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 September 30, 2007

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

For the transition period from                      to                     

Commission File Number: 001-16783

VCA Antech, Inc.

Delaware		95-4097995
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		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, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ     Accelerated filer o      Non-accelerated filer o

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 84,253,313 shares as of November 6, 2007.

 

 

VCA Antech, Inc.
Form 10-Q
September 30, 2007

Table of Contents

		Page
		Number
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Condensed, Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006			1
Condensed, Consolidated Income Statements for the Three and Nine Months Ended September 30, 2007 and 2006			2
Condensed, Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006			3
Notes to Condensed, Consolidated Financial Statements			4
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			15
Item 3. Quantitative and Qualitative Disclosures About Market Risk			26
Item 4. Controls and Procedures			26
Part II. Other Information
Item 1. Legal Proceedings			27
Item 1A. Risk Factors			27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			27
Item 3. Defaults Upon Senior Securities			27
Item 4. Submission of Matters to a Vote of Security Holders			27
Item 5. Other Information			27
Item 6. Exhibits			27
Signature			28
Exhibit Index			29
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VCA Antech, Inc. and Subsidiaries

		September 30,				December 31,
		2007				2006
Assets
Current assets:
Cash and cash equivalents		$	87,155			$	45,104
Trade accounts receivable, less allowance for uncollectible accounts of $11,297 and $11,195 at September 30, 2007 and December 31, 2006, respectively			46,503				44,491
Inventory			21,332				21,420
Prepaid expenses and other			13,616				13,492
Deferred income taxes			17,866				14,935
Prepaid income taxes			—				13,523
Total current assets			186,472				152,965
Property and equipment, less accumulated depreciation and amortization of $126,894 and $111,165 at September 30, 2007 and December 31, 2006, respectively			206,347				166,033
Goodwill			847,942				625,748
Other intangible assets, net			16,586				16,293
Notes receivable, net			2,897				2,675
Deferred financing costs, net			1,623				979
Other			11,278				7,264
Total assets		$	1,273,145			$	971,957
Liabilities and Stockholders’ Equity
Current liabilities:
Current portion of long-term obligations		$	7,997			$	6,648
Accounts payable			23,905				23,328
Accrued payroll and related liabilities			32,932				33,864
Accrued interest			608				388
Other accrued liabilities			43,353				30,573
Total current liabilities			108,795				94,801
Long-term obligations, less current portion			554,205				384,067
Deferred income taxes			45,647				39,804
Other liabilities			12,118				13,294
Minority interest			10,634				9,686
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, 84,210 and 83,560 shares outstanding as of September 30, 2007 and December 31, 2006, respectively			84				84
Additional paid-in capital			292,223				275,013
Accumulated earnings			250,975				154,586
Accumulated other comprehensive (loss) income			(1,536	)			622
Total stockholders’ equity			541,746				430,305
Total liabilities and stockholders’ equity		$	1,273,145			$	971,957

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

VCA Antech, Inc. and Subsidiaries

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
Revenue		$	306,537			$	251,632			$	871,987			$	740,962
Direct costs			220,235				181,167				619,887				532,014
Gross profit			86,302				70,465				252,100				208,948
Selling, general and administrative expense			22,295				18,946				65,811				57,315
Loss (gain) on sale of assets			333				3				875				(200	)
Operating income			63,674				51,516				185,414				151,833
Interest expense, net			8,930				6,084				21,374				18,323
Other (income) expense			(1	)			73				226				(24	)
Minority interest in income of subsidiaries			1,187				846				3,061				2,520
Income before provision for income taxes			53,558				44,513				160,753				131,014
Provision for income taxes			21,329				17,536				64,364				44,825
Net income		$	32,229			$	26,977			$	96,389			$	86,189
Basic earnings per share		$	0.38			$	0.32			$	1.15			$	1.04
Diluted earnings per share		$	0.38			$	0.32			$	1.13			$	1.02
Weighted-average shares outstanding for basic earnings per share			83,957				83,339				83,769				83,092
Weighted-average shares outstanding for diluted earnings per share			85,752				85,187				85,572				84,864

