UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2008

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

VCA Antech, Inc.

Delaware (State or other jurisdiction of incorporation or organization)		95-4097995 (I.R.S. Employer Identification No.)

12401 West Olympic Boulevard
Los Angeles, California 90064-1022
(Address of principal executive offices)

(310) 571-6500
(Registrant’s telephone number, including area code)

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 þ  No o.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o  No þ.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: common stock, $0.001 par value, 84,351,947 shares as of May 1, 2008.

 

 

VCA Antech, Inc.
Form 10-Q
March 31, 2008

Table of Contents

				Page
				Number
Part I.		Financial Information
Item 1.		Financial Statements (Unaudited)
		Condensed, Consolidated Balance Sheets as of March 31, 2008 and December 31, 2007			1
		Condensed, Consolidated Income Statements for the Three Months Ended March 31, 2008 and 2007			2
		Condensed, Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2008 and 2007			3
		Notes to Condensed, Consolidated Financial Statements			4
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			14
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			27
Item 4.		Controls and Procedures			27
Part II.		Other Information
Item 1.		Legal Proceedings			28
Item 1A.		Risk Factors			28
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			28
Item 3.		Defaults Upon Senior Securities			28
Item 4.		Submission of Matters to a Vote of Security Holders			28
Item 5.		Other Information			28
Item 6.		Exhibits			28
		Signature			29
		Exhibit Index			30
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VCA Antech, Inc. and Subsidiaries
Condensed, Consolidated Balance Sheets
(Unaudited)
(In thousands, except par value)

		March 31,				December 31,
		2008				2007
Assets
Current assets:
Cash and cash equivalents		$	86,244			$	110,866
Trade accounts receivable, less allowance for uncollectible accounts of $10,834 and $10,940 at March 31, 2008 and December 31, 2007, respectively			48,445				42,650
Inventory			25,100				25,517
Prepaid expenses and other			15,246				15,307
Deferred income taxes			14,659				14,402
Prepaid income taxes			—				8,160
Total current assets			189,694				216,902
Property and equipment, less accumulated depreciation and amortization of $130,832 and $124,884 at March 31, 2008 and December 31, 2007, respectively			220,879				214,020
Goodwill			866,096				821,967
Other intangible assets, net			24,548				22,373
Notes receivable, net			9,510				3,493
Deferred financing costs, net			1,421				1,537
Other			15,427				6,419
Total assets		$	1,327,575			$	1,286,711
Liabilities and Stockholders’ Equity
Current liabilities:
Current portion of long-term obligations		$	7,794			$	7,886
Accounts payable			29,998				28,092
Accrued payroll and related liabilities			32,712				38,341
Income taxes payable			8,673				—
Other accrued liabilities			49,073				42,074
Total current liabilities			128,250				116,393
Long-term obligations, less current portion			550,411				552,294
Deferred income taxes			27,871				28,197
Other liabilities			10,709				11,236
Minority interest			12,015				10,207
Commitments and contingencies
Preferred stock, par value $0.001, 11,000 shares authorized, none outstanding			—				—
Stockholders’ equity:
Common stock, par value $0.001, 175,000 shares authorized, 84,350 and 84,335 shares outstanding as of March 31, 2008 and December 31, 2007, respectively			84				84
Additional paid-in capital			297,673				296,037
Accumulated earnings			306,800				275,598
Accumulated other comprehensive loss			(6,238	)			(3,335	)
Total stockholders’ equity			598,319				568,384
Total liabilities and stockholders’ equity		$	1,327,575			$	1,286,711

The accompanying notes are an integral part of these condensed, consolidated financial statements.

VCA Antech, Inc. and Subsidiaries
Condensed, Consolidated Income Statements
(Unaudited)
(In thousands, except per share amounts)

		Three Months Ended
		March 31,
		2008				2007
Revenue		$	307,832			$	265,145
Direct costs			224,801				189,225
Gross profit			83,031				75,920
Selling, general and administrative expense			23,178				21,473
Write-down and (gain) loss on sale of assets			(184	)			122
Operating income			60,037				54,325
Interest expense, net			7,615				5,773
Other expense			177				55
Income before minority interest and provision for income taxes			52,245				48,497
Minority interest in income of subsidiaries			957				846
Income before provision for income taxes			51,288				47,651
Provision for income taxes			20,086				19,338
Net income		$	31,202			$	28,313
Basic earnings per share		$	0.37			$	0.34
Diluted earnings per share		$	0.36			$	0.33
Weighted-average shares outstanding for basic earnings per share			84,348				83,924
Weighted-average shares outstanding for diluted earnings per share			85,865				85,649

The accompanying notes are an integral part of these condensed, consolidated financial statements.

VCA Antech, Inc. and Subsidiaries
Condensed, Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)

		Three Months Ended
		March 31,
		2008				2007
Cash flows from operating activities:
Net income		$	31,202			$	28,313
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			7,263				5,931
Amortization of debt costs			116				61
Provision for uncollectible accounts			820				1,425
Write-down and (gain) loss on sale of assets			(184	)			122
Share-based compensation			1,309				1,217
Minority interest in income of subsidiaries			957				846
Distributions to minority interest partners			(760	)			(645	)
Deferred income taxes			2,329				1,159
Excess tax benefit from exercise of stock options			(133	)			(922	)
Other			86				(142	)
Changes in operating assets and liabilities:
Accounts receivable			(6,463	)			(6,040	)
Inventory, prepaid expenses and other assets			(2,351	)			(398	)
Accounts payable and other accrued liabilities			2,767				(2,279	)
Accrued payroll and related liabilities			(5,629	)			(2,270	)
Income taxes			16,946				17,637
Net cash provided by operating activities			48,275				44,015
Cash flows used in investing activities:
Business acquisitions, net of cash acquired			(47,826	)			(32,203	)
Real estate acquired in connection with business acquisitions			(3,612	)			(7,929	)
Property and equipment additions			(9,463	)			(11,875	)
Proceeds from sale of assets			1,747				1,564
Other			(12,124	)			110
Net cash used in investing activities			(71,278	)			(50,333	)
Cash flows used in financing activities:
Repayment of long-term obligations			(1,966	)			(2,302	)
Proceeds from issuance of common stock under stock option plans			214				839
Excess tax benefit from exercise of stock options			133				922
Net cash used in financing activities			(1,619	)			(541	)
Decrease in cash and cash equivalents			(24,622	)			(6,859	)
Cash and cash equivalents at beginning of period			110,866				45,104
Cash and cash equivalents at end of period		$	86,244			$	38,245

The accompanying notes are an integral part of these condensed, consolidated financial statements.

