UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

Commission file number: 000-26326

PROFESSIONAL VETERINARY PRODUCTS, LTD.

     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 proceeding 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 o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K (§229.405 of this chapter) 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. x

     Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes o No x

     As of August 31, 2004, the aggregate market value of the voting and non-voting Common Stock held by non-affiliates of the Registrant was $5,788,000. Shares of Common Stock held by each executive officer and director of the Registrant have been excluded in that such persons may be deemed to be affiliates of the Registrant. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of September 30, 2004, 1,944 shares of the Registrant’s Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the definitive Proxy Statement for the Registrant’s 2004 Annual Meeting of Stockholders to be filed within 120 days of the fiscal year ended July 31, 2004 are incorporated by reference into Part III of this Annual Report on Form 10-K.

PROFESSIONAL VETERINARY PRODUCTS, LTD.
INDEX TO 10-K FOR THE FISCAL
YEAR ENDED JULY 31, 2004

PART I

THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS BASED ON THE COMPANY’S CURRENT EXPECTATIONS, ASSUMPTIONS, ESTIMATES AND PROJECTIONS ABOUT THE COMPANY AND ITS INDUSTRY. THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES. THE COMPANY’S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN SUCH FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, AS MORE FULLY DESCRIBED ELSEWHERE IN THIS REPORT. THE COMPANY UNDERTAKES NO OBLIGATION TO UPDATE PUBLICLY ANY FORWARD-LOOKING STATEMENTS FOR ANY REASON, EVEN IF NEW INFORMATION BECOMES AVAILABLE OR OTHER EVENTS OCCUR IN THE FUTURE.

ITEM 1. BUSINESS

Overview

     The Company is a leading wholesale distributor of animal health products to practicing veterinarians and their related businesses. The Company distributes approximately 18,000 different items including biologicals, pharmaceuticals, parasiticides, instruments and equipment. Routinely some 12,000 items are inventoried for immediate shipment. The balance of items are either drop-shipped from the manufacturer to the customer or are special order items. The Company primarily sells branded products as marketed by the major animal health manufacturers and suppliers. The Company does not currently private label any products, but would consider a private label product agreement if there was a decisive competitive advantage for doing such.

     The Company operates through its three operating segments: Wholesale Distribution, Logistics Services, and Direct Customer Services. The Wholesale Distribution segment is a wholesaler of pharmaceuticals and other veterinary related items and accounted for 90% of net sales and other revenue during fiscal year 2004. This segment distributes products primarily to Company shareholders, who are licensed veterinarians or business entities comprised of licensed veterinarians. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Operating Segments” below and in Note 13 of the Company’s 2004 Consolidated Financial Statements for quantitative segment information.

     The Company’s business strategy is to be the leading supplier of animal health products to veterinarians and veterinary clinics by offering a complete assortment of items at competitive prices which are supported by superior levels of customer service. The Company believes that this strategy provides it with a competitive advantage by combining the broad product selection with everyday low prices and support from very efficient operations. The shareholder veterinary clinics are able to lower their product acquisition costs which both increases profitability and gives them a competitive market advantage.

     The Company has heavily invested in electronic information systems to maximize efficiencies. All phases of the transactional process are electronically driven. The Company believes this advanced electronic technology will assist in earlier adoption of electronic commerce through the internet by both its customers and suppliers.

Background

     The Company was founded in 1982 by veterinarians whose primary interests were “food animal” related and was chartered on August 2, 1982 as a Missouri corporation. Since January 1, 1983 the Company has operated from various facilities in Omaha, Nebraska. After obtaining shareholder approval, the Company surrendered its Missouri charter and became a Nebraska corporation on September 22, 1999.

     Initially, the Company distributed its products predominately to existing shareholders who were veterinarians or business entities established to deliver veterinary services and/or products in which

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medical decisions were made by licensed veterinarians. Each shareholder and all of the shareholder’s affiliates were and are limited to ownership of one share of common stock. In fiscal year 2004, net sales and other revenue to non-shareholders totaled $81.6 million or 24% of total net sales and other revenue.

     The Company’s fiscal year begins on August 1 and concludes on July 31 of the following year.

Value-Added Services

     The Company offers its customers and suppliers a comprehensive menu of value-added services. These services allow individual customers various selections based on their individual needs. The Company manages a database of all transactions so that its customers may maximize their participation in promotions frequently offered by suppliers. The customer is periodically apprised, either by phone or mailings, of their level of participation in these promotions. This promotional tracking service gives the customer the option to maximize their participation in a promotion which can ultimately increase their profitability and allow them to more effectively compete in certain markets.

