May 2006 Update and Company Reports

VCA Antech (WOOF 30) is the leading provider of pet health care services in the U.S. It operates 373 animal hospitals in 37 states, along with 31 veterinarian clinical laboratories, the largest such system in the U.S. Hospitals compose about 70% of revenues, while laboratories contribute 26%. Sales and operating income growth of 18% per annum over the past five years was driven by a torrid pace of acquiring existing hospitals and laboratories.

The American Pet Products Manufacturers Association, Inc. states that the U.S. pet population reached 210 million in 2004 and that 69% of U.S. households own at least one pet. Over $18 billion was spent on their care. Medical technology continues to migrate from human healthcare to animal healthcare. New and increasingly complex procedures, diagnostic tests, and pharmaceuticals are gaining wider acceptance as pet owners expect human technology to be applied to their pets. For example, diagnostic tests and treatment for cancer are now available for animals. Medical technologies developed for humans at great expense are migrating to animals with the development expense already amortized. And, the FDA does not require 10 years of development and clinical studies for animals. VCA is the largest provider of post-graduate education to veterinarians, driving the application of new technologies to animal healthcare.

VCA Antech is the sole consolidator of veterinary hospitals and clinical laboratories. If a veterinarian wants to sell his business, it is virtually the only big buyer. The company’s growth objective is to acquire 20 to 25 independent animal hospitals per year with aggregate annual revenues of $30 to $35 million. However, in 2004, 85 hospitals were acquired, followed by 68 in 2005. The prices paid, at 1 times revenue and 4 to 5 times cash flow, have historically been very reasonable, economically similar to buying stock that has a 20% cash dividend yield. With about 22,000 animal hospitals in the U.S. it appears the company is at an early stage in its potential to expand through acquisition.

The consolidation of the industry is driven by several factors:

· The cost of investing in medical equipment, which is being used more and more to make diagnoses.

· The desire of veterinarians to focus their time practicing medicine rather than administering a business.

· Diversification of the veterinarian’s personal portfolio enabled by selling all or a portion of his hospital.

· The purchasing, marketing, and administrative cost efficiencies of a larger veterinary provider.

· Work schedule flexibility for the veterinarian.

A trend of increased focus on diagnostic testing by both practicing veterinarians and veterinary schools is driving double-digit growth of the diagnostic business. The close connection between hospitals and laboratories allows a higher quality of care for pets. Since pets cannot explain where it hurts, timely diagnostic tests can play an important role in a diagnosis.

A relatively new business for the company is the sale of medical technology for ultrasound and digital radiography imaging. Sound Technologies contributed $33 million of sales, 4% of VCA Antech’s total, in 2005.

Animal healthcare has great cost advantages over human healthcare. As mentioned above, medical technology is largely paid for by the time it passes to animals. Furthermore, providers of veterinary services are not dependent on third-party payers in order to collect fees. Over 95% of animal hospital services are paid for in cash or by credit card at the time of service. Thus, long collection cycles, money wasted on supporting a gigantic payment bureaucracy, and pricing pressures from third-party payers are avoided. Malpractice attorneys do not find this field lucrative, reducing another significant cost passed through to the human healthcare consumer. The consumer has an incentive to shop around for a veterinarian, because he is paying the bill. Anytime consumers can shop prices, prices suffer competitive pressure. This is virtually non-existent in human healthcare. As a result, prices for veterinary services remain a low percentage of a pet-owner’s income.

Revenue growth has been an exceptionally strong 26% over the past three quarters due to an unusually large acquisition closed in July, 2005. Pet’s Choice brought an additional 46 hospitals into VCA, twice the annual acquisition objective. Economies of scale drove even faster pre-tax earnings growth of 30%. However, revenue growth will regress to the mean if acquisitions do likewise later this year. Analyst consensus earnings per share estimates for the next five years are $1.13 in 2006, followed by $1.30, $1.53, $1.81, and $2.14, respectively. Cash earnings drive intrinsic value, so an intrinsic value estimate based on these earnings is currently in the low 30’s and in five years should grow to the high 50’s.

The primary risk to the stock price of this company is the continuation of growth through hospital acquisitions. Adding to the critical mass of hospitals has not only driven revenue growth, it has also driven profit growth due to economies of scale. Most hospitals acquired have had lower profit margins, and the ability of management to integrate and improve profitability has a good track record, but is not a given. The laboratory and medical technology divisions of this company compete with some very large companies. There is a shortage of veterinarians.

All in all, we find a large growth opportunity exits for VCA Antech in a highly stable business.

Biosite (BSTE 47) is endeavoring to create paradigm change in the field of medical diagnosis. The company’s innovations increase the accuracy of medical diagnoses and improve both the quality and cost efficiency of medical care. Sales efforts have astutely focused on hospital emergency departments, where doctors must make timely diagnoses, often under hectic conditions. The area of healthcare most afflicted by malpractice claims is the emergency department. Extending the company’s products into other hospital departments and into doctor’s offices creates a substantial opportunity for patient safety, cost efficiency, and Biosite revenue growth.