VCA Antech, Inc. and Subsidiaries
Notes To Condensed, Consolidated Financial Statements
March 31, 2008
(Unaudited)

1. Nature of Operations

     Our company, VCA Antech, Inc. (“VCA”) is a Delaware corporation formed in 1986 and is based in Los Angeles, California. We are an animal healthcare company with three strategic segments: veterinary diagnostic laboratories (“Laboratory”), animal hospitals (“Animal Hospital”) and veterinary medical technology (“Medical Technology”).

     We operate a full-service veterinary diagnostic laboratory network serving all 50 states. Our laboratory network provides sophisticated testing and consulting services used by veterinarians in the detection, diagnosis, evaluation, monitoring, treatment and prevention of diseases and other conditions affecting animals. At March 31, 2008, we operated 36 laboratories of various sizes located strategically throughout the United States.

     Our animal hospitals offer a full range of general medical and surgical services for companion animals. Our animal hospitals treat diseases and injuries, provide pharmaceutical products and perform a variety of pet-wellness programs, including health examinations, diagnostic testing, vaccinations, spaying, neutering and dental care. At March 31, 2008, we operated 456 animal hospitals throughout 39 states.

     Our medical technology segment sells digital radiography and ultrasound imaging equipment, provides education and training on the use of that equipment, and provides consulting and mobile imaging services.

2. Basis of Presentation

     Our accompanying unaudited, condensed, consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States for interim financial information and in accordance with the rules and regulations of the United States Securities and Exchange Commission. Accordingly, they do not include all of the information and notes required by GAAP in the United States for annual financial statements as permitted under applicable rules and regulations. In the opinion of management, all normal recurring adjustments considered necessary for a fair presentation have been included. The results of operations for the three months ended March 31, 2008, are not necessarily indicative of the results to be expected for the full year ending December 31, 2008. For further information, refer to our consolidated financial statements and notes thereto included in our 2007 Annual Report on Form 10-K.

     The preparation of our condensed, consolidated financial statements in accordance with GAAP in the United States requires management to make estimates and assumptions that affect the amounts reported in our condensed, consolidated financial statements and notes thereto. Actual results could differ from those estimates.

3. Acquisitions

     We acquired the following animal hospitals during the three months ended March 31, 2008:

Animal hospitals:
Acquisitions			21
Acquisitions relocated into our existing animal hospitals			(1	)
Total			20

VCA Antech, Inc. and Subsidiaries
Notes To Condensed, Consolidated Financial Statements (Continued)

3. Acquisitions, continued

     Animal Hospital Acquisitions

     The following table summarizes the preliminary purchase price, including acquisition costs, paid by us for the 21 animal hospitals we acquired during the three months ended March 31, 2008, and the preliminary allocation of the purchase price (in thousands):

Preliminary Purchase Price:
Cash		$	45,789
Liabilities assumed			2,394
Total		$	48,183
Preliminary Allocation of the Purchase Price:
Tangible assets		$	1,918
Identifiable intangible assets			3,568
Goodwill (1)			42,697
Total		$	48,183

     Other Acquisition Payments

     In connection with substantially all of our acquisitions, we withheld a portion of the purchase price (“holdback”) as security for indemnification obligations of the sellers under the acquisition agreement. We paid $1.3 million to sellers for the unused portion of holdbacks during the three months ended March 31, 2008. The total outstanding holdbacks at March 31, 2008 and December 31, 2007 were $3.1 million and $2.2 million, respectively.

     We also paid $213,000 for earn-out payments during the three months ended March 31, 2008.

4. Goodwill and Other Intangible Assets

     Goodwill represents the excess of the cost of an acquired entity over the net of the fair value of identifiable assets acquired and liabilities assumed. The following table presents the changes in the carrying amount of our goodwill for the three months ended March 31, 2008 (in thousands):

						Animal				Medical
		Laboratory				Hospital				Technology				Total
Balance as of December 31, 2007		$	95,344			$	707,463			$	19,160			$	821,967
Goodwill acquired			—				42,697				—				42,697
Goodwill related to partnership interests (1)			—				2,168				—				2,168
Other (2)			—				(736	)			—				(736	)
Balance as of March 31, 2008		$	95,344			$	751,592			$	19,160			$	866,096

VCA Antech, Inc. and Subsidiaries
Notes To Condensed, Consolidated Financial Statements (Continued)

4. Goodwill and Other Intangible Assets, continued

     Other Intangible Assets

     In addition to goodwill, we have amortizable intangible assets at March 31, 2008 and December 31, 2007 as follows (in thousands):

		As of March 31, 2008												As of December 31, 2007
		Gross								Net				Gross								Net
		Carrying				Accumulated				Carrying				Carrying				Accumulated				Carrying
		Amount				Amortization				Amount				Amount				Amortization				Amount
Covenants not-to-compete		$	15,275			$	(7,223	)		$	8,052			$	13,487			$	(6,928	)		$	6,559
Non-contractual customer relationships			14,336				(3,161	)			11,175				12,992				(2,755	)			10,237
Favorable lease asset			5,612				(1,174	)			4,438				5,594				(1,019	)			4,575
Technology			1,270				(885	)			385				1,270				(822	)			448
Trademarks			582				(199	)			383				582				(185	)			397
Contracts			380				(333	)			47				380				(309	)			71
Client lists			116				(48	)			68				137				(51	)			86
Total		$	37,571			$	(13,023	)		$	24,548			$	34,442			$	(12,069	)		$	22,373

     The following table summarizes our aggregate amortization expense related to other intangible assets (in thousands):

		Three Months Ended
		March 31,
		2008				2007
Aggregate amortization expense		$	1,204			$	965

     The estimated amortization expense related to intangible assets for each of the five succeeding years and thereafter as of March 31, 2008 is as follows (in thousands):

Remainder of 2008		$	4,059
2009			4,391
2010			3,581
2011			2,761
2012			1,563
Thereafter			8,193
Total		$	24,548

VCA Antech, Inc. and Subsidiaries
Notes To Condensed, Consolidated Financial Statements (Continued)

5. Other Accrued Liabilities

     Other accrued liabilities consisted of the following (in thousands):

		March 31,				December 31,
		2008				2007
Accrued workers’ compensation insurance		$	6,218			$	6,051
Deferred revenue			7,476				7,018
Interest rate swap liability			10,573				5,827
Accrued health insurance			3,532				3,273
Holdbacks			3,100				2,215
Accrued lease payments			2,168				2,329
Accrued liability insurance			1,897				1,787
Accrued post-retirement healthcare			1,562				1,281
Accrued accounting fees			1,038				690
Other			11,509				11,603
		$	49,073			$	42,074

