1 In the case of an assignment, an amount equal to the "TRANSFER CONSIDERATION PERCENTAGE" (as that term is hereinafter more particularly defined) of all consideration actually paid to Lessee by the assignee for or by reason of the assignment, whether paid in a lump sum or over time, including but not limited to any sums paid for personal Page 29 property, tenant improvements or fixtures in excess of the fair market value thereof after deduction (amortized over the term of the assignment on a straight line basis) of: (a) Lessee's reasonable costs for tenant improvements (prorated by the ratio that the assignment term and square footage bears to the term and square footage of this Lease), if any; (b) the brokerage commission, if any, in connection with such assignment, if any; (c) advertising costs in connection with such assignment, if any; and, (d) reasonable legal fees paid by Lessee in connection with such assignment, if any. In no event shall Lessor be required to pay Lessee any amount in connection with such assignment. 80.1.2 In the case of a sublease, an amount equal to the Transfer Consideration Percentage of the amount by which the sublease rent and any other consideration actually paid to Lessee, whether paid in a lump sum or over time, including but not limited to any sums paid for personal property, tenant improvements or fixtures in excess of the fair market value thereof exceeds the rents payable which are proportionately allocable to the subleased premises based on the ratio of the area of the subleased premises to the area of the entire Premises, after deduction (amortized over the term of the sublease on a straight line basis) of: (a) Lessee's reasonable costs for tenant improvements (prorated by the ratio that the sublease term and square footage bears to the term and square footage of this Lease), if any; (b) the brokerage commission, if any, paid by Lessee in connection with such subletting, if any; (c) advertising costs in connection with such subletting, if any; and, (d) reasonable legal fees paid by Lessee in connection with such subletting, if any. In no event shall Lessor be required to pay Lessee any amount in connection with such sublease. 80.1.3 TRANSFER CONSIDERATION PERCENTAGE DEFINED. The "TRANSFER CONSIDERATION PERCENTAGE" shall mean the percentage set forth in the following table which corresponds to the following years during which an assignment occurs or during which any sublease is in effect, as follows: YEAR DURING WHICH ASSIGNMENT OCCURS TRANSFER CONSIDERATION OR DURING WHICH SUBLEASE IS IN EFFECT: PERCENTAGE -------------------------------------- ---------------------- Year 11 60% Year 12 70% Year 13 80% Year 14 90% Year 15 90% Any year during the Option Periods 50% If a sublease is in effect for more than one (1) of the years above, then the Transfer Consideration Percentage shall be the percentage for each year set forth above. For example, if the sublease is in effect during Years 13 through 15, then The Transfer Consideration Percentage in Year 13 shall be 80%, the Transfer Consideration Percentage in Year 14 shall be 90% and the Transfer Consideration Percentage in Year 15 shall be 90%. Page 30 80.2 PERMITTED TRANSFERS. Notwithstanding anything to the contrary contained in PARAGRAPH 12 of the Lease, Lessee shall have the right to make "PERMITTED TRANSFERS" (as that term is more particularly hereinafter defined) without Lessor's prior written consent and without payment of any Transfer Consideration; provided, however, that prior to such Permitted Transfer Lessee gives Lessor written evidence reasonably satisfactory to Lessor that the Transfer in question fulfills the definition of a Permitted Transfer together with a written representation and warranty of Lessee that the Permitted Transfer is a Permitted Transfer. Lessee shall be entitled to keep all consideration of any kind received in connection with any Permitted Transfer. In the event of a Permitted Transfer, the original Lessee named herein, shall remain primarily liable after such Permitted Transfer under this Lease for all of the obligations and payments of Rent required under this Lease. The term "PERMITTED TRANSFER" shall mean and include only the involvement of Lessee or its assets in any transaction, or series of transactions (by way of merger, sale, acquisition, financing, transfer, leveraged buy-out or otherwise), whether or not a formal assignment or hypothecation of this Lease or Lessee's assets occurs, which does not result or will not result in a reduction of the Net Worth of Lessee by an amount greater than twenty-five percent (25 %) of such Net Worth as it was represented at the time of the execution of this Lease or at the time of the most recent assignment to which Lessor has consented, or as it exists immediately prior to said transaction or transactions constituting such reduction, whichever was or is greater. "NET WORTH OF LESSEE" shall mean the net worth of Lessee (excluding any guarantors) established under generally accepted accounting principles. 