VCA Inc.
VCA ANTECH INC (Form: 10-Q, Received: 11/08/2006 16:19:23)
Table of Contents

 
 
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, 2006
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 001-16783
 
VCA ANTECH, INC.
(Exact name of registrant as specified in its charter)
     
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 83,498,763 shares as of November 3, 2006.

 


Table of Contents

VCA ANTECH, INC.
FORM 10-Q
SEPTEMBER 30, 2006
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  EXHIBIT 31.1
  EXHIBIT 31.2
  EXHIBIT 32.1

 


Table of Contents

PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VCA ANTECH, INC. AND SUBSIDIARIES
CONDENSED, CONSOLIDATED BALANCE SHEETS
As of September 30, 2006 and December 31, 2005
(Unaudited)
(In thousands, except par value)
                 
    September 30,     December 31,  
    2006     2005  
ASSETS
               
 
               
Current assets:
               
Cash and cash equivalents
  $ 32,821     $ 58,488  
Trade accounts receivable, less allowance for uncollectible accounts of $11,100 and $9,409 at September 30, 2006 and December 31, 2005, respectively
    41,091       36,104  
Inventory
    20,483       17,856  
Prepaid expenses and other
    12,315       9,867  
Deferred income taxes
    11,850       10,972  
Prepaid income taxes
    18,235       12,337  
 
           
Total current assets
    136,795       145,624  
Property and equipment, less accumulated depreciation and amortization of $106,551 and $93,305 at September 30, 2006 and December 31, 2005, respectively
    159,287       143,781  
Other assets:
               
Goodwill
    615,784       586,444  
Other intangible assets, net
    15,006       10,735  
Deferred financing costs, net
    1,041       1,340  
Other
    10,459       9,149  
 
           
Total assets
  $ 938,372     $ 897,073  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
 
               
Current liabilities:
               
Current portion of long-term obligations
  $ 6,620     $ 5,884  
Accounts payable
    18,021       20,718  
Accrued payroll and related liabilities
    28,203       30,131  
Accrued interest
    314       306  
Other accrued liabilities
    28,778       23,930  
 
           
Total current liabilities
    81,936       80,969  
Long-term obligations, less current portion
    385,403       446,828  
Deferred income taxes
    38,267       30,803  
Other liabilities
    13,975       19,775  
Minority interest
    10,181       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, 83,460 and 82,759 shares outstanding as of September 30, 2006 and December 31, 2005, respectively
    83       83  
Additional paid-in capital
    272,603       258,402  
Retained earnings
    135,246       49,057  
Accumulated other comprehensive income
    678       1,209  
 
           
Total stockholders’ equity
    408,610       308,751  
 
           
Total liabilities and stockholders’ equity
  $ 938,372     $ 897,073  
 
           
The accompanying notes are an integral part of these condensed, consolidated financial statements.

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VCA ANTECH, INC. AND SUBSIDIARIES
CONDENSED, CONSOLIDATED INCOME STATEMENTS
For the Three and Nine Months Ended September 30, 2006 and 2005
(Unaudited)
(In thousands, except per share amounts)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2006     2005     2006     2005  
Revenue
  $ 251,632     $ 229,242     $ 740,962     $ 622,689  
Direct costs
    181,167       166,598       532,014       448,783  
 
                       
Gross profit
    70,465       62,644       208,948       173,906  
Selling, general and administrative expense
    18,946       18,394       57,315       47,943  
Loss (gain) on sale of assets
    3       115       (200 )     27  
 
                       
Operating income
    51,516       44,135       151,833       125,936  
Interest expense, net
    6,084       6,034       18,323       18,782  
Debt retirement costs
                      19,282  
Other expense (income)
    73       (130 )     (24 )     1  
Minority interest in income of subsidiaries
    846       778       2,520       2,309  
 
                       
Income before provision for income taxes
    44,513       37,453       131,014       85,562  
Provision for income taxes
    17,536       15,196       44,825       34,797  
 
                       
Net income
  $ 26,977     $ 22,257     $ 86,189     $ 50,765  
 
                       
 
                               
Basic earnings per common share
  $ 0.32     $ 0.27     $ 1.04     $ 0.62  
 
                       
Diluted earnings per common share
  $ 0.32     $ 0.26     $ 1.02     $ 0.61  
 
                       
 
                               
Shares used for computing basic earnings per share
    83,339       82,526       83,092       82,364  
 
                       
Shares used for computing diluted earnings per share
    85,187       84,019       84,864       83,818  
 
                       
The accompanying notes are an integral part of these condensed, consolidated financial statements.

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VCA ANTECH, INC. AND SUBSIDIARIES
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2006 and 2005
(Unaudited)
(In thousands)
                 
    Nine Months Ended  
    September 30,  
    2006     2005  
Cash flows from operating activities:
               
Net income
  $ 86,189     $ 50,765  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    16,347       13,947  
Amortization of debt costs
    299       482  
Provision for uncollectible accounts
    4,174       2,996  
Debt retirement costs
          19,282  
Loss (gain) on sale of assets
    (200 )     27  
Share-based compensation
    2,326        
Minority interest in income of subsidiaries
    2,520       2,309  
Distributions to minority interest partners
    (2,439 )     (1,968 )
Deferred income taxes
    7,222       4,029  
Excess tax benefit from exercise of stock options
    (5,774 )      
Other
    (750 )     (337 )
Changes in operating assets and liabilities:
               
Increase in accounts receivable
    (8,500 )     (7,009 )
Increase in inventory, prepaid expenses and other assets
    (6,816 )     (5,796 )
Increase (decrease) in accounts payable and other accrued liabilities
    (2,507 )     4,439  
Decrease in accrued payroll and related liabilities
    (1,928 )     (3,862 )
Increase (decrease) in accrued interest
    8       (1,251 )
Decrease in prepaid income taxes
    567       13,161  
 
           
Net cash provided by operating activities
    90,738       91,214  
 
           
Cash flows from investing activities:
               
Business acquisitions, net of cash acquired
    (37,612 )     (83,702 )
Real estate acquired in connection with business acquisitions
    (2,872 )     (2,929 )
Property and equipment additions
    (23,800 )     (22,725 )
Proceeds from sale of assets
    533       368  
Other
    268       3,540  
 
           
Net cash used in investing activities
    (63,483 )     (105,448 )
 
           
Cash flows from financing activities:
               
Repayment of long-term obligations
    (64,106 )     (445,721 )
Proceeds from the issuance of long-term obligations
          475,000  
Payment of financing costs
          (3,257 )
Proceeds from issuance of common stock under stock option plans
    5,410       1,749  
Excess tax benefit from exercise of stock options
    5,774        
 
           
Net cash provided by (used in) financing activities
    (52,922 )     27,771  
 
           
Increase (decrease) in cash and cash equivalents
    (25,667 )     13,537  
Cash and cash equivalents at beginning of period
    58,488       30,964  
 
           
Cash and cash equivalents at end of period
  $ 32,821     $ 44,501  
 
           
The accompanying notes are an integral part of these condensed, consolidated financial statements.