6. Interest Rate Swap Agreements

     We have entered into interest rate swap agreements whereby we pay to the counterparties amounts based on fixed interest rates and set notional principal amounts in exchange for the receipt of payments from counterparties based on current LIBOR and the same set notional principal amounts. The purpose of these hedges is to offset the variability of cash flows due to our outstanding variable rate debt under our senior term notes. A summary of these agreements is as follows:

Interest Rate Swap Agreements

Fixed interest rate

4.07%

3.98%

5.51%

4.95%

5.34%

2.64%

Notional amount (in millions)

$50.0

$50.0

$50.0

$75.0

$100.0

$100.0

Effective date

5/26/2005

6/2/2005

6/20/2006

4/30/2007

6/11/2007

2/12/2008

Expiration date

5/26/2008

5/31/2008

6/30/2009

4/30/2009

12/31/2009

2/26/2010

Counterparties

Goldman Sachs

Wells Fargo

Goldman Sachs

Wells Fargo

Goldman Sachs

Wells Fargo

Qualifies for hedge accounting

Yes

Yes

Yes

Yes

Yes

Yes

     The following table summarizes cash received or cash paid and unrealized gains or losses recognized as a result of our interest rate swap agreements (in thousands):

		Three Months
		Ended March 31,
		2008				2007
Cash paid (received) (1)		$	782			$	(489	)
Recognized loss (2)		$	177			$	55

     On January 1, 2008, we adopted the applicable provisions of SFAS No. 157, Fair Value Measurements (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measurements related to financial instruments. In December 2007, the FASB provided a one-year deferral of SFAS No. 157 for non-financial assets and non-financial liabilities, except those that are recognized or

VCA Antech, Inc. and Subsidiaries
Notes To Condensed, Consolidated Financial Statements (Continued)

6. Interest Rate Swap Agreements, continued

disclosed at fair value on a recurring basis, at least annually. Accordingly, our adoption of SFAS No. 157 was limited to our financial assets and liabilities, which consist of our interest rate swap agreements.

     We use the market approach to measure fair value for our interest rate swap agreements. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.

     SFAS No. 157 includes a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques that are used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs reflect a reporting entity’s pricing based upon their own market assumptions. SFAS No. 157 establishes a three-tiered fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:

	•		Level 1. Observable inputs such as quoted prices in active markets;
	•		Level 2. Inputs, other than quoted prices, that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active; and
	•		Level 3. Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

     The following table reflects the fair value as defined by SFAS No. 157, of our interest rate swap agreements which are measured on a recurring basis (in thousands):

Basis of Fair Value Measurement

Quoted Prices

Significant Other

Significant

Balance at

In Active Markets

Observable

Unobservable

March 31,

for Identical Items

Inputs

Inputs

2008

(Level 1)

(Level 2)

(Level 3)

Interest rate swap agreements:

Other accrued liabilities

$

10,573

$

—

$

10,573

$

—

7. Share-Based Compensation

     Stock Option Activity

     There were no stock options granted during the three months ended March 31, 2008. The aggregate intrinsic value of our stock options exercised during the three months ended March 31, 2008 was $415,000 and the actual tax benefit realized on options exercised during this period was $162,000. The total fair value of options vested during the three months ended March 31, 2008 was $36,000.

     At March 31, 2008 there was $953,000 of total unrecognized compensation cost related to our stock options. This cost is expected to be recognized over a weighted-average period of less than one year.

     The compensation cost that has been charged against income for stock options for the three months ended March 31, 2008 and 2007 was $437,000 and $572,000, respectively. The corresponding income tax benefit recognized was $170,000 and $217,000 for the three months ended March 31, 2008 and 2007, respectively.

VCA Antech, Inc. and Subsidiaries
Notes To Condensed, Consolidated Financial Statements (Continued)

7. Share-Based Compensation, continued

     Non-vested Stock Activity

     During the three months ended March 31, 2008, we granted 410,780 shares of non-vested common stock, 177,000 of which were issued to certain of our executives and contain performance conditions. These awards provide that the number of shares that will ultimately vest will be between 0% and 100% of the total granted based upon the attainment of performance targets. Assuming continued service through each vesting date, these awards vest in three installments as follows: 25% in March 2010, 50% in March 2011 and 25% in March 2012.

     Total compensation cost charged against income related to non-vested stock awards was $872,000 and $645,000 for the three months ended March 31, 2008 and 2007, respectively. The corresponding income tax benefit recognized in the income statement was $339,000 and $256,000 for the three months ended March 31, 2008 and 2007, respectively. At March 31, 2008, there was $19.2 million of unrecognized compensation cost related to these non-vested shares that will be recognized over a weighted-average period of 3.5 years, assuming the performance conditions are met. A summary of our non-vested stock activity for the three months ended March 31, 2008 is as follows (in thousands, except per share amounts):

						Weighted-
						Average Fair
						Value
		Shares				Per Share
Outstanding at December 31, 2007			352,832			$	32.90
Granted			410,780				30.30
Vested			—				—
Forfeited/Canceled			(1,500	)			32.34
Outstanding at March 31, 2008			762,112			$	31.50

8. Calculation of Earnings per Share

     Basic earnings per share is calculated by dividing net income by the weighted-average number of shares outstanding during the period. Diluted earnings per share is calculated by dividing net income by the weighted-average number of common shares outstanding after giving effect to all dilutive potential common shares outstanding during the period. Basic and diluted earnings per share were calculated as follows (in thousands, except per share amounts):

		Three Months Ended
		March 31,
		2008				2007
Net income		$	31,202			$	28,313
Weighted-average common shares outstanding:
Basic			84,348				83,924
Effect of dilutive potential common shares:
Stock options and non-vested shares			1,517				1,725
Diluted			85,865				85,649
Basic earnings per share		$	0.37			$	0.34
Diluted earnings per share		$	0.36			$	0.33

VCA Antech, Inc. and Subsidiaries
Notes To Condensed, Consolidated Financial Statements (Continued)

8. Calculation of Earnings per Share, continued

     For the three months ended March 31, 2008 and 2007, potential common shares of 39,997 and 39,341, respectively, were excluded from the computation of diluted earnings per share because their inclusion would have had an anti-dilutive effect.