     The Company has developed a multi-day inventory management and purchasing techniques seminar for its customers. This seminar is held at either of the two company locations. The customer is trained to better use the Company’s resources and also be increasingly efficient in managing their product and inventory activities.

     The Company has Electronic Data Interchange (EDI) capability which provides the supplier with product sales and movement. The supplier is able to monitor sales activities, advertising effectiveness and market trends in an efficient manner. The Company also assists the manufacturer in the design of effective promotions. The historical transactional database and the promotional tracking service are unique tools to assist the manufacturer in tailoring effective promotions.

Our Shareholders

     As of July 31, 2004, the Company had 1,952 shareholders, all of whom were veterinarians or veterinary clinics. These shareholders are principally located from the Rocky Mountains to the Atlantic Seaboard with some presence in the southern United Sates. Our shareholders also are our primary customers. No shareholder represented more than 2% of the Company’s total revenues during fiscal year 2004.

     Due to the geographical location of the majority of its shareholders, nearly 48% of the Company’s gross sales are related to products used for the treatment and/or prevention of diseases in food animals. The balance of product sales are for the treatment and/or prevention of diseases in companion animals and equine.

Rebates to Shareholders

     The Company and its shareholders are in a contractual relationship evidenced in the Company’s Amended and Restated Articles of Incorporation (Articles of Incorporation) which requires that all sales of Company products to Company shareholders be at no more than 5% over the cost of the Company as determined by a certified public accountant. Based on this requirement, a certified public accounting firm (not the same firm who was appointed auditors of the Company) annually makes a determination of the shareholder’s product costs. This valuation of the shareholder product costs is then divided by 95% and compared to shareholder sales including any vendor rebates. Amounts in excess of this computation are overcharges which are then rebated back to shareholders by credit memo. Such rebates are made on a pro rata basis to shareholders, based on the aggregate amount of products purchased by each shareholder during the year for which the rebate is made. Rebates are included in the Company’s financial statements and are netted against sales and accounts receivable on the Company’s financial statements.

     The Company recently modified its policies and procedures relating to the shareholder rebate in

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order to address concerns regarding late payments by shareholders. Effective August 1, 2003, the determination of the amount rebated back to shareholders by credit memo during any fiscal year will include a review of whether the respective shareholder made timely payments to the Company and whether there are any past due invoices as of the end of the fiscal year. The Company will determine the shareholder’s “average days to pay” which is the number of days past the due date on which the Company receives the shareholder payment. If the average days to pay exceeds 30 days, the amount of the rebate credited back to the shareholder will be reduced according to the Company’s then current reduction percentage policy. If a shareholder has any unpaid amount which is more than 90 days past due as of the fiscal year end, no rebate will be issued to the shareholder for that fiscal year.

Company Subsidiaries

     The Company has two direct wholly-owned subsidiaries: Exact Logistics, LLC and ProConn, LLC. Exact Logistics, LLC and ProConn, LLC both were organized in the State of Nebraska on December 6, 2000 and are limited liability companies that are single member entities and 100% owned by the Company. The purpose of Exact Logistics, LLC is to act as a contract logistics partner to warehouse and ship products. The purpose of ProConn, LLC is to act as a supplier of animal health products directly to the producer and/or consumer. Producers and end users order veterinary products directly from ProConn instead of the manufacturer or supplier and ProConn then sells and delivers the products directly to producers and consumers. ProConn is responsible for all shipping, billing and related services. As part of its business operations, ProConn enters into agreements with “veterinarians of record” pursuant to which ProConn agrees to pay the “veterinarian of record” a percentage of the sale received by ProConn from qualified purchases. The “veterinarian of record” is responsible for providing various services to the producers and consumers, including, without limitation, conducting on-site visits of producers’ facilities, reviewing the producers’ or consumers’ data pertaining to purchases from ProConn, and maintaining compliance with all pharmaceutical-related laws, regulations and any applicable food safety guidelines.

Operating Segments

     The Company has three reportable segments: Wholesale Distribution, Logistics Services, and Direct Customer Services. The Wholesale Distribution segment is a wholesaler of pharmaceuticals and other veterinary related items. This segment distributes products primarily to Company shareholders, who are licensed veterinarians or business entities comprised of licensed veterinarians.

     The Logistics Services segment provides logistics and distribution service operations for vendors of animal health products. The Logistic Services segment serves its customers by consolidating, packaging and delivering animal health products closer to the final destination, resulting in reduced freight costs and improved delivery performance.

     The Direct Customer Services segment is as a supplier of animal health products to the producer or consumer. Animal health products are shipped to locations closer to the final destination. The segment’s trucking operations transport the products directly to the producer or consumer.