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

VCA Antech, Inc. and Subsidiaries

		Nine Months Ended
		September 30,
		2007				2006
Cash flows from operating activities:
Net income		$	96,389			$	86,189
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			19,764				16,347
Amortization of debt costs			253				299
Provision for uncollectible accounts			3,561				4,174
Loss (gain) on sale of assets			875				(200	)
Share-based compensation			3,429				2,326
Minority interest in income of subsidiaries			3,061				2,520
Distributions to minority interest partners			(2,262	)			(2,439	)
Deferred income taxes			4,627				7,222
Excess tax benefit from exercise of stock options			(6,576	)			(5,774	)
Other			(115	)			(750	)
Changes in operating assets and liabilities:
Accounts receivable			(4,823	)			(8,500	)
Inventory, prepaid expenses and other assets			1,140				(6,816	)
Accounts payable and other accrued liabilities			(1,195	)			(2,499	)
Accrued payroll and related liabilities			(3,958	)			(1,928	)
Income taxes			20,983				567
Net cash provided by operating activities			135,153				90,738
Cash flows from investing activities:
Business acquisitions, net of cash acquired			(214,758	)			(37,612	)
Real estate acquired in connection with business acquisitions			(7,962	)			(2,872	)
Property and equipment additions			(38,033	)			(23,800	)
Proceeds from sale of assets			1,774				533
Other			(188	)			268
Net cash used in investing activities			(259,167	)			(63,483	)
Cash flows from financing activities:
Repayment of long-term obligations			(6,282	)			(64,106	)
Proceeds from the issuance of long-term obligations			160,000				—
Payment of financing costs			(897	)			—
Proceeds from issuance of common stock under stock option plans			6,668				5,410
Excess tax benefit from exercise of stock options			6,576				5,774
Net cash provided by (used in) financing activities			166,065				(52,922	)
Increase (decrease) in cash and cash equivalents			42,051				(25,667	)
Cash and cash equivalents at beginning of period			45,104				58,488
Cash and cash equivalents at end of period		$	87,155			$	32,821

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

VCA Antech, Inc. and Subsidiaries

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 September 30, 2007, we operated 35 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 September 30, 2007, we operated 441 animal hospitals throughout 38 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 and nine months ended September 30, 2007, are not necessarily indicative of the results to be expected for the full year ending December 31, 2007. For further information, refer to our consolidated financial statements and notes thereto included in our 2006 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 nine months ended September 30, 2007:

Hospital acquisitions, excluding Healthy Pet (1)			29
Healthy Pet (1)			44
Acquisitions relocated into our existing animal hospitals			(7	)
Total			66

     We acquired two laboratories during the nine months ended September 30, 2007, one of which was acquired with Healthy Pet and was merged into our existing operations.

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

3. Acquisitions, continued

Animal Hospital and Laboratory Acquisitions, Excluding Healthy Pet

     The following table summarizes the preliminary purchase price, including acquisition costs, paid by us for the 29 animal hospitals and one laboratory we acquired during the nine months ended September 30, 2007, and the preliminary allocation of the purchase price (in thousands):

Preliminary Purchase Price:
Cash		$	57,990
Liabilities assumed			2,755
Total		$	60,745
Preliminary Allocation of the Purchase Price:
Tangible assets		$	2,662
Identifiable intangible assets			2,906
Goodwill (1)			55,177
Total		$	60,745

Healthy Pet

     On June 1, 2007, we acquired Healthy Pet, which operated at the time of its acquisition, 44 animal hospitals and a small laboratory, which primarily serviced its own animal hospitals. This acquisition allowed us to expand our animal hospital operations, particularly in Massachusetts, Connecticut, Virginia and Georgia. Our condensed, consolidated financial statements reflect the operating results of Healthy Pet since June 1, 2007.