9. Comprehensive Income

     Total comprehensive income consists of net income and the other comprehensive loss. The following table provides a summary of comprehensive income (in thousands):

		Three Months Ended
		March 31,
		2008				2007
Net income		$	31,202			$	28,313
Other comprehensive loss:
Unrealized loss on hedging instruments, net of tax benefit of $1,919 in 2008 and $178 in 2007			(3,011	)			(374	)
Loss on hedging instruments reclassified to income, net of tax benefit of $70 in 2008 and $22 in 2007			108				33
Other comprehensive loss			(2,903	)			(341	)
Total comprehensive income		$	28,299			$	27,972

10. Segment Reporting

     Our reportable segments are Laboratory, Animal Hospital, and Medical Technology. These segments are strategic business units that have different services, products and/or functions. The segments are managed separately because each is a distinct and different business venture with unique challenges, risks and rewards. Our Laboratory segment provides diagnostic laboratory testing services for veterinarians, both associated with our animal hospitals and those independent of us. Our Animal Hospital segment provides veterinary services for companion animals and sells related retail and pharmaceutical products. Our Medical Technology segment sells digital radiography and ultrasound imaging equipment, related computer hardware, software and ancillary services to the veterinary market. We also operate a corporate office that provides general and administrative support services for our other segments.

     The accounting policies of our segments are the same as those described in the summary of significant accounting policies included in our 2007 Annual Report on Form 10-K. We evaluate the performance of our segments based on gross profit and operating income. For purposes of reviewing the operating performance of our segments, all intercompany sales and purchases are accounted for as if they were transactions with independent third parties at current market prices.

VCA Antech, Inc. and Subsidiaries
Notes To Condensed, Consolidated Financial Statements (Continued)

10. Segment Reporting, continued

     The following is a summary of certain financial data for each of our segments (in thousands):

						Animal				Medical								Intercompany
		Laboratory				Hospital				Technology				Corporate				Eliminations				Total
Three Months Ended March 31, 2008
External revenue		$	69,058			$	226,100			$	12,674			$	—			$	—			$	307,832
Intercompany revenue			7,671				—				1,175				—				(8,846	)			—
Total revenue			76,729				226,100				13,849				—				(8,846	)			307,832
Direct costs			39,387				184,963				8,936				—				(8,485	)			224,801
Gross profit			37,342				41,137				4,913				—				(361	)			83,031
Selling, general and administrative expense			4,951				5,478				3,434				9,315				—				23,178
Write-down and (gain) loss on sale of assets			(11	)			(193	)			20				—				—				(184	)
Operating income (loss)		$	32,402			$	35,852			$	1,459			$	(9,315	)		$	(361	)		$	60,037
Depreciation and amortization		$	1,647			$	4,883			$	397			$	459			$	(123	)		$	7,263
Capital expenditures		$	1,778			$	7,055			$	82			$	825			$	(277	)		$	9,463
Three Months Ended March 31, 2007
External revenue		$	67,242			$	187,171			$	10,732			$	—			$	—			$	265,145
Intercompany revenue			6,355				—				440				—				(6,795	)			—
Total revenue			73,597				187,171				11,172				—				(6,795	)			265,145
Direct costs			37,595				151,591				6,861				—				(6,822	)			189,225
Gross profit			36,002				35,580				4,311				—				27				75,920
Selling, general and administrative expense			4,967				5,560				2,935				8,011				—				21,473
Write-down and loss on sale of assets			—				122				—				—				—				122
Operating income (loss)		$	31,035			$	29,898			$	1,376			$	(8,011	)		$	27			$	54,325
Depreciation and amortization		$	1,353			$	3,870			$	379			$	418			$	(89	)		$	5,931
Capital expenditures		$	3,123			$	6,956			$	248			$	1,610			$	(62	)		$	11,875
At March 31, 2008
Total assets		$	184,071			$	969,392			$	49,063			$	132,351			$	(7,302	)		$	1,327,575
At December 31, 2007
Total assets		$	178,846			$	934,366			$	54,954			$	125,173			$	(6,628	)		$	1,286,711

11. Commitments and Contingencies

     We have certain commitments, including operating leases and supply purchase agreements. These items are discussed in detail in our consolidated financial statements and notes thereto included in our 2007 Annual Report on Form 10-K. We also have contingencies as follows:

     a. Earn-out Payments

      We have contractual arrangements in connection with certain acquisitions, whereby additional cash may be paid to former owners of acquired companies upon attainment of specified financial criteria as set forth in the respective agreements. The amount to be paid cannot be determined until the earn-out periods expire and the attainment of criteria is established. If the specified financial criteria are attained, at March 31, 2008, we will be obligated to pay an additional $1.0 million.

VCA Antech, Inc. and Subsidiaries
Notes To Condensed, Consolidated Financial Statements (Continued)

11. Commitments and Contingencies, continued

     b. Officers’ Compensation

     Each of our Chief Executive Officer (“CEO”), Chief Operating Officer (“COO”) and Chief Financial Officer (“CFO”) has entered into an employment agreement with our company. The agreements provide for a base salary and annual bonuses set by our Compensation Committee of the Board of Directors. As of any given date, under their contracts, each officer has the following remaining term: five years for the CEO, three years for the COO and two years for the CFO. Our Senior Vice President (“SVP”) has entered into a letter agreement with the Company pursuant to which certain payments will be made to our SVP in the event his employment is terminated.

     In the event any of these officers’ employment is terminated due to death or disability, each officer, or their estate, is entitled to receive the remaining base salary during the remaining scheduled term of his employment agreement (and in the case of our SVP, for two years), the continued vesting of his non-vested stock, the acceleration of the vesting of his options that would have vested during the 24 months following the date of termination, which options shall remain exercisable for the full term, and the right to continue receiving specified benefits and perquisites.

     In the event any of these officers terminate their employment agreements for cause (or, in the case of our SVP, he terminates his employment for good reason), we terminate any of their employment agreements (or, in the case of our SVP, we terminate his employment) without cause or a change of control occurs (in which case such employment agreements, and our SVP’s employment with us, terminate automatically), each officer is entitled to receive the remaining base salary during the remaining scheduled term of his employment agreement (and in the case of our SVP, for two years), a bonus based on past bonuses, the continued vesting of his non-vested stock, the acceleration of the vesting of his options, which options shall remain exercisable for the full term, and the right to continue receiving specified benefits and perquisites. Notwithstanding the foregoing, if the CFO’s employment agreement or our SVP’s employment is terminated by us without cause, accelerated vesting of their respective options will be limited to those options that would have vested during the 24 months following the date of termination.

     In the event of a change of control, the cash value of all benefits due under their employment contracts (or, in the case of our SVP, his letter agreement) as a result of the termination would be immediately payable to the officers. In addition, if any of the amounts payable to these officers under these provisions constitute “excess parachute payments” under the Internal Revenue Code, each officer is entitled to an additional payment to cover the tax consequences associated with the excess parachute payment.

      c. Other Contingencies

     We have certain contingent liabilities resulting from litigation and claims incident to the ordinary course of our business. We believe that the probable resolution of such contingencies will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.