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VCA ANTECH, INC. AND SUBSIDIARIES
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
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 notes 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 and nine months ended September 30, 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 notes thereto included in our 2005 annual report on Form 10-K.
     The preparation of our condensed, consolidated financial statements in accordance with generally accepted accounting principles in the United States requires our 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.
2. Acquisitions
     During the nine months ended September 30, 2006, we acquired 17 animal hospitals, four of which were merged into existing animal hospitals, two laboratories, one of which was merged into an existing laboratory, and a lab-related business that we will utilize in our laboratory operations. The following table summarizes the aggregate consideration, including acquisition costs, paid by us for those acquisitions that occurred during the nine months ended September 30, 2006 and the allocation of the purchase price (in thousands):
         
Consideration:
       
Cash
  $ 35,812  
Notes payable and other liabilities assumed
    4,844  
 
     
Total
  $ 40,656  
 
     
 
       
Purchase Price Allocation:
       
Tangible assets
  $ 4,371  
Identifiable intangible assets (1)
    6,932  
Goodwill (2)
    29,353  
 
     
Total
  $ 40,656  
 
     
 
(1)   The acquired identifiable intangible assets have a weighted-average useful life of approximately 19 years and are comprised of non-contractual customer relationships of $4.9 million (25-year weighted-average useful life), covenants not-to-compete of $2.0 million (five-year weighted-average useful life) and client lists of $14,000 (three-year weighted-average useful life).
 
(2)   We expect that $25.6 million of the goodwill recorded for these acquisitions will be fully deductible for income tax purposes.
   Other Acquisition Payments
     In connection with certain acquisitions, we withheld a portion of the purchase price, or the holdback, as security for indemnification obligations of the sellers under the acquisition agreement. We paid $1.7 million to sellers for the unused portion of holdbacks during the nine months ended September 30, 2006.

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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 nine months ended September 30, 2006 (in thousands):
                                 
            Animal     Medical        
    Laboratory     Hospital     Technology     Total  
Balance as of December 31, 2005
  $ 94,246     $ 473,038     $ 19,160     $ 586,444  
Goodwill acquired
    877       28,476             29,353  
Other (1)
          8             8  
Goodwill related to sale of animal hospitals
          (21 )           (21 )
 
                       
Balance as of September 30, 2006
  $ 95,123     $ 501,501     $ 19,160     $ 615,784  
 
                       
 
(1)   Comprised of purchase price adjustments.
     In addition to goodwill, we have amortizable intangible assets at September 30, 2006 and December 31, 2005 as follows (in thousands):
                                                 
    September 30, 2006     December 31, 2005  
    Gross             Net     Gross             Net  
    Carrying     Accumulated     Carrying     Carrying     Accumulated     Carrying  
    Amount     Amortization     Amount     Amount     Amortization     Amount  
Covenants not-to-compete
  $ 12,231     $ (5,761 )   $ 6,470     $ 11,145     $ (4,970 )   $ 6,175  
Non-contractual customer relationships
    8,313       (1,346 )     6,967       3,235       (701 )     2,534  
Technology
    1,270       (504 )     766       1,270       (314 )     956  
Trademarks
    569       (113 )     456       569       (70 )     499  
Contracts
    397       (207 )     190       397       (129 )     268  
Client lists
    464       (307 )     157       461       (158 )     303  
 
                                   
Total
  $ 23,244     $ (8,238 )   $ 15,006     $ 17,077     $ (6,342 )   $ 10,735  
 
                                   
     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,  
    2006     2005     2006     2005  
Aggregate amortization expense
  $ 933     $ 796     $ 2,661     $ 2,393  
 
                       
     The estimated amortization expense related to intangible assets for each of the five succeeding years and thereafter as of September 30, 2006 is as follows (in thousands):
         
Remainder of 2006
  $ 906  
2007
    3,398  
2008
    2,777  
2009
    1,733  
2010
    997  
Thereafter
    5,195  
 
     
Total
  $ 15,006  
 
     

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4. Share-Based Compensation Plans
   Stock Incentive Plans
     At September 30, 2006, there were 5,389,377 shares of common stock issuable upon exercise of outstanding options granted under our existing stock incentive plans. We maintain three plans, the 1996 Stock Incentive Plan, or the 1996 Plan, the 2001 Stock Incentive Plan, or the 2001 Plan, and the 2006 Equity Incentive Plan, or the 2006 Plan. New options and other stock awards may only be granted under the 2006 Plan. The maximum aggregate number of shares of common stock that may be issued under the 2006 Plan to our employees, directors, consultants and those of our affiliates is (a) 6,490,412 shares of common stock; plus (b) 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. At September 30, 2006, all of these shares were available for grant. Outstanding options granted under our plans typically vest over periods that range from two to four years and expire between seven and ten years from the date of grant.
   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 granted to our employees and directors, 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.
     The effect of adopting SFAS No. 123R on our condensed, consolidated financial statements for the three and nine months ended September 30, 2006 is as follows (in thousands, except per share amounts):
                 
    Three Months     Nine Months  
    Ended     Ended  
    September 30, 2006     September 30, 2006  
Share-based compensation:
               
Laboratory direct cost
  $ 172     $ 492  
Laboratory selling, general and administrative expense
    128       382  
Animal hospital selling, general and administrative expense
    376       807  
Corporate selling, general and administrative expense
    205       645  
 
           
 
    881       2,326  
Tax benefit
    (334 )     (878 )
 
           
Net decrease in net income
  $ 547     $ 1,448  
 
           
 
               
Effect on:
               
Basic earnings per common share
  $ 0.01     $ 0.01  
 
           
Diluted earnings per common share
  $     $ 0.01  
 
           
 
               
Effect on:
               
Cash flows from operating activities
          $ (5,774 )
 
             
Cash flows from financing activities
          $ 5,774  
 
             

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     No share-based compensation was recognized during the three and nine months ended September 30, 2005, however, the following table presents net income and earnings per common share as if we had recognized share-based compensation using the fair-value-based method (in thousands, except per share amounts):
                 
    Three Months     Nine Months  
    Ended     Ended  
    September 30, 2005     September 30, 2005  
Net income, as reported
  $ 22,257     $ 50,765  
Deduct: Total share-based compensation determined under fair-value-based method for all awards, net of tax
    (503 )     (4,457 )
 
           
Pro forma net income
  $ 21,754     $ 46,308  
 
           
 
               
Earnings per common share:
               
Basic — as reported
  $ 0.27     $ 0.62  
Basic — pro forma
  $ 0.26     $ 0.56  
 
               
Diluted — as reported
  $ 0.26     $ 0.61  
Diluted — pro forma
  $ 0.26     $ 0.55  
     Prior to the adoption of SFAS No. 123R, we reported all income 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 benefits of tax deductions from the exercise of options in excess of the compensation cost for those options to be classified as cash provided by financing activities. As such, the $5.8 million excess tax benefit classified as a financing activity on our condensed, consolidated statement of cash flows for the nine months ended September 30, 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. There were 39,341 options granted during the nine months ended September 30, 2006 with a weighted-average fair value of $10.97. The weighted-average fair value of options granted during the nine months ended September 30, 2005 was $8.05. No options were granted during the three months ended September 30, 2006 and 2005. The following assumptions were used to determine the fair value of those options granted during the nine months ended September 30, 2006 and 2005:
                 
    Nine Months   Nine Months
    Ended   Ended
    September 30, 2006   September 30, 2005
Expected volatility (1)
    35.5 %   39.1% to 39.6%
Weighted-average volatility (1)
    35.5 %     39.5 %
Expected dividends
    0.0 %     0.0 %
Expected term (2)
  4.3 years   5 years
Risk-free rate (3)
    4.99 %   3.9% to 4.2%
 
(1)   We estimate the volatility of our common stock on the date of grant based on historical volatility.
 