80.3 STANDARD OF CONSENT. Lessor's consent to any proposed assignment or subletting shall not be unreasonably withheld. 80.4 CHANGE IN CONTROL. PARAGRAPH 11.1(B) of the Printed Lease is hereby deleted in its entirety and the following is hereby substituted in lieu thereof: "(b) If the stock in Lessee (or in Lessee's parent or successor corporation) is not publicly traded on a national stock exchange such as, by way of illustration only, NASDAQ, the New York Stock Exchange, American Stock Exchange or Pacific Stock Exchange, then a change in control of Lessee shall constitute an assignment requiring consent. The transfer, on a cumulative basis, of twenty-five percent (25%) or more of the voting control of Lessee shall constitute a change in control for this purpose." 81. HAZARDOUS SUBSTANCES. 81.1 Prior to Lessor delivering the Premises to the Lessee, Lessor shall deliver to Lessee a Phase I report of the Premises which shall be prepared by Lessor's consultant at Lessor's sole cost and expense. Lessor hereby warrants and represents to Lessee as of the date this Lease is fully executed and delivered that Lessor has no actual knowledge that there are any Hazardous Substances in, under or about the Premises, other than as disclosed (or to be disclosed) in said Phase I report. In the event that such report discloses that there is a Hazardous Substance Condition as to which Applicable Requirements require remediation, then Lessor shall have the right, at its sole discretion, to either: (a) remediate said Hazardous Substance Condition at Lessor's sole cost and expense; or, (b) terminate this Lease in which event Lessor shall promptly return to Lessee all sums Lessee has paid to Lessor as advance Rent. Page 31 81.2 PARAGRAPH 5.2(G) of the Printed Lease is hereby deleted in its entirety and the following is hereby substituted in lieu thereof: "(g) LANDLORD TERMINATION OPTION. If a Hazardous Substance Condition occurs during the term of this Lease, unless Lessee is legally responsible therefor (in which case Lessee shall make the investigation and remediation thereof required by the Applicable Requirements and this Lease shall continue in full force and effect, but subject to Lessor's rights under PARAGRAPH 5.2(D) and PARAGRAPH 12), Lessor may, at Lessor's option, either (i) investigate and remediate such Hazardous Substance Condition, if required, as soon as reasonably possible at Lessor's expense, in which event this Lease shall continue in full force and effect, or (ii) if the estimated cost to remediate such condition exceeds twenty five percent (25%) of the fair market value of the Premises (as defined below in this PARAGRAPH 5.2(G)), give written notice to Lessee within thirty (30) days after receipt by Lessor of knowledge of the occurrence of such Hazardous Substance Condition, of Lessor's desire to terminate this Lease as of the date sixty (60) days following the date of such notice. In the event Lessor elects to give a termination notice, this Lease shall terminate as of the date specified in Lessor's notice of termination. In the event Lessor does not elect to give a termination notice, this Lease shall continue in full force and effect, and Lessor shall proceed to make such remediation as soon as reasonably possible. The "FAIR MARKET VALUE OF THE PREMISES" for purposes only of this PARAGRAPH 5.2(G) shall be the fair market value of the Premises for its then use that a comparable owner of comparable quality property in the vicinity of the Premises ("COMPARABLE PREMISES" herein) would accept in current transactions between non-affiliated parties, from a buyer which is not a lessee of the Comparable Premises, of comparable credit worthiness, for comparable space, with comparable parking, with comparable operating expenses, with comparable real property taxes, for a comparable period of time." 82. INDEMNITY FROM LESSOR. Lessor shall indemnify, protect, defend and hold harmless Lessee and its agents, partners and lenders, from and against any and all claims, loss of rents and/or damages, liens, judgments, penalties, attorneys' and consultants' fees, expenses and/or liabilities arising out of, involving, or in connection with, the Lessor's gross negligence or willful misconduct. If any action or proceeding is brought against Lessee by reason of any of the foregoing matters, Lessor shall upon notice defend the same at Lessor's expense by counsel reasonably satisfactory to Lessee and Lessee shall cooperate with Lessor in such defense. Lessee need not have first paid any such claim in order to be defended or indemnified. 