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, 2006

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, 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 83,083,505 shares as of May 5, 2006.

 

 

VCA ANTECH, INC.
FORM 10-Q
MARCH 31, 2006

TABLE OF CONTENTS

				Page
				Number
Part I.		Financial Information
Item 1.		Financial Statements (Unaudited)
		Condensed, Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005			1
		Condensed, Consolidated Income Statements for the Three Months Ended March 31, 2006 and 2005			2
		Condensed, Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2006 and 2005			3
		Notes to Condensed, Consolidated Financial Statements			4
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			12
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			25
Item 4.		Controls and Procedures			25
Part II.		Other Information
Item 1.		Legal Proceedings			26
Item 1A.		Risk Factors			26
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			26
Item 3.		Defaults Upon Senior Securities			26
Item 4.		Submission of Matters to a Vote of Security Holders			26
Item 5.		Other Information			26
Item 6.		Exhibits			26
		Signature			27
		Exhibit Index			28
Exhibit 4.1
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VCA ANTECH, INC. AND SUBSIDIARIES

		March 31,				December 31,
		2006				2005
ASSETS
Current assets:
Cash and cash equivalents		$	32,180			$	58,488
Trade accounts receivable, less allowance for uncollectible accounts of $10,173 and $9,409 at March 31, 2006 and December 31, 2005, respectively			36,773				36,104
Inventory			17,309				17,856
Prepaid expenses and other			10,507				9,867
Deferred income taxes			12,168				10,972
Prepaid income taxes			2,314				12,337
Total current assets			111,251				145,624
Property and equipment, less accumulated depreciation and amortization of $97,680 and $93,305 at March 31, 2006 and December 31, 2005, respectively			150,600				143,781
Other assets:
Goodwill			603,191				586,444
Other intangible assets, net			10,674				10,735
Deferred financing costs, net			1,208				1,340
Other			9,994				9,149
Total assets		$	886,918			$	897,073
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term obligations		$	5,667			$	5,884
Accounts payable			19,561				20,718
Accrued payroll and related liabilities			21,771				25,201
Accrued interest			207				306
Other accrued liabilities			29,976				28,860
Total current liabilities			77,182				80,969
Long-term obligations, less current portion			409,046				446,828
Deferred income taxes			35,129				30,803
Other liabilities			13,476				19,775
Minority interest			9,923				9,947
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, 82,942 and 82,759 shares outstanding as of March 31, 2006 and December 31, 2005, respectively			83				83
Additional paid-in capital			261,674				258,402
Retained earnings			78,716				49,057
Accumulated other comprehensive income			1,689				1,209
Total stockholders’ equity			342,162				308,751
Total liabilities and stockholders’ equity		$	886,918			$	897,073

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

VCA ANTECH, INC. AND SUBSIDIARIES

		Three Months Ended
		March 31,
		2006				2005
Revenue		$	234,180			$	186,863
Direct costs			170,659				136,336
Gross profit			63,521				50,527
Selling, general and administrative expense			18,885				14,132
Gain on sale of assets			(118	)			(10	)
Operating income			44,754				36,405
Interest expense, net			6,312				6,667
Other (income) expense			(66	)			64
Minority interest in income of subsidiaries			774				685
Income before provision for income taxes			37,734				28,989
Provision for income taxes			8,075				11,743
Net income		$	29,659			$	17,246
Basic earnings per common share		$	0.36			$	0.21
Diluted earnings per common share		$	0.35			$	0.21
Shares used for computing basic earnings per share			82,813				82,220
Shares used for computing diluted earnings per share			84,583				83,511

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

VCA ANTECH, INC. AND SUBSIDIARIES

CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2006 and 2005
(Unaudited)
(In thousands)

		Three Months Ended
		March 31,
		2006				2005
Cash flows from operating activities:
Net income		$	29,659			$	17,246
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			5,422				4,342
Amortization of debt costs			132				209
Provision for uncollectible accounts			1,562				1,033
Gain on sale of assets			(118	)			(10	)
Share-based compensation			776				—
Minority interest in income of subsidiaries			774				685
Distributions to minority interest partners			(798	)			(656	)
Deferred income taxes			2,917				1,004
Excess tax benefit from exercise of stock options			(1,277	)			—
Other			(235	)			(248	)
Changes in operating assets and liabilities:
Increase in accounts receivable			(2,132	)			(3,771	)
Increase in inventory, prepaid expenses and other assets			(222	)			(2,429	)
Increase (decrease) in accounts payable and other accrued liabilities			(6,479	)			2,059
Increase (decrease) in accrued payroll and related liabilities			(3,430	)			1,892
Increase (decrease) in accrued interest			(99	)			4,191
Decrease in prepaid income taxes			11,300				9,821
Net cash provided by operating activities			37,752				35,368
Cash flows used in investing activities:
Business acquisitions, net of cash acquired			(15,863	)			(14,322	)
Real estate acquired in connection with business acquisitions			(1,779	)			(221	)
Property and equipment additions			(7,860	)			(7,209	)
Proceeds from sale of assets			286				92
Other			76				77
Net cash used in investing activities			(25,140	)			(21,583	)
Cash flows used in financing activities:
Repayment of long-term obligations			(41,416	)			(3,414	)
Proceeds from issuance of common stock under stock option plans			1,219				191
Excess tax benefit from exercise of stock options			1,277				—
Net cash used in financing activities			(38,920	)			(3,223	)
Increase (decrease) in cash and cash equivalents			(26,308	)			10,562
Cash and cash equivalents at beginning of period			58,488				30,964
Cash and cash equivalents at end of period		$	32,180			$	41,526

