-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, V2U4/CqDGHlom0QDYrwJYVV6DSHCUXqGvm61xNchPvsB9hKemWLTdqrsjZlc+u4+ QxNRrBEZLyHorO0VIdOmWQ== 0001011438-97-000053.txt : 19970501 0001011438-97-000053.hdr.sgml : 19970501 ACCESSION NUMBER: 0001011438-97-000053 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970430 SROS: NASD 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: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-19935 FILM NUMBER: 97592179 BUSINESS ADDRESS: STREET 1: 3420 OCEAN PARK BLVD STE 1000 CITY: SANTA MONICA STATE: CA ZIP: 90405 BUSINESS PHONE: 3103929599 MAIL ADDRESS: STREET 1: 3420 OCEAN PARK BLVD STE 1000 CITY: SANTA MC STATE: CA ZIP: 90405 10-K/A 1 AMENDMENT NO. 1 TO ANNUAL REPORT ON FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A AMENDMENT NO. 1 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 1-10787 VETERINARY CENTERS OF AMERICA, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 95-4097995 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 3420 OCEAN PARK BOULEVARD, SUITE 1000 Santa Monica, California 90405 (Address of principal executive offices and zip code) (310) 392-9599 (Registrant's telephone number, including area code) SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: Common stock, $.001 par value Redeemable Warrants Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes _X_ No ___. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any Amendment to this Form 10-K. [ ] At March 26, 1997, there were outstanding 19,344,643 shares of the Common Stock of Registrant and the aggregate market value of the shares held on that date by non-affiliates of Registrant, based on the closing price ($10.75 per share) of the Registrant's Common Stock on the NASDAQ National Market, was $188,228,000. For purposes of this computation, it has been assumed that the shares beneficially held by directors and officers of Registrant were "held by affiliates;" this assumption is not to be deemed to be an admission by such persons that they are affiliates of Registrant. DOCUMENTS INCORPORATED BY REFERENCE Portions of Registrant's Proxy Statement relating to its 1997 Annual Meeting of Stockholders are incorporated by reference in Part III of this Annual Report. PART II ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General Founded in 1986, VCA is a leading companion animal health care company operating in the markets for veterinary care, veterinary diagnostic laboratories and premium pet food. The Company made its first animal hospital acquisition in December 1986, when it acquired West Los Angeles Animal Hospital, one of the largest privately-owned teaching animal hospitals in the United States. Between 1987 and 1992, the Company's operations were directed primarily at establishing a corporate infrastructure and building a network of animal hospitals in selected regional markets. During this period, the Company grew with the acquisition of 17 additional animal hospitals and one veterinary diagnostic laboratory. In 1993, the Company began to expand the scope of its operations in order to realize its goals of integrating the markets for veterinary care, veterinary diagnostic laboratories and premium pet food. The integration of these three markets is the foundation of the Company's business strategy to leverage its access to its primary customers, veterinarians and pet owners. From January 1, 1993 through December 31, 1995, the Company acquired and integrated into its operations 36 animal hospitals. Also in 1993, the Company entered into a joint venture called Vet's Choice with HPP to develop, manufacture and market a full-line of premium pet food. In March 1994, the Company expanded its veterinary diagnostic laboratory operations by acquiring a 70 percent interest in Professional Animal Laboratory ("PAL"). In January 1995, the Company acquired an additional veterinary diagnostic laboratory, Cenvet, Inc. ("Cenvet"), which it then contributed in March 1995 to, Vet Research Laboratories, LLC ("Vet Research"), a joint venture, in exchange for a 51 percent interest therein. Vet Research is a combination of the operations of Cenvet and that of a full-service veterinary laboratory known as Vet Research, Inc. ("VRI"). In 1995, the Company further expanded its veterinary diagnostic laboratory operations by acquiring three smaller, regional veterinary diagnostic laboratories and by purchasing the remaining 30 percent interest in PAL. In 1996, the Company continued its expansion of animal hospital operations with the mergers with Pets' Rx in June 1996 (16 hospitals) and Pet Practice in July 1996 (84 hospitals) as well as the acquisition of an additional 22 animal hospitals in separate transactions throughout the year. The Company's laboratory operations were expanded with the acquisition of Southwest Veterinary Diagnostics Laboratory, Inc. ("Southwest") in March 1996, and five other laboratories throughout the year. At December 31, 1996, the Company owned or operated 161 animal hospitals which were located in 22 states. The Company's network of veterinary diagnostic laboratories consists of four full-service laboratories and eight "STAT" (quick response) laboratories located throughout the country. The acquisition of all of the outstanding shares of Pets' Rx in June 1996 was treated for accounting purposes as a pooling of interests. Accordingly, the accompanying financial statements reflect the combined results of the pooled businesses for the respective periods presented. Previously reported financial information for VCA and Pets' Rx for each of the three years in the period ended December 31, 1996, is shown in the table below.
Years Ended December 31, 1996 1995 1994 ------------ ----------- ---------- Revenues: Pre-merger VCA $ 64,763,000 $ 92,072,000 $42,233,000 Pets' Rx 7,849,000 15,622,000 9,638,000 ------------ ------------ ------------ 72,612,000 107,694,000 51,871,000 Post-merger 109,548,000 -- -- ------------ ------------ ------------ $182,160,000 $107,694,000 $51,871,000 PAGE 2 Net (loss) income: Pre-merger VCA $1,647,000 $2,564,000 $589,000 Pets' Rx (658,000) (1,977,000) (2,805,000) Merger adjustments 212,000 (1,801,000) 309,000 ------------- ------------ ------------ 1,201,000 (1,214,000) (1,907,000) Post-merger (15,833,000) -- -- ------------- ------------ ------------ $(14,632,000) $(1,214,000) $(1,907,000) ============= ============ ============
VCA's 1996 pre-merger net income includes merger expenses of $2,901,000; these expenses consist principally of legal, accounting, investment advisor, termination of employment agreements and severance costs. The merger adjustments were recorded to conform certain accounting methods of Pets' Rx to those of VCA. These adjustments reduced intangible asset amortization expense by $212,000, $347,000 and $309,000 in 1996, 1995 and 1994, respectively, and wrote-off intangible assets of $2,148,000 in 1995 associated with certain animal hospitals whose projected future operating results would not result in the recovery of such intangible assets under VCA's accounting method. RECENT ACQUISITIONS For a discussion of recent acquisitions see "Business--Recent Developments." BASIS OF REPORTING For 1996, the Company reported its operations in three business lines- - -Animal Hospital, Laboratory and Premium Pet Food. Animal Hospital operations include the operations of the Company's animal hospitals. Laboratory operations include the operations of VCA Lab (merged into PAL in March 1994), PAL (acquired in March 1994), Cenvet (from the date acquired, January 1, 1995 through the formation of Vet Research in March 1995), Vet Research and four smaller veterinary laboratories since the date of acquisition in 1995 and Southwest (acquired in March 1996) and 5 smaller laboratories acquired in 1996. The Company acquired the remaining 30 percent interest in PAL from its minority interest partner effective July 1, 1995. Throughout 1996, the Company owned a 51 percent interest in Vet Research. The Company acquired the remaining 49% in January 1997. Premium Pet Food includes the operations of the Vet's Choice joint venture of which the Company owns a 50.5 percent interest. During 1993, Vet's Choice was primarily engaged in developing and testing the formulas for its first product line, SELECT BALANCE, and building a marketing infrastructure in anticipation of commencing distribution in 1994. Vet's Choice began to generate revenue in March 1994 with the launch of SELECT BALANCE. In 1995, Vet's Choice began selling its second product line, SELECT CARE. The Company's operating results include the results of operations of the joint ventures on a consolidated basis. Commencing February 1, 1997, the day-to-day management of Vet's Choice was assumed by HPP. The Company maintains its 50.5% equity interest in Vet's Choice but profits and losses are allocated 99.9% to HPP and 0.1% to the Company. The Company will no longer report the results of operations of Vet's Choice on a consolidated basis. The Company's animal hospitals use the Company's veterinary diagnostic laboratory services and purchase and resell the pet food products of Vet's Choice. Revenue and the corresponding expense from intercompany sales totaling $4,130,000, $1,727,000 and $759,000 in 1996, 1995, 1994, respectively, have been eliminated from the Company's operating results. PAGE 3 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the percentage of certain items in relation to revenues.
Percentage of Revenues For the Years Ended December 31, -------------------------------- 1996 1995 1994 ------ ------ ------ Revenues 100.0% 100.0% 100.0% Direct costs 76.6 74.4 78.6 Gross profit 23.4 25.6 21.4 Selling, general and administrative 10.8 12.7 16.9 Depreciation and amortization 4.1 3.8 4.0 Merger costs 1.6 -- -- Restructuring charges 3.1 1.0 -- Writedown of assets 5.3 2.0 -- Operating (loss) income (1.5) 6.1 0.5 Interest income 2.5 0.8 0.8 Interest expense 4.3 3.2 4.6 (Loss) income before minority interest and income taxes (3.3) 3.7 (3.3) Minority interest in income (loss) of subsidiaries 3.6 2.7 (1.0) (Loss) income before income taxes (6.9) 1.0 (2.3) Provision for income taxes 1.1 2.1 1.4 Net loss (8.0)% (1.1)% (3.7)%
REVENUES Animal Hospital operations represented approximately 66.3%, 62.2% and 80.0% of total Company revenues in 1996, 1995 and 1994, respectively. Laboratory operations represented 30.0%, 34.2% and 18.6% of total Company revenues in 1996, 1995 and 1994, respectively. Premium Pet Food operations represented 3.7%, 3.6% and 1.4% of total Company revenues in 1996, 1995 and 1994, respectively. The Company anticipates that Animal Hospital revenues as a percentage of total revenues will increase in future periods as a result of the expansion of the Company's animal hospital operations and the elimination of revenues from the Premium Pet Food operations in 1997 when the Company will no longer consolidate the Vet's Choice joint venture. The following table summarizes the Company's revenues for each of the three years in the period ended December 31, 1996:
1996 1995 1994 ------------- ------------- ------------ Animal Hospital $120,842,000 $67,059,000 $41,484,000 Laboratory 56,774,000 37,606,000 10,150,000 Premium Pet Food 8,674,000 4,756,000 996,000 Intercompany Sales (4,130,000) (1,727,000) (759,000) ------------- ------------- ------------ $182,160,000 $107,694,000 $51,871,000 ============= ============= ============
Revenues of the Animal Hospital operations increased 61.7% from 1994 to 1995 and 80.2% from 1995 to 1996. This growth was primarily the result of growth in the number of facilities owned and operated by the Company. The increase in revenues resulting from changes in volume or prices at facilities operated during all of 1994 and 1995 was 6.0%. The increase in revenues resulting from change in volume or prices at facilities operated during all of 1995 and 1996 was 4.7%. Revenues of the laboratory operations increased 270.5% from 1994 to 1995 due primarily to the acquisition of Cenvet in January 1995 and the subsequent formation of the Vet Research joint venture in March 1995. Revenues of the laboratory operations increased by 51.0% from 1995 to 1996 due primarily to the acquisition of Southwest in March 1996. PAGE 4 Vet's Choice began generating revenues in March 1994 when it commenced commercial distribution of SELECT BALANCE through the Company's network of animal hospitals in March 1994. Distribution was expanded nationally to independent veterinary hospitals in selected regional markets beginning in the second quarter of 1994. Vet's Choice revenue increased further in 1995 and 1996 with the introduction of SELECT CARE in the beginning of 1995. Pursuant to the restructuring agreement and other related agreements between HPP and the Company, the Company has agreed to provide certain consulting and management services for a three year period commencing February 1, 1997 and to continue to support and sell the SELECT BALANCE and SELECT CARE brands through its network of animal hospitals. The agreements call for the Company to receive an aggregate of $15.3 million payable in semi-annual installments over a five year period. GROSS PROFIT The following table summarizes the Company's gross profit for each of the three years in the period ended December 31, 1996:
1996 1995 1994 ----------- ----------- ----------- Animal Hospital $17,858,000 $11,767,000 $7,111,000 Laboratory 21,184,000 14,277,000 3,652,000 Premium Pet Food 3,532,000 1,551,000 349,000 ----------- ----------- ----------- $42,574,000 $27,595,000 $11,112,000 =========== =========== ===========
Animal Hospital gross profit represents the contribution from the Animal Hospital operations and is comprised of revenues less all costs of services and products at the animal hospitals, including salaries of veterinarians, technicians and all other hospital-based personnel, facilities rent and occupancy costs and medical supply costs. Animal Hospital gross profit increased from $7,111,000 in 1994 to $11,767,000 in 1995 and to $17,858,000 in 1996, increases of $4,656,000 or 65.5% and $6,091,000 or 51.8%, respectively. As a percentage of Animal Hospital revenues, gross profit increased from 17.1% in 1994 to 17.5% in 1995 and decreased to 14.8% in 1996. The 1996 decrease was attributable primarily to the lower gross profit margins at the newly acquired facilities. Gross profit margins at existing hospitals decreased to 16.8% in 1996 from 18.3% in 1995 due to a 4.7% increase in revenues compared to a 6.6% increase in direct costs composed primarily of a 7.4% increase in salaries and benefits and a 10.6% increase in supply costs. Gross profit margins at newly acquired hospitals were 13.5% in 1996. Laboratory gross profit is comprised of revenues less all direct costs of services at the veterinary diagnostic laboratories, including salaries of veterinarians, technicians and other non-administrative laboratory-based personnel, facilities rent and occupancy costs and supply costs. Laboratory gross profit increased from $3,652,000 in 1994 to $14,277,000 in 1995 and to $21,184,000 in 1996, increases of $10,625,000 and $6,907,000, respectively. As a percentage of Laboratory revenues, gross profit earned by Laboratory operations increased from 36.0% in 1994 to 38.0% in 1995 and decreased to 37.3% in 1996. The increase in the gross profit contributed by Laboratory operations as a percentage of revenues in 1995 over 1994 was attributable to the acquisition of Cenvet and the formation of Vet Research in January and March 1995, respectively. The decrease in gross profit as a percentage of revenue in 1996 compared to 1995, was attributable to difficulties with the assimilation of the 1996 laboratory acquisitions primarily on the west coast, an increase in advertising costs associated with the Laboratory's name change to the "Antech Diagnostics" name at all laboratories, the effect of promotional pricing programs and the addition of operating personnel. Premium Pet Food gross profit is comprised of revenues less cost of goods sold, including freight and distribution costs. Premium Pet Food gross profit totaled $349,000 in 1994, $1,551,000 in 1995 and $3,532,000 in 1996. As a percentage of revenues, gross profit was 35.0% in 1994, 32.6% in 1995 and 40.7% in 1996. The decrease in gross profit as a percent of revenue in 1995 compared to 1994 was attributable to the release of SELECT CARE in 1995, which has lower gross profit margins than SELECT BALANCE. Gross profit also decreased in 1995 due to increased sales to distributors which have lower gross profit margins than sales to veterinary hospitals, which were PAGE 5 the Company's primary source of sales in 1994. The increase in gross profit as a percentage of revenues from 1995 to 1996 was primarily attributable to decreased distribution costs. The Company's Animal Hospital business historically has realized gross profit margins that are lower than that of the Laboratory and Premium Pet Food businesses. As the portion of the Company's revenues attributable to its Animal Hospitals operations grows in the future, the historical gross profit margins for the Company as a whole may not be indicative of those to be expected in the future. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES The following table sets forth the Company's selling, general and administrative expense for each of the three years in the period ended December 31, 1996:
1996 1995 1994 ----------- ----------- ---------- VCA Corporate $10,450,000 $ 6,029,000 $4,539,000 Laboratory 4,619,000 3,569,000 812,000 Premium Pet Food 4,666,000 4,086,000 3,428,000 ----------- ---------- ---------- $19,735,000 $13,684,000 $8,779,000 =========== =========== ==========