     We acquired Healthy Pet for a preliminary purchase price of $184.7 million. The following table summarizes the preliminary purchase price and the preliminary allocation of the purchase price (in thousands):

Preliminary Purchase Price:
Cash paid to holders of Healthy Pet stock and debt, net of cash acquired		$	153,568
Cash paid for professional services			1,216
Debt and capital leases assumed			17,761
Liabilities assumed			8,708
Liabilities for our plan to eliminate duplicate functions and to close certain animal hospitals			3,432
Total		$	184,685
Preliminary Allocation of the Purchase Price:
Tangible assets		$	15,110
Identifiable intangible assets			383
Goodwill (1)			169,192
Total		$	184,685

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

3. Acquisitions, continued

     The final purchase price and the valuation of the net assets acquired is expected to be completed as soon as practicable, but no later than one year from the date of acquisition. The final calculation of the purchase price, which is based on Healthy Pet’s working capital at June 1, 2007, is currently pending review by an independent accounting firm. In addition, given the relative size and complexity of the acquisition, the fair value of certain assets and liabilities acquired, primarily fixed and intangible assets, lease obligations, the 2007 tax liability and deferred tax balances, is still preliminary. We have engaged various third-parties to provide valuation expertise where necessary and have not yet received their completed analyses. With respect to lease obligations, we are currently engaged in negotiating the termination of certain contracts. Also, we have not received final billings related to professional services used in the acquisition as the service provider has not completed its billing process or the work has not yet been completed.

Other Acquisition Payments

     In connection with certain acquisitions, we withheld a portion of the purchase price (“holdback”) as security for indemnification obligations of the sellers under the acquisition agreement. We paid $1.2 million to sellers for the unused portion of the holdbacks during the nine months ended September 30, 2007.

     During the nine months ended September 30, 2007, we paid $745,000 to purchase the ownership interest in two partially-owned subsidiaries.

4. Long-Term Obligations and Interest Rate Swap Agreements

     On June 1, 2007, we amended our senior credit facility to allow for additional senior term notes in the amount of $160.0 million. The funds borrowed from the additional senior term notes were primarily used to fund the acquisition of Healthy Pet on June 1, 2007. The terms, including the interest rate, of these additional senior term notes are the same as the senior term notes existing prior to the amendment. Principal payments on the additional senior term notes are due quarterly in the amount of $400,000 and a final payment in the amount of $153.6 million is due on May 16, 2011. In connection with this amendment, we incurred debt-issue costs in the amount of $897,000.

     During the nine months ended September 30, 2007, we entered into the following interest rate swap agreements to mitigate our exposure to the risk of interest rates increasing:

Fixed interest rate		4.95%		5.34%
Notional amount (in millions)		$75.0		$100.0
Effective date		4/30/2007		6/11/2007
Expiration date		4/30/2009		12/31/2009
Counterparties		Wells Fargo		Goldman Sachs
Qualifies for hedge accounting		Yes		Yes

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

5. 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 nine months ended September 30, 2007 (in thousands):

						Animal				Medical
		Laboratory				Hospital				Technology				Total
Balance as of December 31, 2006		$	95,310			$	511,278			$	19,160			$	625,748
Goodwill acquired			21				224,348				—				224,369
Goodwill related to partnership interests			—				753				—				753
Other (1)			—				(2,928	)			—				(2,928	)
Balance as of September 30, 2007		$	95,331			$	733,451			$	19,160			$	847,942

     In addition to goodwill, we have amortizable intangible assets at September 30, 2007 and December 31, 2006 as follows (in thousands):

		As of September 30, 2007												As of December 31, 2006
		Gross								Net				Gross								Net
		Carrying				Accumulated				Carrying				Carrying				Accumulated				Carrying
		Amount				Amortization				Amount				Amount				Amortization				Amount
Covenants not-to-compete		$	14,110			$	(6,890	)		$	7,220			$	12,687			$	(6,169	)		$	6,518
Non-contractual customer relationships			10,459				(2,204	)			8,255				9,869				(1,553	)			8,316
Technology			1,270				(758	)			512				1,270				(568	)			702
Trademarks			582				(170	)			412				569				(127	)			442
Contracts			380				(285	)			95				397				(231	)			166
Client lists			136				(44	)			92				506				(357	)			149
Total		$	26,937			$	(10,351	)		$	16,586			$	25,298			$	(9,005	)		$	16,293

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

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
Aggregate amortization expense		$	967			$	933			$	2,997			$	2,661

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

5. Goodwill and Other Intangible Assets, continued

     The estimated amortization expense related to intangible assets for each of the five succeeding years and thereafter as of September 30, 2007 is as follows (in thousands):