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

VCA ANTECH, INC. AND SUBSIDIARIES

1. General

          The accompanying unaudited condensed, consolidated financial statements of our company, VCA Antech, Inc. and subsidiaries, have been prepared in accordance with generally accepted accounting principles 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 footnotes required by generally accepted accounting principles in the United States for annual financial statements as permitted under applicable rules and regulations. In the opinion of our 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, 2006 are not necessarily indicative of the results to be expected for the full year. For further information, refer to our consolidated financial statements and footnotes thereto included in our 2005 annual report on Form 10-K.

2. Acquisitions

          During the three months ended March 31, 2006, we acquired eight animal hospitals, one of which was merged into an existing animal hospital operated by us. The following table summarizes the aggregate consideration, including acquisition costs, paid by us for those animal hospitals acquired during the three months ended March 31, 2006 and the allocation of the purchase price (in thousands):

Consideration:
Cash		$	14,934
Notes payable and other liabilities assumed			4,244
Total		$	19,178
Purchase Price Allocation:
Goodwill (1)		$	16,234
Identifiable intangible assets			800
Tangible assets			2,144
Total		$	19,178

     Other Acquisition Payments

          We paid $930,000 to sellers for the unused portion of holdbacks during the three months ended March 31, 2006.

3. Goodwill and Other Intangible Assets

          Goodwill represents the excess of the cost of an acquired entity over the net of the amounts assigned to 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, 2006 (in thousands):

						Animal				Medical
		Laboratory				Hospital				Equipment				Total
Balance as of December 31, 2005		$	94,246			$	473,038			$	19,160			$	586,444
Goodwill acquired			—				16,234				—				16,234
Other (1)			—				534				—				534
Goodwill related to sale of animal hospital			—				(21	)			—				(21	)
Balance as of March 31, 2006		$	94,246			$	489,785			$	19,160			$	603,191

          In addition to goodwill, we have amortizable intangible assets at March 31, 2006 and December 31, 2005 as follows (in thousands):

		As of March 31, 2006												As of December 31, 2005
		Gross								Net				Gross								Net
		Carrying				Accumulated				Carrying				Carrying				Accumulated				Carrying
		Amount				Amortization				Amount				Amount				Amortization				Amount
Covenants not-to-compete		$	11,573			$	(5,164	)		$	6,409			$	11,145			$	(4,970	)		$	6,175
Non-contractual customer relationships			3,368				(982	)			2,386				3,235				(701	)			2,534
Technology			1,270				(377	)			893				1,270				(314	)			956
Trademarks			569				(85	)			484				569				(70	)			499
Contracts			397				(155	)			242				397				(129	)			268
Client lists			465				(205	)			260				461				(158	)			303
Total		$	17,642			$	(6,968	)		$	10,674			$	17,077			$	(6,342	)		$	10,735

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

		Three Months Ended
		March 31,
		2006				2005
Aggregate amortization expense		$	860			$	804

          The estimated amortization expense related to intangible assets for each of the five succeeding years and thereafter as of March 31, 2006 is as follows (in thousands):

Remainder of 2006		$	2,449
2007			2,972
2008			2,341
2009			1,298
2010			563
Thereafter			1,051
Total		$	10,674

4. Share-Based Compensation Plans

     Stock Incentive Plans

          We have two existing stock incentive plans, the Amended and Restated 1996 Plan and the 2001 Stock Incentive Plan, or the Existing Plans. As of March 31, 2006, there were 5,896,724 shares subject to outstanding options granted under the Existing Plans, or Prior Outstanding Options, and there were an additional 383,000 shares that were available for grant under the Existing Plans but which were not the subject of outstanding options or other awards, or Available Shares. On March 7, 2006, our Board of Directors adopted our 2006 Equity Incentive Plan and amended and restated the Existing Plans to provide that if the 2006 Equity Incentive Plan is approved by our shareholders, no additional awards may be granted under the Existing Plans. No awards may be granted under the 2006 Equity Incentive Plan unless it is approved by our shareholders. The maximum aggregate number of shares of common stock that may be issued under the 2006 Equity Incentive Plan to our employees, directors and consultants and those of our affiliates is (a) 6,000,000 newly authorized shares of common stock; plus (b) the 383,000 Available Shares under the Existing Plans; and (c) any shares of common stock underlying Prior Outstanding Options that expire, are forfeited, cancelled or terminate for any reason without having been exercised in full.