(2)   The expected term represents the period of time that we expect the options to be outstanding. We estimated the expected term based on the simplified method permitted under SEC Staff Accounting Bulletin, or SAB, No. 107.
 
(3)   The risk-free interest rate is based on the implied yield in effect at the time of option grant on U.S. Treasury zero-coupon issues with equivalent remaining terms.
     We use historical data to estimate pre-vesting option forfeitures. We recognize share-based compensation only for those awards that we expect to vest.

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Stock Option Activity
     A summary of our stock option activity for all share-based compensation plans during the nine months ended September 30, 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
    39       30.70                  
Exercised
    (701 )     7.72                  
Canceled
    (39 )     16.50                  
 
                           
Options outstanding at September 30, 2006
    5,389     $ 15.58       5.3     $ 110,382  
 
                       
 
                               
Options exercisable at September 30, 2006
    4,372     $ 15.58       5.4     $ 89,552  
 
                       
 
                               
Options expected to vest at September 30, 2006
    991     $ 15.57       4.5     $ 20,300  
 
                       
     The total intrinsic value of options exercised during the nine months ended September 30, 2006 was $16.5 million and the total tax benefit realized on the options exercised was $6.5 million.
     At September 30, 2006, there was $4.1 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 1.9 years.
5. Long-Term Obligations and Interest Rate Hedging Agreements
     During the nine months ended September 30, 2006, we prepaid $60.0 million of our senior term notes.
     In June 2006, we entered into a no-fee swap agreement with a fixed interest rate of 5.51% and a set notional amount of $50.0 million to hedge against the risk of increasing interest rates.
     At September 30, 2006, we had four no-fee swap agreements with an aggregate notional amount of $200.0 million, a weighted-average fixed-interest rate of 4.4% and a fair market value of $1.4 million. At December 31, 2005, we had three no-fee swap agreements with an aggregate notional amount of $150.0 million, a weighted- average fixed-interest rate of 4.0% and a fair market value of $2.2 million. The fair market value of these no-fee swap agreements is included in prepaid expenses and other in our condensed, consolidated balance sheets. As of September 30, 2006, all four of our no-fee swap agreements qualify for hedge accounting.
6. Income Taxes
     In prior periods we recognized contingent liabilities for differences between the probable tax bases and the as-filed tax bases of certain assets and liabilities. These amounts totaled $6.8 million and were recorded in other liabilities in our condensed, consolidated balance sheets at December 31, 2005. During the first quarter of 2006, we determined that these contingencies no longer existed due to the outcome of an income tax audit and recognized a tax benefit of $6.8 million.

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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     Nine Months Ended  
    September 30,     September 30,  
    2006     2005     2006     2005  
Net income
  $ 26,977     $ 22,257     $ 86,189     $ 50,765  
 
                       
 
                               
Weighted-average common shares outstanding:
                               
Basic
    83,339       82,526       83,092       82,364  
Effect of dilutive potential common shares:
                               
Stock options
    1,848       1,493       1,772       1,454  
 
                       
Diluted
    85,187       84,019       84,864       83,818  
 
                       
 
                               
Basic earnings per common share
  $ 0.32     $ 0.27     $ 1.04     $ 0.62  
 
                       
Diluted earnings per common share
  $ 0.32     $ 0.26     $ 1.02     $ 0.61  
 
                       
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, risks and rewards. 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 imaging 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 and operating income. 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.

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     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, 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  
 
                                               
Three Months Ended September 30, 2005
                                               
External revenue
  $ 51,600     $ 167,815     $ 9,827     $     $     $ 229,242  
Intercompany revenue
    4,955             768             (5,723 )      
 
                                   
Total revenue
    56,555       167,815       10,595             (5,723 )     229,242  
Direct costs
    31,478       133,571       6,881             (5,332 )     166,598  
 
                                   
Gross profit
    25,077       34,244       3,714             (391 )     62,644  
Selling, general and administrative expense
    3,636       4,072       2,806       7,880             18,394  
Loss on sale of assets
          115                         115  
 
                                   
Operating income (loss)
  $ 21,441     $ 30,057     $ 908     $ (7,880 )   $ (391 )   $ 44,135  
 
                                   
 
                                               
Depreciation and amortization
  $ 1,025     $ 3,383     $ 320     $ 454     $ (20 )   $ 5,162  
Capital expenditures
  $ 3,080     $ 4,214     $ 191     $ 915     $ (356 )   $ 8,044  

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            Animal     Medical             Intercompany        
    Laboratory     Hospital     Technology     Corporate     Eliminations     Total  
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  
 
                                               
Nine Months Ended September 30, 2005
                                               
External revenue
  $ 154,532     $ 449,128     $ 19,029     $     $     $ 622,689  
Intercompany revenue
    13,739             1,408             (15,147 )      
 
                                   
Total revenue
    168,271       449,128       20,437             (15,147 )     622,689  
Direct costs
    91,947       357,332       14,026             (14,522 )     448,783  
 
                                   
Gross profit
    76,324       91,796       6,411             (625 )     173,906  
Selling, general and administrative expense
    10,347       11,582       6,295       19,719             47,943  
Loss on sale of assets
          27                         27  
 
                                   
Operating income (loss)
  $ 65,977     $ 80,187     $ 116     $ (19,719 )   $ (625 )   $ 125,936  
 
                                   
 
                                               
Depreciation and amortization
  $ 2,805     $ 9,034     $ 921     $ 1,223     $ (36 )   $ 13,947  
Capital expenditures
  $ 5,941     $ 13,081     $ 436     $ 4,014     $ (747 )   $ 22,725  
 
                                               
At September 30, 2006
                                               
Total assets
  $ 165,740     $ 655,457     $ 47,158     $ 74,308     $ (4,291 )   $ 938,372  
 
                                   
At December 31, 2005
                                               
Total assets
  $ 146,902     $ 614,492     $ 47,114     $ 90,977     $ (2,412 )   $ 897,073  
 
                                   
9. Recent Accounting Pronouncements
     In June 2006, the Financial Accounting Standards Board, or FASB, issued Interpretation No. 48, or FIN 48, Accounting for Uncertainty in Income Taxes— an interpretation of FASB Statement No. 109 , which clarifies the accounting for uncertainty in tax positions. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken in a tax return. FIN 48 will be effective for our company on January 1, 2007. We are currently evaluating the impact of adopting FIN 48 on our consolidated financial statements.
     In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements , which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. 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 September 2006, the SEC issued SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements , which requires that public companies utilize a “dual-approach” to assessing the quantitative effects of financial misstatements. This dual-approach includes both an income statement focused assessment and a balance sheet focused assessment. The guidance in SAB No. 108 must be applied to our annual consolidated financial statements for the fourth quarter of 2006. We are currently assessing

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the impact of adopting SAB No. 108, however, we do not expect that it will have a material effect on our consolidated financial statements.
10. 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 pay an additional $413,000.
   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.
     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 are set by our Compensation Committee of the Board of Directors.