VCA Corporate selling, general and administrative expense consists of administrative expense at the Company's headquarters, including the salaries of corporate officers and other personnel, accounting, legal and other professional expense, and rent and occupancy costs. VCA Corporate selling, general and administrative expense increased from $4,539,000 in 1994 to $6,029,000 in 1995, and to $10,450,000 in 1996, increases of $1,490,000 or 32.8%, and $4,421,000 or 73.3% respectively. As a percentage of Animal Hospital revenues, VCA Corporate general and administrative expense decreased from 10.9% in 1994 to 9.0% in 1995 and 8.6% in 1996. The decreases from 1994 to 1996 are primarily attributable to spreading the expenses over a larger revenue base. Laboratory selling, general and administrative expense consists primarily of sales and administrative personnel and selling, marketing and promotional expense. Laboratory selling, general and administrative expense increased to $4,619,000 for the year ended December 31, 1996 from $3,569,000 for the comparable period in 1995, an increase of $1,050,000. As a percentage of Laboratory revenues, Laboratory selling, general and administrative expense increased from 8.0% in 1994 to 9.5% in 1995 and decreased to 8.1% in 1996. The increase in selling, general and administrative expense from 1994 to 1995 was primarily attributable to the addition of Cenvet in January 1995 and the formation of Vet Research in March 1995. The decrease from 1995 to 1996 was primarily attributable to spreading the expenses over a larger revenue base. Premium Pet Food selling, general and administrative expense consists primarily of sales and administrative personnel and selling, marketing and promotional expense. Premium Pet Food general and administrative expense increased from $4,086,000 in 1995 to $4,666,000 in 1996, an increase of $580,000 or 14.2%. The increases from 1994 to 1995 were primarily attributable to additional sales and administrative personnel and increases in marketing and promotional expenses associated with the launch of SELECT BALANCE in March 1994 and the launch of SELECT CARE in April 1995. The increases from 1995 to 1996 were primarily attributable to increases in selling and promotional costs. DEPRECIATION AND AMORTIZATION Depreciation and amortization expense primarily relates to the depreciation of capital assets and the amortization of excess cost over the fair value of net assets acquired (goodwill) and certain other intangibles. Depreciation and amortization expense increased from $2,065,000 in 1994 to $4,144,000 in 1995 and to $7,496,000 in 1996, representing 4.0%, 3.8% and 4.1% of revenue in 1994, 1995 and 1996, respectively. The Company's policy is to amortize goodwill over the expected period to be benefited, not exceeding forty years. The increase in depreciation and amortization expense is primarily due to the acquisition of animal hospitals and veterinary diagnostic laboratories. PAGE 6 RESTRUCTURING AND ASSET WRITEDOWN As a result of the acquisition of Pets' Rx, Pet Practice and Southwest in 1996, the Company conducted a complete review of its animal hospital and laboratory operations during the third quarter ended September 30, 1996. As a result of this review, the Company determined to restructure its laboratory operations and close, merge or sell certain of its hospitals which do not meet new standards for performance adopted in light of the increase in the size of the Company's animal hospital operations. Accordingly, the Company adopted a restructuring plan and recorded a restructuring and asset writedown charge of approximately $15.2 million. The major components of the restructuring plan include (1) the termination of leases, the writedown of intangibles, property and equipment, and employee terminations in connection with the closure, sale or consolidation of five VCA animal hospitals, (2) the termination of contracts and leases, the writedown of certain real and personal property and equipment and the termination of employees in connection with the restructuring of the Company's laboratory operations, (3) contract terminations and writedown of assets in connection with the move to common communications and computer systems, and (4) the closure, sale or consolidation of certain Pet Practice hospitals (which are recorded in the purchase price allocation and not as part of the restructuring and asset writedown charge). The restructuring plan is expected to be executed over the period continuing through the second quarter of 1997. As part of the restructuring, the Company expects to close, merge or sell eight existing VCA hospitals as well as 17 hospitals acquired in connection with the Pet Practice merger. Collectively, the hospitals have aggregate annual revenues of approximately $10.9 million. The Company is continuing to evaluate the financial performance of certain Pet Practice animal hospitals and may sell, close or merge additional facilities once this evaluation is complete. In connection with the anticipated closure of the eight VCA animal hospitals, the Company has recognized writedowns of intangibles and property and equipment of $7,919,000, charges associated with the termination of leases in the amount of $1,877,000 and severance costs of $307,000. As indicated above, the closures of the Pet Practice animal hospitals are reflected in the allocation of the purchase price and do not result in a charge against earnings. The intended restructuring of the Company's laboratory operations has resulted in accruals of approximately $490,000 for contract and lease terminations, $265,000 in severance and other employee related costs and a writedown of fixed assets in the amount of $867,000. The charge to move the Company's communications and computer systems to common systems includes an accrual for contract terminations of $2,763,000 and asset writedowns of $725,000. Of the $15.2 million in restructuring and asset writedown charges, $5.7 million represents cash charges and the remainder represents non-cash charges. Of the cash charges, $93,000 had been paid at December 31, 1996 and the remainder is expected to be paid over the next 60 months. The operations of Cenvet (acquired January 1, 1995) were merged into VRI's operations to form Vet Research. The combined operations were restructured in 1995 to eliminate duplicate operating and overhead costs. In connection with the restructuring, the Company recorded a charge of $1,086,000 in the first quarter of 1995 to accrue the estimated costs associated with the restructuring, consisting primarily of lease termination and severance costs. During 1995, the Company charged $2,148,000 to operations related to a writedown of goodwill and certain intangible assets at three Pets' Rx facilities. These facilities that were written down in 1995 collectively had a net loss in 1996 of approximately $16,000 and will approximate break even in 1997. The Company's goal in 1997 is to minimize the facilities' cash flow requirements and ultimately bring the facilities to a breakeven status. Management of the Company believes that the Company's strategy of building a network of animal hospitals is served by continuing to operate these animal hospitals even though the facilities themselves may not generate profits. PAGE 7 MERGER COSTS In connection with the Pets' Rx merger, the Company recorded the estimated costs to complete the transaction. The costs, amounting to $2,901,000 primarily include legal, accounting, investment advisor, termination of employment agreements and severance costs. OPERATING (LOSS) INCOME Operating (loss) income increased from income of $268,000 in 1994 to income of $6,533,000 in 1995 and decreased to a loss of $2,771,000 in 1996. Operating income in 1995 includes restructuring and asset writedown changes totaling $3,234,000. The operating loss in 1996 includes restructuring and asset writedown charges and merger costs totaling $18,114,000. (See Notes 2 and 14 of Notes to Consolidated Financial Statements.) Operating (loss) income in 1994, 1995 and 1996 also includes the operating losses of Vet's Choice amounting to $3,094,000, $2,573,000 and $1,263,000, respectively. Excluding these items, operating income would have been $3,362,000, $12,340,000 and $16,606,000, respectively, representing an increase of $8,978,000 in 1995 over 1994 and $4,266,000 in 1996 over 1995. The increase from 1994 to 1995 and from 1995 to 1996 primarily reflects higher operating income at the Company's veterinary diagnostic laboratories, increased pet food sales and an increase in the number of animal hospitals and veterinary diagnostic laboratories owned and operated by the Company. As a percentage of revenues, operating income excluding the Vet's Choice losses and the restructuring and asset writedown and merger costs would have been 6.5% in 1994, 11.5% in 1995 and 9.1% in 1996. INTEREST INCOME Interest income increased from $404,000 in 1994 to $828,000 in 1995 and to $4,487,000 in 1996, an increase of $424,000 and $3,659,000, respectively. These increases are primarily due to changes in the Company's average daily cash and marketable securities balances which in 1996 were attributable to the proceeds from the sale of the convertible debentures. As a percentage of revenues, interest income increased from 0.8% in 1994 and 1995 to 2.5% in 1996. INTEREST EXPENSE Interest expense increased from $2,388,000 in 1994 to $3,377,000 in 1995 and $7,812,000 in 1996, increases of $989,000 or 41.4% and $4,435,000 or 131.3%, respectively. These increases are primarily due to increases in the Company's outstanding indebtedness incurred for acquisitions and the sale of $84,385,000 of 5.25% convertible subordinated debentures in April 1996. As a percentage of revenues, interest expense decreased from 4.6% in 1994 to 3.1% in 1995 and increased to 4.3% in 1996. INCOME TAXES Income taxes were $731,000, $2,238,000 and $1,959,000 in 1994, 1995 and 1996, respectively. A reconciliation of the provision for income taxes for each of the three years in the period ended December 31, 1996 to the amount computed at the Federal statutory rate is included in Note 12 of Notes to Consolidated Financial Statements. The Company's effective income tax rate for each of the years was higher than the statutory rate and the Company expects that its effective income tax rate will be higher than the statutory rate in the future primarily due to the nondeductibility for income tax purposes of the amortization of goodwill at certain of the Company's facilities. In addition, the Company's effective tax rate was higher than the statutory rate in 1996 and 1995 due to the nondeductibility of the writedown of certain assets, restructuring charges and acquisition related costs. MINORITY INTEREST Minority interest in income (loss) of the consolidated subsidiaries was ($540,000), $2,960,000 and 6,577,000 in 1994, 1995 and 1996, respectively. The increases are primarily due to the earnings of the Vet Research joint venture and the reduced losses of Vet's Choice. In 1997, the Company acquired the remaining 49% interest in the Vet Research joint venture and the Vet's Choice joint venture was restructured such that it will no longer be PAGE 8 consolidated. Consequently, minority interest in income of the consolidated subsidiaries in the future will represent solely partners' interest in various hospitals which in 1996 amounted to approximately $357,000. LIQUIDITY AND CAPITAL RESOURCES The Company's operations require continued access to cash, primarily to fund acquisitions, reduce long-term debt obligations and to fund property and equipment additions. Cash provided by operations during the years ended December 31, 1996, 1995 and 1994 was $1,603,000, $3,837,000 and $1,081,000, respectively. The Company's operating cash flow was adversely impacted by the Vet's Choice joint venture, which had a net cash outflow of $1,715,000, $3,043,000 and $2,878,000 in 1996, 1995 and 1994, respectively. Excluding the Vet's Choice operations, cash provided by operations in 1996, 1995 and 1994 was $3,318,000, $6,880,000 and $3,959,000, respectively. During 1996, 1995 and 1994, in connection with acquisitions, the Company used cash in the amounts of $27,496,000 (acquisition of 122 hospitals and six veterinary diagnostic laboratories), $9,147,000 (acquisition of 25 hospitals, six veterinary diagnostic laboratories and the remaining 30 percent interest in PAL) and $6,810,000 (acquisition of five animal hospitals and one veterinary diagnostic laboratory). Additionally, in 1995 and 1994, the Company paid $250,000 and $60,000 to acquire options to purchase the land and building of four facilities. From January 1, 1997 through March 26, 1997, the Company used $825,000 in connection with the acquisition of three animal hospitals and $18.6 million in cash to acquire the remaining 49% interest in Vet Research Laboratory. During 1996, 1995 and 1994, the Company used $6,962,000, $2,983,000 and $1,166,000 to purchase property, plant and equipment and $11,135,000, $6,241,000 and $3,097,000 to reduce long-term obligations. In April 1996, the Company received net proceeds of $82,034,000 related to the sale, in an offshore offering and concurrent private placement in the United States, of $84,385,000 of 5.25% convertible subordinated debentures due in 2006. The debentures, non-callable for three years, are convertible into approximately 2.5 million shares of the Company's common stock at a rate of $34.35 per share. Also in 1996 and in 1995, the Company received net proceeds of $13,800,000 and $8,896,000 in connection with the exercise of 1,962,452 and 1,271,508, respectively, of its redeemable warrants. The warrants expired in October 1996. In connection with the formation of Vet Research in March 1995, the Company issued warrants to purchase 363,636 shares of its common stock at $11.00 per share (the "Vet Research warrants"). During 1996 and 1995, the Company received $2,134,000 and $550,000 in connection with the exercise of 194,000 and 50,000 of these warrants, respectively. The warrants expired in the first quarter of 1997. In January 1995, Star-Kist Foods, Inc. through its division, HPP, purchased 1,159,420 shares of the Company's common stock at $8.625 per share, resulting in net proceeds to the Company of $9,980,000. In November 1995, the Company completed a secondary public offering of 2,965,026 shares of common stock for net proceeds of approximately $33,932,000. Of its cash and equivalents on hand at December 31, 1996 and 1995, approximately $2,023,000 and $1,907,000, respectively, was restricted for use by Vet's Choice. During the year ended December 31, 1995, Vet's Choice used $3,075,000 of cash to fund its operating losses, the opening of three regional warehouses, marketing and promotional expenses and an increase in its sales force. As provided for in its joint venture agreement, the Company and HPP each contributed $1.0 million to Vet's Choice in 1996 and 1995.In connection with the restructuring of the Vet's Choice joint venture agreement in February 1997, Vet's Choice made a capital distribution to the Company amounting to $1,329,000. The Company has achieved its growth in the past, and anticipates it will continue its growth in the future, through the acquisition of animal hospitals and veterinary diagnostic laboratories for cash, stock and notes payable. Subject to available capital, the Company anticipates it will complete the acquisition of an additional 20 to 30 individual animal hospitals in 1997, which will require cash of up to $15.0 million. In addition, the Company continues to examine acquisition opportunities in the veterinary laboratory field which may impose additional cash requirements. PAGE 9 The Company has debt payment obligations related to the Animal Hospital and Laboratory operations owned as of March 26, 1997 of approximately $14.2 and $16.8 million in the years ended December 31, 1997 and 1998, respectively. In addition, interest payments on the convertible debentures amount to $4,430,000 annually. In addition to normal property and plant additions, the Company expects to continue to upgrade its management information systems in 1997 and change the signage at over 100 animal hospitals for a combined cost of approximately $1 million. Excluding Vet's Choice, the Company had cash and marketable securities of $100,904,000 at December 31, 1996. The Company intends to fund its future cash requirements primarily from cash on hand, the sale of its marketable securities and internally generated funds. The Company believes these sources of funds will be sufficient to continue the Company's operations and planned capital expenditures for at least the next 12 months. A significant portion of the Company's cash requirements is determined by the pace and size of its acquisitions. Consequently, the Company may need to obtain additional debt or equity financings. The type, timing and terms of financing selected by the Company will be dependent upon the Company's cash needs, the availability of other financing sources and prevailing conditions in the financial markets. NEW ACCOUNTING PRONOUNCEMENTS In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The Statement requires that long-lived assets and certain identifiable intangibles held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The adoption of this statement in January 1996 did not impact the Company's financial position or results of operations. In November 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 "Accounting for Stock- Based Compensation." The Company adopted the Statement in 1996 by making the required note disclosures only. Therefore, the adoption of the Statement did not have an effect on the Company's financial position or results of operations. SEASONALITY AND QUARTERLY FLUCTUATIONS Although not readily detectable because of the impact of acquisitions, the Company's operations are somewhat seasonal. In particular, revenues at the Company's animal hospitals historically have been greater in the second and third quarters than in the first and fourth quarters. The demand for the Company's 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 ticks, the number of daylight hours, as well as general economic conditions. The Company expects its laboratory operations to experience the same seasonality as its animal hospitals. A substantial portion of the Company's costs are fixed and do not vary with the level of demand. Consequently, net income for the second and third quarters, at individual animal hospitals, generally has been higher than that experienced in the first and fourth quarters. The following table sets forth revenues, gross profit and operating income for each of the quarters since January 1, 1995:
Quarter Ended ---------------------------------------------------------- (In thousands) December 31, September 30, June 30, March 31, 1996 1996 1996 1996 ----------- ------------ ---------- --------- 1996 Revenues $52,321 $52,399 $42,208 $35,232 Net income (loss) (2,619) (11,469) (1,304) 760 Earnings (loss) per share (0.14) (0.66) (0.09) 0.05 PAGE 10 Quarter Ended ---------------------------------------------------------- December 31, September 30, June 30, March 31, 1995 1995 1995 1995 ----------- ------------ ---------- --------- 1995 Revenues $30,578 $31,015 $27,449 $18,652 Net income (loss) (1,777) 1,032 567 (1,036) Earnings (loss) per share (0.16) 0.09 0.05 (0.13)