          Options granted under the Existing Plans vest over periods that range from immediate to four years, with the majority vesting over periods from three to four years, and the majority expiring seven or ten years from the date of grant. Those options that vested immediately were issued in 2005 and include restrictions on the sale of the shares underlying the options.

     Adoption of SFAS No. 123R

          Prior to January 1, 2006, we accounted for our share-based payments under the intrinsic value method as prescribed in Accounting Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees. Under that method, when options are granted with a strike price equal to or greater than market price on date of issuance, there is no impact on earnings either on the date of grant or thereafter, absent modification to the options. Accordingly, we recognized no share-based compensation expense in periods prior to January 1, 2006.

          Effective January 1, 2006, we adopted Statement of Financial Accounting Standards, or SFAS, No. 123R, Share-Based Payment. SFAS No. 123R requires us to measure the cost of share-based payments to employees, including stock options, based on the grant date fair value and to recognize the cost over the requisite service period, which is typically the vesting period. We adopted SFAS No. 123R using the modified prospective transition method, which requires us to recognize compensation expense for share-based payments granted or modified on or after January 1, 2006. Additionally, we are required to recognize compensation expense for the fair value of unvested share-based awards at January 1, 2006 over the remaining requisite service period. Operating results from prior periods have not been restated.

          In accordance with SFAS No. 123R, we recognized share-based employee compensation of $776,000 and a related tax benefit of $285,000 during the three months ended March 31, 2006. The effect of adopting SFAS No. 123R on our condensed, consolidated financial statements for the three months ended March 31, 2006 is as follows (in thousands, except per share amounts):

		Three Months
		Ended
		March 31, 2006
Share-based employee compensation:
Laboratory direct cost		$	160
Laboratory selling, general and administrative expense			128
Animal hospital selling, general and administrative expense			215
Corporate selling, general and administrative expense			273
			776
Tax benefit			(285	)
Net decrease in net income		$	491
Effect on:
Basic earnings per common share		$	(0.01	)
Diluted earnings per common share		$	(0.01	)
Effect on:
Cash flows from operating activities		$	(1,277	)
Cash flows from financing activities		$	1,277

          No share-based employee compensation was recognized during the three months ended March 31, 2005, however, the following table presents net income and earnings per common share as if we had recognized share-based employee compensation (in thousands, except per share amounts):

		Three Months
		Ended
		March 31, 2005
Net income, as reported		$	17,246
Deduct: Total share-based employee compensation determined under fair-value based method for all awards, net of tax			(2,303	)
Pro forma net income		$	14,943
Earnings per common share:
Basic — as reported		$	0.21
Basic — Pro forma		$	0.18
Diluted — as reported		$	0.21
Diluted — Pro forma		$	0.18

          Prior to the adoption of SFAS No. 123R, we presented all tax benefits resulting from the exercise of stock options as cash provided by operating activities on our condensed, consolidated statements of cash flows. SFAS No. 123R requires the cash flows resulting from the tax benefits in excess of the compensation expense recorded for those options to be classified as cash provided by financing activities. As such, the $1.3 million excess tax benefit classified as a financing activity on our condensed, consolidated statement of cash flows for the three months ended March 31, 2006 would have been recognized as an operating activity if we had not adopted SFAS No. 123R.

     Calculation of Fair Value

          The fair value of our options is estimated on the date of grant using the Black-Scholes option-pricing model. We amortize the fair value of our options on a straight-line basis over the requisite service period. The following assumptions were used to determine the fair value of those options granted during the three months ended March 31, 2005:

Risk-free interest rate (1)			4.1	%
Dividend yield			0.0	%
Expected volatility (2)			39.5	%
Weighted-average fair value		$	7.98
Expected term (3)		5 years

          No options were granted during the three months ended March 31, 2006.

          We use historical data to estimate pre-vesting option forfeitures. We recognize share-based employee compensation only for those awards that we expect to vest.