83. SUBMISSION OF LEASE. THE SUBMISSION OF THIS LEASE BY LESSOR SHALL NOT CONSTITUTE AN OFFER TO LEASE THE PREMISES TO LESSEE. THIS LEASE SHALL NOT BE BINDING BETWEEN LESSOR AND LESSEE UNTIL IT IS FULLY EXECUTED AND DELIVERED AND ALL SUMS LESSEE IS REQUIRED TO PAY LESSOR UPON THE EXECUTION HEREOF HAVE BEEN PAID ON THE EXECUTION Page 32 HEREOF AND ALL DOCUMENTS WHICH LESSEE IS REQUIRED TO DELIVER TO LESSOR UPON THE EXECUTION HEREOF HAVE BEEN DELIVERED TO LESSOR; [The remainder of this page has intentionally been left blank.] Page 33 AND THIS LEASE SHALL NOT BE CONSTRUED IN FAVOR OR AGAINST THE PARTY WHO DRAFTED IT. LESSOR: DATED: February __, 1999. /S/ WERNER WOLFEN ------------------------------------- WERNER WOLFEN, TRUSTEE OF THE LOUIS GLASIER 1974 REVOCABLE TRUST /S/ MICHAEL DUNITZ ------------------------------------- MICHAEL DUNITZ /S/ NANCY BRUCH ------------------------------------- NANCY BRUCH /S/ DOROTHY A. DUNITZ ------------------------------------- DOROTHY A. DUNITZ /S/ HARVEY ROSENBERG ------------------------------------- HARVEY ROSENBERG /S/ JUDY ROSENBERG ------------------------------------- JUDY ROSENBERG LESSEE: DATED: February __, 1999. VETERINARY CENTERS OF AMERICA, INC., A DELAWARE CORPORATION BY: /s/ Robert L. Antin Robert L. Antin Its President BY: /s/ Tomas Fuller Tomas Fuller Its Vice President Page 34 SCHEDULE OF EXHIBITS Exhibit "A" - Plot Plan of Premises Exhibit "B" - Demolition Plan Exhibit "C" - Window Plan Exhibit "D" - Estimates from Prats/Coffee Page 35 EXHIBIT "A" PLOT PLAN OF PREMISES [See attachment.] Page 36 EXHIBIT "B" DEMOLITION PLAN Lessor shall: (a) remove all presently existing interior tenant improvements in Buildings A, B and C back to the perimeter walls; and, (b) expose the interior underside of the roof in Buildings A and B. Page 37 EXHIBIT "C" WINDOW PLAN 1. BUILDING A. a. IN GENERAL. Lessor shall clean the interior and exterior sides of the presently existing windows and window frames. Lessor shall replace any broken glass. If any windows have been blacked-out, Lessor will remove the blacked-out portions. If the blacked-out panes cannot be removed, Lessor will replace the glass with clear glass panes. b. NORTH WALL. Lessor shall install window frames and windows where there were once windows which are presently bricked up. It is not possible as of the date this Lease is prepared to determine how many windows there were in the north wall because there are tenant improvements and trailers covering the walls. Once those tenant improvements and trailers are removed, it will be possible to determine the number of windows which once existed in the north wall; provided, Lessor shall not be required to install more than three (3) new windows and window frames in the north wall. 2. BUILDING B. a. EAST WALL. Lessor shall clean the interior and exterior sides of the presently existing windows and window frames. Lessor shall replace any broken glass. If any windows have been blacked-out, Lessor will remove the blacked-out portions. If the blacked-out panes cannot be removed, Lessor will replace the glass with clear glass panes. b. WEST WALL. i. Lessor shall clean the interior and exterior sides of the presently existing window and window frame. Lessor shall replace any broken glass. If any window has been blacked-out, Lessor will remove the blacked-out portions. If the blacked-out panes cannot be removed, Lessor will replace the glass with clear glass panes. ii. There is a presently existing door in the west wall. If Lessee's floor plan calls for a window to be installed where said door exists, the Lessor shall install a window and window frame where said door exists, subject to structural engineering for the building permitting same. c. NORTH WALL. There are currently no windows in the north wall. Lessor shall not be required to install window frames or windows where there were once windows which are presently bricked up or otherwise covered over with stucco or other building materials. d. SOUTH WALL. There are currently no windows in the south wall. Lessor shall install window frames and windows where there were once windows which are presently bricked up or otherwise covered over with stucco or other building materials, subject to structural engineering for the building permitting same. It is not possible as of the date this Lease is prepared to determine how many windows there were in the south wall because there are interior Page 38 tenant improvements (i.e., the cyclorama), trailers, and brick, stucco or other building materials covering the walls. Once those tenant improvements and trailers are removed and the brick, stucco or other building materials exposed, it will be possible to determine the number of windows which once existed in the south wall. It appears that the number of windows in the south wall originally matched the number and placement of the windows in the north wall. Lessor shall not be required to install more than four (4) new windows and window frames in the south wall. 3. BUILDING C. a. SOUTH WALL. There are roll-up doors in the south wall of each unit of Building C. Any work in connection with removing any or all of said roll-up doors and replacing same with windows, shall be part of Lessee's Work for which the Allowance is being furnished, as more particularly provided in Paragraph 53.1 of this Lease. 