12. Recent Accounting Pronouncements

     In September 2006, the FASB issued SFAS No. 157 which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements. However, it eliminates inconsistencies in the guidance provided in previous accounting pronouncements. In December 2007, the FASB provided a one-year deferral of SFAS No. 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value on a recurring basis, at least annually. Accordingly, we adopted SFAS No. 157 on January 1, 2008, as required for our financial assets and financial liabilities, which did not have a material impact on our consolidated financial statements. The provisions of SFAS No. 157 as it related to our non-financial assets and liabilities will be effective for our company on January 1, 2009. We are currently evaluating the impact of SFAS No. 157 with respect to our non-financial assets and liabilities on our consolidated financial statements.

     In February 2007, the FASB issued SFAS No. 159, Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”), which permits entities to choose to measure certain financial instruments and other

VCA Antech, Inc. and Subsidiaries
Notes To Condensed, Consolidated Financial Statements (Continued)

12. Recent Accounting Pronouncements, continued

eligible items at fair value when the items are not otherwise currently required to be measured at fair value. We adopted SFAS No. 159 on January 1, 2008. Upon adoption, we did not elect the fair value option for any items within the scope of SFAS No. 159 and, therefore, the adoption of SFAS No. 159 did not have an impact on our consolidated financial statements.

     In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS No. 141R”). SFAS No. 141R will significantly change the accounting for business combinations in a number of areas including the treatment of contingent consideration, contingencies, acquisition costs, in-process research and development and restructuring costs. In addition, under SFAS No. 141R, changes in deferred tax asset valuation allowances and acquired income tax uncertainties in a business combination after the measurement period will impact income tax expense. The provisions of SFAS No. 141R will be effective for our company on January 1, 2009. We are currently evaluating the impact of adopting SFAS No. 141R on our consolidated financial statements.

     In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51 (“SFAS No. 160”). SFAS No. 160 will change the accounting and reporting for minority interests, which will be re-characterized as non-controlling interests and classified as a component of equity. This new standard will significantly change the accounting for transactions with minority interest holders. The provisions of SFAS No. 160 will be effective for our company on January 1, 2009. We are currently evaluating the impact of adopting SFAS No. 160 on our consolidated financial statements.

     In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities — an amendment of SFAS No. 133 (“SFAS No. 161”). SFAS No. 161 will change the disclosure requirement for derivative instruments and hedging activities to enhance the current disclosure framework in SFAS No. 133. The additional disclosures will require information about how derivatives and hedging activities affect an entity’s financial position, financial performance, and cash flows. The provisions of SFAS No. 161 will be effective for our company on January 1, 2009. We are currently evaluating the impact of adopting SFAS No. 161 on our consolidated financial statements.

     In April 2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of Intangible Assets (“FSP FAS 142-3”). FSP FAS 142-3 amends FASB Statement No. 142, Goodwill and Other Intangible Assets, to improve the consistency between the useful life of a recognized intangible asset under Statement No. 142 and the period of expected cash flows used to measure the fair value of the asset under Statement No 141, Business Combinations, and other U.S. GAAP. The provisions of FSP FAS 142-3 will be effective for our company on January 1, 2009. We are currently evaluating the impact of adopting FSP FAS 142-3 on our consolidated financial statements.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

		Page
		Number
Introduction			15
Executive Overview			15
Critical Accounting Policies			16
Consolidated Results of Operations			17
Segment Results			20
Liquidity and Capital Resources			23

Introduction

     The following discussion should be read in conjunction with our condensed, consolidated financial statements provided under Part I, Item I of this quarterly report on Form 10-Q. We have included herein statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We generally identify forward-looking statements in this report using words like “believe,” “intend,” “expect,” “estimate,” “may,” “plan,” “should plan,” “project,” “contemplate,” “anticipate,” “predict,” “potential,” “continue,” or similar expressions. You may find some of these statements below and elsewhere in this report. These forward-looking statements are not historical facts and are inherently uncertain and outside of our control. Any or all of our forward-looking statements in this report may turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Many factors mentioned in our discussion in this report will be important in determining future results. Consequently, no forward-looking statement can be guaranteed. Actual future results may vary materially. Factors that may cause our plans, expectations, future financial condition and results to change are described throughout this report and in our Annual Report on Form 10-K, particularly in “Risk Factors,” Part I, Item 1A of that report.

     The forward-looking information set forth in this quarterly report on Form 10-Q is as of May 9, 2008, and we undertake no duty to update this information. Shareholders and prospective investors can find information filed with the SEC after May 9, 2008 at our website at http://investor.vcaantech.com or at the SEC’s website at www.sec.gov.

     We are a leading national animal healthcare company. We provide veterinary services and diagnostic testing to support veterinary care and we sell diagnostic imaging equipment, other medical technology products and related services to veterinarians. Our reportable segments are as follows:

	•		Our laboratory segment operates the largest network of veterinary diagnostic laboratories in the nation. Our laboratories provide sophisticated testing and consulting services used by veterinarians in the detection, diagnosis, evaluation, monitoring, treatment and prevention of diseases and other conditions affecting animals. At March 31, 2008, our laboratory network consisted of 36 laboratories serving all 50 states.
	•		Our animal hospital segment operates the largest network of freestanding, full-service animal hospitals in the nation. Our animal hospitals offer a full range of general medical and surgical services for companion animals. We treat diseases and injuries, offer pharmaceutical and retail products and perform a variety of pet wellness programs, including health examinations, diagnostic testing, routine vaccinations, spaying, neutering and dental care. At March 31, 2008, our animal hospital network consisted of 456 animal hospitals in 39 states.
	•		Our medical technology segment sells digital radiography and ultrasound imaging equipment, related computer hardware, software and ancillary services.

     The practice of veterinary medicine is subject to seasonal fluctuation. In particular, demand for veterinary services is significantly higher during the warmer months because pets spend a greater amount of time outdoors where they are more likely to be injured and are more susceptible to disease and parasites. In addition, use of veterinary services may be affected by levels of flea infestation, heartworm and ticks, and the number of daylight hours.

Executive Overview

     The company delivered strong operating results during the three months ended March 31, 2008, achieved through a combination of continued internal revenue growth and acquisitions. Although we experienced some impact from both economic factors and high internal revenue comparisons related to the 2007 pet food recall, our laboratory internal revenue growth was 4.1%, while our animal hospital same-store revenue growth was 1.9%.