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

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ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
         
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    Number  
    15  
 
       
    15  
 
       
    17  
 
       
    23  
 
       
    25  
 
       
    28  
 
       
    28  

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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 including new factors discussed in “Risk Factors,” Part II, Item 1A 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 7, 2006, and we undertake no duty to update this information. Shareholders and prospective investors can find information filed with the SEC after November 7, 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. Our four reportable segments are discussed below.
     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, 2006, our laboratory network consisted of 33 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 products and perform a variety of pet wellness programs, including health examinations, diagnostic testing, routine vaccinations, spaying, neutering and dental care. At September 30, 2006, our animal hospital network consisted of 376 animal hospitals in 37 states.
     Our medical technology segment sells ultrasound and digital radiography imaging equipment, related computer hardware, software and ancillary services.
     Our corporate segment provides 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, heartworms and ticks and the number of daylight hours.
Executive Overview
     Our operating results for the three and nine months ended September 30, 2006 were marked by continued growth in our laboratory and animal hospital operating segments. During the three months ended September 30, 2006, our consolidated revenue increased 9.8% to $251.6 million, our consolidated gross profit margin was 28.0% compared to 27.3% in the same prior year quarter, and our consolidated operating income margin was 20.5% compared to 19.3% in the same prior year quarter. During the nine months ended September 30, 2006, our consolidated revenue increased 19% to $741.0 million, our consolidated gross profit margin was 28.2% compared to 27.9% in the same prior year period, and our consolidated operating income margin was 20.5% compared to 20.2% in the same prior year period. Our consolidated margins were impacted by the adoption of Statement of Financial

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Accounting Standards, or SFAS, No. 123R, Share-Based Payment , on January 1, 2006, which resulted in a pre-tax non-cash compensation charge of $881,000 and $2.3 million for the three and nine months ended September 30, 2006, respectively.
   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 17 independent animal hospitals, two laboratories and a lab-related business during the nine months ended September 30, 2006. The following table summarizes the changes in the number of facilities operated by our laboratory and animal hospital segments:
         
Laboratories:
       
Facilities at December 31, 2005
    31  
Acquisitions
    2  
Acquisitions relocated into a laboratory operated by us
    (1 )
New facilities
    1  
 
       
Facilities at September 30, 2006
    33  
 
       
         
Animal hospitals:
       
Facilities at December 31, 2005
    367  
Acquisitions
    17  
Acquisitions relocated into hospitals operated by us
    (4 )
Sold or closed
    (4 )
 
       
Facilities at September 30, 2006
    376  
 
       

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      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,
    2006   2005   2006   2005
Revenue:
                               
Laboratory
    26.3 %     24.7 %     26.3 %     27.0 %
Animal hospital
    73.0       73.2       72.9       72.1  
Medical technology
    3.6       4.6       3.4       3.3  
Intercompany
    (2.9 )     (2.5 )     (2.6 )     (2.4 )
 
                               
Total revenue
    100.0       100.0       100.0       100.0  
Direct costs
    72.0       72.7       71.8       72.1  
 
                               
Gross profit
    28.0       27.3       28.2       27.9  
Selling, general and administrative expense
    7.5       8.0       7.7       7.7  
Gain on sale of assets
                       
 
                               
Operating income
    20.5       19.3       20.5       20.2  
Interest expense, net
    2.4       2.7       2.5       3.0  
Debt retirement costs
                      3.1  
Other expense
    0.1                    
Minority interest in income of subsidiairies
    0.3       0.3       0.3       0.4  
 
                               
Income before provision for income taxes
    17.7       16.3       17.7       13.7  
Provision for income taxes
    7.0       6.6       6.1       5.5  
 
                               
Net income
    10.7 %     9.7 %     11.6 %     8.2 %
 
                               
   Revenue
     The following table summarizes our revenue (in thousands, except percentages):
                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2006     2005     % Change     2006     2005     % Change  
Laboratory
  $ 66,054     $ 56,555       16.8 %   $ 195,064     $ 168,271       15.9 %
Animal hospital
    183,592       167,815       9.4 %     540,117       449,128       20.3 %
Medical technology
    8,956       10,595       (15.5 )%     25,348       20,437       24.0 %
Intercompany
    (6,970 )     (5,723 )     21.8 %     (19,567 )     (15,147 )     29.2 %
 
                                       
Total revenue
  $ 251,632     $ 229,242       9.8 %   $ 740,962     $ 622,689       19.0 %
 
                                       

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    Laboratory Revenue
     Laboratory revenue increased $9.5 million for the three months ended September 30, 2006 and increased $26.8 million for the nine months ended September 30, 2006 as compared to the same periods in the prior year. The components of the increase in laboratory revenue are detailed below (in thousands, except percentages and average revenue per requisition):
                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2006     2005     % Change     2006     2005     % Change  
Internal growth:
                                               
Number of requisitions (1)
    2,786       2,397       16.2 %     8,387       7,232       16.0 %
Average revenue per requisition (2)
  $ 23.39     $ 23.59       (0.8 )%   $ 23.09     $ 23.27       (0.8 )%
 
                                       
Total internal revenue (1)
  $ 65,177     $ 56,555       15.2 %   $ 193,674     $ 168,271       15.1 %
Acquired revenue (3)
    877                     1,390                
 
                                       
Total
  $ 66,054     $ 56,555       16.8 %   $ 195,064     $ 168,271       15.9 %
 
                                       
 
(1)   Internal revenue and requisitions were calculated using laboratory operating results, adjusted to exclude the operating results of acquired laboratories for the comparable periods that we did not own them in the prior year.
 
(2)   Computed by dividing internal revenue by the number of requisitions.
 
(3)   Acquired revenue represents the revenue of the laboratory acquired on May 1, 2006 and the laboratory acquired on September 1, 2006.
     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. 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.

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   Animal Hospital Revenue
     Animal hospital revenue increased $15.8 million for the three months ended September 30, 2006 and increased $91.0 million for the nine months ended September 30, 2006 as compared to the same periods in the prior year. The components of the increase are summarized in the following table (in thousands, except percentages and average revenue per order):
                                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2006     2005     % Change     2006     2005     % Change  
Same-store facilities:
                                               
Orders (1)(2)
    1,308       1,345       (2.8 )%     3,319       3,411       (2.7 )%
Average revenue per order (3)
  $ 133.28     $ 123.65       7.8 %   $ 130.81     $ 120.78       8.3 %
 
                                       
Same-store revenue (1)
  $ 174,297     $ 166,321       4.8 %   $ 434,238     $ 411,981       5.4 %
Business day adjustment (4)
                        1,666                
Net acquired revenue (5)
    9,295       1,494               104,213       37,147          
 
                                       
Total
  $ 183,592     $ 167,815       9.4 %   $ 540,117     $ 449,128       20.3 %
 
                                       
 
(1)   Same-store revenue and orders were calculated using animal hospital operating results, adjusted to exclude the operating results for the newly acquired animal hospitals that we did not own a full 12 months from the beginning of the applicable period and adjusted for the impact resulting from any differences in the number of business days in the periods presented. Same-store revenue also includes revenue generated by customers referred from our relocated or combined animal hospitals, including those merged upon acquisition.
 