INFLATION Historically, the Company's operations have not been materially affected by inflation. There can be no assurance that the Company's operations will not be affected by inflation in the future. RISK FACTORS ANTICIPATED EFFECTS OF ACQUISITIONS VCA has acquired Pets' Rx and Pet Practice with the expectation that the transactions will result in beneficial synergies for the combined business. These synergies include the potential to realize improved operating margins at animal hospitals through a strategy of centralizing various corporate and administrative functions and leveraging fixed costs while providing customers with improved services. Achieving these anticipated benefits depends in part on the efficient, effective and timely integration of the operations of Pets' Rx and Pet Practice with those of the Company. The combination of these businesses requires, among other things, integration of the companies' management staffs, coordination of the companies' sales and marketing efforts, integration and coordination of the companies' development teams and the identification and elimination of redundant overhead and poor-performing hospitals. These tasks are substantially complete as of the date of this report. However, full integration will require additional efforts. As a result of the integration process, the Company was unable to engage in adequate marketing activities and, as a result, same-store sales growth of the animal hospitals of the Company and those acquired through the Pet Practice and Pets' Rx acquisitions declined. In addition, there existed significant redundant overhead at the regional and corporate offices of the companies which resulted in increased operational expenses during the integration period. Also during this period, the Company closed, combined or sold approximately 17 animal hospitals which did not meet the Company's performance criteria. The integration process also required significant dedication of management resources. During the integration period, the accounting staff of the Company primarily focused on closing the books of the Pet Practice and Pets' Rx and recording the acquisition on the books of the Company. Operations personnel focused on integrating the management staffs and organizational cultures of the three geographically separated organizations. The combined staff focused on reducing overhead, integrating personnel policies and procedures and developing the VCA identity in marketing materials and hospital signage. Consequently, during this period, the Company experienced operational inefficiencies and increased expenses. Moreover, during the integration period, the Company was in the process of implementing new management information systems designed to integrate the financial information of all of the animal hospitals and veterinary laboratories of the companies in one system. See "Management Information Systems" below. While a significant portion of the integration of the companies is complete, it is anticipated that the integration will continue to require substantial dedication from management. There can be no assurance that the problems associated with the integration identified above will not continue or that the integration on an ongoing basis will proceed smoothly or successfully. Furthermore, even if the operations of the three companies are ultimately successfully integrated, it is anticipated that the integration will continue to be accomplished over time and, in the interim, the combination may continue to have an adverse effect on the business, results of operations and financial condition of VCA. PAGE 11 RAPID EXPANSION AND MANAGEMENT OF GROWTH Due to the number and size of acquisitions completed since January 1, 1995, the Company has experienced rapid growth. In 1995, the Company completed 32 acquisitions (25 animal hospitals, six veterinary diagnostic laboratories and the remaining 30 percent interest in Professional Animal Laboratory). In 1996, the Company completed the acquisition of Pet Practice, Pets' Rx, 22 animal hospitals and 6 veterinary diagnostic laboratories. As a result of these acquisitions, the Company's revenues have grown from $42.2 million in 1994 to $92.1 million in 1995, to $182.2 million in 1996 and to unaudited proforma 1996 revenue of over $228 million. In addition, during this period, the Company entered two new lines of business, veterinary diagnostic laboratories and premium pet food. The Company's growth and pace of acquisitions have placed, and will continue to place, a substantial strain on its management, operational, financial and accounting resources. The successful management of this growth will require the Company to continue to implement and improve its financial and management information systems and to train, motivate and manage its employees. There can be no assurance that the combined business will be able to identify, consummate or integrate acquisitions without substantial delays, costs or other problems. Once integrated, acquisitions may not achieve sales, profitability and asset productivity commensurate with the combined business' other operations. In addition, acquisitions involve several other risks, including adverse short-term effects on the combined business' reported operating results, impairments of goodwill and other intangible assets, the diversion of management's attention, the dependence on retention, hiring and training of key personnel, the amortization of intangible assets and risks associated with unanticipated problems or legal liabilities. The combined business' failure to manage growth effectively would have a material adverse effect on the combined business' results of operations and its ability to execute its business strategy. MANAGEMENT INFORMATION SYSTEMS The growth experienced by the Company, and specifically the acquisitions of Pet Practice and Pets' Rx, and the corresponding increased need for timely information, have placed significant demands on the Company's existing accounting and management information systems. The Company is in the process of implementing new management information systems to collect and organize data from all of its operations. Once integrated, the Company anticipates that the new systems will result in the automation of certain time intensive manual procedures, daily access, if desired, to information relating to sales, revenues and other financial and operational data from each animal hospital and veterinary laboratory and ultimately in the delivery of financial information to management and preparation of consolidated financial reports, each on a more timely basis. While the Company has begun the process of implementing new system, the continued development and installation of the systems involves the risk of unanticipated delay and expenses. There can be no assurance that the Company will successfully or timely implement the new systems or that it will effectively serve the Company's future information requirements. DEPENDENCE ON ACQUISITIONS FOR FUTURE GROWTH The Company's growth strategy is dependent principally on its ability to acquire existing animal hospitals. Successful acquisitions involve a number of factors which are difficult to control, including the identification of potential acquisition candidates, the willingness of the owners to sell on reasonable terms and the satisfactory completion of negotiations. In addition, 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 the Company's operations through the assessment of fines or penalties against the Company or the possible requirement of divestiture of one or more of the Company's operations. There can be no assurance that the Company will be able to identify and acquire acceptable acquisition candidates on terms favorable to the Company in a timely manner in the future. Assuming the availability of capital, the Company's plans include an aggressive acquisition program involving the acquisition of at least 15 to 25 facilities per year. The Company continues to evaluate acquisitions and negotiate with several potential acquisition candidates. The failure to complete acquisitions and continue expansion could have a material adverse effect on the Company's financial performance. As the combined business proceeds with its acquisition strategy, it will continue to encounter the risks associated with the integration of acquisitions described above. PAGE 12 LEVERAGE The Company has incurred substantial indebtedness in connection with the acquisition of its animal hospitals and veterinary diagnostic laboratories and through the sale of the $84,385,000 of 5.25% convertible debentures in April 1996. The Company had at December 31, 1996, consolidated long-term obligations (including current portion) of $148.8 million. At December 31, 1996 and 1995, the Company's ratio of long-term debt to total stockholders' equity was 88.9% and 49.1%, respectively. RISKS ASSOCIATED WITH INTANGIBLE ASSETS A substantial portion of the assets of the Company consists of intangible assets, including goodwill and covenants not to compete relating to the acquisition of animal hospitals and veterinary diagnostic laboratories. At December 31, 1996, the Company's balance sheet reflected $183.7 million of intangible assets of these types, a substantial portion of the Company's $354.0 million in total assets at such date. The Company expects the aggregate amounts of goodwill and other intangible assets on its balance sheet to increase in the future in connection with additional acquisitions. This increase will have an adverse impact on earnings as goodwill and other intangible assets will be amortized against earnings. In the event of any sale or liquidation of the Company, there can be no assurance that the value of these intangible assets will be realized. In addition, the Company continually evaluates whether events and circumstances have occurred that indicate the remaining balance of intangible assets may not be recoverable. When factors indicate that these intangible assets should be evaluated for possible impairment, they may be required to reduce the carrying value of intangible assets, which could have a material adverse effect on results of operations during the periods in which such reduction is recognized. In accordance with this policy, the Company recognized a writedown of goodwill and related assets in the amount of $2.3 million in 1993 in connection with three of the Company's facilities which were not performing. Further, the Company has recognized a writedown of goodwill and related assets in the amount of $9.5 million as part of its restructuring plan adopted during the third and fourth quarters of 1996. There can be no assurance that the Company will not be required to writedown assets further in future periods. GUARANTEED PAYMENTS In connection with acquisitions in which the purchase price consists, in part, of the Company's common stock (the "Guarantee Shares"), the Company often guarantees (the "Guarantee Right") that the value of such stock (the "Measurement Price") two to three years following the date of the acquisition (the "Guarantee Period") will equal or exceed the value of the stock on the date of acquisition (the "Issue Price"). In the event the Measurement Price does not equal or exceed the Issue Price, the Company typically is obligated either to (i) pay to the seller in cash, notes payable or additional shares of the Company's common stock the difference between the Issue Price and the Measurement Price multiplied by the number of Guarantee Shares then held by the seller, or (ii) purchase the Guarantee Shares then held by the seller. Once the Guarantee Shares are delivered and registered for resale under the Securities Act, which registration the Company covenants to effect generally within nine months of issuance of the Guarantee Shares, the seller's Guarantee Right typically terminates if the Company's common stock trades at 110% to 120% of the Issue Price (the "Release Price") for five to 15 consecutive days, depending on the terms of the specific acquisition at issue. There are 256,672 Guarantee Shares outstanding at March 26, 1997 with Issue Prices ranging from $11.62 to $24.53, with a weighted average of $17.30, that have not met their respective Release Prices for the specified period or have not been delivered due to escrow arrangements. If the value of the Company's common stock decreases and is less than an Issue Price at the end of the respective Guarantee Period for these shares, the Company may be obligated to compensate these sellers. SEASONALITY AND FLUCTUATING QUARTERLY RESULTS A large portion of the business of the Company is seasonal, with operating results varying substantially from quarter to quarter. Historically, the Company's revenues have been greater in the second and third quarters than in the first and fourth quarters. The demand for the Company's 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 PAGE 13 infestation of fleas, heartworms and ticks, and the number of daylight hours, as well as general economic conditions. A substantial portion of the Company's costs are fixed and do not vary with the level of demand. Consequently, net income for the second and third quarters at individual animal hospitals generally has been higher than that experienced in the first and fourth quarters. DEPENDENCE ON KEY MANAGEMENT The Company's success will continue to depend to a significant extent on the Company's executive officers and other key management, particularly its Chief Executive Officer, Robert L. Antin. VCA has an employment contract with Mr. Robert Antin, Mr. Arthur Antin, Chief Operating Officer of VCA, and Mr. Neil Tauber, Senior Vice President of VCA, each of which expires in December 2002. VCA has no other written employment agreements with its executive officers. None of VCA's officers are parties to noncompetition covenants which extend beyond the term of their employment with VCA. VCA maintains "key man" life insurance on Mr. Robert Antin in the amount of $3.0 million, of which VCA is the sole beneficiary. VCA does not maintain any insurance on the lives of its other senior management. As VCA continues to grow, it will continue to hire, appoint or otherwise change senior managers and other key executives. There can be no assurance that VCA will be able to retain its executive officers and key personnel or attract additional qualified members to management in the future. In addition, the success of certain of VCA's acquisitions may depend on VCA's ability to retain selling veterinarians of the acquired companies. The loss of services of any key manager or selling veterinarian could have a material adverse effect upon VCA's business. COMPETITION The companion animal health care industry is highly competitive and subject to continual change in the manner in which services are delivered and providers are selected. The Company believes that the primary competitive factors in connection with animal hospitals are convenient location, recommendation of friends, reasonable fees, quality of care and convenient hours. The Company's primary competitors for its animal hospitals in most markets are individual practitioners or small, regional multi-clinic practices. In addition, certain national companies in the pet care industry, including the operators of super-stores, are developing multi-regional networks of animal hospitals in markets which include the Company's animal hospitals. Among veterinary diagnostic laboratories, the Company believes that quality, price and the time required to report results are the major competitive factors. There are many clinical laboratory companies which provide a broad range of laboratory testing services in the same markets serviced by the Company. In addition, several national companies provide on-site diagnostic equipment that allows veterinarians to perform their own laboratory tests. GOVERNMENT REGULATION The laws of many states prohibit veterinarians from splitting fees with non-veterinarians and 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 restrictions 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 states. ANTI-TAKEOVER EFFECT A number of provisions of the Company's Certificate of Incorporation and bylaws and certain Delaware laws and regulations relating to matters of corporate governance, certain rights of directors and the issuance of preferred stock without stockholder approval, may be deemed to have and may have the effect of making more difficult, and thereby discouraging, a merger, tender offer, proxy contest or assumption of control and change of incumbent management, even when stockholders other than the Company's principal stockholders consider such a transaction to be in their best interest. In addition, H.J. Heinz Company has an option to purchase the Company's interest in PAGE 14 the Vet's Choice joint venture upon the occurrence of a change in control (as defined in the joint venture agreement), which may have the same effect. Accordingly, stockholders may be deprived of an opportunity to sell their shares at a substantial premium over the market price of the shares. IMPACT OF SHARES ELIGIBLE FOR FUTURE SALE Future sales by existing stockholders could adversely affect the prevailing market price of the Company's common stock. As of March 26, 1997, the Company had 19,344,643 shares of common stock outstanding (including 97,773 shares held in treasury), most of which are either freely tradeable in the public market without restriction or tradeable in accordance with Rule 144 under the Act. There are also 237,199 shares which the Company is obligated to issue in connection with the Pets' Rx and Pet Practice mergers and certain acquisitions; 583,333 shares issuable upon conversion of outstanding preferred stock; 3,688,930 shares of the Company's common stock issuable upon exercise of outstanding stock options; 41,608 shares issuable upon conversion of convertible notes; and 2,456,623 shares issuable upon conversion of convertible debentures. Shares may also be issued under price guarantees delivered in connection with acquisitions. These shares will be eligible for immediate sale upon issuance. POSSIBLE VOLATILITY OF STOCK PRICE The market price of the Company's common stock could be subject to significant fluctuations caused by variations in quarterly operating results, litigation involving the Company, announcements by the Company or its competitors, general conditions in the companion animal health care industry and other factors. The stock market in recent years has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of publicly traded companies. The broad fluctuations may adversely affect the market price of the Company's common stock. ALLEGED MISSTATEMENTS REGARDING THE COMPANY'S OPERATIONS AND PROSPECTS The Company and certain of its current and former officers and directors have been named as defendants in a class action lawsuit filed on April 1, 1997, entitled Marilyn J. Thompson, et al. v. Veterinary Centers of America, Inc., et al., Los Angeles Superior Court, Case No. BC168547. The lawsuit has been filed on behalf of individuals claiming to have purchased Common Stock of the Company during the time period from February 15, 1996 through November 14, 1996, and the plaintiffs seek unspecified damages arising from alleged misstatements regarding the Company's animal hospitals, diagnostic laboratories, pet food operations and success in integrating certain acquisitions. While the Company has not yet filed an answer to the complaint, the Company intends to vigorously defend itself against the lawsuit. Since discovery has not yet commenced, the Company is unable to assess the likelihood of an adverse result in the class action lawsuit. There can be no assurances as to the outcome of such lawsuit. The inability of the Company to resolve the claims that are the basis for the lawsuit or to prevail in any related litigation could result in the Company being required to pay substantial monetary damages for which the Company may not be adequately insured, which could have a material adverse effect on the Company's business, financial condition and results of operations. In any event, the Company's defense of such lawsuit, even if the outcome is favorable to the Company, may result in substantial costs to the Company, as well as significant dedication of management resources. PAGE 15 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO CONSOLIDATED FINANCIAL STATEMENTS VETERINARY CENTERS OF AMERICA, INC. AND SUBSIDIARIES _________________ PAGE Report of Independent Public Accountants 17 Consolidated Balance Sheets at December 31, 1996 and 1995 18 Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994 19 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1996, 1995 and 1994 20 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 21 Notes to Consolidated Financial Statements 23 PAGE 16 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Shareholders of Veterinary Centers of America, Inc.: We have audited the accompanying consolidated balance sheets of Veterinary Centers of America, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. 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 generally accepted auditing standards. 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 Veterinary Centers of America, Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles. /s/ Arthur Andersen LLP ----------------------- ARTHUR ANDERSEN LLP Los Angeles, California March 14, 1997 (Except for the matter discussed in Note 17, as to which the date is April 28, 1997) PAGE 17