4. GENERAL. a. The size and materials for any new windows frames and windows Lessor is obligated to install shall match as closely as possible the presently existing windows in any of the Buildings. b. In the event Lessor is obligated to install new window frames, the parties acknowledge that the lead time to order the window frames is approximately 6 weeks. Lessor will require at least that much time after it receives Lessee's floor plan to order the window frames and windows and any time periods provided in this Lease for Lessor to install such new windows shall be automatically extended to incorporate said lead time. Page 39 EXHIBIT "D" ESTIMATES FROM PRATS/COFFEE [See attachment.] Page 40 "PRATS/COFFEE LETTERHEAD" 1/18/99 Mr. Rick Wolfen ROCK ASSET MANAGEMENT 9777 Wilshire Blvd., Suite 710 Beverly Hills, CA 90212 RE: Estimate. DESCRIPTION: Olympic property. 1. DEMOLITION $115,000.00 -Demolish and remove the existing improvements in the three (3) buildings including mechanical roof equipment not in use to be discarded. -Miscellaneous items typically not part of improvements. 2. SAND BLASTING $16,200.00 -Sand blast brick wall in building #1 and building #2. -Sand blast trusses and roof decking. -Clean up. 3. ROOFING $90,000.00 -Remove existing roof material to wood deck. -Furnish and install 2-1/2" rigid foam board. -Furnish and install 1/2" fiber board. -Install 3-ply roof system. *This roof is guaranteed for 10 years. **Price does not include 1/2 plywood sheathing if required. 4. HVAC $76,000.00 -Install new HVAC system in building #1. -System is to be designed to accommodate new tenant. -55-ton package is estimated. -Building #2 design and reuse existing equipment. -Remove equipment not needed. 5. FLOORING $10,000.00 -Provide clean floor. -Evaluate condition of floor after demolition. -Patch to level condition. *This item will need to be discussed, an allowance has been made. 6. REST ROOMS $50,000.00 -Build new restrooms in building #1 and building #2. -Location and size to be determined. *This is an allowance 7. SKYLIGHTS $30,000.00 -Clerestory type of skylights considered for the three buildings. -Location and size to be determined. *This is an allowance only as we need to know structural requirements. 8. WINDOWS $15,000.00 -Windows are to be cleaned. -Broken glass replaced. -Hardware shall be repaired and left in working condition. -Windows removed by previous tenant shall be replaced to match existing. 9. SPRINKLERS $6,500.00 -Existing sprinkler heads shall be removed and relocated under roof deck to accommodate new design. *This is an allowance only. 10. PARKING LOT $3,900.00 -Repair damaged areas and slurry coat surface of front parking lot (approximately 12,000 s.f.) -Replace damaged concrete bumpers and restripe area. Page 42 Sub-total $412,600.00 Contingency 5% $ 20,630.00 Sub-total $433,230.00 General Conditions/Overhead/Profit 20% $ 86,646.00 ------------ TOTAL PROPOSAL $519,876.00 Page 43 FIRST AMENDMENT TO STANDARD INDUSTRIAL/COMMERCIAL SINGLE-TENANT LEASE - NET This First Amendment to Standard Industrial/Commercial Single-Tenant Lease - Net ("AMENDMENT" herein) is made and entered into as of March 11, 1999 by and between WERNER WOLFEN, TRUSTEE OF THE LOUIS GLASIER 1974 REVOCABLE TRUST, MICHAEL DUNITZ, NANCY BRUCH, DOROTHY A. DUNITZ, HARVEY ROSENBERG, AND JUDY ROSENBERG ("LESSOR" collectively herein) and VETERINARY CENTERS OF AMERICA, INC., A DELAWARE CORPORATION ("LESSEE" herein) with reference to the following facts: A. Lessor and Lessee entered into that certain Standard Industrial/Commercial Single-Tenant Lease - Net dated January 1, 1999 ("LEASE" herein). B. The Lease provided that certain matters would be left for future agreement of the Parties. C. The Parties desire to amend the Lease as hereinafter more particularly provided. NOW, THEREFORE, in consideration of the covenants, premises and agreements, the parties hereto do hereby agree as follows: 1. DESCRIPTION OF LESSOR'S WORK. Paragraph 52.1 of the Lease is hereby deleted in its entirety and the following is hereby inserted in lieu thereof: "52.1 DESCRIPTION OF LESSOR'S WORK. 52.1.1 LESSOR'S PHASE ONE WORK. After all contingencies to the effectiveness of this Lease have expired or been waived, at Lessor's sole cost and expense, Lessor shall perform only the following Alterations for Lessee ("LESSOR'S PHASE ONE WORK" collectively herein): (A) Lessor shall