     Stock Option Activity

          A summary of our stock option activity for all share-based compensation plans during the three months ended March 31, 2006 is as follows (in thousands, except weighted average exercise price and weighted average remaining contractual term):

										Weighted
										Average
						Weighted				Remaining
						Average				Contractual				Aggregate
						Exercise				Term				Intrinsic
		Shares				Price				(Years)				Value
Options outstanding at January 1, 2006			6,090			$	14.58
Granted			—				—
Exercised			(183	)			6.67
Canceled			(10	)			3.23
Options outstanding at March 31, 2006			5,897			$	14.85				5.8			$	80,392
Options exercisable at March 31, 2006			4,575			$	15.07				5.9			$	61,345

          The total intrinsic value of options exercised during the three months ended March 31, 2006 was $4.0 million.

          At March 31, 2006, there was $4.6 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under our stock incentive plans. This cost is expected to be recognized over a weighted-average period of 2.0 years.

5. Long-Term Obligations

          During the three months ended March 31, 2006, we prepaid $40.0 million of our senior term notes.

6. Income Taxes

          In prior periods we recognized liabilities for differences between the probable tax bases and the as-filed tax bases of certain assets and liabilities. These amounts were recorded in other liabilities in our condensed, consolidated balance sheets and at December 31, 2005 totaled $6.8 million. During the three months ended March 31, 2006, we determined that these differences were no longer probable due to a favorable outcome of an income tax audit and recognized a tax benefit of $6.8 million.

7. Calculation of Earnings per Common Share

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

		Three Months Ended
		March 31,
		2006				2005
Net income		$	29,659			$	17,246
Weighted average common shares outstanding:
Basic			82,813				82,220
Effect of dilutive potential common shares:
Stock options			1,770				1,291
Diluted			84,583				83,511
Basic earnings per common share		$	0.36			$	0.21
Diluted earnings per common share		$	0.35			$	0.21

8. Lines of Business

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

          The accounting policies of our segments are the same as those described in the summary of significant accounting policies included in our 2005 annual report on Form 10-K. We evaluate the performance of our segments based on gross profit. For purposes of reviewing the operating performance of the segments, all intercompany sales and purchases are accounted for as if they were transactions with independent third parties at current market prices.

          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 March 31, 2006
External revenue		$	56,126			$	170,523			$	7,531			$	—			$	—			$	234,180
Intersegment revenue			5,411				—				461				—				(5,872	)			—
Total revenue			61,537				170,523				7,992				—				(5,872	)			234,180
Direct costs			32,987				137,926				5,490				—				(5,744	)			170,659
Gross profit			28,550				32,597				2,502				—				(128	)			63,521
Selling, general and administrative expense			4,094				4,823				2,651				7,317				—				18,885
Loss (gain) on sale of assets			10				(128	)			—				—				—				(118	)
Operating income (loss)		$	24,446			$	27,902			$	(149	)		$	(7,317	)		$	(128	)		$	44,754
Depreciation and amortization		$	1,072			$	3,528			$	401			$	452			$	(31	)		$	5,422
Capital expenditures		$	770			$	6,730			$	47			$	440			$	(127	)		$	7,860
Three Months Ended March 31, 2005
External revenue		$	49,310			$	133,354			$	4,199			$	—			$	—			$	186,863
Intersegment revenue			4,129				—				285				—				(4,414	)			—
Total revenue			53,439				133,354				4,484				—				(4,414	)			186,863
Direct costs			29,570				107,619				3,445				—				(4,298	)			136,336
Gross profit			23,869				25,735				1,039				—				(116	)			50,527
Selling, general and administrative expense			3,365				3,703				1,567				5,497				—				14,132
Gain on sale of assets			—				(10	)			—				—				—				(10	)
Operating income (loss)		$	20,504			$	22,042			$	(528	)		$	(5,497	)		$	(116	)		$	36,405
Depreciation and amortization		$	902			$	2,744			$	299			$	397			$	—			$	4,342
Capital expenditures		$	1,681			$	3,881			$	120			$	1,832			$	(305	)		$	7,209
At March 31, 2006
Total assets		$	156,156			$	637,706			$	44,903			$	51,036			$	(2,883	)		$	886,918
At December 31, 2005
Total assets		$	146,902			$	614,492			$	47,114			$	90,977			$	(2,412	)		$	897,073

9. Commitments and Contingencies

          We have certain commitments, including operating leases and supply purchase agreements, incidental to the ordinary course of our business. These items are discussed in detail in our consolidated financial statements and notes thereto included in our 2005 annual report on Form 10-K. We also have contingencies, which are discussed below.