VETERINARY CENTERS OF AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS At December 31, 1996 and 1995 A S S E T S 1996 1995 --------------- --------------- CURRENT ASSETS: Cash and equivalents $ 23,820,000 $ 5,396,000 Marketable securities 79,107,000 42,155,000 Trade accounts receivable, less allowance for uncollectible accounts of $4,212,000 and $1,671,000 at December 31, 1996 and 1995, respectively 9,583,000 6,508,000 Inventory, prepaid expenses and other 8,788,000 4,084,000 Deferred income taxes 2,331,000 1,175,000 Prepaid income taxes 2,137,000 494,000 --------------- --------------- Total current assets 125,766,000 59,812,000 PROPERTY, PLANT AND EQUIPMENT, NET. 37,467,000 18,169,000 DEFERRED INCOME TAXES 1,352,000 -- OTHER ASSETS: Goodwill, net 178,806,000 66,943,000 Covenants not to compete, net 4,933,000 5,210,000 Building purchase options 887,000 1,087,000 Notes receivable 1,486,000 978,000 Deferred costs and other 3,312,000 1,217,000 --------------- --------------- $ 354,009,000 $ 153,416,000 =============== =============== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of long-term obligations $ 14,055,000 $ 7,496,000 Accounts payable 6,923,000 5,930,000 Accrued payroll and related liabilities 7,177,000 2,972,000 Accrued restructuring costs 8,847,000 849,000 Accrued interest 1,256,000 288,000 Other accrued liabilities 8,857,000 2,729,000 --------------- --------------- Total current liabilities 47,115,000 20,264,000 LONG-TERM OBLIGATIONS, less current portion 134,767,000 36,778,000 DEFERRED INCOME TAXES -- 1,301,000 MINORITY INTEREST 4,777,000 4,856,000 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock; $.001 par value; authorized -- 1,000,000 shares: Issued and outstanding -- 583,333 at December 31, 1996 and 1995 1,000 1,000 Common stock; $.001 par value; authorized -- 60,000,000 shares: Issued and outstanding including shares in treasury -- 19,268,648 and 12,845,831 at December 31, 1996 and 1995, respectively 20,000 13,000 Additional paid-in capital 192,167,000 99,685,000 Accumulated deficit (24,114,000) (9,482,000) Less cost of common stock held in treasury, 97,773 shares at December 31, 1996 (724,000) -- --------------- --------------- Total stockholders' equity 167,350,000 90,217,000 --------------- --------------- $ 354,009,000 $ 153,416,000 =============== ===============
The accompanying notes are an integral part of these consolidated balance sheets. PAGE 18
VETERINARY CENTERS OF AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended December 31, 1996, 1995 and 1994 1996 1995 1994 --------------- --------------- --------------- Revenues $ 182,160,000 $ 107,694,000 $ 51,871,000 Direct costs 139,586,000 80,099,000 40,759,000 --------------- --------------- --------------- Gross profit 42,574,000 27,595,000 11,112,000 Selling, general and administrative 19,735,000 13,684,000 8,779,000 Depreciation and amortization 7,496,000 4,144,000 2,065,000 Merger costs 2,901,000 -- -- Restructuring charges 5,701,000 1,086,000 -- Writedown of assets 9,512,000 2,148,000 -- --------------- --------------- --------------- Operating (loss) income (2,771,000) 6,533,000 268,000 Interest income 4,487,000 828,000 404,000 Interest expense 7,812,000 3,377,000 2,388,000 --------------- --------------- --------------- (Loss) income before minority interest and provision for income taxes (6,096,000) 3,984,000 (1,716,000) Minority interest in income (loss) of subsidiaries 6,577,000 2,960,000 (540,000) --------------- --------------- --------------- (Loss) income before provision for income taxes (12,673,000) 1,024,000 (1,176,000) Provision for income taxes 1,959,000 2,238,000 731,000 --------------- --------------- --------------- Net loss $ (14,632,000) $ (1,214,000) $ (1,907,000) =============== =============== =============== Net loss per common share $ (0.92) $ (0.13) $ (0.31) =============== ============== =============== Average common shares used for computing loss per share 15,941,000 9,224,000 6,202,000 =============== =============== ===============
The accompanying notes are an integral part of these consolidated financial statements. PAGE 19
VETERINARY CENTERS OF AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the Years Ended December 31, 1996, 1995 and 1994 Additional Common Stock Preferred Stock Treasury Stock Paid-In Accumulated Shares Amount Shares Amount Shares Amount Capital (Deficit) -------- ------- ------- ------- ------- ------- ------------ ----------- BALANCES, December 31, 1993 5,483,806 $ 5,000 583,333 $ 1,000 -- $ -- $ 26,238,000 $(6,137,000) Sale of common stock 125,808 -- -- -- -- -- 3,245,000 -- Sale of warrants -- -- -- -- -- -- 13,000 -- Exercise of warrants 55,580 -- -- -- -- -- 55,000 -- Stock dividend 8,256 -- -- -- -- -- 224,000 (224,000) Stock issued for payment of interest 30,841 -- -- -- -- -- 223,000 -- Issued under stock option plans 32,765 -- -- -- -- -- 198,000 -- Business acquisitions 237,483 -- -- -- -- -- 1,732,000 -- Conversion of convertible debt 210,373 1,000 -- -- -- -- 1,232,000 -- Settlement of guaranteed purchase price contingently payable in cash or common stock 63,214 -- -- -- -- -- 470,000 -- Net loss -- -- -- -- -- -- -- (1,907,000) ---------- -------- -------- -------- ------- -------- ------------- ----------- BALANCES, December 31, 1994 6,248,126 6,000 583,333 1,000 -- -- 33,630,000 (8,268,000) Sale of common stock 4,129,616 4,000 -- -- -- -- 44,058,000 -- Sale of redeemable warrants 4,607 -- -- -- -- -- 58,000 -- Exercise of redeemable warrants 1,271,508 2,000 -- -- -- -- 8,894,000 -- Exercise of warrants issued in connection with the Vet Research joint venture 50,000 -- -- -- -- -- 550,000 -- Issued under stock plans 29,367 -- -- -- -- -- 209,000 -- Business acquisitions 1,075,288 1,000 -- -- -- -- 11,979,000 -- Conversion of convertible debt 37,319 -- -- -- -- -- 254,000 -- Settlement of guaranteed purchase price contingently payable in cash or common stock -- -- -- -- -- -- 53,000 -- Net loss -- -- -- -- -- -- -- (1,214,000) ---------- -------- -------- -------- ------- ------- ------------- ----------- BALANCES, December 31, 1995 12,845,831 13,000 583,333 1,000 -- -- 99,685,000 (9,482,000) Sale of common stock 7,514 -- -- -- -- -- 207,000 -- Exercise of redeemable warrants 1,962,452 2,000 -- -- -- -- 13,798,000 -- Exercise of warrants issued in connection with the Vet Research joint venture 194,000 -- -- -- -- -- 2,134,000 -- Issued under stock option plans 79,090 -- -- -- -- -- 337,000 -- Business acquisitions 4,120,100 5,000 -- -- -- -- 74,814,000 -- Conversion of convertible debt 5,742 -- -- -- -- -- 54,000 -- Settlement of guaranteed purchase price contingently payable in cash or common stock 9,169 -- -- -- -- -- -- -- Purchase of treasury shares -- -- -- -- (97,773) (724,000) -- -- Issuance of stock in settlement of employment obligations 44,750 -- -- -- -- -- 1,138,000 -- Net loss -- -- -- -- -- -- -- (14,632,000) ---------- -------- -------- -------- ------- ------- ------------- ------------- BALANCES, December 31, 1996 19,268,648 $ 20,000 583,333 $ 1,000 (97,773)$(724,000) $192,167,000 $(24,114,000) ========== ======== ======= ======= ======== ========= ============= =============
The accompanying notes are an integral part of these consolidated financial statements. PAGE 20
VETERINARY CENTERS OF AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1996, 1995 and 1994 1996 1995 1994 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(14,632,000) $ (1,214,000) $(1,907,000) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 7,496,000 4,144,000 2,065,000 Gain on sale of land and building -- (19,000) -- Amortization of debt discount 290,000 454,000 15,000 Utilization of acquired NOL carryforwards -- 69,000 -- Restructuring costs and asset writedowns 15,213,000 3,234,000 -- Minority interest in income (loss) of subsidiary 6,577,000 2,960,000 (540,000) Distributions to minority interest partners (7,292,000) (4,058,000) (904,000) Issuance of common stock in settlement of employment obligations 1,138,000 -- -- Increase in accounts receivable, net (729,000) (2,140,000) (124,000) Increase in inventory and other (2,111,000) (1,875,000) (203,000) Increase in prepaid income taxes (1,643,000) (322,000) (509,000) Increase in other assets, net (231,000) (208,000) (122,000) Decrease (increase) in deferred income tax asset 1,249,000 (737,000) 408,000 Increase in accounts payable and accrued liabilities (2,421,000) 3,112,000 2,829,000 (Decrease) increase in deferred income tax liability (1,301,000) 437,000 73,000 ----------- ----------- ----------- Net cash provided by operating activities 1,603,000 3,837,000 1,081,000 CASH FLOWS FROM INVESTING ACTIVITIES: Business acquisitions, net of cash acquired (27,496,000) (9,147,000) (6,810,000) Property, plant and equipment additions, net (6,962,000) (2,983,000) (1,166,000) Investments in marketable securities (36,952,000) (42,155,000) -- Proceeds from the sale of assets 209,000 600,000 -- Payments for building purchase options -- (250,000) (60,000) ----------- ----------- ----------- Net cash used in investing activities (71,201,000) (53,935,000) (8,036,000) ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from issuance of convertible subordinated debentures 82,034,000 -- -- (Repayment of) proceeds from line of credit and addition of long-term obligations -- (1,100,000) 1,394,000 Reduction of long-term obligations and notes payable (11,135,000) (6,241,000) (3,097,000) Payments received (advances made) on notes receivable 379,000 272,000 (43,000) Payments on guaranteed purchase price contingently payable in cash or common stock -- (19,000) -- Net proceeds from sale of common stock 207,000 44,062,000 3,245,000 Net proceeds from exercise of redeemable warrants 13,800,000 8,896,000 55,000 Proceeds from exercise of warrants issued in connection with Vet Research joint venture 2,134,000 550,000 -- Proceeds from sale of warrants -- 58,000 13,000 Proceeds from issuance of common stock under stock option plans 337,000 209,000 198,000 Capital contribution of minority interest partners 990,000 1,000,000 30,000 Purchase of treasury stock (724,000) -- -- ----------- ----------- ----------- Net cash provided by financing activities 88,022,000 47,687,000 1,795,000 ----------- ----------- ----------- INCREASE (DECREASE) IN CASH AND EQUIVALENTS 18,424,000 (2,411,000) (5,160,000) CASH AND EQUIVALENTS AT BEGINNING OF YEAR 5,396,000 7,807,000 12,967,000 ----------- ----------- ----------- CASH AND EQUIVALENTS AT END OF YEAR $ 23,820,000 $ 5,396,000 $ 7,807,000 ============ =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. PAGE 21
VETERINARY CENTERS OF AMERICA, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1996, 1995 and 1994 (Continued) 1996 1995 1994 --------------- --------------- --------------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid $ 6,828,000 $ 2,878,000 $ 2,277,000 Income taxes paid 3,774,000 2,688,000 759,000 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 $ 146,756,000 $ 43,223,000 $ 19,584,000 Less: Consideration given Cash paid (25,345,000) (9,147,000) (6,810,000) Cash paid in settlement of assumed liabilities (2,151,000) -- -- Common stock issued (74,819,000) (11,980,000) (1,732,000) --------------- --------------- --------------- Liabilities assumed including notes payable issued $ 44,441,000 $ 22,096,000 $ 11,042,000 =============== =============== =============== In connection with the formation of the joint venture and partnerships, assets and liabilities contributed by the partners were as follows: Assets $ 295,000 $ 3,467,000 $ 330,000 Liabilities -- 1,063,000 -- --------------- --------------- --------------- Non-cash capital contribution of minority interest partners $ 295,000 $ 2,404,000 $ 330,000 =============== =============== =============== Issuance of common stock in exchange for convertible debt $ 54,000 $ 254,000 $ 1,232,000 =============== =============== =============== Settlement of guaranteed purchase price through issuance of common stock $ -- $ 53,000 $ 482,000 =============== =============== =============== Non-cash increase in long-term obligations due to purchase of equipment and building $ 510,000 $ 262,000 $ 164,000 =============== =============== =============== Conversion of accounts payable to notes payable $ -- $ 381,000 $ -- =============== =============== =============== Payment of accrued interest on notes by issuance of common stock $ -- $ -- $ 223,000 =============== =============== ===============
The accompanying notes are an integral part of these consolidated financial statements. PAGE 22 VETERINARY CENTERS OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 1. THE COMPANY Veterinary Centers of America, Inc. ("VCA" or the "Company"), a Delaware corporation, was founded in 1986 and is a leading companion animal health care company. The Company operates one of the largest networks of free- standing, full service animal hospitals in the country and one of the largest networks of veterinary-exclusive diagnostic laboratories in the nation. The Company also markets both a life-stage and a therapeutic line of premium pet foods through Vet's Choice, a joint venture with Heinz Pet Products ("HPP"), an affiliate of H.J. Heinz Company. In 1993, the Company began to expand the scope of its operations in order to realize its goals of integrating the markets for veterinary care, veterinary diagnostic laboratories and premium pet food. The integration of these three markets is the foundation of the Company's business strategy to leverage its access to its primary customers, veterinarians and pet owners. From January 1, 1993 through December 31, 1995, the Company acquired and integrated into its operations 36 animal hospitals. Also in 1993, the Company entered into a joint venture called Vet's Choice, with HPP to develop, manufacture and market a full-line of premium pet food. In March 1994, the Company expanded its veterinary diagnostic laboratory operations by acquiring a 70 percent interest in Professional Animal Laboratory ("PAL"). In January 1995, the Company acquired an additional veterinary diagnostic laboratory, Cenvet, Inc. ("Cenvet"), which it then contributed in March 1995 to Vet Research Laboratories, LLC ("Vet Research"), a joint venture in exchange for a 51 percent interest therein. Vet Research is a combination of the operations of Cenvet and that of a full-service veterinary laboratory known as Vet Research, Inc. In 1995, the Company further expanded its veterinary diagnostic laboratory operations by acquiring four smaller, regional veterinary diagnostic laboratories and by purchasing the remaining 30 percent interest in PAL. In 1996, the Company continued its expansion of its animal hospital operations with the mergers with Pets' Rx, Inc. ("Pets' Rx") in June 1996 (16 hospitals) and The Pet Practice, Inc. ("Pet Practice") in July 1996 (84 hospitals) as well as the acquisition of an additional 22 animal hospitals in separate transactions throughout the year. The Company's laboratory operations were expanded with the acquisition of Southwest Veterinary Diagnostics Laboratory, Inc. ("Southwest") in March 1996, and five other laboratories throughout the year. At December 31, 1996, the Company owned or operated 161 animal hospitals, 20 of which were located in Northern California, 18 in each of Southern California, Florida and Illinois, 15 in Michigan, 10 in Indiana, nine in Pennsylvania, seven in each of Massachusetts, Maryland and Ohio, six in Nevada, five in Texas, three in each of Delaware, Virginia, New Mexico and Alaska, two in each of Colorado and Utah, and one in each of Arizona, Georgia, Hawaii, West Virginia and New Jersey. The Company's animal hospitals provide primary care, diagnostic, surgical and boarding services for animals. The Company's network of veterinary diagnostic laboratories consists of four full-service laboratories and eight "STAT" (quick response) laboratories located throughout the country. On June 19, 1996, the Company acquired all of the outstanding shares of Pets' Rx in exchange for 801,054 shares of VCA common stock. Pets' Rx owned 16 veterinary hospitals. The business combination was treated for accounting purposes as a pooling of interests, and accordingly, the accompanying financial statements reflect the combined results of the pooled businesses for the respective periods presented. Previously reported financial information for VCA and Pets' Rx for each of the three years in the period ended December 31, 1996, is shown in the table below. PAGE 23 The following table summarizes the revenues and net loss for each of the companies combined:
Years Ended December 31, --------------------------------------------- 1996 1995 1994 ------------- ------------ ----------- Revenues: Pre-merger VCA $64,763,000 $92,072,000 $42,233,000 Pets' Rx 7,849,000 15,622,000 9,638,000 ------------- ------------ ------------ 72,612,000 107,694,000 51,871,000 Post-merger 109,548,000 -- -- ------------- ------------ ------------ $182,160,000 $107,694,000 $51,871,000 ============= ============ ============ Net (loss) income: Pre-merger VCA $ 1,647,000 $ 2,564,000 $ 589,000 Pets' Rx (658,000) (1,977,000) (2,805,000) Merger adjustments 212,000 (1,801,000) 309,000 ------------- ------------ ------------ 1,201,000 (1,214,000) (1,907,000) Post-merger (15,833,000) -- -- ------------- ------------ ------------ $(14,632,000) $(1,214,000) $(1,907,000) ============= ============ ============
VCA's 1996 pre-merger net income includes merger expenses of $2,901,000; these expenses consist principally of legal, accounting, investment advisor, termination of employment agreements and severance costs. The merger adjustments were recorded to conform certain accounting methods of Pets' Rx to those of VCA. These adjustments reduced intangible asset amortization expense by $212,000, $347,000 and $309,000 in 1996, 1995 and 1994, respectively, and wrote-off intangible assets of $2,148,000 in 1995 associated with certain animal hospitals whose projected future operating results would not result in the recovery of such intangible assets under VCA's accounting method. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES a. PRINCIPLES OF CONSOLIDATION In addition to veterinary hospitals which the Company owns, it also manages the operations of certain other animal hospitals. The Company has direct or indirect unilateral and perpetual control over the assets and operations of the professional corporations for all periods presented, other than by means of owning the majority of the voting stock of the professional corporation. Each professional corporation has entered into a management agreement with the Company pursuant to which the Company manages all aspects of its operations other than the practice of veterinary medicine, which is the sole domain of the licensed professional. Additionally, the Company or one of its subsidiaries and each shareholder/director has entered into a shareholder's agreement pursuant to which the Company has the option to purchase, or to designate a purchaser for, the stock of the professional corporation for a nominal amount. Consequently, these professional corporations are consolidated with the other controlled operations of the Company. The Company believes that consolidation of the financial statements of these professional corporations is necessary to present fairly the financial position and results of operations of the Company. All significant inter-entity transactions have been eliminated in consolidation. b. CASH AND EQUIVALENTS For purposes of the balance sheets and statements of cash flows, the Company considers only highly liquid investments to be cash equivalents. Of its cash on hand at December 31, 1996 and 1995, $2,023,000 and $1,907,000, respectively, was restricted for use in the conduct of the Vet's Choice joint venture. PAGE 24 c. MARKETABLE SECURITIES All marketable securities are classified as held for sale and are available to support current operations and acquisitions. The Company currently invests in only high quality, short-term investments. There were no significant differences between amortized cost and estimated fair value at December 31, 1996 and 1995. Additionally, because investments are short- term and are generally allowed to mature, realized gains and losses for both years have been minimal. d. INVENTORY Inventory is valued at the lower of cost or market using the first-in, first-out method. e. NOTES RECEIVABLE Notes receivable are not market traded financial instruments. The amounts recorded approximate fair value. The notes bear interest at rates varying from 8% to 9% per annum. f. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment is recorded at cost. Land, buildings and equipment held under capital leases are 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 10 to 15 years Furniture and equipment 5 to 7 years Property held under capital leases 5 to 30 years Property, plant and equipment consisted of:
1996 1995 ----------- ----------- Land $6,635,000 $2,795,000 Land held under capital leases 362,000 -- Building and improvements 13,774,000 6,709,000 Buildings held under capital leases 835,000 -- Leasehold improvements 3,915,000 2,410,000 Furniture and equipment 17,468,000 8,942,000 Equipment held under capital leases 1,552,000 1,334,000 ------------ ------------ 44,541,000 22,190,000 Less -- Accumulated depreciation (7,074,000) (4,021,000) ------------ ------------ $37,467,000 $18,169,000 ============ ============
Accumulated depreciation on buildings and equipment held under capital leases amounted to $527,000 and $303,000 at December 31, 1996 and 1995, respectively. g. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill relating to acquisitions represents the purchase price paid and liabilities incurred in excess of the fair market value of net assets acquired. Goodwill is amortized over the expected period to be benefited, not exceeding 40 years, on a straight-line basis. Subsequent to its acquisitions, the Company continually evaluates whether events and circumstances have occurred that indicate the remaining estimated useful life of goodwill may warrant revision or that the remaining balance of PAGE 25 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 net income over the remaining life of the goodwill in measuring whether the goodwill is recoverable (Note 14). Other intangible assets principally include covenants not to compete. The value assigned to the covenants not to compete is amortized on a straight- line basis over the term of the agreements (principally 5 to 10 years). Accumulated amortization of goodwill and covenants not to compete at December 31, 1996 is $14,424,000 and $3,871,000, respectively. Accumulated amortization of goodwill and covenants not to compete at December 31, 1995 is $3,563,000 and $2,986,000, respectively. In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." The Statement requires that long-lived assets and certain identifiable intangibles held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The adoption of this Statement in the first quarter of 1996 did not impact the Company's financial position or its results of operations. h. USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. i. RECENT ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board has issued Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). The Company adopted SFAS 123 in 1996 by making the required note disclosures only. Therefore, the adoption of SFAS 123 did not have an effect on the Company's financial positions or results of operations. j. RECLASSIFICATIONS Certain 1995 balances have been reclassified to conform with the 1996 financial statement presentation. 3. ACQUISITIONS AND DISPOSITIONS On July 19, 1996, the Company completed the acquisition of Pet Practice for a total consideration (including acquisition costs) of $97,930,000 consisting of 3,516,268 shares of VCA common stock, with a value at the date of acquisition of $65,930,000, and the assumption of liabilities totaling $32,000,000. In addition, outstanding employee stock options were converted into options to purchase an additional 41,280 shares of VCA common stock. On the acquisition date, Pet Practice was the operator of 84 veterinary clinics located in 11 states. The acquisition of Pet Practice was accounted for as a purchase. On June 19, 1996, the Company completed the merger with Pets' Rx for 801,054 shares of VCA common stock. In addition, outstanding Pets' Rx warrants, options and convertible securities were converted into the right to purchase an additional 111,607 shares of VCA common stock. Pets' Rx owned 16 veterinary hospitals in the San Jose and Sacramento, California and the Las Vegas, Nevada markets. The Pets' Rx acquisition was accounted for as a pooling of interests. During 1996, the Company purchased 22 animal hospitals for an aggregate consideration (including acquisition costs) of $28,261,000 consisting of $9,691,000 in cash, $9,296,000 in debt, 518,056 shares of VCA common stock, with a value of $7,389,000, and the assumption of liabilities totaling $1,885,000. PAGE 26 Also during 1996, the Company purchased six veterinary diagnostic laboratories for an aggregate consideration of $20,565,000, including acquisition costs, consisting of $15,654,000 in cash, $2,510,000 in long- term obligations, 85,776 shares of VCA common stock, with a value of $1,500,000 and the assumption of liabilities totaling $901,000. Through December 31, 1996, the Company has sold, closed or merged 11 of the Pet Practice hospitals with annual revenues of approximately $4.0 million. Net proceeds from the sale of the hospitals amounted to $134,000. The Company is continuing to evaluate the financial performance of the remaining Pet Practice animal hospitals and may close or sell additional facilities as the evaluation is completed. The Company will complete this evaluation process by the end of the second quarter of 1997 and will record any reserves required for these possible closures as a component of the final purchase price allocation. Also, during 1996, the Company sold two hospitals for a total consideration of $75,000 in cash which approximated the net book value of the hospitals. During 1995, the Company purchased 26 animal hospitals for an aggregate consideration (including acquisition costs) of $29,237,000, consisting of $6,476,000 in cash, $10,899,000 in debt, 836,576 shares of common stock of the Company with a value of $9,780,000, and the assumption of liabilities totaling $2,082,000. In addition, the Company paid $250,000 to acquire an option to purchase the land and building of two of the hospitals. During 1995, a limited liability company (LLC) was formed by combining a veterinary clinic owned by Pets' Rx with the practice of another veterinary clinic owned by an unrelated party. Certain assets were contributed by each party to form the new entity, which is not liable for any contracts or for any indebtedness relating to the predecessor clinics. The Company has an 80% interest in the LLC. Also during 1995, the Company purchased substantially all of the assets of Cenvet, a full-service veterinary diagnostic laboratory, four other veterinary diagnostic laboratories and the remaining 30 percent interest in PAL, for an aggregate consideration of $13,986,000, including acquisition costs, consisting of $2,671,000 in cash, $8,633,000 in long-term obligations, 238,712 shares of VCA common stock with a value of $2,200,000 and the assumption of liabilities totaling $482,000. On March 20,1995, the Company and Vet Research, Inc., ("VRI"), formed Vet Research. In connection with the formation of Vet Research, VRI contributed all of the assets and certain of the liabilities of VRI's full- service veterinary diagnostic laboratory located in Farmingdale, New York. The Company contributed substantially all of the assets and certain of the liabilities of Cenvet for a 51 percent controlling interest in the joint venture (Note 4). In connection with the formation of Vet Research, the Company issued warrants to purchase 363,636 shares of the common stock of the Company at $11.00 per share. The warrants were purchased at $0.001 per warrant and were exercisable until January 1997. In 1994, the Company purchased 10 veterinary hospitals for a total consideration (including acquisition costs) of $9,785,000 consisting of $2,191,000 in cash, $3,663,000 in non-recourse promissory notes payable and $2,529,000 in secured notes payable, 91,996 shares of VCA common stock with a value of $680,000, and 2,154 shares of Pets' Rx common stock with a value of $15,000, and the assumption of liabilities totaling $382,000. In addition, the Company paid $60,000 to acquire an option to purchase the land and building of one of the hospitals. In 1994, the Company acquired substantially all of the assets and assumed certain of the liabilities of PAL, a full-service veterinary laboratory located in Irvine, California. In connection with the purchase, the Company also acquired from a principal shareholder of PAL the real property and building occupied by the business of PAL. The business is operated by a partnership to which the Company contributed the veterinary laboratory that it previously owned. The net consideration (including acquisition costs) paid by the Company in connection with these transactions, totaling $9,799,000, consisted of $4,619,000 in cash, $3,446,000 in notes payable, 143,333 shares of VCA common stock with a value of $1,037,000, and the assumption of liabilities totaling $697,000. PAGE 27 All acquisitions described above (the "Acquired Companies"), with the exception of the merger with Pets' Rx, have been accounted for using the purchase method of accounting. The operations of the Acquired Companies are included in the accompanying consolidated financial statements from the dates of acquisition. The pro forma results listed below are unaudited and reflect purchase price accounting adjustments assuming 1995 and 1996 acquisitions occurred at January 1, 1995. 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.
(Unaudited) ---------------------------------- 1996 1995 -------------- ------------- Revenue $228,048,000 $227,181,000 Net loss $(14,679,000) $(2,993,000) Primary loss per share $(0.75) $(0.20) Weighted average shares used for computing loss per share 19,700,000 15,299,000
4. JOINT VENTURES In January 1993, the Company entered into a joint venture with HPP, Vet's Choice, to develop, manufacture and market new pet products and services. The Company obtained a 50.5 percent controlling interest in the joint venture for a capital contribution of $3,030,000 in cash and was the managing general partner. HPP contributed $2,970,000 in cash for a 49.5 percent minority interest in the joint venture. As provided by the joint venture agreement, the Company and HPP each contributed approximately $1 million to the joint venture in each of 1996 and 1995. Subsequent to year end, the joint venture was restructured (Note 16). Through December 31, 1996, the Company operated Vet Research in a joint venture with VRI. Vet Research's operating results have been accounted for as part of the consolidated operations of the Company. Distributions of distributable cash, as defined, were made pursuant to a formula contained in the operating agreement between the Company and VRI. Pursuant to that formula, during each contract year, the first $1.5 million of distributable cash was distributed to VRI; the next $3 million of distributable cash was distributed to the Company; and the remaining distributable cash was distributed 25 percent to the Company and 75 percent to VRI. The Company has recorded minority interest expense related to the joint venture of $6,809,000 and $3,646,000 in 1996 and 1995, respectively, representing 57.3 percent and 52.4 percent, respectively, of Vet Research's income. The Company has an option pursuant to an agreement with VRI to acquire VRI's entire interest in Vet Research for a purchase price as computed in accordance with the operating agreement (Note 16). PAGE 28 5. LONG-TERM OBLIGATIONS Long-term obligations consisted of the following at December 31, 1996 and 1995:
1996 1995 ------------ ------------ MORTGAGE DEBT Notes payable and other obligations, various maturities through 2006, secured by land and buildings of certain subsidiaries, various interest rates ranging from 7.3 percent to 10.5 percent with a weighted average of 8.9 percent at December 31, 1996 $2,381,000 $1,314,000 SECURED DEBT Notes payable and other obligations, various maturities through 2007, secured by assets and stock of certain subsidiaries, various interest rates ranging from 4.0 percent to 12.5 percent with a weighted average of 7.1 percent at December 31, 1996 53,813,000 37,694,000 CONVERTIBLE DEBT Notes payable, convertible into VCA common stock at prices ranging from $7.00 to $15.00 per share, due through 2003, secured by stock of certain subsidiaries at a range of interest from 5.0 percent to 12.0 percent with a weighted average of 8.2 percent at December 31, 1996 1,659,000 2,427,000 UNSECURED DEBT Notes payable, various maturities through 2015, adjustable interest rates from 6.3 percent to 7.0 percent adjusted annually, and fixed interest rates ranging from 5.0 percent to 7.8 percent with a weighted average of 6.4 percent at December 31, 1996. 4,847,000 2,159,000 DEBENTURES Convertible subordinated 5.25 percent debentures, due in 2006, convertible into VCA common stock at $34.35 per share 84,385,000 -- ------------ ------------ Total debt obligations 147,085,000 43,594,000 Capital lease obligations 1,901,000 931,000 Less--unamortized discount (164,000) (251,000) ------------ ------------ 148,822,000 44,274,000 Less--current portion (14,055,000) (7,496,000) ------------- ------------ $134,767,000 $36,778,000 ============= ============
The annual aggregate scheduled maturities of debt obligations for the five years subsequent to December 31, 1996 are presented below: 1997 $ 14,055,000 1998 11,691,000 1999 8,752,000 2000 9,114,000 2001 5,448,000 Thereafter 99,762,000 ------------ $148,822,000 ============
The convertible subordinated debentures may be redeemed at the option of the Company in whole or in part at any time after May 15, 1999 at 103%, after May 15, 2000 at 102%, after May 15, 2001 at 101%, and after May 15, 2002 at 100%. Certain acquisition debt of the Company included above and amounting to $56,194,000 and $39,008,000 at December 31, 1996 and 1995, respectively, is non-recourse debt secured solely by the assets or the stock of the veterinary hospital acquired under security arrangements whereby the creditor's sole remedy in the event of default PAGE 29 is the contractual right to take possession of the entire veterinary hospital regardless of the outstanding indebtedness at the time of default. The following disclosure of the estimated fair value of the Company's debt is made in accordance with the requirements of Statement of Financial Accounting Standards No. 107 "Disclosures about Fair Value of Financial Instruments." The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. Considerable judgment is required to develop the estimates of fair value, the estimates provided therein are not necessarily indicative of the amounts that could be realized in a current market exchange.