deliver Buildings A, B and C to Lessee in broom clean condition; and, (B) Lessor shall demolish the non-structural improvements in Buildings A, B and C (including the presently existing men's and women's restrooms in Buildings A, B and C) which improvements are shown on the Demolition Plan which is attached hereto as EXHIBIT "B"; and, (C) Lessor shall perform Lessor's Phase One Work in compliance with all Applicable Requirements including, but not limited to, compliance with fire code requirements and any work necessary for the Lessor's Phase One Work to comply with the Americans with Disabilities Act or any similar Applicable Requirements pertaining to access by handicapped persons, all of which shall be accomplished without regard to Lessee's Work. Lessee shall at Lessee's sole cost and expense cause any of Lessee's Work to comply with the Americans With Disabilities Act including but not limited to any compliance with the Americans With Disabilities Act for matters which are not Lessee's Work which are triggered by Lessee's Work. After the Commencement Date, Lessee shall at Lessee's sole cost and expense (except as Page 1 provided above) cause the Premises and any Alterations and/or Utility Installations done by Lessee and Lessee's Work to comply with the Americans With Disabilities Act; and, (D) Lessor shall provide Lessee with information concerning the condition and specifications of the presently existing electrical system. By signing this Lease, Lessee approves such condition and specifications; and, (E) Provide level floors throughout the Premises using the existing floor as a benchmark; and, (F) Abate asbestos-containing material, if any, or other Hazardous Substances, if any, in the Premises in accordance with Applicable Requirements. Lessor shall have the sole right to determine whether the method employed will be removing or remediating the asbestos, taking into consideration the extent that Lessee's Work will disturb any existing asbestos-containing materials or other Hazardous Substances; and, (G) The presently existing fire sprinkler system shall be delivered in good working order without reference to the use for which Lessee shall use the Premises. 52.1.2 LESSOR'S PHASE TWO WORK. After all contingencies to the effectiveness of this Lease have expired or been waived, and after Lessee has delivered Lessor Plans (as defined in PARAGRAPH 53.7 which have been approved by the City of Los Angeles and Lessor, Lessor's sole cost and expense, Lessor shall perform only the following Alterations for Lessee ("LESSOR'S PHASE TWO WORK" collectively herein); provided, however, Lessor may, but shall not be obligated to, perform the Lessor's Phase Two Work prior to Lessee delivering to Lessor the Plans which have been approved by the City of Los Angeles and Lessor: (A) HVAC. (1) IN GENERAL. Lessor shall provide information to Lessee regarding the condition and specifications of the presently existing HVAC units. By signing this Lease, Lessee approves such condition and specifications. Lessor shall deliver the HVAC units to Lessee in good operating condition as required by and subject to PARAGRAPH 2.2 of this Lease. Lessor and Lessee shall use the same contractor for performing their respective work in connection with the HVAC system in Building A, Building B and Building C. Notwithstanding anything to the contrary contained in this Lease, Lessee shall not be responsible for the capital costs of replacing such HVAC units unless the reason for such replacement was that Lessee failed to maintain the HVAC service contracts required by this Lease or failed to perform routine maintenance of such units. Lessee shall keep in force and effect at Lessee's sole cost and expense a service and maintenance contract with respect to the HVAC units. (2) BUILDING A. Lessor shall install new HVAC equipment for Building A, the tonnage for which shall not exceed 57 tons. Lessee (not Lessor) shall be responsible for: (a) distribution of the HVAC within the Building A as well as condensate drains; and, (b) bringing electricity from the panel to the HVAC units for Building A. Concurrently with the execution and delivery of this Lease, Lessee shall provide the specific size of the units, number of units and location of said units. Lessor is not able to order nor perform such work unless and until Lessee has provided said information to Lessor. Page 2 (3) BUILDING B. Lessor shall provide one (1) of the presently existing 10 ton HVAC units and one (1) presently existing 7.5 ton HVAC units; both of said units are presently on Building B. Lessor shall also provide heat. Lessee (not Lessor) shall be responsible for distribution of the HVAC within Building B as well as condensate drains. Lessor shall bring electricity from the panel to the HVAC units for Building B. (4) BUILDING C. Lessor shall provide one (1) of the presently existing 5 ton HVAC units and one (1) of the presently existing 10 ton units; both of said units are presently on Building C. In addition, Lessor shall relocate one (1) of the presently existing 10 ton units from Building B to Building C. In addition, Lessor shall provide a new 6 to 7 ton unit on Building C. Lessor shall also hook up the gas to provide heat to Building C. Lessee (not Lessor) shall be responsible for distribution of the HVAC within the Building C as well as condensate drains. Lessor shall bring electricity from the panel to the HVAC units for Building C; and, (B) Re-install or install the windows shown on the Window Plan which is attached hereto as EXHIBIT "C" and incorporated herein by this reference. The Window Plan shall also contain the size and specifications for such windows; and, (C) Remove the presently existing broadcast tower at the rear of the Premises; and, (D) Install a new roof on the A Building, B Building and C Building; and, (E) Lessor shall sandblast the interior and exterior walls and ceilings of Buildings A and B only, including the north exterior side of Building B as to which side approximately four inches of concrete shall not be removed unless Lessee, in Lessee's sole and absolute discretion, disapproves the appearance of the north exterior side of Building B after it has been sandblasted and sealed. If Lessee disapproves such appearance, Lessor shall apply a plaster skim coat to said north exterior side of Building B; and, (F) Building to meet City seismic code requirements but only if mandated and required by any earthquake hazard ordinance in effect as of the Commencement Date (but not if required due to Lessee's Work, Lessee Owned Alterations and/or Utility Installations or by the use to which Lessee will put the Premises); and, (G) Install rigid insulation with an R-factor of R-19, which meets current building codes on the roof of Building A, Building B and Building C; provided, however, that if Lessee wants any insulation which costs more than R-19, Lessee shall pay be increased cost; and, (H) Lessor to provide sewer and water to Building B. Any modifications required by Lessee's Plans to the presently existing sewer and water lines to Building C shall be paid for and performed by Lessee; and, (I) Slurry coat, re-stripe and repair the parking lot area; and, Page 3 (J) Install skylights in the front two (2) buildings; and, (K) Install windows where there are roll-up doors in the C Building." 2. EXHIBIT "C" - WINDOW PLAN. Exhibit "C" which is attached to the Lease is hereby deleted in its entirety and Exhibit "C" which is attached to this Amendment is hereby substituted in lieu thereof. 3. LESSEE'S WORK. Paragraph 53.1 of the Lease is hereby deleted in its entirety and the following is hereby inserted in lieu thereof. "53.1 LESSEE'S WORK. If Lessee desires any Alterations and/or Utility Installations to the Premises ("LESSEE'S WORK" herein), Lessee shall comply with all of the terms and provisions of this Lease including but not limited to PARAGRAPH 6 of this Lease. Lessee shall construct all of such Lessee's Work at Lessee's sole cost and expense, except as hereinafter provided. Lessor hereby agrees to provide Lessee with an Allowance in the total amount of One Hundred Thousand Three Hundred Dollars ($100,300), subject to PARAGRAPH 52.7, so that Lessee shall perform the following as part of Lessee's Work: 53.1.1 Install new men's and women's restrooms in Buildings A, B and C in compliance with all Applicable Requirements. The restroom fixtures and configuration shall be subject to the mutual approval of Lessor and Lessee; and, 53.1.2 Slurry coat, re-stripe and repair the parking lot area; and, 53.1.3 Install skylights in the front two (2) buildings; and, 53.1.4 Install windows where there are roll-up doors in the C Building as shown on the Window Plan which is attached hereto as EXHIBIT "C". The Window Plan shall also contain the size and specifications for such windows. The amount of the Allowance is based on amounts contained in EXHIBIT "D". The Parties recognize that said figure is based on estimates which have not been bid out to subcontractors. The only way to determine the exact amount of any particular item is to have it bid out to subcontractors. The successful subcontractor would then sign a contract becoming contractually bound to honor the price for the particular work in question. The Lessee has an immediate need for the Premises because Lessee's existing office lease expires soon. The Parties are using said estimates, rather than figures which have been bid to subcontractors, in order to get this Lease signed in time for work to be done so Lessee may move into the Premises on or about the time its existing office lease expires. Lessee acknowledges that Lessee has had said estimates reviewed by Lessee and by its design professionals, including but not limited to architect, space planner, engineers, and contractors. Lessor shall not be liable to Lessee and the amount of the Allowance shall not be increased if said estimates are not accurate, except as hereinafter provided." 