     Acquisitions and Facilities

     Our growth strategy includes the acquisition of independent animal hospitals. We currently anticipate that animal hospital acquired revenue for 2008 will range from $60.0 million to $70.0 million. In addition, we also evaluate the acquisition of animal hospital chains, laboratories or related businesses if favorable opportunities are presented. The following table summarizes the changes in the number of facilities operated by our animal hospital segment during the three months ended March 31, 2008:

Animal hospitals:
Beginning of period			438
Acquisitions			21
Acquisitions relocated into our existing animal hospitals			(1	)
Sold or closed			(2	)
End of period			456

Critical Accounting Policies

     Our consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States, which require management to make estimates and assumptions that affect reported amounts. The estimates and assumptions are based on historical experience and on other factors that management believes to be reasonable. Actual results may differ from those estimates. Critical accounting policies represent the areas where more significant judgments and estimates are used in the preparation of our consolidated financial statements. A discussion of such critical accounting policies, which include revenue recognition, valuation of goodwill and other intangible assets, income taxes, and self-insured liabilities can be found in our Annual Report on Form 10-K for the year ended December 31, 2007. There have been no material changes to those policies as of this Quarterly Report on Form 10-Q for the period ended March 31, 2008.

Consolidated Results of Operations

     The following table sets forth components of our condensed, consolidated income statements expressed as a percentage of revenue:

		Three Months Ended
		March 31,
		2008				2007
Revenue:
Laboratory			24.9	%			27.8	%
Animal hospital			73.4				70.6
Medical technology			4.5				4.2
Intercompany			(2.8	)			(2.6	)
Total revenue			100.0				100.0
Direct costs			73.0				71.4
Gross profit			27.0				28.6
Selling, general and administrative expense			7.5				8.1
Operating income			19.5				20.5
Interest expense, net			2.5				2.2
Income before minority interest and provision for income taxes			17.0				18.3
Minority interest in income of subsidiairies			0.3				0.3
Income before provision for income taxes			16.7				18.0
Provision for income taxes			6.6				7.3
Net income			10.1	%			10.7	%

     Revenue

     The following table summarizes our revenue (in thousands, except percentages):

		Three Months Ended March 31,
		2008								2007
						% of								% of
		$				Total				$				Total				% Change
Laboratory		$	76,729				24.9	%		$	73,597				27.8	%			4.3	%
Animal hospital			226,100				73.4	%			187,171				70.6	%			20.8	%
Medical technology			13,849				4.5	%			11,172				4.2	%			24.0	%
Intercompany			(8,846	)			(2.8	)%			(6,795	)			(2.6	)%			30.2	%
Total revenue		$	307,832				100.0	%		$	265,145				100.0	%			16.1	%

     Consolidated revenue increased $42.7 million for the three months ended March 31, 2008. The increase in consolidated revenue was attributable primarily to revenue from acquired animal hospitals, including Healthy Pet which was acquired on June 1, 2007. The increase was also due to an increase in organic revenues. During the three months ended March 31, 2008, we experienced animal hospital same-store revenue growth of 1.9% driven mainly by an increase in the average revenue per order which resulted from the overall mix of business as discussed further below under Segment Results. Also contributing to the increase in organic revenues were medical technology revenue growth of 24.0% and laboratory internal revenue growth of 4.1%.

     Gross Profit

     The following table summarizes our gross profit and our gross profit as a percentage of applicable revenue, or gross margin (in thousands, except percentages):

		Three Months Ended March 31,
		2008								2007
						Gross								Gross
		$				Margin				$				Margin				% Change
Laboratory		$	37,342				48.7	%		$	36,002				48.9	%			3.7	%
Animal hospital			41,137				18.2	%			35,580				19.0	%			15.6	%
Medical technology			4,913				35.5	%			4,311				38.6	%			14.0	%
Intercompany			(361	)							27
Total gross profit		$	83,031				27.0	%		$	75,920				28.6	%			9.4	%

     Consolidated gross profit increased $7.1 million for the three months ended March 31, 2008. The increase was primarily due to acquired animal hospitals as discussed above and organic growth. The increase in organic gross profit was due primarily to growth in the year over year requisitions in our laboratory business combined with an increase in the average revenue per order in our hospital business. Our hospital same-store gross margin remained relatively flat in comparison to the previous year totaling 19.0%.

     Selling, General and Administrative Expense

     The following table summarizes our selling, general and administrative expense (“SG&A”) and our expense as a percentage of applicable revenue (in thousands, except percentages):

		Three Months Ended March 31,
		2008								2007
						% of								% of
		$				Revenue				$				Revenue				% Change
Laboratory		$	4,951				6.5	%		$	4,967				6.7	%			(0.3	)%
Animal hospital			5,478				2.4	%			5,560				3.0	%			(1.5	)%
Medical technology			3,434				24.8	%			2,935				26.3	%			17.0	%
Corporate			9,315				3.0	%			8,011				3.0	%			16.3	%
Total SG&A		$	23,178				7.5	%		$	21,473				8.1	%			7.9	%

     Consolidated selling, general and administrative expense increased $1.7 million for the three months ended March 31, 2008. The increase was primarily attributable to expanding our administrative operations in order to manage our recent acquisitions, compensation and benefits related to annual salary increases, share-based compensation expense due to non-vested shares granted in 2007, and commissions as a result of our medical technology segment’s strong operating performance.

     Write-down and (Gain) Loss on Sale of Assets

     During the three months ended March 31, 2008, we sold certain assets, including real estate, for a net gain of $303,000 and wrote-off certain other assets totaling $119,000.

     Operating Income

     The following table summarizes our operating income (in thousands, except percentages):

		Three Months Ended March 31,
		2008								2007
						% of								% of
		$				Revenue				$				Revenue				% Change
Laboratory		$	32,402				42.2	%		$	31,035				42.2	%			4.4	%
Animal hospital			35,852				15.9	%			29,898				16.0	%			19.9	%
Medical technology			1,459				10.5	%			1,376				12.3	%			6.0	%
Corporate			(9,315	)			(3.0	)%			(8,011	)			(3.0	)%			16.3	%
Intercompany			(361	)			4.1	%			27				(0.4	)%			(1,437.0	)%
Total operating income		$	60,037				19.5	%		$	54,325				20.5	%			10.5	%

     The increase in our consolidated operating income was primarily due to both revenue growth and our ability to leverage our existing cost structure.

     Interest Expense, Net

     The following table summarizes our interest expense, net of interest income (in thousands):

		Three Months Ended
		March 31,
		2008				2007
Interest expense (income):
Senior term notes		$	7,013			$	6,405
Interest rate hedging agreements			782				(489	)
Capital leases and other			641				350
Amortization of debt costs			116				61
			8,552				6,327
Interest income			937				554
Total interest expense, net of interest income		$	7,615			$	5,773

     The increase in net interest expense was primarily attributable to interest payments related to our fixed rate interest rate swap agreements. During the prior year we received interest income from our swap agreements however due to the overall reduction in LIBOR rates during the current year we have been required to record interest expense related to these agreements. In addition, we incurred incremental interest expense related to the June 1, 2007 borrowing of $160.0 million under our senior credit facility related to the Healthy Pet acquisition.