December 31, 1996 ----------------------------- Carrying Fair Amount Value ------------ ------------ Fixed-rate long-term debt $132,025,000 $102,475,000 Variable-rate long-term debt 2,742,000 2,742,000
The estimated fair value of the Company's fixed-rate long-term debt is based on prime plus an estimated spread at December 31, 1996 for similar securities with similar remaining maturities. The carrying value of variable-rate long-term debt is a reasonable estimate of its fair value. 6. PREFERRED STOCK On December 22, 1992, the Company completed the sale of 583,333 shares of convertible preferred stock for net proceeds of $2,985,000. The shares are convertible into 583,333 shares of the Company's common stock commencing December 22, 1997. The preferred stock participates in any dividend payments on the Company's common stock on an "as if" converted basis. The preferred stock has a liquidation preference of $5.14 per share and it is callable by the Company any time after March 22, 1998 at a price of $5.14 per share. The preferred stock has no voting rights. Under the Company's certificate of incorporation, the Company is authorized to issue additional series of preferred stock. The rights, preferences and privileges of the preferred stock are to be determined by the board of directors and do not require stockholder approval. 7. COMMON STOCK On July 19, 1996, the stockholders of the Company approved an amendment to its Certificate of Incorporation to increase the number of authorized shares of VCA Common Stock from 30,000,000 to 60,000,000. On July 19, 1996, the stockholders of the Company approved the adoption of the Veterinary Centers of America, Inc. 1996 Employee Stock Purchase Plan and authorized the reservation of up to 250,000 shares of VCA Common Stock for issuance under the Plan. No shares have been issued under the Plan. On November 13, 1996, the Company's Board of Directors authorized the Company to repurchase its common stock on the open market. As of December 31, 1996, the Company has acquired 97,773 shares for a total consideration of $724,000. During 1996, the Company issued 3,516,268 shares of VCA common stock, with a value of $65,930,000, as a portion of the consideration for the Pet Practice acquisition and 603,832 shares of VCA common stock, with a value of $8,889,000 as a portion of the consideration for 22 animal hospitals and six veterinary diagnostic laboratories acquired in separate transactions. Also, in 1996, the Company issued 801,054 shares of its stock in the merger with Pets' Rx. Of this amount, 438,341 shares of common stock had not been issued as of December 31, 1996. Such shares are reflected as though they are outstanding in the accompanying consolidated financial statements. PAGE 30 In January 1995, Star-Kist Foods, Inc. through its division, HPP, purchased 1,159,420 shares of the Company's common stock at $8.625 per share, resulting in net proceeds to the Company of $9,980,000. In November 1995, the Company completed a secondary public offering of 2,965,026 shares of common stock for net proceeds of $33,932,000. During 1995, the Company issued 1,075,226 shares of its common stock valued at $11,980,000, the fair market value at the date of commitment, as a portion of the consideration for 15 animal hospitals and three veterinary diagnostic laboratories. Of this amount, 156,303 shares of common stock valued at $1,970,000 had not been issued as of December 31, 1995. Such shares are reflected as though they are outstanding in the accompanying consolidated financial statements. In conjunction with the acquisition of two hospitals and PAL in 1994, the Company issued 235,329 shares of common stock with a market value at the date of issuance of $1,717,000. Also in 1994, the Company issued 63,214 shares of common stock in settlement of a guaranteed purchase price contingently payable in cash or common stock (Note 9). On October 6, 1991, the Company completed a public offering of 2,400,000 shares of common stock and 3,240,000 redeemable warrants for $12,598,000. Each redeemable warrant entitled the holder to purchase one share of common stock for $7.20 commencing April 10, 1992 until October 10, 1996, and was redeemable at the option of the Company at any time after April 10, 1992 on 30 days prior written notice, provided that the market price of the common stock equals or exceeds $9.00 per share for 20 consecutive trading days ending within 10 days prior to notice of redemption. Such market price exceeded $9.00 per share for 20 consecutive days on March 10,1995. During 1996 and 1995, redeemable warrants were exercised for 1,962,452 and 1,271,508 shares of common stock, respectively. Cash proceeds from the exercise of redeemable warrants in 1996 and 1995 amounted to $13,800,000 and $8,896,000, respectively. 8. STOCK BASED COMPENSATION PLANS The Company has granted stock options to various employees and directors. The Company accounts for these plans under APB Opinion No. 15, under which no compensation cost has been recognized. In November 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation." The statement recommends changes in accounting for employee stock-based compensation plans, and requires certain disclosures with respect to these plans. The Statement's 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 and earnings per share would have been reduced to the following PRO FORMA amounts:
1996 1995 ------------- ------------- Net (loss) income As reported $(14,632,000) $(1,214,000) Pro forma (17,510,000) (1,997,000) Primary EPS As reported $(0.92) $(0.13) Pro forma (1.09) (0.21)
Because the SFAS 123 method of accounting has not been applied to options granted prior to December 31, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. 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 used for grants in 1996 and 1995: risk free interest rates of 6.4 PAGE 31 percent and 6.3 percent, respectively; expected volatility of 55.1 percent and 54.7 percent respectively; weighted average fair value of options of $10,756 and $7,432, respectively; expected lives of seven years for both years and no expected dividend yield for either year. Under the provisions of the Company's non-qualified and incentive stock option plans for officers and key employees, 750,000 shares of common stock were reserved for issuance at December 31, 1992. On May 5, 1995, the stockholders of the Company approved the adoption of the Veterinary Centers of America, Inc. 1995 Stock Incentive Plan, and authorized the reservation of 750,000 shares of common stock for issuance under the Plan. On July 19, 1996, the stockholders of the Company approved the adoption of the Veterinary Centers of America, Inc. 1996 Stock Incentive Plan, and authorized the reservation of 1,500,000 shares of common stock for issuance under the Plan. The options become exercisable over a two to five year period, commencing at the date of grant or one year from the date of grant depending on the option. All options expire 10 years from the date of grant. The prices of all options granted were greater than or equal to the fair market value at the date of the grant. The table below summarizes the transactions in the Company's stock option plans during 1996, 1995 and 1994:
1996 1995 1994 --------- --------- --------- Options outstanding at beginning of year 1,579,903 754,171 635,627 Granted 254,780 859,965 144,993 Exercised (69,498) (21,033) (9,499) Canceled (54,391) (13,200) (16,950) ---------- --------- --------- Options outstanding at end of year ($.75 to $36.79 per share) 1,710,794 1,579,903 754,171 ========== ========== ========= Exercisable at end of year 847,478 664,642 433,168 ========== ========== =========
The following table summarizes information about certain options in the stock option plans outstanding as of December 31, 1996 in accordance with SFAS 123:
Options Outstanding Options Exercisable - ------------------------------------------------------------------------------ -------------------------------- Weighted Avg. Range of Number Remaining Weighted Avg. Number Weighted Avg. Exercise Price Outstanding Contractual Life Exercise Price Exercisable Exercise Price -------------- ---------- ---------------- -------------- ------------ -------------- Less than $15.00 866,874 8.61 years $11.770 427,276 $11.616 $15.00 to $26.00 206,354 9.62 years 17.340 163 25.754 $26.00 and up 13,963 6.53 years 28.425 7,616 27.571 --------- ------- 1,087,191 435,055 ========= =======
In addition to the options granted under VCA's stock option plans, the Company had 30,667 and 45,667 options outstanding at December 31, 1996 and 1995, respectively, to certain members of the board of directors and to the previous owners of certain acquired companies. During 1996, 10,000 of these options were exercised. The options are exercisable at $.75 to $6.00 per share. At December 31, 1996, 30,667 of the options are exercisable. 9. GUARANTEED PURCHASE PRICE CONTINGENTLY PAYABLE IN CASH OR COMMON STOCK The Company has guaranteed the value of certain shares of its common stock issued in connection with the acquisition of certain animal hospitals in 1996 and 1995. If the aggregate market value of the stock (as quoted by a nationally recognized stock exchange) at various specified valuation dates is below the value of the stock on the acquisition date, the Company has agreed to pay the difference in additional shares of stock, cash or notes payable. The Company's guarantee of the value, however, terminates if the common stock is registered for resale and trades at 110 percent to 120 percent of the issue price of the stock for five to twenty consecutive days. At December 31, 1996, there were 256,672 shares of stock outstanding with such guarantees, with issue prices ranging from $11.62 to $24.53, with a weighted average of $17.30. PAGE 32 In connection with certain acquisitions completed prior to 1995, the Company guaranteed the price of certain shares of its common stock issued in connection with the acquisitions. If the aggregate market value of the stock (as quoted by a nationally recognized stock exchange) had not reached the guaranteed value, which exceeded the value of the stock at the acquisition date, by the various specified valuation dates, the Company agreed to pay the difference in additional shares of stock, cash, or notes payable. The guaranteed purchase price contingently payable in cash or common stock represents the liability for the difference between the aggregate guaranteed value of the common stock net of the Company's estimate of the fair market value of the stock at the date of the acquisition, discounted at 10 percent. In 1995, pursuant to two of these stock guarantee arrangements pertaining to a total of 13,494 shares, the Company paid $19,000 in cash for the difference between the guaranteed value of the stock held and the market value of the stock, as defined. The difference between the $19,000 and the $72,000 liability for the guaranteed purchase price contingently payable in cash or common stock, amounting to $53,000, was credited to additional paid-in-capital. In 1994, pursuant to a stock guarantee arrangement for 80,000 shares, the Company issued 63,214 shares of common stock for the difference between the guaranteed value of the stock held and the market value of the stock, as defined. The market value of the additional shares issued, totaling $470,000, was charged to the liability for the guaranteed purchase price contingently payable in cash or common stock. 10. COMMITMENTS 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 Company also leases certain medical and computer equipment under capital leases. The future minimum lease payments on operating leases at December 31, 1996, including renewal option periods, are as follows: 1997 $ 5,517,000 1998 5,351,000 1999 4,869,000 2000 4,686,000 2001 4,703,000 Thereafter 65,240,000 ----------- $90,366,000 ===========
Rent expense totaled $7,036,000, $3,880,000 and $2,158,000 for the years ended December 31, 1996, 1995 and 1994, respectively. Rental income totaled $313,000, $246,000 and $96,000 for the years ended December 31, 1996, 1995 and 1994, respectively. In connection with the acquisition of Pet Practice, the Company assumed certain contractual arrangements, whereby additional shares of the Company's common stock and cash may be issued to former owners of acquired hospitals upon attainment of specified financial criteria over periods of three to five years, as set forth in the respective agreements ("Earnout Payments"). The number of shares of common stock and cash to be issued cannot be determined until the earnout periods expire and the attainment of criteria is established. Earnout Payments in 1996 amounted to approximately $2,015,000, consisting of $752,000 in cash, 30,709 shares of common stock valued on the date of issuance at $356,000, and a $907,000 note payable. If the specified financial criteria is attained in the future, but not exceeded, the Company will be obligated to make cash payments of approximately $875,000 and issue approximately 22,800 shares of common stock over the next three years. PAGE 33 The Company has employment agreements with three officers of the Company which currently expire on December 31, 2002. Each of the agreements provide for annual compensation (subject to upward adjustment) which aggregated $616,000 for the year ended December 31, 1996. 11. CALCULATION OF PER SHARE AMOUNTS Earnings per share calculations are based on the weighted average common shares outstanding including obligated shares (Note 7) plus common shares subject to dilutive stock options, common shares contingently issuable pursuant to the guaranteed purchase price contingently payable in cash or common stock as discussed in Note 9, convertible debt and shares issuable upon redemption of redeemable warrants and conversion of preferred stock. Stock options, common shares contingently issuable and shares issuable upon conversion of preferred stock are not included in the weighted average common shares in 1994, 1995 and 1996 as they have an anti-dilutive effect. 12. INCOME TAXES The provision for income taxes is comprised of the following:
1996 1995 1994 ----------- ----------- ---------- Federal: Current $1,842,000 $1,888,000 $183,000 Deferred (444,000) (192,000) 296,000 ----------- ----------- --------- 1,398,000 1,696,000 479,000 ----------- ----------- --------- State: Current 450,000 560,000 239,000 Deferred 111,000 (18,000) 13,000 ----------- ----------- --------- 561,000 542,000 252,000 ----------- ----------- --------- $1,959,000 $2,238,000 $731,000 =========== =========== =========
The Company has adopted the provision of Statement of Financial Accounting Standards No. 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 in effect for the year in which the differences are expected to reverse. The net deferred tax asset (liability) is comprised of the following:
1996 1995 ----------- ----------- Current deferred tax assets (liabilities): Accounts receivable $692,000 $301,000 State taxes (923,000) 156,000 Other liabilities and reserves 1,072,000 588,000 Start-up costs 33,000 59,000 Property, plant and equipment -- 95,000 Restructuring charges 5,100,000 345,000 Other assets (2,000) (4,000) Inventory 768,000 -- Valuation allowance (4,409,000) (365,000) ----------- ----------- Total current deferred tax asset, net $2,331,000 $1,175,000 =========== ===========
PAGE 34
1996 1995 ----------- ----------- Non-current deferred tax (liabilities) assets: Net operating loss carryforwards $9,395,000 $2,482,000 Writedown of assets 1,587,000 1,587,000 Start-up costs 288,000 288,000 Other assets 59,000 (119,000) Intangible assets 832,000 (2,037,000) Property, plant and equipment 190,000 258,000 Valuation allowance (10,999,000) (3,760,000) ------------ ------------ Total non-current deferred tax asset (liability), net $1,352,000 $(1,301,000) ============ ============
At December 31, 1996, the Company has federal net operating loss ("NOL") carryforwards of approximately $25,400,000, comprised principally of NOL carryforwards acquired in the Pets' Rx and Pet Practice mergers. These NOL carryforwards expire at various dates through 2010. Under the Tax Reform Act of 1986, the utilization of NOL carryforwards to reduce taxable income will be restricted under certain circumstances. Events which 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 and Pet Practice 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. A reconciliation of the provision for income taxes to the amount computed at the Federal statutory rate is as follows:
1996 1995 1994 ------- ------- ------- Federal income tax at statutory rate (34.0)% 34.0% (34.0)% Effect of amortization of goodwill 5.0 5.0 9.0 State taxes, net of Federal benefit 3.0 8.0 12.0 Tax exempt income (3.0) -- -- Subsidiary net operating loss 10.0 -- -- Increase in valuation allowance associated with certain writedown of assets, restructuring and acquisition related costs 34.0 172.0 75.0 ------- ------- ------- 15.0% 219.0% 62.0% ======= ======= =======