4. EXHIBIT "D". Exhibit "D" which is attached to the Lease is hereby deleted in its entirety and Exhibit "D" which is attached to this Amendment is hereby substituted in lieu thereof. Page 4 5. ASSIGNMENT AND SUBLETTING - PERMITTED TRANSFER. Paragraph 80.2 of the Lease is hereby deleted in its entirety and the following is hereby inserted in lieu thereof: " 80.2 PERMITTED TRANSFERS. Notwithstanding anything to the contrary contained in PARAGRAPH 11 of the Lease, Lessee shall have the right to make "PERMITTED TRANSFERS" (as that term is more particularly hereinafter defined) without Lessor's prior written consent and without payment of any Transfer Consideration; provided, however, that prior to such Permitted Transfer Lessee gives Lessor written evidence reasonably satisfactory to Lessor that the Transfer in question fulfills the definition of a Permitted Transfer together with a written representation and warranty of Lessee that the Permitted Transfer is a Permitted Transfer. Lessee shall be entitled to keep all consideration of any kind received in connection with any Permitted Transfer. In the event of a Permitted Transfer, the original Lessee named herein, shall remain primarily liable after such Permitted Transfer under this Lease for all of the obligations and payments of Rent required under this Lease. The term "PERMITTED TRANSFER" shall mean and include only the involvement of Lessee or its assets in any transaction, or series of transactions (by way of merger, sale, acquisition, financing, transfer, leveraged buy-out or otherwise), whether or not a formal assignment or hypothecation of this Lease or Lessee's assets occurs, which does not result or will not result in a reduction of the Net Worth of Lessee below the "PERMITTED TRANSFER NET WORTH" (as that term is hereinafter more particularly defined). "PERMITTED TRANSFER NET WORTH" shall mean: (a) during the first twelve (12) months after the date of this Lease, the Net Worth of Lessee in the amount of Thirty Five Million Dollars ($35,000,000); and, in each twelve (12) month period thereafter during the Original Term and during any Option Period, the amount of the Permitted Transfer Net Worth for the immediately preceding twelve (12) month period multiplied by 1.03. "NET WORTH OF LESSEE" shall mean the net worth of Lessee (excluding any guarantors) established under generally accepted accounting principles." 6. ASSIGNMENT AND SUBLETTING - CHANGE IN CONTROL. Paragraph 80.4 of the Lease is hereby deleted in its entirety and the following is hereby inserted in lieu thereof: " 80.4 CHANGE IN CONTROL. PARAGRAPH 11.1(B) of the Printed Lease is hereby deleted in its entirety and the following is hereby substituted in lieu thereof: `(b) If the stock in Lessee (or in Lessee's parent or successor corporation) is not publicly traded on a national stock exchange such as, by way of illustration only, NASDAQ, the New York Stock Exchange, American Stock Exchange or Pacific Stock Exchange, then a change in control of Lessee shall constitute an assignment requiring consent. The transfer, on a cumulative basis, of more than fifty percent (50%) of the voting control of Lessee shall constitute a change in control for this purpose."' 7. DEFINED TERMS. Capitalized terms which are not defined in this Amendment shall have the same definitions as in the Agreement. [The remainder of this page has intentionally been left bank.] Page 5 [Continuation of First Amendment to Standard Industrial/Commercial Single-Tenant Lease - Net made and entered into as of March 11, 1999] 8. RATIFICATION. Except as provided in this Amendment, the Lease shall remain unmodified and in full force and effect. IN WITNESS WHEREOF, the parties have executed this Amendment as of the day and year first mentioned above. Page 6 LESSOR DATED: March __, 1999 /S/ WERNER WOLFEN ------------------------------------ WERNER WOLFEN, TRUSTEE OF THE LOUIS GLASIER 1974 REVOCABLE TRUST /s/ Michael Dunitz ------------------------------------ MICHAEL DUNITZ /s/ Nancy Bruch ------------------------------------ NANCY BRUCH /s/ Dorothy A. Dunitz ------------------------------------ DOROTHY A. DUNITZ /s/ Harvey Rosenberg ------------------------------------ HARVEY ROSENBERG /s/ Judy Rosenberg ------------------------------------ JUDY ROSENBERG LESSEE: DATED: March 11, 1999 VETERINARY CENTERS OF AMERICA, INC., A DELAWARE CORPORATION By: /s/ Robert L. Antin Robert L. Antin Its: President By: /s/ Tomas Fuller Tomas Fuller Its: Vice President Page 7 EXHIBIT "C" WINDOW PLAN 1. BUILDING A. a. IN GENERAL. Lessor