(2)   The change in orders may not calculate exactly due to rounding.
 
(3)   Computed by dividing same-store revenue by same-store orders. The average revenue per order may not calculate exactly due to rounding.
 
(4)   The business day adjustment reflects the impact of one additional business day for the nine months ended September 30, 2006 as compared to the nine months ended September 30, 2005.
 
(5)   Net acquired revenue represents the revenue from those animal hospitals acquired, net of revenue from those animal hospitals sold or closed, on or after the beginning of the comparable period, which was July 1, 2005 for the three months ended September 30, 2006, and January 1, 2005 for the nine months ended September 30, 2006. Fluctuations in net acquired revenue occur due to the volume, size and timing of acquisitions and disposals during the periods from this date through the end of the applicable period.
     Over the last few years, some pet-related products 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 most 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 $9.0 million and $10.6 million for the three months ended September 30, 2006 and 2005, respectively, and $25.3 million and $20.4 million for the nine months ended September 30, 2006 and 2005, respectively. Revenue for the nine months ended September 30, 2006 increased as compared to the same period in the prior year due to sales of our digital radiography imaging equipment. Although we sold more digital radiography imaging units during the three months ended September 30, 2006 as compared to the same period in the prior year, our revenue decreased because of the increase in the number of sales where the total sales revenue was deferred and will be recognized over the support period. This increase in the number of sales deferred was the result of a change in support programs provided to certain customers.

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     Sales of our ultrasound imaging equipment declined during the three and nine months ended September 30, 2006 as compared to the same periods in the prior year. This decline is attributed to the sale of our digital radiography imaging equipment, which was first introduced at the end of 2004. Our sales force has invested significant time and resources related to the introduction and rollout of our digital radiography imaging equipment, which has shifted some focus away from the sale of our ultrasound imaging equipment.
     At September 30, 2006, we had deferred revenue of $11.2 million, $10.0 million of which related to sales of our digital radiography imaging equipment.
   Intercompany Revenue
     For the three and nine months ended September 30, 2006, $5.8 million and $17.1 million of our laboratory revenue was intercompany revenue that was generated by providing laboratory services to our animal hospitals compared to $5.0 million and $13.7 million in the same periods of the prior year. For the three and nine months ended September 30, 2006, $1.2 million and $2.5 million, respectively, of our medical technology revenue was intercompany revenue that was generated by providing products and services to our animal hospitals compared to $768,000 and $1.4 million in the same periods of the prior year. 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 September 30,     Nine Months Ended September 30,  
    2006     2005             2006     2005        
            Gross             Gross                     Gross             Gross        
            Profit             Profit     %             Profit             Profit     %  
    $     Margin     $     Margin     Change     $     Margin     $     Margin     Change  
Laboratory
  $ 30,013       45.4 %   $ 25,077       44.3 %     19.7 %   $ 91,087       46.7 %   $ 76,324       45.4 %     19.3 %
Animal hospital
    37,460       20.4 %     34,244       20.4 %     9.4 %     109,708       20.3 %     91,796       20.4 %     19.5 %
Medical technology
    3,426       38.3 %     3,714       35.1 %     (7.8 )%     9,072       35.8 %     6,411       31.4 %     41.5 %
Intercompany
    (434 )             (391 )                     (919 )             (625 )                
 
                                                                       
Total gross profit
  $ 70,465       28.0 %   $ 62,644       27.3 %     12.5 %   $ 208,948       28.2 %   $ 173,906       27.9 %     20.1 %
 
                                                                       
   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

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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. 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, in the aggregate, have been favorably impacted subsequent to the acquisition by improvements in animal hospital revenue, increased operating leverage and 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 margin was primarily the result of a change in the mix of products and services sold. Specifically, revenue from the sale of our digital radiography imaging equipment, which has a higher gross profit margin than our other products and services, has increased as a percentage of our total medical technology revenue.
     At September 30, 2006, we had deferred revenue and costs of $11.2 million and $5.2 million, respectively. Included in these amounts at September 30, 2006 was $10.0 million of deferred revenue and $5.2 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 September 30,     Nine Months Ended September 30,  
    2006     2005             2006     2005        
            % of             % of     %             % of             % of     %  
    $     Revenue     $     Revenue     Change     $     Revenue     $     Revenue     Change  
Laboratory
  $ 4,350       6.6 %   $ 3,636       6.4 %     19.6 %   $ 12,793       6.6 %   $ 10,347       6.1 %     23.6 %
Animal hospital
    5,161       2.8 %     4,072       2.4 %     26.7 %     15,107       2.8 %     11,582       2.6 %     30.4 %
Medical technology
    2,534       28.3 %     2,806       26.5 %     (9.7 )%     7,734       30.5 %     6,295       30.8 %     22.9 %
Corporate
    6,901       2.7 %     7,880       3.4 %     (12.4 )%     21,681       2.9 %     19,719       3.2 %     9.9 %
 
                                                                       
Total SG&A
  $ 18,946       7.5 %   $ 18,394       8.0 %     3.0 %   $ 57,315       7.7 %   $ 47,943       7.7 %     19.5 %
 
                                                                       
   Laboratory SG&A
     Laboratory SG&A consists primarily of salaries of sales, 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, commission payments as a result of an increase in revenue, and recognizing $128,000 and $382,000 of share-based compensation for the three and nine months ended September 30, 2006, respectively, as a result of adopting SFAS No. 123R on January 1, 2006.
   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.

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     The increase in animal hospital SG&A was primarily attributed to expanding the animal hospital administrative operations to absorb the recent acquisitions and recognizing $376,000 and $807,000 of share-based compensation for the three and nine months ended September 30, 2006, respectively, 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, administrative and accounting personnel, selling, marketing and promotional expense and research and development costs.
     The increase in medical technology SG&A for the nine months ended September 30, 2006 as compared to the same period in the prior year was primarily attributed to increasing our sales force and administrative support, and commission payments as a result of an increase in revenue. The decrease in medical technology SG&A for the three months ended September 30, 2006 as compared to the same period in the prior year was attributed to a decrease in certain selling costs.
   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.
     We have expanded our corporate office and will continue to do so in order to absorb recent and future acquisitions. The increase in corporate SG&A for the nine months ended September 30, 2006 as compared to the same period in the prior year was the result of such expansion. This increase was partially offset by one-time integration costs incurred during 2005 in connection with the acquisition of Pet’s Choice, Inc.
     The decrease in Corporate SG&A for the three months ended September 30, 2006 as compared to the same period in the prior year was attributed to the one-time integration costs described above and a decrease in legal and accounting fees.
   Interest Expense, Net
     The following table summarizes our interest expense, net of interest income (in thousands):
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2006     2005     2006     2005  
Interest expense:
                               
Senior term notes
  $ 6,597     $ 5,847     $ 19,515     $ 12,488  
9.875% senior subordinated notes
                      6,342  
Interest rate hedging agreements
    (484 )     190       (1,054 )     75  
Capital leases and other
    432       453       1,041       863  
Amortization of debt costs
    73       132       299       482  
 
                       
 