Remainder of 2007		$	997
2008			3,556
2009			2,512
2010			1,739
2011			1,250
Thereafter			6,532
Total		$	16,586

6. Share-Based Compensation

Stock Option Activity

     A summary of our stock option activity for the nine months ended September 30, 2007 is as follows (in thousands, except weighted-average exercise price and weighted-average remaining contractual term):

										Weighted-
										Average
						Weighted-				Remaining
						Average				Contractual				Aggregate
		Stock				Exercise				Term				Intrinsic
		Options				Price				(Years)				Value
Outstanding at December 31, 2006			5,290			$	15.72				5.0			$	87,136
Granted			—				—
Exercised			(650	)			10.26
Forfeited/Canceled			(83	)			20.59
Outstanding at September 30, 2007			4,557			$	16.41				4.3			$	115,472
Exercisable at September 30, 2007			4,030			$	16.32				4.4			$	102,487
Expected to vest at September 30, 2007			510			$	17.10				3.5			$	12,580

     The following table summarizes information about the options outstanding at September 30, 2007 (in thousands, except per share amounts and the weighted-average remaining contractual life):

Options Outstanding																		Options Exercisable
										Weighted-Avg.
										Remaining
						Number				Contractual				Weighted-Avg.				Number				Weighted-Avg.
Exercise Price						Outstanding				Life				Exercise Price				Exercisable				Exercise Price
$0.50							149				3.0			$	0.50				149			$	0.50
$6.26 - $7.97							1,114				5.2			$	7.01				1,114			$	7.01
$15.33 - $30.70							3,294				4.0			$	20.30				2,767			$	20.92
							4,557												4,030

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

6. Share-Based Compensation, continued

     At September 30, 2007, there was $1.8 million of total unrecognized compensation cost related to our stock options. This cost is expected to be recognized over a weighted-average period of 1.0 years.

Non-vested Stock Activity

     During the nine months ended September 30, 2007, we granted 351,432 non-vested shares of common stock with a weighted-average grant date fair value of $32.75 per share. At September 30, 2007, there was $9.1 million of unrecognized compensation cost related to these non-vested shares that will be recognized over a weighted-average period of 3.3 years.

7. Income Taxes

     The effective tax rate for the nine months ended September 30, 2007 and 2006 was 40.0% and 34.2%, respectively. The effective tax rate for the nine months ended September 30, 2006 includes a tax benefit in the amount of $6.8 million recognized during the first quarter of 2006 due to the outcome of an income tax audit that resulted in a reduction to our estimated tax liabilities.

8. Comprehensive Income

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

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
Net income		$	32,229			$	26,977			$	96,389			$	86,189
Other comprehensive loss:
Unrealized loss on hedging instruments, net of tax			(2,171	)			(1,262	)			(2,359	)			(517	)
Loss (gain) on hedging instruments reclassified to income, net of tax			65				44				201				(14	)
Other comprehensive loss			(2,106	)			(1,218	)			(2,158	)			(531	)
Total comprehensive income		$	30,123			$	25,759			$	94,231			$	85,658

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

9. Calculation of Earnings per Share

     Basic earnings per share is calculated by dividing net income by the weighted-average number of shares outstanding during each 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 each period. Basic and diluted earnings per share were calculated as follows (in thousands, except per share amounts):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
Net income		$	32,229			$	26,977			$	96,389			$	86,189
Weighted-average common shares outstanding:
Basic			83,957				83,339				83,769				83,092
Effect of dilutive potential common shares:
Stock options and non-vested shares			1,795				1,848				1,803				1,772
Diluted			85,752				85,187				85,572				84,864
Basic earnings per share		$	0.38			$	0.32			$	1.15			$	1.04
Diluted earnings per share		$	0.38			$	0.32			$	1.13			$	1.02

     For the nine months ended September 30, 2007 and the three and nine months ended September 30, 2006, potential common shares of 49,729 and 39,341, respectively, were excluded from the computation of diluted earnings per share because their inclusion would have had an anti-dilutive effect. There were no anti-dilutive shares for the three months ended September 30, 2007.