Financial Information About Operating Segments

     The sales and operating profits of each operating segment and the identifiable assets attributable to each operating segment for each of the three years in the period ended July 31, 2004 are set forth in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Operating Segments” below and in Note 13 of Notes to Consolidated Financial Statements.

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Financial Information About Geographic Areas

     All of the Company’s customers are located in the United States. The Company does not export any products outside of the United States. All of the Company’s assets are located within the United States.

MARKETLink

     In August 1999, the Company, American Animal Hospital Association (AAHA) and AAHA Services Corporation (SERVCO) d/b/a MARKETLink, a wholly-owned subsidiary of AAHA, entered into an agreement pursuant to which the Company became the logistics partner for MARKETLink, a buying group and distribution service provided by AAHA to its veterinary clinic members. AAHA’s members include over 13,000 veterinarians in over 7,000 animal hospitals providing veterinary services to companion animals. AAHA established MARKETLink based on a belief that it was possible to improve the purchasing economics of its members’ practices by allowing members to buy animal health products at low average prices while maintaining or exceeding the level of service obtained by existing distributors.

     Under MARKETLink, members of AAHA are able to purchase products directly from MARKETLink at a cost savings. Under the terms of the August 1999 Agreement, SERVCO has certain responsibilities, including, without limitation, marketing the MARKETLink program, determining the mix, price, sales and shipping policies and line of products, and being responsible for all aspects of the credit approval, accounts receivable and collections in connection with the sale of MARKETLink products. The Company’s responsibilities include, without limitation, purchasing and managing the required inventory, paying all accounts payable and complying with other contract terms with manufacturers, suppliers or customers relating to shipping, receiving and billing for MARKETLink products, maintaining sales and service representatives for all in-bound and out-bound telephone sales necessary to process orders, cross-selling alternative products, implementing special promotional programs, and fulfilling and shipping all orders received via the Company’s MARKETLink sales and service representatives or the SERVCO email order entry system, including at the time of shipment an MARKETLink invoice in the shipment.

     In June 2000, the Company purchased a 20% interest in MARKETLink for $1,500,000. After the transaction, the remaining 80% continued to be owned by AAHA. Lionel L. Reilly, the Company’s CEO and President serves on the Board of Directors of SERVCO.

     During the fiscal year ended July 31, 2004, MARKETLink represented approximately 9% of the Company’s total revenues.

Customers and Suppliers

     Management does not consider the Company’s business to be dependent on a single customer or a few customers, and the loss of any of our customers (excluding MARKETLink) would not have a material adverse effect on our results. Except for MARKETLink, which comprised approximately 9% of the Company’s total revenues during the fiscal year ended July 31, 2004, no single customer accounted for more than 2% of our fiscal 2004 revenues. The Company currently has an agreement with MARKETLink and believes that its relationship with MARKETLink currently is good and will be a long lasting relationship. The Company typically does not enter into long-term contracts with its customers. To offset the loss of any customers, the Company continually seeks to diversify its customer base.

     The changing trends of veterinary medicine has resulted in a gradual shift toward the sale of more “companion animal” products which products account for nearly 52% of the Company’s revenues in fiscal year 2004. Historically, companion animal product related transactions have enjoyed higher margins than sales of food producing animal products. However, as competition increases in the companion animal sector it is likely that margins will begin to erode. We believe there is likely to be consolidation of the many small privately owned veterinary clinics, which will result in an increasing number of larger veterinary practice business units. As a result, the larger veterinary practices will have increased purchasing leverage and will negotiate for lower product costs which will reduce margins at the

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distribution level and impact Company revenue and net income.

     There are two major types of transactions that affect the flow of products to the Company’s customers. Traditional “buy/sell” transactions account for a significant majority of the Company’s business. In this type of transaction the customer places an order with the Company, which is then picked, packed, shipped, invoiced to the customer, followed by payment from the customer to the Company. There are a few product lines where the Company provides all transactional activities described above, except that the manufacturer retains title to the product. The manufacturer retains title in accordance with the distribution agreements for these products. Within these agreements the manufacturer determines if any promotional funds or rebates will be given to the Company. Animal health manufacturers create and implement sales promotions for the products they distributed to the veterinarian. These promotions reward the veterinarian for their purchase of certain products or volume of products. The Company submits the relevant purchase data to the manufacturer. The Company is paid or reimbursed by the manufacturer, and the veterinarian receives value pursuant to the terms of the promotion. The “consignment” transactions account for approximately 1 1/2 percent (1.5%) of the Company’s business. The Company inventories these products for the manufacturer but does not pay the manufacturer until the product is sold to the customer and reported to the manufacturer. The Company is responsible for maintaining insurance on the products but the value of the product is not included in the inventory for accounting purposes.