    6,618       6,622       19,801       20,250  
Interest income
    534       588       1,478       1,468  
 
                       
Total interest expense, net of interest income
  $ 6,084     $ 6,034     $ 18,323     $ 18,782  
 
                       
     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
     The effective tax rate for the three and nine months ended September 30, 2006 was 39.4% and 34.2%, respectively, and reflects a lower weighted-average state statutory tax rate when compared to the comparable prior

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year periods due to a favorable shift in the number of facilities that we operated in states with lower tax rates or no state income tax. The effective tax rate for the nine months ended September 30, 2006 also reflects 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 change to our estimated tax liabilities. We estimate that our effective tax rate for the three months ended December 31, 2006 will approximate 39.4%.
      Liquidity and Capital Resources
     The following table summarizes our cash flows (in thousands):
                 
    Nine Months Ended  
    September 30,  
    2006     2005  
Cash provided by (used in):
               
Operating activities
  $ 90,738     $ 91,214  
Investing activities
    (63,483 )     (105,448 )
Financing activities
    (52,922 )     27,771  
 
           
Increase (decrease) in cash and cash equivalents
    (25,667 )     13,537  
Cash and cash equivalents at beginning of year
    58,488       30,964  
 
           
Cash and cash equivalents at end of period
  $ 32,821     $ 44,501  
 
           
   Cash Flows from Operating Activities
     Net cash provided by operating activities decreased $476,000 in the nine months ended September 30, 2006 as compared to the same period in the prior year. Although we experienced growth in our core segments through acquisitions and internal growth, cash flows from operating activities declined primarily due to an increase in taxes paid of $26.5 million and changes in working capital. Also contributing to the decline in cash flows from operating activities was a $5.8 million excess tax benefit from the exercise of stock options. SFAS No. 123R, which we adopted on January 1, 2006, requires the benefits of tax deductions from the exercise of options in excess of the compensation cost for those options to be classified as cash provided by financing activities . Excess tax benefits in periods prior to 2006 were classified as an operating activity.
     Significant increases in interest rates may materially impact our operating cash flows in future periods because of the variable-rate nature of our senior term notes.
   Cash Flows from Investing Activities
     Net cash used in investing activities primarily consisted of cash used for acquisitions 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 for a total purchase price 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 17 hospitals, two laboratories and a lab-related business in 2006 for total cash consideration of $35.8 million. 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 remaining three months of 2006, we intend to spend approximately $10.0 million for animal hospital acquisitions and $10.0 million to $15.0 million for property and equipment.
   Cash Flows from Financing Activities
     Net cash used in financing activities during the nine months ended September 30, 2006 consisted primarily of cash used to repay our long-term obligations, including $60.0 million to prepay a portion of our senior term notes. This use of cash was partially offset by a $5.8 million excess tax benefit from the exercise of stock options. SFAS No. 123R, which we adopted on January 1, 2006, requires the benefits of tax deductions from the exercise of options in excess of the compensation cost for those options to be classified as cash provided by financing activities . Excess

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tax benefits in periods prior to 2006 were classified as an operating activity. Our financing activities during the nine months ended September 30, 2005 reflects $475.0 million in borrowings used to retire our existing senior term notes and 9.875% senior subordinated notes aggregating $404.1 million, and to fund the acquisition of Pet’s Choice, Inc. on July 1, 2005. In addition, we used $35.0 million to prepay a portion of our senior term notes in August 2005.
   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
  $ 376,544     $ 1,282     $ 5,377     $ 4,181     $ 3,879     $ 3,880     $ 357,945  
Capital lease obligations
    15,479       255       1,039       1,070       1,144       1,283       10,688  
Operating leases
    500,500       7,685       30,650       30,543       30,297       28,850       372,475  
Fixed cash interest expense
    6,917       351       1,257       1,329       1,069       767       2,144  
Variable cash interest expense (2)
    122,651       6,632       26,265       26,457       26,547       26,630       10,120  
Swap agreements (2)
    (3,476 )     (613 )     (1,994 )     (795 )     (74 )            
Purchase obligations
    54,548       7,718       13,759       8,383       8,942       9,744       6,002  
Other long-term liabilities (3)
    46,761             65       65       65             46,566  
Earn-out payments (4)
    413             363       50                    
 
                                         
 
  $ 1,120,337     $ 23,310     $ 76,781     $ 71,283     $ 71,869     $ 71,154     $ 805,940  
 
                                         
 
(1)   Consists of the period from October 1, 2006 through December 31, 2006.
 
(2)   We have variable-rate debt. The interest payments on our variable-rate debt are based on a variable-rate component plus a fixed 1.50%. For purposes of this computation, we have assumed that the interest rate on our variable-rate debt (including the fixed-rate portion) will be 7.1%, 7.1%, 7.2%, 7.3%, 7.4% and 7.5% for years 2006 through thereafter, respectively. These estimates are based on interest rate projections used to price our interest rate swap agreements. Our consolidated financial statements included in our 2005 annual report on Form 10-K discuss these variable-rate notes in more detail.
 
(3)   Includes deferred income taxes of $38.3 million.
 
(4)   Represents contractual arrangements whereby additional cash may be paid to former owners of acquired businesses upon attainment of specified performance targets.
     We anticipate that our cash on-hand, net cash provided by operations and, if needed, our revolving credit facility, will provide sufficient cash resources to fund our operations for more than the next 12 months. If we consummate one or more significant acquisitions during this period we may need to seek additional debt or equity financing.
   Debt Related Covenants
     Our senior credit facility contains certain financial covenants pertaining to fixed-charge coverage and leverage ratios. In addition, the senior credit facility has restrictions pertaining to capital expenditures, acquisitions and the payment of cash dividends. As of September 30, 2006, we were in compliance with these covenants, including the two covenant ratios, the fixed-charge coverage ratio and the leverage ratio.
     The senior credit facility defines the fixed-charge coverage ratio as that ratio which is calculated on a last 12-month basis by dividing pro forma earnings before interest, taxes, depreciation and amortization, as defined by the agreement, by fixed charges. Pro forma earnings before interest, taxes, depreciation and amortization include 12 months of operating results for businesses acquired during the period. Fixed charges are defined as cash interest expense, scheduled principal payments on debt obligations, capital expenditures, and provision for income taxes. At September 30, 2006, we had a fixed-charge coverage ratio of 1.85 to 1.00, which was in compliance with the required ratio of no less than 1.20 to 1.00.