     Provision for Income Taxes

     Our effective tax rate was 39.2% and 40.6% for the three months ended March 31, 2008 and 2007, respectively. The effective tax rate is subject to ongoing review and evaluation by management and could change in future quarters.

Segment Results

     Laboratory Segment

     The following table summarizes revenue and gross profit for our laboratory segment (in thousands, except percentages):

		Three Months Ended March 31,
		2008								2007
						Gross								Gross
		$				Margin				$				Margin				% Change
Revenue		$	76,729							$	73,597								4.3	%
Gross profit		$	37,342				48.7	%		$	36,002				48.9	%			3.7	%

     Laboratory revenue increased $3.1 million for the three months ended March 31, 2008 as compared to the same period in the prior year. The components of the increase in laboratory revenue are detailed below (in thousands, except percentages and average price per requisition):

		Three Months Ended March 31,
		2008				2007				% Change
Laboratory Revenue:
Internal growth:
Number of requisitions (1)			3,224				3,118				3.4	%
Average revenue per reqisition (2)		$	23.76			$	23.60				0.7	%
Total internal revenue (1)		$	76,615			$	73,597				4.1	%
Acquired revenue (3)			114				—
Total		$	76,729			$	73,597				4.3	%

     The increase in requisitions from internal growth is the result of a continued trend in veterinary medicine to focus on the importance of laboratory diagnostic testing in the diagnosis, early detection and treatment of diseases, and the migration of certain tests to outside laboratories that have historically been performed in veterinary hospitals. This trend is driven by an increase in the number of specialists in the veterinary industry relying on diagnostic testing, the increased focus on diagnostic testing in veterinary schools and general increased awareness through ongoing marketing and continuing education programs provided by us, pharmaceutical companies and other service providers in the industry.

     No single customer represented more than 10% of our laboratory revenues during the periods presented. We derive our laboratory revenue from services provided to over 16,000 clients and shifts in the purchasing habits of any individual animal hospital or small group of animal hospitals is not material to our laboratory revenues. Other companies are developing networks of animal hospitals, however, and shifts in the purchasing habits of these networks have the potential of a greater impact on our laboratory revenues.

     The change in the average revenue per requisition is attributable to changes in the mix, including performing lower-priced tests historically performed at the veterinary hospitals, the type and number of tests performed per requisition and price increases. The price increases for most tests ranged from 3% to 4% in both February 2008 and February 2007.

     Laboratory gross profit is calculated as laboratory revenue less laboratory direct costs. Laboratory direct costs are comprised of all costs of laboratory services, including but not limited to, salaries of veterinarians, specialists,

technicians and other laboratory-based personnel, transportation and delivery costs, facilities rent, occupancy costs, depreciation and amortization and supply costs.

      Animal Hospital Segment

     The following table summarizes revenue and gross profit for the animal hospital segment (in thousands, except percentages):

		Three Months Ended March 31,
		2008								2007
						Gross								Gross
		$				Margin				$				Margin				% Change
Revenue		$	226,100							$	187,171								20.8	%
Gross profit		$	41,137				18.2	%		$	35,580				19.0	%			15.6	%

     Animal hospital revenue increased $38.9 million for the three months ended March 31, 2008 as compared to the same period in the prior year. The components of the increase are summarized in the following table (in thousands, except percentages and average price per order):

		Three Months Ended March 31,
Animal Hospital Revenue:		2008				2007				% Change
Same-store facilities:
Orders (1)(2)			1,293				1,326				(2.5	)%
Average revenue per order (3)		$	144.23			$	138.01				4.5	%
Same-store revenue (1)		$	186,490			$	183,001				1.9	%
Net acquired revenue (4)			39,610				4,170
Total		$	226,100			$	187,171				20.8	%

     Our business strategy is to place a greater emphasis on comprehensive wellness visits and advanced medical procedures, which typically generate higher-priced orders. Over the last few years, some pet-related products traditionally sold in our animal hospitals are now widely available in retail stores and other distribution channels. In addition, there has been a decline in the number of vaccinations as some recent professional literature and research has suggested that vaccinations can be given to pets less frequently. These trends have resulted in a decrease in lower-priced orders and an increase in higher-priced orders. During the three months ended March 31, 2008, we experienced a decrease in the number of orders primarily due to the reasons discussed above. We expect that this trend may continue in future periods.

     Price increases, which approximated 5% to 6% on most services at most hospitals in both February 2008 and February 2007, also contributed to the increase in the average revenue per order. Prices are reviewed on an annual basis for each hospital and adjustments are made based on market considerations, demographics and our costs.

     Animal hospital gross profit is calculated as animal hospital revenue less animal hospital direct costs. Animal hospital direct costs are comprised of all costs of services and products at the animal hospitals, including, but not limited to, salaries of veterinarians, technicians and all other animal hospital-based personnel, facilities rent, occupancy costs, supply costs, depreciation and amortization, certain marketing and promotional expenses and costs of goods sold associated with the retail sales of pet food and pet supplies.

     Consistent with our growth strategies, over the last several years we have acquired a significant number of animal hospitals. Many of these newly acquired animal hospitals had lower gross margins at the time of acquisition than those previously operated by us. Historically, these lower gross margins, in the aggregate, have been favorably impacted subsequent to the acquisition by improvements in animal hospital revenue, increased operating leverage and our integration efforts. However, due to the substantial amount of acquisition activity that has occurred in a relatively short period of time, our gross margins have declined. Our animal hospital gross margin for the three months ended March 31, 2008 and 2007 was 18.2% and 19.0%, respectively. Our animal hospital same-store gross margins remained relatively unchanged totaling 19.0% and 19.1% for the three months ended March 31, 2008 and 2007, respectively.

     Medical Technology Segment

     The following table summarizes revenue and gross profit for the medical technology segment (in thousands, except percentages):

		Three Months Ended March 31,
		2008								2007
						Gross								Gross
		$				Margin				$				Margin				% Change
Revenue		$	13,849							$	11,172								24.0	%
Gross profit		$	4,913				35.5	%		$	4,311				38.6	%			14.0	%

     Medical technology revenue increased $2.7 million for the three months ended March 31, 2008 as compared to the same period in the prior year which was primarily attributable to revenue on sales of our digital radiography and ultrasound imaging equipment. Although we recognized an increase in ultrasound revenue, we believe the business life cycle for this equipment is maturing and accordingly, the demand for these types of products and related services may decline in the near term.

