VETERINARY PET SERVICES, INC. AND SUBSIDIARIES

PART I. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS

(AMOUNTS IN THOUSANDS – EXCEPT SHARE AMOUNTS)

See Notes to Unaudited Consolidated Financial Statements

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VETERINARY PET SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(AMOUNTS IN THOUSANDS – EXCEPT SHARE AND PER SHARE DATA)

See Notes to Unaudited Consolidated Financial Statements

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VETERINARY PET SERVICES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(AMOUNTS IN THOUSANDS)

See Notes to Unaudited Consolidated Financial Statements

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VETERINARY PET SERVICES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Six Months Ended June 30, 2003

1. Basis of Presentation

        The financial information included in this report includes the accounts of Veterinary Pet Services, Inc. (“VPSI”) and its subsidiaries (collectively referred to as the “Company”), Veterinary Pet Insurance Company (“VPI”) and V.P.I. Services, Inc. (“VPIS”), and VPI’s subsidiary, DVM Insurance Agency (“DVM”), and has been prepared in accordance with accounting principles generally accepted in the United States of America and the instructions to Form 10-Q and Article 10 of Regulation S-X. All adjustments, consisting of normal recurring accruals considered necessary for a fair presentation, have been included. The statements do not include all disclosures required by accounting principles generally accepted in the United States of America for annual financial statements and should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2002. The results of operations for the six months ended June 30, 2003 are not necessarily indicative of the results to be expected for the year ending December 31, 2003.

2. Earnings (Loss) Per Share

        The Company presents “basic” earnings (loss) per share, representing net earnings (loss) divided by the weighted average shares outstanding (excluding all Common Stock equivalents), and “diluted” earnings (loss) per share, representing the dilutive effect of all Common Stock equivalents. The following table illustrates the computation of basic and diluted earnings (loss) per share.

        Had the Company recognized net income in the three months ended June 30, 2003, incremental shares attributable to the assumed exercise of outstanding options and warrants would have increased diluted shares outstanding by 737,000 shares.

3. Comprehensive Income (Loss)

        Comprehensive income (loss) includes net income as well as certain items that are reported directly within a separate component of shareholders’ equity that bypass net income. Other comprehensive income (loss) is comprised of net unrealized gains (losses) on available-for-sale securities. The related before and after federal income tax amounts are as follows:

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4. Stock Based Compensation

        The Company accounts for its stock options in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees and Related Interpretations.” Compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. SFAS No. 123, Accounting for Stock-Based Compensation, permits entities to recognize the fair value of all stock-based awards on the date of grant as expense over the vesting period. Alternatively, SFAS No. 123 allows the Company to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income disclosures for employee stock options grants made in 1995 and future years as if the fair-value-based method defined in SFAS No. 123 had been applied. All options granted had an exercise price equal to the market value of the underlying common stock on the date of grant; therefore, no stock-based compensation cost is reflected in net earnings. The following table illustrates the effect on net earnings and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation,” to stock-based employee compensation:

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        The effects of applying SFAS No. 123 to the Company’s option and warrant grants would result in an immaterial effect on the Company’s results of operations for the three months and six months ended June 30, 2002.

5. Equity Transactions

        On April 14, 2003, the Company sold 750,000 shares of its Common Stock to Scottsdale Insurance Company (“SIC”) at a purchase price of $12.00 per share for gross proceeds of $9.0 million, of which $5.0 million was contributed to the statutory capital and surplus of VPI. On April 15, 2003, the Company sold 500,000 shares of its Common Stock to The Iams Company (“Iams”), a subsidiary of The Procter & Gamble Company, at a purchase price of $12.00 per share for gross proceeds of $6.0 million, all of which was contributed to the statutory capital and surplus of VPI. As a condition to the sale of the shares to Iams, all of the Company’s shares of Series A Preferred Stock and Series B Preferred Stock were converted on April 15, 2003 to 2,615,288 shares of Common Stock, of which SIC received 2,580,648 shares. The conversion of the Company’s 403,226 shares of Series A Preferred Stock and 250,596 shares of Series B Preferred Stock to 2,615,288 shares of Common Stock was an $8.1 million non-cash financing transaction.

        During April 2003, in connection with the sale of shares to SIC and Iams and the contribution of $11.0 million to VPI’s statutory capital and surplus, VPI applied for approval from the California Department of Insurance (the “DOI”) for an addendum to the Reinsurance Agreement with SIC to return to the 80% (VPI): 20% (SIC) quota share reinsurance percentage, retroactive to January 1, 2003. The DOI has not yet completed its review of VPI’s application.

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

General

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