For financial reporting purposes, the benefit arising from the utilization of NOL carryforwards generated by certain companies, including Pet Practice and Pets' Rx, prior to their acquisition by the Company is accounted for as a reduction of goodwill of the acquired companies. Such benefit amounted to $69,000 for the year ended December 31, 1995. No benefit was realized for the years ended December 31, 1994 and 1996. 13. 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 eligible employees and provides for annual matching contributions by the Company at the discretion of the Company's board of directors. In 1996, 1995 and 1994, the Company provided a matching contribution at the discretion of the Board of Directors. Such matching contributions approximated $250,000, $87,000 and $46,000 in 1996, 1995 and 1994, respectively. 14. RESTRUCTURING AND ASSET WRITEDOWN As a result of the acquisition of Pets' Rx, Pet Practice and Southwest in 1996, the Company conducted a complete review of its animal hospital and laboratory operations during the third quarter ended September 30, 1996. As a result of this review, the Company determined to restructure its laboratory operations and close, merge or sell certain of its hospitals which do not meet new standards for performance adopted in light of the increase in the size PAGE 35 of the Company's animal hospital operations. Accordingly, the Company adopted a restructuring plan and recorded a restructuring and asset writedown charge of approximately $15.2 million. The major components of the restructuring plan include (1) the termination of leases, the writedown of intangibles, property and equipment, and employee terminations in connection with the closure, sale or consolidation of five VCA animal hospitals, (2) the termination of contracts and leases, the writedown of certain real and personal property and equipment and the termination of employees in connection with the restructuring of the Company's laboratory operations, (3) contract terminations and writedown of assets in connection with the move to common communications and computer systems, and (4) the closure, sale or consolidation of certain Pet Practice hospitals which are recorded in the purchase price allocation and not as part of the restructuring and asset writedown charge. The restructuring plan is expected to be executed over the period continuing through the second quarter of 1997. As part of the restructuring, the Company expects to close, merge or sell eight existing VCA hospitals as well as 17 hospitals acquired in connection with the Pet Practice merger. Collectively, the hospitals have aggregate annual revenues of approximately $10.8 million. The Company is continuing to evaluate the financial performance of the Pet Practice animal hospitals and may sell, close or merge additional facilities once this evaluation is complete. In connection with the anticipated closure of the eight VCA animal hospitals, the Company has recognized writedowns of intangibles and property and equipment of $7,919,000, charges associated with the termination of leases in the amount of $1,877,000 and severance costs of $307,000. As indicated above, the closures of the Pet Practice animal hospitals are reflected in the allocation of goodwill and do not result in a charge against earnings. The intended restructuring of the Company's laboratory operations has resulted in accruals of approximately $490,000 for contract and lease terminations, $265,000 in severance and other employee related costs and a writedown of fixed assets in the amount of $867,000. The charge to move the Company's communications and computer systems to common systems includes an accrual for contract terminations of $2,763,000 and asset writedowns of $725,000. Of the $15.2 million in restructuring and asset writedown charges recorded in 1996, $5.7 million represents cash charges and the remainder represents non-cash charges. Of the cash charges, $93,000 had been paid at December 31, 1996 and the remainder is expected to be paid over the next 60 months. The operations of Cenvet (acquired January 1, 1995) were merged into VRI's operations to form Vet Research. The combined operations were restructured to eliminate duplicate operating and overhead costs. In connection with the restructuring, the Company recorded a charge of $1,086,000 in the first quarter of 1995 to accrue the estimated costs associated with the restructuring, consisting primarily of lease termination and severance costs (the "1995 restructuring charge"). The 1995 restructuring charges included employee severance cost s of $468,000, lease termination costs of $433,000 and other costs of $185,000. During 1996 and 1995, the Company utilized $473,000 and $237,000, respectively, of the 1995 restructuring reserve. At December 31, 1996, $376,000 of the 1995 restructuring reserve remained on the Company's balance sheet. During 1995, the Company charged $2,148,000 to operations related to a writedown of goodwill and certain intangible assets at three Pets' Rx facilities. These facilities that were written down in 1995 collectively had a net loss in 1996 of approximately $16,000 and will approximate break even in 1997. The Company's goal in 1997 is to minimize the facilities' cash flow requirements and ultimately bring the facilities to a breakeven status. Management of the Company believes that the Company's strategy of building a network of animal hospitals is served by continuing to operate these animal hospitals even though the facilities themselves may not generate profits. 15. LINES OF BUSINESS The Company classifies its business operations into three segments: Animal Hospital, Laboratory and Premium Pet Food. PAGE 36 The following is a summary of certain financial data for each of the three segments:
Animal Premium (In thousands) Hospital Laboratory Pet Food Corporate Eliminations Total -------- ---------- -------- --------- ------------ --------- 1996 Revenues $120,842 $56,774 $8,674 $-- $(4,130) $182,160 Operating income (loss) (1,295) 13,120 (1,263) (13,333) -- (2,771) Depreciation/amortization expense 5,156 1,823 129 388 -- 7,496 Identifiable assets 188,675 48,205 4,491 112,638 -- 354,009 Capital expenditures 4,575 1,049 169 1,679 -- 7,472 1995 Revenues $67,059 $37,606 $4,756 $-- $(1,727) $107,694 Operating income (loss) 6,776 8,359 (2,573) (6,029) -- 6,533 Depreciation/amortization expense 2,779 1,263 38 64 -- 4,144 Identifiable assets 74,819 29,798 3,854 44,945 -- 153,416 Capital expenditures 1,571 1,194 179 101 -- 3,045
Corporate operating loss includes (1) salaries, general and administrative expense for the executive finance, accounting, human resources, marketing, purchasing and regional operational management functions that support the Animal Hospital Laboratory and Premium Pet food segments; and (2) certain restructuring charges and asset writedowns amounting to $3,488,000 for the year ended December 31, 1996. 16. SUBSEQUENT EVENTS From January 1, 1997 through March 26, 1997, the Company purchased three animal hospitals in separate transactions for a total consideration (including acquisition costs) of $3,220,000, consisting of $875,000 in cash, $1,195,000 in notes payable, 107,477 shares of VCA common stock with a value of $1,150,000. In January 1997, the Company acquired the remaining 49% interest in the Vet Research Joint Venture for a price as computed in accordance with the operating agreement, amounting to $18,600,000 in cash and a $29,000,000 note payable, payable in quarterly installments over six years. In February 1997, Vet's Choice was restructured and management of the joint venture was assumed by HPP. Pursuant to a restructuring agreement, the Company maintains its 50.5% equity interest in Vet's Choice but profits and losses are allocated 99.9% to HPP and .01% to the Company. Additionally, the Company agreed to provide certain consulting and management services for a three year period commencing on February 1, 1997 and to continue to support and sell the SELECT BALANCE and SELECT CARE brands through its network of animal hospitals. On or after the earlier of a change of control in the Company or January 1, 2000, HPP may purchase all of the Company's interest in the partnership at a purchase price equal to (i) 51% of (ii) 1.3 times the annual sales of all products bearing the SELECT BALANCE or SELECT CARE brand (the "Annual Sales") less (iii) $4.5 million. If HPP fails to exercise its option prior to January 1, 2001, the Company may purchase all of the interest of HPP in the partnership at a purchase price equal to (i) 49.5% of (ii) 1.3 times the Annual Sales plus (iii) $4.5 million. 17. SHAREHOLDER LAWSUIT The Company and certain of its current and former officers and directors have been named as defendants in a class action lawsuit filed on April 1, 1997 in Los Angeles Superior Court, entitled Marilyn J. Thompson, et al. v. Veterinary Centers of America, Inc., et al. The lawsuit has been filed on behalf of individuals claiming to have purchased Common Stock of the Company during the time period from February 15, 1996 through November 14, 1996, and the plaintiffs seek unspecified damages arising from alleged misstatements regarding the Company's animal hospitals, diagnostic laboratories, pet food operations and success in integrating certain acquisitions. While the Company has not yet filed an answer to the complaint, the Company intends to vigorously defend itself against the lawsuit. PAGE 37 Since discovery has not yet commenced, the Company is unable to assess the likelihood of an adverse result in the class action lawsuit. There can be no assurances as to the outcome of such lawsuit. The inability of the Company to resolve the claims that are the basis for the lawsuit or to prevail in any related litigation could result in the Company being required to pay substantial monetary damages for which the Company may not be adequately insured, which could have a material adverse effect on the Company's business, financial position and results of operations. In any event, the Company's defense of such lawsuit may result in substantial costs to the Company, as well as significant dedication of management resources. PAGE 38 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Financial Statement Schedules: Form 10-K Page No. ---------- Report of Independent Public Accountants 45 Schedules for the years ended December 31, 1996, 1995, 1994 II - Valuation and Qualifying Accounts 46 Schedules other than those listed above are omitted since they are not applicable, not required or the information required to be set forth herein is included in the consolidated financial statements or notes thereto. (b) Reports on Form 8-K: None (c) Exhibits: See attached Exhibit Index PAGE 39 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, this 30th day of April, 1997. VETERINARY CENTERS OF AMERICA, INC. (Registrant) By: /s/ Tomas W. Fuller -------------------- Tomas W. Fuller Its: Chief Financial Officer PAGE 40 EXHIBIT INDEX Item Exhibit - ---- ------- 2.1 Agreement and Plan of Reorganization dated March 21, 1996 by and among Veterinary Centers of America, Inc., Golden Merger Corporation and the Pet Practice, Inc. (attached as Appendix A to the Joint Proxy Statement/Prospectus included in this Registration Statement (1) 2.2 Agreement and Plan of Reorganization dated February 27, 1996, as amended on April 11, 1996, May 23, 1996 and June 7, 1996 by and among Veterinary Centers of America, Inc., PRI Merger Company, Pets Rx, Inc. and the Principal Stockholder. (1) 2.3 Irrevocable Proxy dated March 21, 1996 by and between Abbingdon Ventures Partners Limited Partnership-II and Veterinary Centers of America, Inc. (1) 3.1 Certificate of Incorporation of Registrant, as amended to date 3.2 Bylaws of Registrant, as currently in effect (3) 4.1 Specimen certificate evidencing Common Stock of Registrant (4) 4.2 Form of Warrant Agreement (4) 4.3 Indenture dates as of April 17, 1996 between Veterinary Centers of America, Inc. and the Chase Manhattan Bank, N.A. (1) 10.1 1987 Stock Option Plan of the Company and form of Stock Option Agreement used therewith, as amended (2) 10.2 Form of Indemnification Agreement between the Company and its Directors (3) 10.3 Employment Agreement, dated January 1, 1994, by and between Robert L. Antin and the Company, as amended (6) 10.4 Employment Agreement, dated January 1, 1994, by and between Arthur J. Antin and the Company, as amended (6) 10.5 Employment Agreement, dated January 1, 1994, by and between Neil Tauber and the Company, as amended (6) 10.6 Lease and Sublease Agreement, dated September 1, 1992, by and among GSK Associates, Gebhart/Sevedge Properties and West Los Angeles Veterinary Medical Group, Inc. (2) 10.7 Stock Purchase Agreement, dated as of December 9, 1992, between Heinz Pet Products Company, a division of Star-Kist Foods, Inc. and Veterinary Centers of America, Inc. (2) 10.8 Partnership Agreement, dated January 1, 1993, of Specialty Pet Products Partners (2) 10.9 Stock Option Agreement, dated March 2, 1989, by and between the Company and Robert L. Antin (3) 10.10 Stock Option Agreement, dated March 2, 1989, by and between the Company and Arthur J. Antin (3) 10.11 Stock Option Agreement, dated March 2, 1989, by and between the Company and Neil Tauber (3) PAGE 41 10.12 Revolving Line of Credit Agreement, dated December 19, 1995 for $3,100,000, by and between First Professional Bank and Veterinary Centers of America, Inc. (11) 10.13 1993 Incentive Stock Plan of the Company and form of Stock Plan Option Agreement used therewith (6) Item Exhibit - ---- ------- 10.14 Asset Purchase Agreement, dated March 4, 1994 by and among VCA Professional Animal Laboratory, Inc., Professional Animal Laboratory, Inc., and Dennis Moore, D.V.M., Paul Greenlee, D.V.M., Andrew Loar, D.V.M. and Lon Rich, D.V.M. (5) 10.15 Agreement of Purchase and Sale, dated March 9, 1994 by and among Veterinary Centers of America and NAWOC Partnership (6) 10.16 Partnership Agreement dated as of March 4, 1994 by and between Dr. Lon Rich, D.V.M., and VCA Professional Animal Laboratory, Inc. (5) 10.17 Asset Purchase Agreement dated as of November 1, between VCA Cenvet, Inc., and Cenvet Inc., a New York corporation and its stockholders, Robert Wilkins, B.V. Sc and Steven R. Gilbertson, D.V.M. (7) 10.18 Management Consulting Agreement by and between VCA Cenvet, Inc. and R&B Management, Inc., a New York corporation, and Robert Wilkins, its President (7) 10.19 Pathology Consulting Agreement by and between VCA Cenvet, Inc. and R&B Management, Inc., a New York corporation, and Robert Wilkins, its President (7) 10.20 Management Consulting Agreement by and between VCA Cenvet, Inc. and SRG Consulting, Inc., a New York corporation, and Steven Gilbertson, its President (7) 10.21 Pathology Consulting Agreement by and between VCA Cenvet, Inc. and SRG Consulting Inc., a New York corporation, and Steven Gilbertson, its President (7) 10.22 Lease of premises located at 32-50 57th Street, Woodside, New York by and between VCA Cenvet, Inc., and RJW Associates, a New York general partnership (7) 10.23 Security Agreement by and among VCA Cenvet, Inc., R&B Management, Inc., and SRG Consulting, Inc. (7) 10.24 Noncompetition Agreement by and between VCA Cenvet, Inc., and Robert Wilkins (7) 10.25 Noncompetition Agreement by and between VCA Cenvet, Inc., and Steven Gilbertson (7) 10.26 Letter Agreement entered into by and between VCA Cenvet, Inc., and Robert Wilkins (7) 10.27 Letter Agreement entered into by and between VCA Cenvet, Inc., and Steven Gilbertson (7) 10.28 Stock Purchase Agreement, dated as of January 11, 1995, by and between Star-Kist Foods, Inc. and Veterinary Centers of America, Inc. (8) 10.29 Registration Rights Agreement, dated as of January 11, 1995, and between Star-Kist Foods, Inc. and Veterinary Centers of America, Inc. (8) PAGE 42 10.30 Shareholders Agreement, dated as of January 11, 1995, by and between Star-Kist Food, Inc., Robert L. Antin and Arthur J. Antin (8) 10.31 First Amendment to Partnership Agreement, dated as of January 11, 1995 by and between HPP Specialty Pet Products Inc. and VCA Specialty Pet Products, Inc. (8) 10.32 Operating Agreement for Vet Research Laboratories, L.L.C. dated as of March 20, 1995 between Veterinary Centers of America, Inc., VCA Cenvet, Inc., and Vet Research, Inc., a Delaware corporation and its stockholders, Robert H. Schneider and Bruce Schneider (9) 10.33 VRI Option Agreement entered into as of March 20, 1995 by and between VCA Cenvet, Inc. and Vet Research Inc. (9) Item Exhibit - ---- ------- 10.34 VCA Option Agreement entered into as of March 20, 1995 by and between Veterinary Center of America, Inc., VCA Cenvet, Inc. and Vet Research Inc. (9) 10.35 Warrant Agreement entered into as of March 20, 1995 by and between Veterinary Centers of America, Inc. and Robert H. Schneider (9) 10.36 Warrant Agreement entered into as of March 20, 1995 by and between Veterinary Centers of America, and Bruce T. Schneider (9) 10.37 Asset Purchase Agreement, dated February 8, 1996, by and among VCA Professional Animal Laboratory, Inc., Veterinary Centers of America, Inc., Southwest Veterinary Diagnostics, Inc., and is stockholders, Robert Bartsch and Merge Westhoff (10) 10.38 Lease Agreement dated June 7, 1996 between Barclay-Curci Investment Company and Veterinary Centers of America, Inc. (1) 10.39 Letter Agreement dated September 9, 1996 between VCA Specialty Pet Products, Inc., Veterinary Centers of America, Inc., HPP Specialty Pet Products, Inc. and Heinz Pet Products. (12) 10.40 Restructuring Agreement between HPP Specialty Products, Inc., Heinz Pet Products, VCA Specialty Products, Inc. and Veterinary Centers of America, Inc. (12) 10.41 VCA 1996 Stock Incentive Plan (1) 10.42 VCA 1996 Employee Stock Purchase Plan (1) 11.1 Computation of Per Share Earnings (12) 21.1 Subsidiaries of Registrant (12) 23.1 Consent of Arthur Andersen LLP 27.1 Financial Data Schedule (12) PAGE 43 (1) Incorporated by reference from Registrant's Registration Statement on Form S-4, File No. 333-6667. (2) Incorporated by reference from Registrant's Report on Form 10-KSB, for the year ended December 31, 1992. (3) Incorporated by reference from Registrant's Registration Statement on Form S-1, File No. 33-40095. (4) Incorporated by reference from Registrant's Registration Statement on Form S-1, File No. 33-42504. (5) Incorporated by reference from Registrant's Report on Form 8-K filed on March 22, 1994. (6) Incorporated by reference from Registrant's Report on Form 10-KSB, for the year ended December 31, 1993. (7) Incorporated by reference from Registrant's Report on Form 8-K, filed on January 14, 1995. (8) Incorporated by reference from Registrant's Report on Form 10-KSB, for the year ended December 31, 1994. (9) Incorporated by reference from Registrant's Report on Form 8-K, filed on April 4, 1995. (10) Incorporated by reference from Registrant's Report on Form 8-K, filed on March 15, 1996. (11) Incorporated by reference from Registrant's Report on 10-K, for the year ended December 31, 1995. (12) Previously filed. PAGE 44 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Shareholders of Veterinary Centers of America, Inc.: We have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Veterinary Centers of America, Inc. and subsidiaries included in this Form 10-K/A and have issued our report thereon dated March 14, 1997 (except for the matter discussed in Note 17, as to which the date is April 28, 1997). Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule identified as "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 consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in a relation to the basic financial statements taken as a whole. /s/ Arthur Andersen LLP ARTHUR ANDERSEN LLP Los Angeles, California March 14, 1997 (Except for the matter discussed in Note 17, as to which the date is April 28, 1997) PAGE 45 VETERINARY CENTERS OF AMERICA, INC. AND SUBSIDIARIES SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS For the Years Ended December 31, 1996, 1995 and 1994
Balance at Charged to beginning costs and Balance at of period expenses Other (1) end of period ---------- ---------- --------- ------------- Year ended December 31, 1994 Allowance for uncollectible accounts $ 374,000 $ 314,000 $ 109,000 $ 797,000 Excess and obsolescence inventory allowance -- 51,000 -- 51,000 Year ended December 31, 1995 Allowance for uncollectible accounts $ 797,000 $ 772,000 $ 102,000 $1,671,000 Excess and obsolescence inventory allowance 51,000 65,000 (96,000) 20,000 Year ended December 31, 1996 Allowance for uncollectible accounts $1,671,000 $1,844,000 $ 697,000 $4,212,000 Excess and obsolescence inventory allowance 20,000 -- -- 20,000 (1) "Other" changes in the allowance for uncollectible accounts include accounts receivable write-offs net of allowances acquired with hospital and laboratory acquisitions.