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     The senior credit facility defines the leverage ratio as that ratio which is calculated as total debt divided by pro forma earnings before interest, taxes, depreciation and amortization, as defined by the agreement. At September 30, 2006, we had a leverage ratio of 1.86 to 1.00, which was in compliance with the required ratio of no more than 3.00 to 1.00.
   Interest Rate Hedging Agreements
     We have swap agreements whereby we pay counterparties amounts based on fixed interest rates and set notional principal amounts in exchange for the receipt of payments from the counterparties based on London Interbank Offer Rates, or LIBOR, and the same set notional principal amounts. We entered into these swap agreements to hedge against the risk of increasing interest rates. The contracts effectively convert a certain amount of our variable-rate debt under our senior credit facility to fixed-rate debt for purposes of controlling cash paid for interest. That amount is equal to the notional principal amount of the swap agreements, and the fixed-rate conversion period is equal to the terms of the contract. The impact of these swap agreements has been factored into our future contractual cash requirements table above. A summary of the swap agreements existing at September 30, 2006 is as follows:
                                 
Fixed interest rate
    4.07%       3.98%       3.94%       5.51%  
Notional amount
  $50.0 million   $50.0 million   $50.0 million   $50.0 million
Effective date
    5/26/2005       6/2/2005       6/30/2005       6/20/2006  
Expiration date
    5/26/2008       5/31/2008       6/30/2007       6/30/2009  
Counterparties
  Goldman Sachs   Wells Fargo   Wells Fargo   Goldman Sachs
Qualifies for hedge accounting
  Yes   Yes   Yes   Yes
     In the future, we may enter into additional interest rate strategies. We have not yet determined what those strategies will be or their possible impact.
   Description of Indebtedness
   Senior Credit Facility
     At September 30, 2006, we had $373.6 million principal amount outstanding under our senior term notes and no borrowings outstanding under our revolving credit facility.
     We pay interest on our senior term notes and our revolving credit facility based on the interest rate offered to our administrative agent on LIBOR plus a margin of 1.50% per annum.
     The senior term notes mature in May 2011 and the revolving credit facility matures in May 2010.
   Other Debt
     At September 30, 2006, we had seller notes secured by assets of certain animal hospitals, unsecured debt and capital leases that totaled $18.4 million.
Critical Accounting Policies
     We believe that the application of the following accounting policies, which are important to our financial position and results of operations, requires significant judgments and estimates on the part of our management. For a summary of all our accounting policies, including the accounting policies discussed below, see our consolidated financial statements included in our 2005 annual report on Form 10-K.
   Revenue
   Laboratory and Animal Hospital Revenue
     We recognize laboratory and animal hospital revenue only after the following criteria are met:

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    there exists adequate evidence of the transaction;
 
    delivery of goods has occurred or services have been rendered; and
 
    the price is not contingent on future activity and collectibility is reasonably assured.
   Medical Technology Revenue
     The majority of our medical technology revenue is derived from the sale of ultrasound imaging equipment and digital radiography imaging equipment. We also derive revenue from: (i) licensing our software; (ii) providing technical support and product updates related to our software, otherwise known as maintenance; and (iii) providing professional services related to our equipment and software, including installations, on-site training and education services. We frequently sell equipment and license our software in multiple element arrangements in which the customer may choose a combination of one or more of the following elements: (i) ultrasound imaging equipment; (ii) digital radiography imaging equipment; (iii) software products; (iv) computer hardware; (v) maintenance; and (vi) professional services.
     The accounting for the sale of equipment is substantially governed by the requirements of Staff Accounting Bulletin, SAB, No. 104, Revenue Recognition , and the sale of software licenses and related items is governed by Statement of Position, SOP, No. 97-2, Software Revenue Recognition , as amended. The determination of the amount of software license, maintenance and professional service revenue to be recognized in each accounting period requires us to exercise judgment and use estimates. In determining whether or not to recognize revenue, we evaluate each of these criteria:
    Evidence of an arrangement : We consider a non-cancelable agreement signed by the customer and us to be evidence of an arrangement.
 
    Delivery : We consider delivery to have occurred when the ultrasound imaging equipment is delivered. We consider delivery to have occurred when the digital radiography imaging equipment is either accepted by the customer if installation is required, or delivered. We consider delivery to have occurred with respect to professional services when those services are provided or on a straight-line basis over the service contract term, based on the nature of the service or the terms of the contract.
 
    Fixed or determinable fee : We assess whether fees are fixed or determinable at the time of sale and recognize revenue if all other revenue recognition requirements are met. We generally consider payments that are due within six months to be fixed or determinable based upon our successful collection history. We only consider fees to be fixed or determinable if they are not subject to refund or adjustment.
 
    Collection is deemed probable : We conduct a credit review for all significant transactions at the time of the arrangement to determine the credit worthiness of the customer. Collection is deemed probable if we expect that the customer will be able to pay amounts under the arrangement as payments become due. If we determine that collection is not probable, we defer the revenue and recognize the revenue upon cash collection.
     Under the residual method prescribed by SOP No. 98-9, Modification of SOP No. 97-2, Software Revenue Recognition, With Respect to Certain Transactions , in multiple element arrangements involving software, revenue is recognized when vendor-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement (i.e., maintenance and professional services), but does not exist for one or more of the delivered elements in the arrangement (i.e., the equipment, computer hardware or the software product). Vendor-specific objective evidence of fair value is based on the price for those products and services when sold separately by us and customer renewal rates for post-contract customer support services. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. If evidence of the fair value of one or more undelivered elements does not exist, the revenue is deferred and recognized when delivery of those elements occurs. Each transaction requires careful analysis to ensure that all of the individual elements in the license transaction have been identified, along with the fair value of each element.

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   Ultrasound Imaging Equipment
     We sell our ultrasound imaging equipment with and without related computer hardware and software. We account for the sale of ultrasound imaging equipment on a stand-alone basis under the requirements of SAB No. 104, and recognize revenue upon delivery. We account for the sale of ultrasound imaging equipment with related computer hardware and software by bifurcating the transaction into separate elements. We account for the ultrasound imaging equipment under the requirements of SAB No. 104, as the software is not deemed to be essential to the functionality of the equipment, and account for the computer hardware and software under the requirements of SOP No. 97-2, as amended. For those sales of our ultrasound imaging equipment that include computer hardware and software, we recognize revenue on the ultrasound imaging equipment, computer hardware and software upon delivery, which occurs simultaneously.
   Digital Radiography Equipment
     We sell our digital radiography imaging equipment with related computer hardware and software. The digital radiography equipment requires the computer hardware and software to function. As a result, we account for digital radiography imaging equipment sales under SOP No. 97-2.
     In the third quarter of 2005, we established vendor-specific objective evidence of the fair value of post-contract customer support services by including renewal rates in the sales contracts. As a result, we began recognizing revenue on the sales of digital radiography imaging equipment, computer hardware and software at the time of customer acceptance if installation is required, or delivery, and revenue from post-contract customer support services on a straight-line basis over the term of the support period. Prior to the third quarter of 2005, we recognized revenue on all elements in these arrangements ratably over the period of the post-contract customer support services, which was generally one year.
   Valuation of Goodwill
     Our 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 total amount of our goodwill at September 30, 2006 was $615.8 million, consisting of $95.1 million for our laboratory segment, $501.5 million for our animal hospital segment and $19.2 million for our medical technology segment.
     Annually, and upon material changes in our operating environment, we test our goodwill for impairment by comparing the fair market value of our reporting units, laboratory, animal hospital and medical technology, to their respective net book value. At December 31, 2005, the estimated fair market value of each of our reporting units exceeded their respective net book value, resulting in a conclusion that our goodwill was not impaired. In addition, we have not tested our goodwill for impairment since December 31, 2005 due to our assessment that there were no material changes in our operating environment.
   Income Taxes
     We account for income taxes under SFAS No. 109, Accounting for Income Taxes . In accordance with SFAS No. 109, we record deferred tax liabilities and deferred tax assets, which represent taxes to be recovered or settled in the future. We adjust our deferred tax assets and deferred tax liabilities to reflect changes in tax rates or other statutory tax provisions. Changes in tax rates or other statutory provisions are recognized in the period the change occurs.
     We make judgments in assessing our ability to realize future benefits from our deferred tax assets, which include operating and capital loss carryforwards. As such, we have a valuation allowance to reduce our deferred tax assets for the portion we believe will not be realized.
     We also assess differences between our probable tax bases and the as-filed tax bases of certain assets and liabilities. At December 31, 2005, we had contingent liabilities of $6.8 million recorded in other liabilities in our condensed, consolidated balance sheet related to such differences. During the first quarter of 2006, we determined that these contingencies no longer existed due to the outcome of an income tax audit and recognized a tax benefit of $6.8 million.
     Effective January 1, 2007, we will be required to assess any uncertain tax positions using the recognition threshold and measurement attribute prescribed by the Financial Accounting Standards Board, or FASB, Interpretation No. 48, or FIN 48. See discussion of FIN 48 below under Recent Accounting Pronouncements.