     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, we will be obligated to make cash payments of $162,500 in 2006.

     b. Officers’ Compensation

          Each of our Chief Executive Officer, Chief Operating Officer and Chief Financial Officer has entered into employment agreements 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, unless any of those agreements are sooner terminated pursuant to their respective provisions, the Chief Executive Officer has five years remaining under the term of his employment agreement, the Chief Operating Officer has three years remaining under the term of his employment agreement, and the Chief Financial Officer has two years remaining under the term of his employment agreement. In addition, these employment agreements provide for certain payments in the event an officer’s employment with our company 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, 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 amounts, 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, in which case all of these employment agreements would terminate simultaneously, collective cash payments would be made to these 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 excess parachute payments.

          Our Senior Vice President of Development’s employment agreement expired September 2004 and his employment with us continues at-will. Pursuant to a letter agreement between our Senior Vice President and our company, in the event our Senior Vice President’s employment is terminated for any reason other than cause, that officer 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. Our Senior Vice President’s base salary and annual bonus is 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. 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.

10. Reclassifications

          Certain prior year balances have been reclassified to conform to the 2006 financial statement presentation.

11. Subsequent Events

          From April 1, 2006 through May 8, 2006, we acquired four animal hospitals and one laboratory, which was merged into an existing laboratory, for an aggregate consideration of $12.5 million, consisting of $12.1 million in cash and the assumption of liabilities of $375,000.

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

		Page
		Number
Introduction		13
Executive Overview		13
Results of Operations		14
Liquidity and Capital Resources		20
Critical Accounting Policies		22
Recent Accounting Pronouncements		24
Forward-Looking Statements		25

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 8, 2006, and we undertake no duty to update this information. Shareholders and prospective investors can find information filed with the SEC after May 8, 2006 at our website at www.investor.vcaantech.com or at the SEC’s website at www.sec.gov.

          We are a leading animal healthcare services company operating in the United States. We provide veterinary services and diagnostic testing to support veterinary care and we sell diagnostic imaging equipment and other medical technology products and related services to veterinarians. We have four reportable segments:

          Laboratory. We operate 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, 2006, our laboratory network consisted of 31 laboratories serving all 50 states.

          Animal hospitals. We operate 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 products and perform a variety of pet wellness programs, including health examinations, diagnostic testing, routine vaccinations, spaying, neutering and dental care. At March 31, 2006, our animal hospital network consisted of 373 animal hospitals in 37 states.

          Medical technology. We sell ultrasound and digital radiography imaging equipment, related computer hardware, software and ancillary services.

          Corporate. We provide selling, general and administrative support for our other segments.

          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, ticks and the number of daylight hours.

Executive Overview

          We experienced strong operating results for the first quarter of 2006. Our revenue increased 25.3% compared to the same period in the prior year to $234.2 million and our consolidated gross profit margin increased to 27.1% compared to 27.0% in the first quarter of 2005. Our consolidated operating margin was 19.1% compared to 19.5% in the comparable prior year quarter. As expected, our consolidated margins were impacted by the 27.9% increase in animal hospital revenue, which have lower margins than our laboratory segment. The significant increase in animal hospital revenue is attributed to recent acquisitions, including Pet’s Choice, Inc., or Pet’s Choice, on July 1, 2005 and same-store growth. Our consolidated margins were also impacted by the adoption of Statement of Financial Accounting Standards, or SFAS, No. 123R, Share-Based Payment, on January 1, 2006, which resulted in a non-cash compensation charge of $776,000.

     Acquisitions and Facilities

          Our growth strategy includes the acquisition of 20 to 25 independent animal hospitals per year with aggregate annual revenues of approximately $30.0 million to $35.0 million. In addition, we also evaluate the acquisition of animal hospital chains, laboratories or related businesses if favorable opportunities are presented. In accordance with our strategy, we acquired eight independent animal hospitals during the three months ended March 31, 2006.

          Our laboratory network consisted of 31 laboratories at March 31, 2006 and December 31, 2005. The following table summarizes our animal hospital facilities growth and animal hospital closures during the three months ended March 31, 2006:

Animal hospitals:
Facilities at December 31, 2005			367
Acquisitions			8
Acquisitions relocated into hospitals operated by us			(1	)
Sold or closed			(1	)
Facilities at March 31, 2006			373

Results of Operations

          The following is a summary of the operating results for each of our segments (in thousands):