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 2006 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

     Below 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 September 30, 2007
External revenue		$	66,964			$	229,409			$	10,164			$	—			$	—			$	306,537
Intercompany revenue			7,302				—				927				—				(8,229	)			—
Total revenue			74,266				229,409				11,091				—				(8,229	)			306,537
Direct costs			38,628				181,825				7,830				—				(8,048	)			220,235
Gross profit			35,638				47,584				3,261				—				(181	)			86,302
Selling, general and administrative expense			4,859				5,411				2,761				9,264				—				22,295
Loss on sale of assets			14				312				6				1				—				333
Operating income (loss)		$	30,765			$	41,861			$	494			$	(9,265	)		$	(181	)		$	63,674
Depreciation and amortization		$	1,742			$	4,461			$	409			$	512			$	(100	)		$	7,024
Capital expenditures		$	2,084			$	7,383			$	142			$	1,468			$	(280	)		$	10,797
Three Months Ended September 30, 2006
External revenue		$	60,261			$	183,592			$	7,779			$	—			$	—			$	251,632
Intercompany revenue			5,793				—				1,177				—				(6,970	)			—
Total revenue			66,054				183,592				8,956				—				(6,970	)			251,632
Direct costs			36,041				146,132				5,530				—				(6,536	)			181,167
Gross profit			30,013				37,460				3,426				—				(434	)			70,465
Selling, general and administrative expense			4,350				5,161				2,534				6,901				—				18,946
Loss (gain) on sale of assets			6				(3	)			—				—				—				3
Operating income (loss)		$	25,657			$	32,302			$	892			$	(6,901	)		$	(434	)		$	51,516
Depreciation and amortization		$	1,221			$	3,577			$	315			$	424			$	(41	)		$	5,496
Capital expenditures		$	2,388			$	4,747			$	404			$	1,354			$	(160	)		$	8,733

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

10. Segment Reporting, continued

						Animal				Medical								Intercompany
		Laboratory				Hospital				Technology				Corporate				Eliminations				Total
Nine Months Ended September 30, 2007
External revenue		$	206,233			$	635,046			$	30,708			$	—			$	—			$	871,987
Intercompany revenue			20,840				—				2,190				—				(23,030	)			—
Total revenue			227,073				635,046				32,898				—				(23,030	)			871,987
Direct costs			115,467				505,581				21,541				—				(22,702	)			619,887
Gross profit			111,606				129,465				11,357				—				(328	)			252,100
Selling, general and administrative expense			14,872				16,292				8,389				26,258				—				65,811
Loss on sale of assets			72				756				46				1				—				875
Operating income (loss)		$	96,662			$	112,417			$	2,922			$	(26,259	)		$	(328	)		$	185,414
Depreciation and amortization		$	4,688			$	12,751			$	1,216			$	1,390			$	(281	)		$	19,764
Capital expenditures		$	9,808			$	23,663			$	566			$	4,604			$	(608	)		$	38,033
Nine Months Ended September 30, 2006
External revenue		$	177,964			$	540,117			$	22,881			$	—			$	—			$	740,962
Intercompany revenue			17,100				—				2,467				—				(19,567	)			—
Total revenue			195,064				540,117				25,348				—				(19,567	)			740,962
Direct costs			103,977				430,409				16,276				—				(18,648	)			532,014
Gross profit			91,087				109,708				9,072				—				(919	)			208,948
Selling, general and administrative expense			12,793				15,107				7,734				21,681				—				57,315
Loss (gain) on sale of assets			14				(214	)			—				—				—				(200	)
Operating income (loss)		$	78,280			$	94,815			$	1,338			$	(21,681	)		$	(919	)		$	151,833
Depreciation and amortization		$	3,373			$	10,674			$	1,089			$	1,320			$	(109	)		$	16,347
Capital expenditures		$	5,352			$	16,124			$	489			$	2,294			$	(459	)		$	23,800
At September 30, 2007
Total assets		$	178,942			$	933,828			$	50,069			$	117,801			$	(7,495	)		$	1,273,145
At December 31, 2006
Total assets		$	167,363			$	671,975			$	53,161			$	85,533			$	(6,075	)		$	971,957

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 2006 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

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

11. Commitments and Contingencies, continued

criteria is established. If the specified financial criteria are attained, we will be obligated to pay an additional $938,000.

b.