     A second transaction model used by the Company is termed the “agency agreement”. Under this approach, the Company receives orders for products from its customer. The Company transmits the order to the manufacturer who then picks, packs, ships, invoices and collects payment from the customer. The Company receives a commission payment for soliciting the order as well as other customer service activities. The Company’s operating expenses associated with this type of sale may be lower than the traditional buy/sell transaction. Agency selling allows the manufacturer and the Company to immediately react to market conditions. This arrangement allows the manufacturer to establish and standardize price of its products in the market. This current information often is used by the Company and the various manufacturers to develop data based marketing programs. The mode of selling products to veterinarians is dictated by the manufacturer.

     Product returns from our customers and to our suppliers occur in the ordinary course of business. The Company extends to its customers the same return of goods policies as extended to the Company by the various manufacturers. The Company does not believe its operations will be adversely impacted due to the return of products. Product returns have a minimum impact on the Company’s performance.

     Our two largest vendors comprised 31.1% and 12.9%, respectively of all of the Company’s purchases for fiscal year 2004. One vendor comprised 24.7% of all of the Company’s purchases for fiscal year 2003. Management believes the loss of any major vendor may have a material adverse effect on our results including the loss of one or both of our two largest vendors.

The Animal Health Industry

     A national veterinary organization lists over 22,000 veterinary practices in the United States. There are some 45,700 veterinarians practicing in the various disciplines of veterinary medicine. This survey indicated nearly 76% of the veterinarians in private clinical practice predominately specialize in companion animal medicine.

     We believe, based on industry sources, the U.S. animal health manufacturer sales of biologicals, pharmaceuticals, insecticides and other packaged goods was over $4.4 billion for calendar year 2003. This segment of business in which the Company participates is intended to meet the product and supply needs of the private clinical practice. The actual Compounded Annual Growth Rate for the last 5 years has averaged 2% and is forecasted to remain in the 2% range for the next 5 years.

     Consolidation is a primary force reshaping the animal health industry. We believe, based on industry sources, sales by the top ten animal health product manufacturers account for over 75% of the

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U.S. market. At this time, the top five U.S. animal health product companies have a market share that nears 60% of the total animal health business.

     Livestock production continues the consolidation trend that started a number of years ago. Agribusiness integrators continue to build larger livestock raising facilities. Improved management systems coupled with new preventative products have resulted in an ongoing reduction in food producing animal product sales for the past several years. There also has been a loss of market share in several key product groups due to generic competition. The generic products generally sell for lower prices which causes a pricing deflation in the market.

     The companion animal market is experiencing considerable growth. Several new therapeutic and preventative products have contributed to most of this increased sales volume. Nutraceuticals (nutritional pharmaceuticals) have an increasing presence in the companion animal market. Based on industry sources, during the past five years companion animal product sales have grown to nearly 50% of the total U.S. market.

Competition

     Distribution of animal health products is characterized by either “ethical” or “OTC” channels of product movement. Ethical distribution is defined as those sales of goods to licensed veterinarians for use in their professional practice. Many of these products are prescription and must only be sold to a licensed professional. OTC (over-the-counter) distribution is the movement of non-prescription goods to the animal owner and the end user. Many of these products will also be purchased by the licensed veterinarian for professional use or for resale to their client.

     There are numerous ethical distribution companies operating in the same geographical regions as the Company and competition in this distribution industry is intense. Our competitors include other animal health distribution companies and manufacturers of animal health products who sell directly to veterinarians and veterinary clinics. Most of the animal health distribution competitors generally offer a similar range of products at prices often comparable to the Company’s. The Company seeks to distinguish itself from its competitors by offering a higher level of customer service as well as having its principal customers also as its shareholders/owners. In addition to competition from other distributors, the Company also faces existing and potentially increased competition from manufacturers who distribute some percentage of their products directly to veterinarians. Although the Company competes against direct sales by manufacturers and suppliers, it is often able to compete with such direct sales by adding new value-added services and pricing differentiation.

     The role of the animal health distributor has changed dramatically during the last decade. Successful distributors have shifted from a selling mentality to providing products and services in a consultative environment. Declining profit margins typify current financial trends. Currently there is an over capacity in the animal health distribution network, although there have been few animal health distributor mergers or acquisitions. We believe the Company must continue to add value to the distribution channel, and reduce the redundancies that exist, while removing unnecessary costs associated with product movement.