     Medical technology gross profit is calculated as medical technology revenue less medical technology direct costs. Medical technology direct costs are comprised of all product and service costs, including, but not limited to, all costs of equipment, related products and services, salaries of technicians, support personnel, trainers, consultants and other non-administrative personnel, depreciation and amortization and supply costs.

     Medical technology gross profit increased $0.6 million for the three months ended March 31, 2008 as compared to the same period in the prior year, which was attributable to an increase in revenue as discussed above. Our medical technology gross margin declined to 35.5% for the three months ended March 31, 2008 as compared to 38.6% in the same period in the prior year, which was primarily the result of an increase in material costs related to the sale of our digital radiography imaging equipment. In 2007, we implemented a strategic shift in our pricing model in an effort to mitigate the effects of increasing competition by providing better value to our customers through additional functionality.

     Intercompany Revenue

     Laboratory revenue for the three months ended March 31, 2008 included intercompany revenue of $7.7 million that was generated by providing laboratory services to our animal hospitals. Medical technology revenue for the three months ended March 31, 2008 included intercompany revenue of $1.2 million that was generated by providing products and services to our animal hospitals and laboratories. For purposes of reviewing the operating performance of our business segments, all intercompany transactions are accounted for as if the transaction was with an independent third party at current market prices. For financial reporting purposes, intercompany transactions are eliminated as part of our consolidation.

Liquidity and Capital Resources

Introduction

     We generate cash primarily from payments made by customers for our veterinary services, payments from animal hospitals and other clients for our laboratory services, and from proceeds received from the sale of our imaging equipment and other related services. Our business historically has experienced strong liquidity, as fees for services provided in our animal hospitals are due at the time of service and fees for laboratory services are collected under standard industry terms. Our cash disbursements are primarily for payments related to the compensation of our employees, supplies and inventory purchases for our operating segments, occupancy and other administrative costs, interest expense, payments on long-term borrowings, capital expenditures and animal hospital acquisitions. Cash outflows fluctuate with the amount and timing of the settlement of these transactions.

     We manage our cash, investments and capital structure so we are able to meet the short-term and long-term obligations of our business while maintaining financial flexibility and liquidity. We forecast, analyze and monitor our cash flows to enable investment and financing within the overall constraints of our financial strategy.

     At March 31, 2008, our consolidated cash and cash equivalents totaled $86.2 million, representing an increase of $48.0 million as compared to the prior year. In addition, cash flows generated from operating activities totaled $48.3 million in 2008, representing an increase of $4.3 million as compared to the three months ended March 31, 2007.

     We also have access to an unused $75.0 million revolving credit facility, which allows us to maintain further operating and financial flexibility. Historically we have been able to obtain cash from other borrowings. The availability of financing in the form of debt or equity however is influenced by many factors including our profitability, operating cash flows, debt levels, debt ratings, contractual restrictions, and market conditions. Although in the past we have been able to obtain financing for material transactions on terms that we believe to be reasonable, there is a possibility that we may not be able to obtain financing on favorable terms in the future.

Future Cash Flows

      Short-term

     Other than our acquisitions of hospital chains, we historically have funded our working capital requirements, capital expenditures and investments in animal hospital acquisitions from internally generated cash flow and our revolving credit facility. We anticipate that our cash on hand, net cash provided by operations and our revolving credit facility will be sufficient to meet our anticipated cash requirements for the next 12 months. If we consummate one or more significant acquisitions during this period, we may seek additional debt or equity financing.

     In 2008, we expect to spend $60.0 million to $70.0 million related to the acquisition of independent animal hospitals. The ultimate number of acquisitions is largely dependent upon the attractiveness of the candidates and the strategic fit with our existing operations. From January 1, 2008 through March 31, 2008, we spent $45.8 million in connection with the acquisition of 21 animal hospitals. In addition, we expect to spend approximately $50.0 million in 2008 for both property and equipment additions and capital costs necessary to maintain our existing facilities.

     Long-term

     Our long-term liquidity needs, other than those related to the day-to-day operations of our business, including commitments for operating leases, generally are comprised of scheduled principal and interest payments for our outstanding long-term indebtedness, capital expenditures related to the expansion of our business and acquisitions in accordance with our growth strategy. In addition to the scheduled payments on our senior term notes, we are required to make mandatory prepayments in the event we have excess cash flow. Pursuant to the terms of our senior credit facility, mandatory prepayments are due on our senior term notes equal to 75% of any excess cash flow at the end of 2008, 2009 and 2010. Excess cash flow is defined as earnings before interest, taxes, depreciation and amortization less voluntary and scheduled debt repayments, capital expenditures, interest payable in cash, taxes payable in cash and cash paid for acquisitions. These payments reduce on a pro rata basis the remaining scheduled principal payments.

     We are unable to project with certainty whether our long-term cash flow from operations will be sufficient to repay our long-term debt when it comes due. If this cash flow is insufficient, we expect that we will need to

refinance such indebtedness, amend its terms to extend the maturity dates, or issue common stock in our company. Our management cannot make any assurances that such refinancing or amendments, if necessary, will be available on attractive terms, if at all.

      Debt Related Covenants

     Our senior credit facility contains certain financial covenants pertaining to fixed charge coverage and leverage ratios. In addition, the senior credit facility has restrictions pertaining to capital expenditures, acquisitions and the payment of cash dividends. As of March 31, 2008, we were in compliance with these covenants.

     At March 31, 2008, we had a fixed charge coverage ratio of 1.61 to 1.00, which was in compliance with the required ratio of no less than 1.20 to 1.00. The senior credit facility defines the fixed charge coverage ratio as that ratio that is calculated on a last 12-month basis by dividing pro forma earnings before interest, taxes, depreciation and amortization, as defined by the senior credit facility (“pro forma earnings”), by fixed charges. Fixed charges are defined as cash interest expense, scheduled principal payments on debt obligations, capital expenditures, and provision for income taxes. Pro forma earnings include 12 months of operating results for businesses acquired during the period.

     At March 31, 2008, we had a leverage ratio of 1.99 to 1.00, which was in compliance with the required ratio of no more than 3.25 to 1.00. The senior credit facility defines the leverage ratio as that ratio which is calculated as total debt divided by pro forma earnings.

Historical Cash Flows

     The following table summarizes our cash flows (in thousands):

		Three Months Ended
		March 31,
		2008				2007
Cash provided by (used in):
Operating activities		$	48,275			$	44,015
Investing activities			(71,278	)			(50,333	)
Financing activities			(1,619	)			(541	)
Decrease in cash and cash equivalents			(24,622	)			(6,859	)
Cash and cash equivalents at beginning of period			110,866				45,104
Cash and cash equivalents at end of period		$	86,244			$	38,245