shall clean the interior and exterior sides of the presently existing perimeter windows and perimeter window frames. Lessor shall replace any broken glass. If any windows have been blacked-out, Lessor will remove the blacked-out portions. If the blacked-out panes cannot be removed, Lessor will replace the glass with clear glass panes. Lessor shall not have any obligation to demolish nor to replace the presently existing interior windows. b. NORTH WALL. Lessor shall clean and repair the presently existing window and door. The presently existing bathroom window in the bathroom along the north side of the building shall be enlarged and replaced to match the other presently existing windows, subject to structural engineer's review and approval. 2. BUILDING B. a. EAST WALL. Lessor shall clean the interior and exterior sides of the presently existing windows and window frames. Lessor shall replace any broken glass. If any windows have been blacked-out, Lessor will remove the blacked-out portions. If the blacked-out panes cannot be removed, Lessor will replace the glass with clear glass panes. b. WEST WALL. i. Lessor shall clean the interior and exterior sides of the presently existing window and window frame. Lessor shall replace any broken glass. If any window has been blacked-out, Lessor will remove the blacked-out portions. If the blacked-out panes cannot be removed, Lessor will replace the glass with clear glass panes. ii. There is a presently existing door in the west wall. If Lessee's floor plan calls for a window to be installed where said door exists, the Lessor shall install a window and window frame where said door exists, subject to structural engineering for the building permitting same. iii. In lieu of restoring the northernmost window on the west wall Building B, Lessor will pay for and install a standard size, roll-up, garage door (with window glass) to fit the existing opening and fill in the area around the new door. c. NORTH WALL. There are currently no windows in the north wall. Since Lessee's plan shows no window in this wall, Lessor shall not be required to install window frames or windows where there were once windows which are presently bricked up or otherwise covered over with stucco or other building materials. Page 8 d. SOUTH WALL. Lessor shall clean the interior and exterior sides of the presently existing perimeter windows and perimeter window frames. Lessor shall replace any broken glass. If any windows have been blacked-out, Lessor will remove the blacked-out portions. If the blacked-out panes cannot be removed, Lessor will replace the glass with clear glass panes. 3. BUILDING C. a. SOUTH WALL. There are roll-up doors in the south wall of each unit of Building C. Any work in connection with removing any or all of said roll-up doors and replacing same with windows, shall be part of Lessee's Work for which the Allowance is being furnished, as more particularly provided in Paragraph 53.1 of this Lease. 4. GENERAL. a. The size and materials for any new window frames and windows Lessor is obligated to install shall match as closely as possible the presently existing windows in any of the Buildings. b. In the event Lessor is obligated to install new window frames, the parties acknowledge that the lead time to order the window frames is approximately 6 weeks. Lessor will require at least that much time after it receives Lessee's floor plan to order the window frames and windows and any time periods provided in this Lease for Lessor to install such new windows shall be automatically extended to incorporate said lead time. c. In lieu of Lessor providing any of Lessor's Work for Building A and for Building B which is provided under this Exhibit "C", Lessee may elect to receive an Allowance from Lessor in the amount of Thirty Thousand Dollars ($30,000), which amount shall be in addition to the Allowance provided in PARAGRAPH 53.1 of the Lease. In order to make this election, Lessee shall give Lessor written notice thereof on or before MARCH 15, 1999. If Lessee fails to give such written notice within the time and in the manner provided herein, it shall be deemed that Lessee has elected not to accept said Allowance. End of Exhibit "C" Page 9 Exhibit "D" COMPUTATION OF ALLOWANCE FOR LESSEE'S WORK ITEM AMOUNT ---------------------------------- ---------------------- Installation of new restrooms $85,000.00 Add: 18% from profit and overhead $15,300.00 TOTAL ALLOWANCE $100,300.00 End of Exhibit "D" Page 10 EX-23 4 ex-23_1.txt EXHIBIT 23.1-CONSENT OF ARTHUR ANDERSEN LLP CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the use in this registration statement of our report dated March 28, 2001 included herein and to all references to our Firm included in this registration statement. /s/ Arthur Andersen LLP ARTHUR ANDERSEN LLP Los Angeles, California October 15, 2001