Government Regulation

     Both state and federal government agencies regulate the manufacturing and distribution of certain animal health products such as pharmaceuticals, vaccines, insecticides and certain controlled substances. Our suppliers of these products are typically regulated by one or more of the following federal agencies, the U.S. Department of Agriculture, the Food and Drug Administration (FDA) and the Drug Enforcement Administration (DEA), as well as several state agencies and therefore, the Company is subject, either directly or indirectly, to regulation by the same agencies. Several states and the DEA require the Company to be registered or otherwise keep a current permit or license to handle controlled substances. Manufacturers of vaccines are required by the Department of Agriculture to comply with various storage and shipping criteria and requirements for the vaccines. To the extent the Company

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distributes such products, the Company must comply with the same Department of Agriculture, FDA and EPA requirements including, without limitation, the storage and shipping requirements for vaccines.

     Several State Boards of Pharmacy require the Company to be licensed in their respective states for the sale of animal health products within their jurisdictions. Some states (as well as certain cities and counties) require the Company to collect sales taxes/use taxes on differing types of animal health products.

     The Company is subject to laws governing its relationship with employees, including minimum wage requirements, overtime, working conditions and citizenship requirements.

Environmental Considerations

     The Company does not manufacture, re-label or in any way alter the composition or packaging of products. All products are distributed in compliance with the relevant rules and regulations as approved by various State and Federal regulatory agencies. The Company’s business practices create no or minimal impact on the environment.

Employees

     As of July 31, 2004 the Company had 307 employees. We are not subject to any collective bargaining agreements and have not experienced any work stoppages. We believe that we have a stable and productive workforce and consider our relationships with our employees to be good.

ITEM 2. PROPERTIES

     The Company owns its building, which contains nearly 100,000 square feet of open warehouse space and 40,000 square feet of finished office area. The building is a facility the Company constructed and completed in late 1999 and is located on 9.6 acres of land in a newly developed industrial subdivision of Omaha, Nebraska. The latest in technology was incorporated into the design of the new facility to maximize distribution efficiencies. The building is subject to a first and second mortgage held by US Bank. In October 2002, the Company purchased 10 acres of land adjacent to the current corporate facility in Omaha, Nebraska for $808,274 in order to provide the Company with land available for future expansion of its Omaha facility.

     On March 15, 2002, the Company signed a lease agreement with Kinsley Equities II Limited Partnership for 70,000 square feet of warehouse space in York, Pennsylvania. The initial term of the lease is five years. The Company uses this facility to ship products to its customers in that geographical area of the United States. In June 2003, the Company exercised an option to lease additional 17,500 square feet of space in the York facility for a total of 87,500 square feet of leased space in York, Pennsylvania.

     Management believes that our existing facilities are and will be adequate for the conduct of our business during the next fiscal year.

ITEM 3. LEGAL PROCEEDINGS

     The Company is not currently a party to any material pending legal proceedings and has not been informed of any claims that could have a material adverse effect on its financial position or results of operations.

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

     No matters were submitted to a vote of security holders during the quarter ended July 31, 2004.

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PART II

     There is no established public trading market for the Company’s common stock. Ownership of the Company’s stock is limited to licensed, practicing veterinarians or any lawful form of business entity established to deliver veterinary services and/or products in which all medical decisions are made by licensed veterinarians (such as a partnership or corporation). Each veterinarian shareholder is limited to ownership of one share of stock, which is purchased at the fixed price of $3,000. The share of stock may not be sold, assigned, or otherwise transferred, except back to the Company at the same $3,000 price. On September 30, 2004, there were 1,944 record holders of the Company’s common stock.

     Holders of common stock have no preemptive rights or rights to convert their common stock into any other securities. There are not redemption or sinking fund provisions applicable to the common stock other than redemption by the Company set forth in the Articles of Incorporation and Bylaws. The Company does not have any preferred stock authorized and has not issued any stock options, stock option plans, warrants, or other outstanding rights or entitlements to common stock.

     The Company has never declared or paid any cash dividends on the common stock. The Company intends to retain any future earnings for funding growth of the Company’s business and therefore does not currently anticipate paying cash dividends in the foreseeable future.

     The Company has not sold any common stock which was not registered under the Securities Act of 1933, as amended within the past three fiscal years ended July 31.

     During the fiscal year ended July 31, 2004, the Company (including its “affiliated purchasers”) repurchased 37 shares of its common stock as set forth in the following table:

     Purchases of Equity Securities by the Company and Affiliated Purchasers:(1)

     (1) The Company’s Bylaws require the Company to repurchase stock within ninety (90) days of receiving written notice from a shareholder requesting redemption of his, her, or its stock, and under the

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Articles of Incorporation, the Company may repurchase shares of any shareholder who is no longer a veterinarian or veterinary clinic or owes money to the Company and fails to make required payments. The redemption amount is the original purchase price of the stock paid by the shareholder. Currently, the price of each share is fixed at $3,000 as provided in the Articles of Incorporation. There is no expiration date.