PAGE 46 EX-3.1 2 CERTIFICATE OF INCORPORATION EXHIBIT 3.1 AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF VETERINARY CENTERS OF AMERICA, INC. Veterinary Centers of America, Inc., a corporation organized and existing under the laws of the State of Delaware, hereby certifies as follows: 1. The name of the Corporation is Veterinary Centers of America, Inc. Veterinary Centers of America, Inc. was originally incorporated under the same name, and the original Certificate of Incorporation of the Corporation was filed with the Secretary of State of the State of Delaware on May 4, 1987. 2. Pursuant to Sections 242 and 245 of the General Corporation Law of the State of Delaware, this Restated Certificate of Incorporation restates and integrates and further amends the provisions of the Certificate of Incorporation of this Corporation. 3. The text of the Certificate of Incorporation as heretofore amended or supplemented is hereby restated and further amended to read in its entirety as follows: FIRST: The name of this Corporation is Veterinary Centers of America, Inc. SECOND: The address of the registered office of this Corporation in the State of Delaware is 1209 Orange Street, City of Wilmington, County of New Castle. The name of its registered agent at that address is The Corporation Trust Company. THIRD: The purpose of this Corporation is to engage in any lawful act or activity for which a corporation may now or hereafter be organized under the General Corporation Law of the State of Delaware as set forth in Title 8 to the Delaware Code (the "GCL"). FOURTH: The total number of shares which the Corporation shall have authority to issue is 13,500,000 consisting of 12,500,000 shares of common stock, par value $0.001 per share (the "Common Stock") and 1,000,000 shares of preferred stock, par value $0.001 per share (the "Preferred Stock"). Shares of the Preferred Stock of the Corporation may be issued from time to time in one or more classes or series, each of which class or series shall have such distinctive designation or title as shall be fixed by the Board of Directors of the Corporation (the "Board of Directors") prior to the issuance of any shares thereof. Each such class or series of Preferred Stock shall have such voting powers, full or limited, or no voting powers, and such preferences and relative, participating, optional or other special rights and such qualifications, limitations or restrictions thereof, as shall be stated in such resolution or resolutions providing for the issue of such class or series of Preferred Stock as may be adopted from time to time by the Board of Directors prior to the issuance of any shares thereof pursuant to the authority hereby expressly vested in it, all in accordance with the laws of the State of Delaware. FIFTH: All rights to vote and all voting power shall be vested in the Common Stock and the holders thereof shall be entitled at all elections of directors to one (1) vote per share. Special meetings of the stockholders for any purpose or purposes may be called at any time only by the Board of Directors, the Chairman of the Board or by the Chief Executive Officer or President of the Corporation. SIXTH: The directors of the Corporation shall be divided into three classes, designated Class I, Class II and Class III. The term of the initial Class I directors shall terminate on the date of the 1994 annual meeting of stockholders; the term of the initial Class II directors shall terminate on the date of the 1993 annual meeting of stockholders and the term of the initial Class III directors shall terminate on the date of the 1992 annual meeting of stockholders. At each annual meeting of stockholders beginning in 1992, successors to the class of directors whose term expires at that annual meeting shall be elected for a three-year term. If the number of directors is changed, any increase or decrease shall be apportioned among the classes so as to maintain the number of directors in each class as nearly equal as reasonably possible, and any additional directors of any class elected to fill a vacancy resulting from an increase in such class shall hold office for a term that shall coincide with the remaining term of that class, but in no case will a decrease in the number of directors shorten the term of any incumbent directors. A director shall hold office until the annual meeting for the year in which his term expires and until his successor shall be elected and shall qualify, subject, however, to prior death, resignation, retirement, disqualification or removal from office. Any vacancy on the Board of Directors, howsoever resulting, shall be filled only by a majority of the directors then in office, even if less than a quorum, or by a sole remaining director and not by the stockholders. Any director elected to fill a vacancy shall hold office for a term that shall coincide with the terms of the class to which such director shall have been elected. Subject to the rights, if any, of the holders of shares of Preferred Stock then outstanding, any or all of the directors of the Corporation may be removed from office at any time, for cause only, by the affirmative vote of the holders of a majority of the outstanding shares of the Corporation then entitled to vote generally in the election of directors, considered for purposes of the Article SIXTH as one class. Notwithstanding the foregoing, whenever the holders of any one or more classes or series of Preferred Stock issued by the Corporation shall have the right, voting separately by class or series, to elect directors at an annual or special meeting of stockholders, the election, term of office, filling of vacancies and other features of such directorships shall be governed by the terms of this Amended and Restated Certificate of Incorporation or the resolution or resolutions adopted by the Board of Directors pursuant to the second paragraph of Article FOURTH applicable thereto, and such directors so elected shall not be divided into classes pursuant to this Article SIXTH unless expressly provided by such terms. SEVENTH: Elections of directors at an annual or special meeting of stockholders need not be by written ballot unless the Bylaws of the Corporation shall otherwise provide. Any action required or permitted to be taken at any annual or special meeting of stockholders may be taken only upon the vote of the stockholders at an annual or special meeting duly noticed and called, as provided in the Bylaws of the Corporation, and may not be taken by written consent of the stockholders pursuant to the GCL. EIGHTH: The officers of the Corporation shall be chosen in such a manner, shall hold their offices for such terms and shall carry out such duties as are determined solely by the Board of Directors, subject to the right of the Board of Directors to remove any officer or officers at any time with or without cause. NINTH: (A) The Corporation shall indemnify to the full extent authorized or permitted by law (as now or hereafter in effect) any person made, or threatened to be made, a defendant or witness to any action, suit or proceeding (whether civil or criminal or otherwise) by reason of the fact that he, his testator or intestate, is or was a director or officer of the Corporation or by reason of the fact that such director or officer, at the request of the Corporation, is or was serving any other corporation, partnership, joint venture, trust, employee benefit plan or enterprise, in any capacity. Nothing contained herein shall affect any rights to indemnification to which employees other than directors and officers may be entitled by law. No amendment or repeal of this Section A or Article NINTH shall apply to or have any effect on any right to indemnification provided hereunder with respect to any acts or omissions occurring prior to such amendment or repeal. (B) No director of the Corporation shall be personally liable to the Corporation or its stockholders for monetary damages for any breach of fiduciary duty by such a director as a director. Notwithstanding the foregoing sentence, a director shall be liable to the extent provided by applicable law (i) for any breach of the Director's duty of loyalty to the Corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) pursuant to Section 174 of the GCL, or (iv) for any transaction from which such director derived an improper personal benefit. No amendment to or repeal of this Section B of Article NINTH shall apply to or have any effect on the liability or alleged liability of any director of the Corporation for or with respect to any acts or omissions of such director occurring prior to such amendment or repeal. (C) In furtherance and not in limitation of the powers conferred by statute: (i) the Corporation may purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the Corporation, or is serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust, employee benefit plan 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 against such liability under the provisions of law; and (ii) the Corporation may create a trust fund, grant a security interest and/or use other means (including, without limitation, letters of credit, surety bonds and/or other similar arrangements), as well as enter into contracts providing indemnification to the full extent authorized or permitted by law and including as part thereof provisions with respect to any or all of the foregoing to ensure the payment of such amounts as may become necessary to effect indemnification as provided therein, or elsewhere. TENTH: In furtherance and not in limitation of the powers conferred by statute, the Board of Directors is expressly authorized to adopt, repeal, alter, amend or rescind the Bylaws of the Corporation. ELEVENTH: The Corporation reserves the right to repeal, alter, amend or rescind any provision contained in this Amended and Restated Certificate of Incorporation, in the manner now or hereafter prescribed by statute, and all rights conferred on stockholders herein are granted subject to this reservation. IN WITNESS WHEREOF, this Amended and Restated Certificate of Incorporation has been signed this 22nd day of April, 1991. /s/ Robert L. Antin ---------------------------------------- Robert L. Antin, Chief Executive Officer ATTEST: /s/ Arthur J. Antin - -------------------------- Arthur J. Antin, Secretary CERTIFICATE OF AMENDMENT OF CERTIFICATE OF INCORPORATION Veterinary Centers of America, Inc., a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, DOES HEREBY CERTIFY: FIRST: That at a meeting of the Board of Directors of Veterinary Centers of America, Inc. (the "Corporation"), resolutions were duly adopted setting forth a proposed amendment of the Amended and Restated Certificate of Incorporation of Veterinary Centers of America, Inc., declaring such amendment to be advisable and authorizing the submission of such amendment to the stockholders of Veterinary Centers of America, Inc. for approval at the 1995 Annual Meeting of Stockholders. The resolutions setting forth the proposed amendment are as follows: WHEREAS, the Board of Directors has determined that it is in the best interests of the Corporation to have available additional authorized shares for making acquisitions and other purposes; NOW, THEREFORE, BE IT RESOLVED, that the number of authorized shares of the Corporation's common stock be increased to 30 million shares; and RESOLVED FURTHER, that Article Fourth of the Certificate of Incorporation of the Corporation is hereby amended in its entirety, effective at the close of business on May 9, 1995, to read as follows: "FOURTH: The total number of shares which the Corporation shall have authority to issue is 31,000,000, consisting of 30,000,000 shares of common stock, par value $0.001 per share (the "Common Stock") and 1,000,000 shares of preferred stock, par value $0.001 per share (the "Preferred Stock"). Shares of the Preferred Stock of the Corporation may be issued from time to time in one or more classes or series, each of which class or series shall have such distinctive designation or title as shall be fixed by the Board of Directors of the Corporation (the "Board of Directors") prior to the issuance of any shares thereof. Each such class or series of Preferred Stock shall have such voting powers, full or limited, or no voting powers, and such preferences and relative, participating, optional or other special rights, and such qualifications, limitations or restrictions thereof, as shall be stated in such resolution or resolutions providing for the issue of such class or series of Preferred Stock as may be adopted from time to time by the Board of Directors prior to the issuance of any shares thereof pursuant to the authority hereby expressly vested in it, all in accordance with the laws of the State of Delaware." RESOLVED FURTHER, that the officers and Directors of the Corporation be, and each of them hereby is, authorized and directed to present and recommend to the Corporation's shareholders the approval of the increase in the number of authorized shares of common stock to 30,000,000, and to file an amendment to the Certificate of Incorporation for the Corporation with the State of Delaware after approval by the Shareholders. SECOND: That thereafter, pursuant to resolution of the Board of Directors of the Corporation, the Annual Meeting of Stockholders of the Corporation was duly called and held, upon notice in accordance with Section 222 of the General Corporation Law of the State of Delaware at which meeting the necessary number of shares as required by statute were voted in favor of the amendment. THIRD: That said amendment was duly adopted in accordance with the provisions of Section 242 of the General Corporation Law of the State of Delaware. IN WITNESS WHEREOF, Veterinary Centers of America, Inc. has caused this certificate to be signed by Robert L. Antin, its Chairman of the Board and Chief Executive Officer, and Arthur J. Antin, its Chief Operating Officer, Senior Vice President and Secretary, this 29th day of June, 1995. BY: /s/ Robert L. Antin __________________________ Robert L. Antin Chairman of the Board and Chief Executive Officer ATTEST: /s/ Arthur J. Antin _________________________ Arthur J. Antin Chief Operating Officer, Senior Vice President and Secretary CERTIFICATE OF AMENDMENT OF CERTIFICATE OF INCORPORATION Veterinary Centers of America, Inc., a corporation organized and existing under and by virtue of the General Corporation Law of the State of Delaware, DOES HEREBY CERTIFY: FIRST: That by Unanimous Written Consent of the Board of Directors of Veterinary Centers of America, Inc. (the "Corporation"), resolutions were duly adopted setting forth a proposed amendment of the Amended and Restated Certificate of Incorporation of Veterinary Centers of America, Inc., (the "Certificate") declaring such amendment to be in the best interest of the Corporation and its stockholders and authorizing the submission of such amendment to the stockholders of the Corporation for approval at the 1996 Annual Meeting of Stockholders. The resolutions setting forth the proposed amendment are as follows: "RESOLVED FURTHER, that the first sentence of Article Fourth of the Certificate be, and it hereby is amended to read in full as follows: "FOURTH: The total number of shares which the Corporation shall have authority to issue is 61,000,000, consisting of 60,000,000 shares of common stock, par value $0.001 per share (the "Common Stock") and 1,000,000 shares of preferred stock, par value $0.001 per share (the "Preferred Stock")." RESOLVED FURTHER, that the forgoing amendment to the Certificate shall be submitted to the stockholders of the Corporation for approval at the Annual Meeting of Stockholders scheduled to be held on July 19, 1996, or on such date as the Annual Meeting is held or a special meeting of Stockholders is called for a vote upon this matter. RESOLVED FURTHER, that upon approval of the forgoing amendment to the Certificate by the stockholders of the Corporation, the officers of the Corporation be, and each of them, is hereby authorized, directed and empowered to prepare, execute and file with the Secretary of State of the State of Delaware a Certificate of Amendment of the Certificate effecting the forgoing amendment to the Certificate." SECOND: That pursuant to resolution of the Board of Directors of the Corporation, the Annual Meeting of Stockholders of the Corporation was duly called and held, upon notice in accordance with Section 222 of the General Corporation Law of the State of Delaware at which meeting the necessary number of shares as required by statute were voted in favor of the amendment. THIRD: That said amendment was duly adopted in accordance with the provisions of Section 242 of the General Corporation Law of the State of Delaware. IN WITNESS WHEREOF, Veterinary Centers of America, Inc. has caused this certificate to be signed by Robert L. Antin, it Chairman of the Board and Chief Executive Officer, and Arthur J. Antin, its Chief Operating Officer, Senior Vice President and Secretary, the 19th day of July 1996. By: /s/ Robert L. Antin -------------------------------- Robert L. Antin, Chairman of the Board and Chief Executive Officer Attest: /s/ Arthur J. Antin ------------------------- Arthur J. Antin, Chief Operating Officer, Senior Vice President and Secretary EX-23.1 3 CONSENT EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included in this Form 10-K/A, into the Company's previously filed Registration Statements on Form S-1 and Form S-3 File No. 33-42504, on Form S-8 File No. 33-44622, File No. 33-56846, File No. 33-56848, File No. 33-57768, File No. 33-57770, File No. 33-57772, File No. 33-67588 and File No. 333-19017, on Form S-3 File No. 33-80212, File No. 333-97682, File No. 333-00376, File No. 333-8441 and File No. 333-18261 and on Form S-4 File No. 333-6667 and File No. 333-9119. /s/ Arthur Andersen LLP ARTHUR ANDERSEN LLP Los Angeles, California April 28, 1997 -----END PRIVACY-ENHANCED MESSAGE-----