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Recent Accounting Pronouncements
     Effective January 1, 2006, we adopted 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. Although the cost recognized as a result of adopting SFAS No. 123R is non-cash, our operating results, including our margins, net income, earnings per common share and operating cash flows, will be negatively impacted in future periods. See Note 4, Share-Based Compensation Plans, of our condensed, consolidated financial statements for a detailed discussion of our adoption of SFAS No. 123R.
     In June 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 , which clarifies the accounting for uncertainty in tax positions. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken in a tax return. FIN 48 will be effective for our company on January 1, 2007. We are currently evaluating the impact of adopting FIN 48 on our consolidated financial statements.
     In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements , which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. 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 September 2006, the SEC issued Staff Accounting Bulletin, or SAB, No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements , which requires that public companies utilize a “dual-approach” to assessing the quantitative effects of financial misstatements. This dual-approach includes both an income statement focused assessment and a balance sheet focused assessment. The guidance in SAB No. 108 must be applied to our annual consolidated financial statements for the fourth quarter of 2006. We are currently assessing the impact of adopting SAB No. 108, however we do not expect that it will have a material effect on our consolidated financial statements.
Forward-Looking Statements
     This quarterly report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, that involve risks and uncertainties, as well as assumptions that, if they materialize or prove incorrect, could cause our results and the results of our consolidated subsidiaries to differ materially from those expressed or implied by these forward-looking statements. 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 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.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     At September 30, 2006, we had borrowings of $373.6 million under our senior credit facility with fluctuating interest rates based on market benchmarks such as LIBOR. For our variable-rate debt, changes in interest rates generally do not affect the fair market value, but do impact earnings and cash flow. To reduce the risk of increasing interest rates, we entered into the following interest rate swap agreements:
                                 
Fixed interest rate
    4.07%       3.98%       3.94%       5.51%  
Notional amount
  $50.0 million   $50.0 million   $50.0 million   $50.0 million
Effective date
    5/26/2005       6/2/2005       6/30/2005       6/20/2006  
Expiration date
    5/26/2008       5/31/2008       6/30/2007       6/30/2009  
Counterparties
  Goldman Sachs   Wells Fargo   Wells Fargo   Goldman Sachs
Qualifies for hedge accounting
  Yes   Yes   Yes   Yes
     These swap agreements have the effect of reducing the amount of our debt exposed to variable interest rates. For the 12-month period ending September 30, 2007, for every 1.0% increase in LIBOR we will pay an additional $2.0 million in interest expense and for every 1.0% decrease in LIBOR we will save $2.0 million in interest expense.
     We may consider entering into additional interest rate strategies. We have not yet determined what those strategies will be or their possible impact.
ITEM 4. CONTROLS AND PROCEDURES
     As of the end of the period covered by this report, we have carried out an evaluation, under the supervision and participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic reports filed with the SEC.
     During our most recent fiscal quarter, there were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
     Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
     We are not subject to any legal proceedings other than ordinarily routine litigation incidental to the conduct of our business.
ITEM 1A. RISK FACTORS
     There have been no material changes in our risk factors from those disclosed in our 2005 annual report on Form 10-K except for the risk factors described below.

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   We may have to write-off certain capitalized software development costs
     We are currently in the process of internally developing software that will be used in our animal hospitals. Costs related directly to the software design, coding, testing and installation will be capitalized and amortized over the expected life of the software when it is deployed. To the extent that we are unable to realize the benefits of this software, we may have to write-off a portion or all of the capitalized costs, which may have an adverse effect on our operating results.
   Failure to receive products and/or supplies in a timely manner will have a negative impact on our operating results
     Our operations depend, in some cases, on the ability of single source suppliers or a limited number of suppliers, to deliver products and supplies on a timely basis. We have in the past experienced, and may in the future experience, shortages of or difficulties in acquiring products and/or supplies in the quantities and of the quality needed. Shortages in the availability of products and/or supplies for an extended period of time will have a negative impact on our operating results.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
     None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
     None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
     None
ITEM 5. OTHER INFORMATION
     None
ITEM 6. EXHIBITS
     
31.1
  Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
31.2
  Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
32.1
  Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURE
     Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on November 7, 2006.
         
     
Date: November 7, 2006  By:   /s/ Tomas W. Fuller  
    Tomas W. Fuller   
    Chief Financial Officer   

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EXHIBIT INDEX
     
Exhibit No.   Description
31.1
  Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
31.2
  Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
32.1
  Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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EXHIBIT 31.1
Certification of
Chief Executive Officer
of VCA Antech, Inc.
I, Robert L. Antin, certify that:
1.   I have reviewed this quarterly report on Form 10-Q of VCA Antech, Inc.;
2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.   The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
  a.   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
  b.   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
  c.   Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
  d.   Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.   The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
  a.   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
  b.   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: November 7, 2006
/s/ Robert L. Antin
Robert L. Antin
Chief Executive Officer

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EXHIBIT 31.2
Certification of
Chief Financial Officer
of VCA Antech, Inc.
I, Tomas W. Fuller, certify that:
1.   I have reviewed this quarterly report on Form 10-Q of VCA Antech, Inc.;
2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.   The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
  a.   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
  b.   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
  c.   Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
  d.   Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.   The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
  a.   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
  b.   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: November 7, 2006
/s/ Tomas W. Fuller
Tomas W. Fuller
Chief Financial Officer

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EXHIBIT 32.1
Certification of
Chief Executive Officer & Chief Financial Officer
of VCA Antech, Inc.
     This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and accompanies this quarterly report on Form 10-Q (the “Report”) for the period ended September 30, 2006 of VCA Antech, Inc. (the “Issuer”).
     Each of the undersigned, who are the Chief Executive Officer and Chief Financial Officer, respectively, of VCA Antech, Inc., hereby certify that, to the best of each such officer’s knowledge:
  (i)   the Report fully complies with the requirements of section 13(a) or section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)); and
 
  (ii)   the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Issuer.
Dated: November 7, 2006
         
 
  /s/ Robert L. Antin
 
Robert L. Antin
   
 
  Chief Executive Officer    
 
       
 
  /s/ Tomas W. Fuller
 
Tomas W. Fuller
   
 
  Chief Financial Officer    

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