     (2) Since inception, each shareholder of the Company has been entitled to have his, her, or its share redeemed in accordance with the Articles of Incorporation and Bylaws.

     (3) The maximum number of shares that may be purchased by the Company varies from time to time due to the addition of new shareholders and on-going redemption of shares. Each shareholder of the Company may have his, her, or its share redeemed in accordance with the Articles of Incorporation and Bylaws.

ITEM 6. SELECTED FINANCIAL DATA

     The historical selected financial data set forth below for the five years ended July 31, 2000, 2001, 2002, 2003 and 2004 are derived from the Company’s Financial Statements included elsewhere in this report and should be read in conjunction with those financial statements and notes thereto. The financial data for the periods ended July 31, 2004, July 31, 2003 and July 31, 2002 is consolidated and includes accounts of Exact Logistics, LLC and ProConn, LLC from December 6, 2000, the date the Company became the sole member of Exact Logistics, LLC and ProConn, LLC. All amounts are in thousands except per share data.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the consolidated financial statements and accompanying notes that are included in this annual report.

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Forward-Looking Statements

     This Annual Report on Form 10-K contains forward-looking statements. Forward-looking statements are contained principally in the sections entitled “Business,” “Risk Factors That May Affect Future Results” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. Forward-looking statements include, but are not limited to, statements about:

	•		the current economic environment affecting the Company and the markets it serves;
	•		sources of revenues and anticipated revenues, including the contribution from the growth of new products and markets;
	•		estimates regarding the Company’s capital requirements and its need for additional financing;
	•		the Company’s ability to attract customers and the market acceptance of its products;
	•		our ability to establish relationships with suppliers of products;
	•		plans for future products and services and for enhancements of existing products and services.

In some cases, you can identify forward-looking statements by terms such as “may,” “intend,” “might,” “will,” “should,” “could,” “would,” “expect,” “believe,” “estimate,” “predict,” “potential,” or the negative of these terms, and similar expressions intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these statements. We discuss many of these risks in this Annual Report on Form 10-K in greater detail under the heading “Risk Factors That May Affect Future Results”. Also, these statements represent our estimates and assumptions only as of the date of this Annual Report on Form 10-K, and we undertake no obligation to publicly update or revise these forward-looking statements.

Overview

     Professional Veterinary Products, Ltd. provides distribution services of animal health and companion animal products through three business segments, Wholesale Distribution, Logistics Services, and Direct Customer Services. The Wholesale Distribution segment is a wholesaler of pharmaceuticals and other veterinary related items. The Logistics Services segment provides logistics and distribution service operations for vendors of animal health products. The Direct Customer Services segment is a supplier of animal health products to the producer or consumer.

     The Company’s revenues have increased from $63.5 million in fiscal year 1995 to $335.4 million in fiscal year 2004. Initially, the Company distributed its products predominately to existing shareholders. In fiscal year 2004, net sales and other revenue to non-shareholders totaled $81.6 million or 24% of total net sales and other revenue.

     The Company’s Wholesale Distribution segment comprises the majority of its operations, representing 90% of consolidated net sales and other revenue in fiscal 2004. Revenues are primarily earned by effectively distributing products to veterinarians or veterinary practices. The main factor that impacts net sales is the Company’s ability to offer a broad product line through excellent and knowledgeable customer service.

     We expect the trend of increases in sales to continue as we continue to increase the number and type of customer accounts. We will continue our strategy of supporting the food producing animal veterinarian with a broad range of products and value-added services. However, sales in the food producing animal sector are subject to very low margins. In view of the increasing maturity of the food producing animal market, the Company must continue to look for future growth in the companion animal sector. The changing trends of veterinary medicine has resulted in a gradual shift toward the sale of

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more “companion animal” products which products account for nearly 52% of the Company’s revenues in fiscal year 2004.

     Historically, companion animal product related transactions have enjoyed higher margins than sales of food producing animal products. We believe that as competition increases in the companion animal sector it is likely that margins will begin to erode. We also believe that there is likely to be consolidation of the many small privately owned veterinary clinics, which will result in an increasing number of larger veterinary practice business units. As a result, the larger veterinary practices will have increased purchasing leverage and will negotiate for lower product costs which will reduce margins at the distribution level and impact Company revenue and net income.