																		Inter-
						Animal				Medical								company
		Laboratory				Hospital				Technology				Corporate				Eliminations				Total
Three Months Ended March 31, 2006
Revenue		$	61,537			$	170,523			$	7,992			$	—			$	(5,872	)		$	234,180
Direct costs			32,987				137,926				5,490				—				(5,744	)			170,659
Gross profit			28,550				32,597				2,502				—				(128	)			63,521
Selling, general and administrative expense			4,094				4,823				2,651				7,317				—				18,885
Loss (gain) on sale of assets			10				(128	)			—				—				—				(118	)
Operating income (loss)		$	24,446			$	27,902			$	(149	)		$	(7,317	)		$	(128	)		$	44,754
Depreciation and amortization		$	1,072			$	3,528			$	401			$	452			$	(31	)		$	5,422
Three Months Ended March 31, 2005
Revenue		$	53,439			$	133,354			$	4,484			$	—			$	(4,414	)		$	186,863
Direct costs			29,570				107,619				3,445				—				(4,298	)			136,336
Gross profit			23,869				25,735				1,039				—				(116	)			50,527
Selling, general and administrative expense			3,365				3,703				1,567				5,497				—				14,132
Gain on sale of assets			—				(10	)			—				—				—				(10	)
Operating income (loss)		$	20,504			$	22,042			$	(528	)		$	(5,497	)		$	(116	)		$	36,405
Depreciation and amortization		$	902			$	2,744			$	299			$	397			$	—			$	4,342

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

		Three Months Ended
		March 31,
		2006				2005
Revenue:
Laboratory			26.3	%			28.6	%
Animal hospital			72.8				71.4
Medical technology			3.4				2.4
Intercompany			(2.5	)			(2.4	)
Total revenue			100.0				100.0
Direct costs			72.9				73.0
Gross profit			27.1				27.0
Selling, general and administrative expense			8.0				7.5
Operating income			19.1				19.5
Interest expense, net			2.7				3.6
Minority interest in income of subsidiairies			0.3				0.4
Income before provision for income taxes			16.1				15.5
Provision for income taxes			3.4				6.3
Net income			12.7	%			9.2	%

Revenue

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

		Three Months Ended March 31,
						% of								% of
		2006				Total				2005				Total				% Change
Laboratory		$	61,537				26.3	%		$	53,439				28.6	%			15.2	%
Animal hospital			170,523				72.8	%			133,354				71.4	%			27.9	%
Medical technology			7,992				3.4	%			4,484				2.4	%			78.2	%
Intercompany			(5,872	)			(2.5	)%			(4,414	)			(2.4	)%			33.0	%
Total revenue		$	234,180				100.0	%		$	186,863				100.0	%			25.3	%

     Laboratory Revenue

          Laboratory revenue increased $8.1 million for the three months ended March 31, 2006 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,
		2006				2005				% Change
Laboratory Revenue:
Number of requisitions			2,624				2,263				16.0	%
Average revenue per requisition (1)		$	23.45			$	23.61				(0.7	)%
Total		$	61,537			$	53,439				15.2	%

          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.

15

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.

          The change in the average revenue per requisition is attributable to changes in the mix, type and number of tests performed per requisition and price increases. The price increases for most tests ranged from 3% to 5% in both February 2006 and February 2005.

     Animal Hospital Revenue

          Animal hospital revenue increased $37.2 million for the three months ended March 31, 2006 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,
		2006				2005				% Change
Animal Hospital Revenue:
Same-store facilities:
Orders (1)			1,057				1,087				(2.8	)%
Average revenue per order (2)		$	129.45			$	119.63				8.2	%
Same-store revenue (1)		$	136,939			$	129,994				5.3	%
Business day adjustment (3)			1,667				—
Net acquired revenue (4)			31,917				3,360
Total		$	170,523			$	133,354				27.9	%

          Over the last few years, some pet-related products, including prescription medications, traditionally sold at animal hospitals have become more widely available in retail stores and other distribution channels, and, as a result, we have fewer customers coming to our animal hospitals solely to purchase those items. 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. Our business strategy continues to place a greater emphasis on comprehensive wellness visits and advanced medical procedures, which typically generate higher-priced orders. These trends have resulted in a decrease in the number of orders and an increase in the average revenue per order.

          Price increases, which approximated 5% to 6% on services at most hospitals in February 2006 and February 2005, 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.

     Medical Technology Revenue

          Medical technology revenue was $8.0 million and $4.5 million for the three months ended March 31, 2006 and 2005, respectively. The increase in medical technology revenue was attributed to sales of our digital radiography imaging equipment, which was first introduced by our medical technology segment in 2004. Also contributing to the increase in medical technology revenue was that effective July 1, 2005, we began recognizing revenue on sales of our digital radiography imaging equipment, computer hardware and software at the time of customer acceptance if installation is required, or delivery, as discussed under Critical Accounting Policies. Prior to July 1, 2005, we recognized all elements in sales of our digital radiography imaging equipment over the period of the post-contract customer support services, which was generally one year.

          At March 31, 2006, we had deferred revenue of $8.8 million, $7.5 million of which related to sales of our digital radiography imaging equipment.