Hospital emergency departments are frequently overloaded with patients for whom a timely diagnosis can mean the difference between life and death. Rapid and accurate diagnostic tests at the point of care for difficult to diagnose symptoms are of great value to the doctor. For example, in fifteen minutes, the company’s Triage BNP test accurately indicates whether a patient has experienced a heart attack. Clinical data shows that this test actually controls healthcare costs by reducing the number of incorrect diagnoses, which either result in unnecessary cardiac ward admissions or a dangerously sick patient being sent home. Biosite has penetrated over half of U.S. hospitals with the little machine that performs the test. As a result, much of the spending required to penetrate the diagnostic market is complete. Now, the objective is to develop a multitude of tests for additional diseases, all of which run on this same machine.

Current products:

Test	Launch Date	2005 Revenues	Comments
Triage BNP	2001	$190 million	86% sensitivity and 98% selectivity in diagnosis of (MI) myocardial infarction (heart attack)
Cardiac Panels, including CardioProfiler and Shortness of Breath Panel	1998, updated 2003 and 2004	$37 million	Test consists of a panel of biomarkers. Aids in diagnosis of MI, assessment of severity of heart failure, assessment of intravascular coagulation and thromboembolic events, including pulmonary embolism.
D-dimer	2005	$3 million	Test for pulmonary embolism and intravascular coagulation
Stroke	EU late 2005	Negligible	Assessment of probability of stroke and brain stress.

Growth opportunities abound in coming years, although significant product launches will not impact revenues until 2008. Biosite’s secret formula is a patent-protected proprietary methodology for making antibodies that, when detected, indicate the existence of a disease state. The development process consists of four steps:

1. Blood samples specific for a targeted disease are compared with disease-free samples.

2. Immunoassays are screened to find biomarkers specific to the disease.

3. A proprietary methodology and software is used to define the priority of the biomarkers in terms of their ability to target the specific disease.

4. Optimal biomarkers are identified and grouped to proceed to product development.

The pipeline of potential products is as follows:

Test	Launch Date	Market Opportunity	Comments
Stroke/Ischemia (stress on brain)	EC approved; U.S. 2008	5.3 million annual test potential. $100 - $250 million	PMA application to FDA recently withdrawn, more clinical data to be added before resubmission in 2007. Stronger and better organized data needed. 8 million patients present to U.S. emergency departments per year; cost $56 billion/year.
Sepsis	EC late 2006, U.S. late ’07 or early ‘08	9 million annual test potential. $200 - $400 million	Sepsis mortality is 50%, so this is a very important test. Sepsis costs U.S. $16 billion per year. “Died of complications” usually means sepsis contracted in hospital.
Acute kidney injury	2007	$100 million	Warns of risk of acute renal failure; should be administered before kidney image scan performed. 8 million Americans have kidney disease. Mortality 40-70%.
MPO	2006 - 2007	$100 million	For chest pain symptoms, myeloperoxidase (MPO) indicates presence of unstable atherosclerotic plaque and acute risk of oncoming myocardial infarction (heart attack.)
Add MPO to Shortness of Breath cardiac panel	2006 without algorithm, 2007 with.	12 million annual test potential at $35 per test.	When added to the current cardiac panel, myeloperoxidase (MPO) adds an indicator of cardiac stress caused by arterial plaque accumulation; signals acute risk of heart attack.
Abdominal Pain	2009	$300 - $400 million	Leading reason for visits to emergency department with 6.8 million annual presentations; often a tough diagnosis.

Collectively, the market for these tests totals over $1 billion. Although these revenues would build gradually, one can foresee some very powerful revenue and earnings growth starting in 2008. This indicates patience will be required for the stock’s performance. Innovators are not easy to own in the early stages. As we know from Medtronic in the early 1990’s, QUALCOMM in the late 1990’s, and Monsanto in the early 2000’s, the rewards from suffering through the early years of ownership can be enormous if the innovation wins.

Biosite has well-established competition in the diagnostics business. Competitors include Abbott Laboratories, Bayer Diagnostics, Dade Behring, Diagnostic Products, Johnson & Johnson, and Roche. Beckman Coulter is both a partner and competitor, in that Biosite has licensed BNP and makes diagnostic slides for it. Biosite is leading an innovation that could obsolete the need for doctors to send tests to remote laboratories inhabited with the competitors’ legacy equipment. Rather, the doctor will have Biosite’s Triage meter in his office or hospital ward, allowing him truly timely testing. As background, I suggest reading Clay Christensen’s The Innovator’s Dilemma.

Biosite’s financial condition is very strong, with $17 million in long-term debt and $132 million in cash. In the last fiscal year, cash flow from operations was $91 million. The recent stock decline has prompted management to use some of these funds to repurchase stock. The consensus earnings per share estimates for 2006 through 2010 are $2.30, $2.50, $2.87, $3.31, and $3.80, respectively. If Biosite succeeds with changing the diagnostic paradigm, earnings in the later years of these estimates could be major upside surprises. The gross margin on new tests exceeds 70%, so strong sales will drive leveraged profit growth. The consensus earnings stream supports an intrinsic value estimate above the current stock price. Note carefully that new product success has the potential to drive very large increases in intrinsic value.

Steven L. Ré, CFA May 19, 2006

This report contains the current opinions of the author and such opinions are subject to change without notice. It has been distributed for information purposes only and is not to be construed as a recommendation to purchase or sell securities. The information contained herein is from sources deemed reliable but is not guaranteed. It should not be assumed that investments in any of the above-mentioned securities will be profitable, and past performance is no guarantee of future results. Earnings projections often miss and markets go up and down. The employees and families of Quality Growth Management, Inc. may own the above-mentioned securities in their own accounts, and may trade them at any time without notice.