Results of Operations

     The following discussion is based on the historical results of operations for fiscal 2004, 2003 and 2002.

Summary Consolidated Results of Operations Table

Fiscal 2004 Compared to Fiscal 2003:

     Net sales and other revenue for the fiscal year ending July 31, 2004 increased by 12.2% or $36.5 million. Net sales and other revenue for the 2004 fiscal year totaled $335.4 million compared to $298.9 million for the previous fiscal year. The growth was principally attributable to sales to new customers of $42.5 million despite a slight decrease in sales to existing customers of $6.0 million.

     Gross profit consists of net sales and other revenue minus cost of sales before operating expenses, other income (expense), and taxes are deducted. Gross profit increased by $3.1 million to $34.0 million for fiscal year 2004 compared to $30.9 million for the previous fiscal year. This increase was primarily due to the increase in revenue. Gross profit as a percentage of total revenue was 10.1% for fiscal 2004 compared to 10.3% for fiscal 2003.

     Operating, general and administrative expense consists mainly of payroll, warehouse operating supplies, insurance, professional fees and other general corporate expenses. Operating, general and administrative expenses increased by $3.0 million to $28.7 million for fiscal year 2004 compared to $25.7 million for the previous year. This increase was primarily due to support the increase in revenue. Such

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operating, general and administrative expenses as a percentage of total revenue remained constant for fiscal 2004 at 8.6%.

     Operating income increased by $115 thousand to $5.3 million for fiscal year 2004 compared to $5.2 million for the previous year. This small increase is primarily attributable to the increase in gross profit while operating, general and administrative expenses only slightly increased.

     Company’s other income (expense) was $565 thousand (expense) for fiscal year 2004 as compared to $189 thousand (expense) for the previous year. In addition, interest income for the period ending July 31, 2004 decreased to $471 thousand as compared to $767 thousand for the same period of the previous year, a decrease of $296 thousand. The decrease was due to a decrease in the finance charged on past due accounts receivable. Interest income was partially offset by additional interest expense of $74 thousand to $1.1 million which was due principally on outstanding debt.

Fiscal 2003 Compared to Fiscal 2002:

     Net sales and other revenue for the fiscal year ending July 31, 2003 increased by 24.6% or $59 million. Net sales and other revenue for the 2003 fiscal year totaled $298.9 million compared to $239.9 million for the previous fiscal year. The growth was principally attributable to increased sales to existing customers of $39.1 million and to new customers of $19.9 million.

     Gross profit consists of net sales and other revenue minus cost of sales before operating expenses, other income (expense), and taxes are deducted. Gross profit increased by $10.8 million to $30.9 million compared to $20.1 million for the previous fiscal year. This increase was primarily due to the increase in revenue plus a reduction in outbound freight costs. Gross profit as a percentage of total revenue was 10.3% for fiscal 2003 compared to 8.4% for fiscal 2002.

     Operating, general and administrative expense consists mainly of payroll, warehouse operating supplies, insurance, professional fees and other general corporate expenses. Operating, general and administrative expenses increased by $7.8 million to $25.7 million for fiscal year 2003 compared to $17.9 million for the previous year. This increase was primarily due to support the increase in revenue plus expenses associated with the additions of the York Pennsylvania warehouse and ProConn LLC. Such operating, general and administrative expenses as a percentage of total revenue for fiscal 2003 was 8.6% compared to 7.5% for fiscal 2002.

     Operating income increased by $3.1 million to $5.2 million for fiscal year 2003 compared to $2.1 million for the previous year. This increase is primarily attributable to the increase in gross profit despite the increase in operating, general and administrative expenses.

     Company’s other income (expense) was $189 thousand (expense) for fiscal year 2003 as compared to $395 thousand (expense) for the previous year. In addition, interest income for the period ending July 31, 2003 increased to $767 thousand as compared to $477 thousand for the same period of the previous year, an increase of $290 thousand. The increase was due to an increase in the finance charged on past due accounts receivable. The increased income was partially offset by interest expense of $1.1 million which was due principally on outstanding debt.

Fiscal 2002 Compared to Fiscal 2001:

     Net sales and other revenue for the fiscal year ending July 31, 2002 increased by 21.5% or $42.4 million. Net sales and other revenue for the 2002 fiscal year totaled $239.9 million compared to $197.5 million for the previous fiscal year. The growth was principally attributable to increased sales to existing customers of $27.1 million and to new customers of $15.3 million.

     Gross profit increased by $4.2 million to $20.1 million compared to $15.9 million for the previous fiscal year. This increase was primarily due to the increase in revenue. Gross profit as a percentage of total revenue was 8.4% for fiscal 2002 compared to 8.0% for fiscal 2001.