     Intercompany Revenue

          For the three months ended March 31, 2006 and 2005, $5.4 million and $4.1 million of our laboratory revenue was intercompany revenue that was generated by providing laboratory services to our animal hospitals. For the three months ended March 31, 2006 and 2005, $461,000 and $285,000 of our medical technology revenue was intercompany revenue that was generated by providing products and services to our animal hospitals. For purposes of reviewing the operating performance of our business segments, all intercompany transactions are accounted for as if they were conducted with an independent third party at current market prices. For financial reporting purposes, intercompany transactions are eliminated as part of our consolidation.

     Gross Profit

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

		Three Months Ended March 31,
		2006								2005
						Gross								Gross
						Profit								Profit				%
		$				Margin				$				Margin				Change
Laboratory		$	28,550				46.4	%		$	23,869				44.7	%			19.6	%
Animal hospital			32,597				19.1	%			25,735				19.3	%			26.7	%
Medical technology			2,502				31.3	%			1,039				23.2	%			140.8	%
Intercompany			(128	)							(116	)
Total gross profit		$	63,521				27.1	%		$	50,527				27.0	%			25.7	%

     Laboratory Gross Profit

          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, facilities rent, occupancy costs, depreciation and amortization and supply costs.

          The increase in laboratory gross profit margin was primarily attributed to increases in laboratory revenue combined with operating leverage associated with our laboratory business. Our operating leverage comes from the incremental margins we realize on additional tests ordered by the same client, as well as when more comprehensive tests are ordered. We are able to benefit from these incremental margins due to the relative fixed cost nature of our laboratory business.

     Animal Hospital Gross Profit

          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 expense, and costs of goods sold associated with the retail sales of pet food and pet supplies.

          Over the last several years we have acquired a significant number of animal hospitals, including 46 in connection with the acquisition of Pet’s Choice on July 1, 2005. Many of these newly acquired animal hospitals had lower gross profit margins at the time of acquisition than those previously operated by us. These lower gross profit margins were offset by improvements in animal hospital revenue, increased operating leverage and the favorable impact of our integration efforts.

     Medical Technology Gross Profit

          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.

          The increase in medical technology gross profit margins was primarily the result of a change in the mix of products and services sold.

          At March 31, 2006, we had deferred revenue and costs of $8.8 million and $3.9 million, respectively. Included in these amounts at March 31, 2006 was $7.5 million of deferred revenue and $3.9 million of deferred costs related to sales of our digital radiography imaging equipment.

     Selling, General and Administrative Expense

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

		Three Months Ended March 31,
		2006								2005
						% of								% of				%
		$				Revenue				$				Revenue				Change
Laboratory		$	4,094				6.7	%		$	3,365				6.3	%			21.7	%
Animal hospital			4,823				2.8	%			3,703				2.8	%			30.2	%
Medical technology			2,651				33.2	%			1,567				34.9	%			69.2	%
Corporate			7,317				3.1	%			5,497				2.9	%			33.1	%
Total SG&A		$	18,885				8.1	%		$	14,132				7.6	%			33.6	%

     Laboratory SG&A

          Laboratory SG&A consists primarily of salaries of sales, customer support, administrative and accounting personnel, selling, marketing and promotional expense.

          The increase in laboratory SG&A was primarily attributed to increasing our sales force and marketing efforts, recognizing share-based compensation as a result of adopting SFAS No. 123R on January 1, 2006 and commission payments as a result of an increase in revenue.

     Animal Hospital SG&A

          Animal hospital SG&A consists primarily of salaries of field management, certain administrative and accounting personnel, recruiting and certain marketing expense.

          The increase in animal hospital SG&A was primarily attributed to expanding the animal hospital administrative operations to absorb the recent acquisitions, including Pet’s Choice, and recognizing share-based compensation as a result of adopting SFAS No. 123R on January 1, 2006.

     Medical Technology SG&A

          Medical technology SG&A consists primarily of salaries of sales, customer support, administrative and accounting personnel, selling, marketing and promotional expense and research and development costs.

          The increase in Medical Technology SG&A was primarily attributed to increasing our sales force and administrative support, and commission payments as a result of an increase in revenue.

     Corporate SG&A

          Corporate SG&A consists of administrative expense at our headquarters, including the salaries of corporate officers, administrative and accounting personnel, rent, accounting, finance, legal and other professional expense, occupancy costs and corporate depreciation.

          The increase in Corporate SG&A was primarily attributed to expanding the corporate operations to absorb the recent acquisitions, including Pet’s Choice, and recognizing share-based compensation as a result of adopting SFAS No. 123R on January 1, 2006.