Officers’ Compensation

     Our Chief Executive Officer (“CEO”), Chief Operating Officer (“COO”) and Chief Financial Officer (“CFO”) have entered into employment agreements with our company that provide for base salaries 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 remaining term: five years for the CEO, three years for the COO and two years for the CFO. The contracts have the following additional provisions:

	•		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, 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.
	•		In the event any of these officers terminate their employment agreements for cause, we terminate any of their employment agreements without cause or a change of control occurs (in which case such employment agreements terminate automatically), each officer is entitled to receive the remaining base salary during the remaining scheduled term of his employment agreement, a bonus based on past bonuses, 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.
	•		In the event of a change of control, the cash value of all benefits due under their employment contracts 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.

     In addition to the agreements described above, we entered into an agreement with one of our Senior Vice Presidents whereby in the event his employment is terminated for any reason other than cause, he is entitled to receive an amount equal to one year’s base salary in effect at the date of termination and the right to continue receiving specified benefits and perquisites for a period of one year. Our Senior Vice President’s base salary and annual bonus are set by our Compensation Committee of the Board of Directors.

c.

Other Contingencies

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

12. Recent Accounting Pronouncements

     In June 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 prescribes recognition thresholds and measurement attributes for the financial statement recognition of uncertain income tax positions. In the first quarter of 2007, we adopted FIN 48. We did not have any unrecognized tax benefits at September 30, 2007, and the adoption of FIN 48 did not have a material effect on our condensed, consolidated financial statements.

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

12. Recent Accounting Pronouncements, continued

     In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (“SFAS No. 157”), which establishes a framework for using and disclosing estimates in accounting for certain assets, liabilities and transactions at fair value. The provisions of SFAS No. 157 will be effective for our company on January 1, 2008. We are currently evaluating the impact of adopting SFAS No. 157 on our consolidated financial statements.

     In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB No.115 (“SFAS No. 159”), which permits entities to choose to measure certain financial instruments and other items at fair value. The provisions of SFAS No. 159 will be effective for our company on January 1, 2008. We are currently evaluating the impact of adopting SFAS No. 159 on our consolidated financial statements.

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

		Page
		Number
Introduction		16
Executive Overview		16
Consolidated Results of Operations		18
Segment Results		20
Liquidity and Capital Resources		23
Critical Accounting Policies		25
Recent Accounting Pronouncements		26
Forward-Looking Statements		26

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 November 6, 2007, and we undertake no duty to update this information. Shareholders and prospective investors can find information filed with the SEC after November 6, 2007 at our website at www.investor.vcaantech.com or at the SEC’s website at www.sec.gov.

     We are a leading national animal healthcare company that provides 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 September 30, 2007, our laboratory network consisted of 35 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 September 30, 2007, our animal hospital network consisted of 441 animal hospitals in 38 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 three and nine months ended September 30, 2007 was marked by continued growth in our laboratory and animal hospital operating segments achieved through a combination of internal growth and acquisitions, including the acquisition of Healthy Pet Corp. (“Healthy Pet”) on June 1, 2007. For the three and nine months ended September 30, 2007, our laboratory internal revenue growth was 11.6% and 14.9%, respectively, and our animal hospital same-store revenue growth, adjusted for one less business day in the current periods, was 5.7% and 6.0%, respectively.

   Acquisitions and Facilities

     Our growth strategy includes the acquisition of independent animal hospitals. We currently anticipate that animal hospital acquired revenue for 2007 (exclusive of our acquisition of Healthy Pet discussed below) will range from $60.0 million to $65.0 million. In addition, we also evaluate the acquisition of animal hospital chains, laboratories or related businesses if favorable opportunities are presented. In accordance with that strategy, on June 1, 2007, we acquired Healthy Pet, which operated at the time of its acquisition, 44 animal hospitals and a small laboratory, which primarily serviced its own animal hospitals. The acquisition of Healthy Pet allowed us to expand our animal hospital operations, particularly in Massachusetts, Connecticut, Virginia and Georgia. The following table summarizes the changes in the number of facilities operated by our laboratory and animal hospital segments during the nine months ended September 30, 2007:

Laboratories:
Beginning of period			33
Acquisitions			2
Acquisitions relocated into our exising laboratories			(1	)
New facilities			1
End of period			35
Animal hospitals:
Beginning of period			379
Acquisitions, excluding Healthy Pet			29
Healthy Pet			44
Acquisitions relocated into our existing animal hospitals			(7	)
Closed			(4	)
End of period			441

   Financing Transaction

     On June 1, 2007, we amended our senior credit facility to allow for additional senior term notes in the amount of $160.0 million. We used the funds borrowed from the additional senior term notes to fund the acquisition of Healthy Pet on June 1, 2007. The terms, including the interest rate, of these additional senior term notes are the same as the senior term notes existing prior to the amendment. Principal payments on the additional senior term notes are due quarterly in the amount of $400,000 and a final payment in the amount of $153.6 million is due on May 16, 2011.

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								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
Revenue:
Laboratory			24.2	%			26.3	%			26.0	%			26.3	%
Animal hospital			74.8				73.0				72.8				72.9
Medical technology			3.6				3.6				3.8				3.4
Intercompany			(2.6	)			(2.9	)			(2.6	)			(2.6	)
Total revenue			100.0				100.0				100.0				100.0
Direct costs			71.8				72.0				71.1				71.8
Gross profit			28.2				28.0				28.9				28.2
Selling, general and administrative expense			7.3				7.5				7.5				7.7
Loss on sale of assets			0.1				—				0.1				—
Operating income			20.8				20.5				21.3				20.5
Interest expense, net			2.9				2.4				2.5				2.5
Other expense			—				0.1				—				—
Minority interest in income of subsidiairies			0.4				0.3				0.4				0.3
Income before provision for income taxes			17.5				17.7				18.4				17.7
Provision for income taxes			7.0				7.0				7.3				6.1
Net income			10.5	%			10.7	%			11.1	%			11.6	%

Revenue

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

		Three Months Ended September 30,																				Nine Months Ended September 30,
		2007								2006												2007								2006
						% of								% of												% of								% of
		$				Total				$				Total				% Change				$				Total				$				Total				% Change
Laboratory		$	74,266				24.2	%		$	66,054				26.3	%			12.4	%		$	227,073				26.0	%		$	195,064				26.3	%			16.4	%
Animal hospital			229,409				74.8	%			183,592				73.0	%			25.0	%			635,046				72.8	%			540,117				72.9	%			17.6	%
Medical technology			11,091				3.6	%			8,956				3.6	%			23.8	%			32,898				3.8	%			25,348				3.4	%			29.8	%
Intercompany			(8,229	)			(2.6	)%			(6,970	)			(2.9	)%			18.1	%			(23,030	)			(2.6	)%			(19,567	)			(2.6	)%			17.7	%
Total revenue		$	306,537				100.0	%		$	251,632				100.0	%			21.8	%		$	871,987				100.0	%		$	740,962				100.0	%			17.7	%

     Consolidated revenue increased $54.9 million for the three months ended September 30, 2007, and $131.0 million for the nine months ended September 30, 2007. The increases in revenue were attributable to revenue from acquired animal hospitals, including Healthy Pet, and organic growth. Our laboratory internal revenue growth was 11.6% and 14.9% for the three and nine months ended September 30, 2007, respectively. Our animal hospital same-store revenue growth, adjusted for one less business day in the current periods, was 5.7% and 6.0% for the three and nine months ended September 30, 2007.

  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 September 30,																				Nine Months Ended September 30,
		2007								2006												2007								2006
						Gross								Gross				%								Gross								Gross				%
		$				Margin				$				Margin				Change				$				Margin				$				Margin				Change
Laboratory		$	35,638				48.0	%		$	30,013				45.4	%			18.7	%		$	111,606				49.1	%		$	91,087				46.7	%			22.5	%
Animal hospital			47,584				20.7	%			37,460				20.4	%			27.0	%			129,465				20.4	%			109,708				20.3	%			18.0	%
Medical technology			3,261				29.4	%			3,426				38.3	%			(4.8	)%			11,357				34.5	%			9,072				35.8	%			25.2	%
Intercompany			(181	)							(434	)											(328	)							(919	)
Total gross profit		$	86,302				28.2	%		$	70,465				28.0	%			22.5	%		$	252,100				28.9	%		$	208,948				28.2	%			20.7	%