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     Operating, general and administrative expenses increased by $3.4 million to $17.9 million for fiscal year 2002 compared to $14.5 million for the previous year. This increase was primarily due to support the increase in revenue. Such operating, general and administrative expenses as a percentage of total revenue for fiscal 2002 was 7.4% vs. 7.4% for fiscal 2001.

     Operating income increased by $823 thousand to $2.1 million for fiscal year 2002 compared to $1.3 million for the previous year. This increase is primarily attributable to the increase in gross profit as a percentage of total revenue while maintaining the percentage of operating, general and administrative expenses.

     Company’s other income (expense) was $395 thousand (expense) for fiscal year 2002 as compared to $626 thousand (expense) for the previous year. In addition, interest expense for the period ending July 31, 2003 decreased to $850 thousand as compared to $1.0 million for the same period of the previous year — a decrease of $156 thousand. The reduction was due to a decrease in the interest rate charged on the Company’s revolving line of credit.

Contractual obligations and commitments

     The Company’s contractual obligations (in thousands) at July 31, 2004 mature as follows:

     In addition, the Company’s Articles of Incorporation require the Company to repurchase stock within ninety (90) days of receiving written notice from a shareholder requesting redemption of their stock. The redemption amount is the original purchase price of the stock paid by the shareholder. The Company was contingently liable for $5.7 million as of July 31, 2004.

Operating Segments

     The Company has three reportable segments: Wholesale Distribution, Logistics Services, and Direct Customer Services. The Wholesale Distribution segment is a wholesaler of pharmaceuticals and other veterinary related items. This segment distributes products primarily to Company shareholders, who are licensed veterinarians or business entities comprised of licensed veterinarians.

     The Logistics Services segment provides logistics and distribution service operations for vendors of animal health products. The Logistic Services segment serves its customers by consolidating, packaging and delivering animal health products closer to the final destination, resulting in reduced freight costs and improved delivery performance.

     The Direct Customer Services segment is a supplier of animal health products to the producer or consumer. Animal health products are shipped to locations closer to the final destination. The segment’s trucking operations transport the products directly to the producer or consumer.

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     The Company’s reportable segments are strategic business units that serve different types of customers in the animal health industry. The separate financial information of each segment is presented consistent with the way results are regularly evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Previously, the Company disclosed one reportable segment. See Note 13 of the Company’s 2004 Consolidated Financial Statements for additional quantitative segment information.

     The following table summarizes the Company’s operations by business segment:

Operating Segments: Fiscal 2004 Compared to Fiscal 2003

Wholesale Distribution

     Net sales and other revenue for the fiscal year ending July 31, 2004 increased by 12.2% or $36.3 million. Net sales and other revenue for the 2004 fiscal year totaled $333.3 million compared to $297 million for the previous fiscal year.

     Gross profit increased by $2.6 million to $30 million for fiscal year 2004 compared to $27.4 million for the previous fiscal year. This increase was primarily due to the increase in revenue. Gross profit as a percentage of total revenue was 9.0% for fiscal 2004 compared to 9.2% for fiscal 2003.

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     Operating, general and administrative expenses increased by $2.4 million to $24.7 million for fiscal year 2004 compared to $22.2 million for the previous year. This increase was primarily due to support the increase in revenue. Such operating, general and administrative expenses as a percentage of total revenue for fiscal 2004 remained constant at 7.4%.

     Operating income increased by $170 thousand to $5.4 million for fiscal year 2004 compared to $5.2 million for the previous year. This increase is primarily attributable to the increase in gross profit less the increase in operating, general and administrative expenses.

     Assets increased by $286 thousand to $84.1 million for fiscal year 2004 compared to $83.8 million for the previous year. This increase was primarily due to an increase in inventories and other assets which were partially offset by a decrease in cash and accounts receivable.

Logistics Services

     Net sales and other revenue for the fiscal year ending July 31, 2004 decreased by 40% or $830 thousand. Net sales and other revenue for the 2004 fiscal year totaled $1.2 million compared to $2.1 million for the previous fiscal year.

     Gross profit decreased by $65 thousand to $56 thousand compared to $121 thousand for the previous fiscal year. Gross profit as a percentage of total revenue was 4.5% for fiscal 2004 compared to 5.8% for fiscal 2003.

     Operating, general and administrative expenses decreased by $1 thousand to $0 for fiscal year 2004 compared to the previous year. Such operating, general and administrative expenses as a percentage of total revenue for fiscal 2004 was less than 1%, fiscal 2003 was also less than 1%.