Interest Expense, Net

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

		Three Months Ended
		March 31,
		2006				2005
Interest expense:
Senior term notes		$	6,414			$	2,420
9.875% senior subordinated notes			—				4,197
Interest rate hedging agreements			(201	)			(94	)
Capital leases and other			413				209
Amortization of debt costs			132				209
			6,758				6,941
Interest income			446				274
Total interest expense, net of interest income		$	6,312			$	6,667

          The change in interest expense was primarily attributed to our debt refinancing transactions, which we discuss in the Liquidity and Capital Resources section of our 2005 annual report on Form 10-K, and changes in LIBOR.

Provision for Income Taxes

          Our effective tax rate was 21.4% and 40.5% for the three months ended March 31, 2006 and 2005, respectively. The effective tax rate for the three months ended March 31, 2006 includes a tax benefit in the amount of $6.8 million, or 18.0% of income before provision for income taxes, due to a favorable outcome of an income tax audit that resulted in a change to our estimated tax liabilities. The effective tax rate for the three months ended March 31, 2006 also reflects a lower weighted-average state statutory tax rate when compared to the comparable prior year quarter due to a favorable shift in the number of facilities that we operated in states with lower tax rates or no state income tax. We estimate that our effective tax rate for the remaining quarters of 2006 will approximate 39.4%.

Liquidity and Capital Resources

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

		Three Months Ended
		March 31,
		2006				2005
Cash provided by (used in):
Operating activities		$	37,752			$	35,368
Investing activities			(25,140	)			(21,583	)
Financing activities			(38,920	)			(3,223	)
Increase (decrease) in cash and cash equivalents			(26,308	)			10,562
Cash and cash equivalents at beginning of year			58,488				30,964
Cash and cash equivalents at end of period		$	32,180			$	41,526

     Cash Flows from Operating Activities

          Net cash provided by operating activities increased $2.4 million in the three months ended March 31, 2006 as compared to the same period in the prior year primarily due to improved operating performance and acquisitions. These factors contributing to an increase in operating cash flows were partially offset by an increase in interest paid of $4.2 million and a use of working capital.

          On a prospective basis, we anticipate cash flow from operating activities to continue growing in line with increases in operating income resulting from improved operating performance and acquisitions. However, we also anticipate that operating cash flow may be negatively impacted by an increase in cash paid for interest as a result of possible future increases in interest rates. Significant increases in interest rates may materially impact our operating cash flows because of the variable-rate nature of our senior term notes.

     Cash Flows used in Investing Activities

          Net cash used in investing activities primarily consisted of cash used for the acquisition of animal hospitals and expenditures for property and equipment.

          Depending upon the attractiveness of the candidates and the strategic fit with our existing operations, we intend to acquire approximately 20 to 25 independent animal hospitals per year with aggregate annual revenues of approximately $30.0 million to $35.0 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, we acquired Pet’s Choice, which operated 46 animal hospitals, on July 1, 2005. In addition, we acquired Sound Technologies, Inc., a supplier of ultrasound and digital imaging radiography equipment and related computer hardware, software and services to the veterinary industry, on October 1, 2004, and we acquired National PetCare Centers, Inc., which operated 67 animal hospitals, on June 1, 2004. We intend to primarily use cash in our acquisitions but, depending on the timing and amount of our acquisitions, we may use stock or debt. For the remainder of 2006, we also intend to spend approximately $32.0 to $37.0 million for property and equipment.

     Cash Flows from Financing Activities

          Net cash used in financing activities primarily consisted of cash used to repay our long-term obligations, including $40.0 million to prepay a portion of our senior term notes during the three months ended March 31, 2006.

Future Cash Requirements

          The following table sets forth the scheduled principal, interest and other contractual cash obligations due by us for each of the years indicated (in thousands):

		Total				2006 (1)				2007				2008				2009				2010				Thereafter
Long-term debt		$	398,721			$	3,563			$	5,580			$	4,384			$	4,082			$	4,083			$	377,029
Capital lease obligations			15,992				766				1,040				1,070				1,144				1,283				10,689
Operating leases			512,723				22,623				29,409				29,060				28,422				28,017				375,192
Fixed cash interest expense			7,635				1,069				1,257				1,329				1,069				767				2,144
Variable cash interest expense(2)			150,917				21,207				28,939				29,030				29,688				30,327				11,726
Swap agreements (2)			(5,067	)			(1,879	)			(2,365	)			(823	)			—				—				—
Purchase obligations			51,581				10,859				7,651				8,383				8,942				9,744				6,002
Other long-term liabilities (3)			42,418				—				65				65				65				—				42,223
Earn-out payments (4)			163				163				—				—				—				—				—
		$	1,175,083			$	58,371			$	71,576			$	72,498			$	73,412			$	74,221			$	825,005